Goods and Services Tax 
- Consultation Document

By David Southwood

In July 2006 the Government issued its long awaited consultation document: "Broadening the Tax Base, Ensuring our Future Prosperity: What's the Best Option for Hong Kong?" 

The document explains the Government's proposals for the possible application of a Goods and Services Tax (GST) in Hong Kong and, as such, could have an impact on Hong Kong's economic future. The document asks for the Hong Kong public's views in a consultation period which will run to 31 March 2007.

This article sets out the background to the release of the document and summarises for the information of our clients the major proposals put forward by the Government.

The impetus behind the protracted debate on GST in Hong Kong can be traced back to the Asian Financial Turmoil and the debate on Hong Kong's narrow tax base.

Hong Kong's narrow tax base
The independent Advisory Committee on New Broad Based Taxes, set up by the Government, reported in early 2002 and concluded that Hong Kong:

The Advisory Committee concluded that Hong Kong needed a tax system with a broader base which does not overly rely upon a limited range of economic activities and sources tax revenues from the economy as a whole, rather than from segments of it.

Would GST broaden Hong Kong's tax base?
The Advisory Committee examined a number of taxes using "eight widely adopted principles of a good tax system" and was of the view that GST was the only one which fitted the primary criteria of being both broadly based and highly revenue productive, even when the tax rate is set at a low level compared with other economies.

The alternatives?
The Advisory Committee identified three potentially viable alternatives to GST which met the main criteria for broadening Hong Kong's tax base:

	a Land and Sea Departure Tax (Boundary Facilities Tax)
	a reduction in the level of Personal Allowances and deductions for Salaries Tax
	an increase in the rates of tenements

The Advisory Committee suggested that some combination of these three alternatives should be introduced pending a decision on GST. A proposal for a Boundaries Facility Tax was put forward by Government but was abandoned in the face of considerable opposition.

The consultation document identifies only two "viable alternatives" to broaden Hong Kong's tax base: GST and a reduction in the level of Personal Allowances and deductions for Salaries Tax. However the document dismisses the latter option, stating that even a substantial reduction in personal allowances would "still leave (Hong Kong's) tax base overly reliant on taxation of income". The document therefore concentrates on the case for GST.

The document does not fully consider the case for an increase in the rates on tenements. Rates is already a broad based levy which has a low cost of collection, and an increase in the level of rates would be easily implemented. It is dismissed as a viable option because rates is already a broad based tax and would not increase the number of taxpayers. The logic here is not clear. If the objective of the exercise is to broaden Hong Kong's tax base, which is not necessarily the same as increasing the number of taxpayers, an increase in rates on tenements appears to deserve more consideration as an alternative to GST.

What are the Government's specific proposals?
The proposals put forward in the consultation document include:

	A general consumption tax as the most suitable method of maintaining and stabilising revenues.
	A credit-invoice type of GST, i.e. GST will be collected at each stage of the chain of production and distribution.
	The adoption of the "destination principle" under which imports are taxed and exports are zero-rated.
	The adoption of a single positive rate at the lowest end of the GST rates adopted by other economies, e.g. Singapore (5%).
	A fairly high registration threshold level, e.g., HK$5 million turnover, with an option to register below that level.
	Consideration of an undertaking not to increase the initial rate of GST for 5-10 years.
	Keeping exemptions and zero-rated items to a minimum to reduce complexities and disputes about which items should qualify for special treatment. However, this has already led to criticism from the public as this would lead to the imposition of GST on education and basic food stuffs.
	Defining certain financial services as zero rated "financial supplies" in the interest of maintaining Hong Kong's competitiveness as a financial centre.
	The provision of a tourist refund scheme, with tourists reclaiming a refund on departure.
	The exemption of resident rental payments. It is proposed to tax non-residential property and exempt residential property (both sales and rentals).

What is the likely impact of the proposals?
According to the consultation document:

	GST at 5% would result in a price effect of around 3% in the short term.
	International experience generally shows that GST itself would not materially alter economic growth trends.
	Private consumption would be unlikely to change much with a low rate of GST as consumption expenditure patterns would return to normal within a short period of time, whilst corresponding tax offset and relief measures would boost household disposable incomes.
	International experience shows that a simple broad-based GST with few exemptions keeps compliance costs at a low level.

Mitigation of the effects of GST
GST is proposed as a revenue protection measure to broaden and protect the tax base and the revenue generated through GST should be applied to reduce other taxes and offer compensation to those not otherwise subject to tax.

Accordingly, the Government is considering the following "compensatory" measures:

	Reducing direct taxes e.g. Salaries Tax and Profits Tax as the tax reform is not intended to generate additional revenue, at least for the first five years after GST introduction.
	Incorporating appropriate compensation for low-income households, e.g. increases in Comprehensive Social Security Assistance payments and annual special payments to low-wage-earners.
	Industry-specific tax relief, e.g. reducing the rates of Petrol, Diesel and Aircraft Fuel Duty to take account of the imposition of GST and abolishing Hotel Accommodation Tax.
	Indirect tax adjustments to take account of the imposition of GST, to reduce economic distortion and revitalise competitiveness.

Summary
The proposed GST would have implications for every household in Hong Kong as it would be broad based and apply to most items of household expenditure and also have important implications for businesses even if they are not required to register for GST.

The consultation period runs to 31 March 2007 and we encourage our clients to participate in the debate on this important topic and to make their views known to the Government through individual, corporate or collective submissions.

If you wish to know more about the Consultation Document please contact us via info@gthk.com.hk.

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