By Alexander Chipman Koty and Vasundhara Rastogi
Hong Kong recently finalized a series of agreements that, taken together, shift Asia’s trade and investment landscape.
On November 12, Hong Kong and ASEAN signed the ASEAN-Hong Kong, China Free Trade Agreement (AHKFTA), and the ASEAN-Hong Kong Investment Agreement (AHKIA). Prior to this, on November 10, Hong Kong and India agreed to a double taxation avoidance agreement (DTAA) with India.
The agreements come amid distress in Hong Kong that the city is losing its traditional advantage as the premier location in Asia for trade and financial services.
Businesses that use Hong Kong as a management, trade, and sourcing hub for operations in China, Southeast Asia, and India will benefit greatly from the new agreements, while Hong Kong as a whole stands to gain from freer and more open trade throughout the region.
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ASEAN-Hong Kong Free Trade Agreement and ASEAN-Hong Kong Investment Agreement
The AHKFTA and the AHKIA include provisions on trade in goods, trade in services, investment, economic and technical cooperation, dispute settlement mechanisms, and other related areas. It represents an opportunity for trade partners and foreign investors operating in Hong Kong, mainland China, and ASEAN to grow and expand their trade and investment.
From January 2018, ASEAN countries will eliminate or reduce customs duties on goods originating from Hong Kong. This will lower operation costs for Hong Kong-based businesses and improve their competitiveness in the international marketplace.
Hong Kong’s services sector also stands to gain with benefits specified for professional services, business and telecommunication, and construction and related engineering areas. Further, the investment agreement will provide Hong Kong-based enterprises a fair and equitable opportunity to invest in ASEAN member states, offering agreed compensation in case of loss due to war, armed conflict, or other extraneous events.
Hong Kong serves as a premier gateway into and out of mainland China for international trade and services across Asia and the world, including ASEAN. Currently, there are over 500 companies from ASEAN member states operating in Hong Kong.
The FTA will strengthen Hong Kong’s role as a pivot point linking ASEAN countries to mainland China, and help establish foreign investors, as well as small and medium enterprises from ASEAN, who have yet to set a foothold in Hong Kong. Foreign enterprises established in ASEAN can also use the FTA to take advantage from Hong Kong’s expertise in the service sector, which includes financial and banking services.
Hong Kong-India Double Tax Avoidance Agreement
After several years of negotiations, India finally gave its approval for a DTAA with Hong Kong earlier this month. The DTAA will have important tax implications on international businesses with operations in both India and Hong Kong when it comes into force. It will also benefit trading companies that do not have a permanent presence in India, but provide services to an India-based entity.
As a general principle, international businesses in Hong Kong are taxed on their territorial income, which is the income generated within the territory of Hong Kong. India, on the other hand, imposes a corporate income tax on the worldwide income of business enterprises that have a permanent presence in India. As a result, India-based multi-national companies deriving income from Hong Kong face the issue of double taxation. That is, they pay tax twice on the same source of earned income.
The DTAA will offer double taxation protection to over 1,500 such Indian companies and businesses that have a presence in Hong Kong. It will provide clarity to businesses regarding tax, as they would be taxed in only one of the signatory regions.
Other benefits of the DTAA that international businesses can take advantage of include lower withholding tax (tax deducted at source), lower dividend distribution tax – an additional tax levied on foreign investors besides the corporate income tax – and in certain circumstances, credits for taxes paid on the double-taxed income that can be encashed at a later date.
The bilateral agreement will provide legal and fiscal certainty to multinational businesses carrying out international operations, and stimulate the flow of investment, technology, and personnel between the two regions. The detailed provisions of the agreement are yet to be announced.
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Important agreements for Hong Kong
Hong Kong’s agreements with India and ASEAN are welcome for international investors in the region – particularly those based in Hong Kong.Traditionally, Hong Kong has been the access point for foreign businesses entering China and Asia at large. Hong Kong brands itself as “Asia’s World City”, and is well-known for its low tax rates, ease of doing business, and robust financial sector.
In recent years, however, Hong Kong has faced growing competition throughout the region. The average corporate tax rate in Asia has fallen from 29 percent in 2006 to 21 percent in 2017, thereby reducing the comparative benefits of Hong Kong’s lower tax rate, which currently stands at 16.5 percent.
The shifting tides of Asia’s economic landscape is deeply intertwined with China’s rapid development. During China’s period of economic reform and opening up, Hong Kong was an ideal location to access the mainland due to its special relationship with the country and its geographic proximity. However, as mainland China has continued to develop and internationalize, Hong Kong’s advantages have become less pronounced.
For example, Shanghai has become an international financial hub despite restrictions on foreign participation in the sector, and is developing a Free Trade Port to go along with its existing Free Trade Zone. Just across the border from Hong Kong, Shenzhen has a thriving high tech and startup industry – as well as a significant financial sector in its own right – and its GDP is set to surpass Hong Kong’s in 2018. Hong Kong is also facing more intense competition elsewhere in Asia, particularly with Singapore. As costs in China rise, ASEAN member states such as Vietnam and Indonesia have attracted significant foreign investment for low-cost manufacturing. Just as Hong Kong has traditionally been the entry point to China, Singapore has acted similarly as the gateway to ASEAN.
Further, Singapore has been more active than Hong Kong in signing DTAAs and FTAs. According to the Asian Development Bank, as of May 2017, Singapore had 22 signed FTAs and nine more under negotiation, while Hong Kong only had four signed and three under negotiation. Additionally, Singapore has concluded DTAAs with 82 jurisdictions, while Hong Kong has DTAAs in effect with just 35 jurisdictions.
Finalizing a DTAA with India, a major emerging economy, and an FTA with ASEAN, a vital 10-member bloc for global trade, maintains Hong Kong’s competitiveness with both Singapore and mainland China, and boosts its relevance as a managerial and trade hub in Asia. Ironically, before the AHKFTA was signed, mainland China had an FTA with ASEAN but Hong Kong, obviously, did not.
The AHKFTA puts Hong Kong in a stronger position to facilitate trade and investment between mainland China and ASEAN, where before there were incentives to bypass Hong Kong. This factor is particularly important given the popularity of “China Plus One” strategies, where businesses are opening lower cost locations in ASEAN or India to complement existing operations in China.
The agreements recently concluded by Hong Kong together re-establish the city’s importance for doing business in Asia. China’s economy is becoming more complex and higher value, which makes the bridge with ASEAN and India more important than ever. And with ongoing regulatory uncertainty regarding the pace of economic liberalization in China, Hong Kong offers a stable and convenient location for managing complex pan-Asia businesses.
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