Tax Rates on Capital Income
in Hong Kong
Hong Kong is often referred to as the last bastion of laissez-faire. 1 The pronounced policy of its government is one of "positive nonintervention." Tax rates are kept low and tax structures, simple. However, this general impression is very misleading and "the truth is that it [the government] acts and intervenes a great deal." 2 In the case of corporation profits tax, there are provisions in the tax laws that have nonneutral effects on investment decisions. The purpose of this chapter is to examine these provisions by making some estimates of effective corporate tax rates on certain types of capital income.
The corporation profits tax system in Hong Kong can be described as a classical system. Companies pay a flat rate on their taxable profits. However, there are no taxes on dividends or capital gains, even at the personal level. At present, the tax is charged at 16.5 percent. Because Hong Kong adopts the territorial-source principle of taxation, the tax is restricted to profits arising in or derived from Hong Kong. As in other countries, the tax base is not pure economic profit but accounting profit adjusted in accordance with the provisions of the tax laws. For the purpose of this chapter, the relevant provisions are those related to deductions for depreciation and interest payments and valuation of inventory. To compute taxable profits in Hong Kong, depreciation is based on historical cost and inventory is valued at cost or market value, whichever is lower, thus increasing taxable profits in times of inflation. This effect is countered by