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In geographical terms, the peninsula and collection of islands in south eastern China which make up the territory of Hong Kong are a little over 400 square miles in size, but in economic terms, the former British colony, which in 1997 was handed back to greater China, packs a serious punch on the world stage and can claim to be the globe’s third largest financial centre after New York and London, and the ninth largest economy in the world.

How has this been achieved? Well, the story of Hong Kong’s economic success has its roots in Britain’s colonial past, and is not really the focus of this feature. However, factors such as Hong Kong’s low business and personal taxation burden, its laissez-faire business environment enshrined in a common law system based upon English principles and its unique position as a trading and investment gateway to China have certainly helped.

One Country, Two Systems

Politically, since July 1, 1997, Hong Kong has been a Special Administrative Region of the People's Republic of China and the constitution known as the ‘Basic Law’ is modelled on the constitution of the People's Republic. Under the slogan of ‘one country, two systems’ which was established before the handover, the Chinese Government agreed that Hong Kong's capitalist system would remain unchanged until the year 2047. This means it has been pretty much business as usual in terms of the day to day functioning of the Hong Kong’s economy, (although it has to be said that question marks remain over Beijing’s desire to promote democracy in the SAR).

Nevertheless, the decision by China not to interfere in the local economy means that little has changed since 1997 to upset Hong Kong’s financial services system (apart from external economic factors beyond its control). Tokyo aside, Hong Kong is Asia’s largest banking hub in terms of external transactions volume. In mid-2006, there were 133 licensed banks, 33 restricted licence banks and 33 deposit-taking companies in business. These 199 authorised institutions operate a comprehensive network of 1,600 local branches. In addition, there were 89 local representative offices of overseas banks in Hong Kong.

Total Employment in the sector in 2006 was nearly 80,000. Banking assets amounted to more than US$1 trillion.

Furthermore, Hong Kong is recognised as the leading fund management centre in Asia, with the industry defined by its international and offshore characteristics and has become a popular choice for hedge fund managers. However, hedge funds are frequently domiciled elsewhere, owing to the fact that they are eligible for profit tax in Hong Kong.

The city’s financial services industry is soon expected to play a key role in the growth of fund management and international banking on the mainland, with China opening up its banking and investment sector under WTO rules.

In March, 2006, Hong Kong's Legislative Council finally passed the Revenue (Profits Tax Exemption for Offshore Funds) Bill 2005.

Under the legislation, offshore funds, i.e. non-resident entities (which can be individuals, partnerships, trustees of trust estates or corporations) administering a fund, are exempt from tax in respect of profits derived from dealings in securities, dealings in futures contracts and leveraged foreign exchange trading in Hong Kong carried out by specified persons such as corporations and authorized financial institutions licensed or registered under the SFO to carry out such transactions.

The exemption will apply retrospectively to the year of assessment 1996/97.

Low Taxation

A great deal of Hong Kong’s economic success is undoubtedly attributable to a policy of low taxation. A big advantage is that tax is levied on a territorial basis, meaning that taxes are only charged on income arising from or derived in Hong Kong itself. Furthermore Hong Kong does not levy capital gains taxes, withholding taxes, annual net worth taxes or sales tax, although recent budgetary constraints have forced the government to actively consider the latter. However, if introduced, sales tax is likely to be at least three years away according to the government.

The main tax encountered by business entities in Hong Kong is profit tax which is charged at a standard rate of 17.5%.

Property tax is also relatively low, and charged at 15% of the annual assessed rental income of the property. Hong Kong does buck the world trend somewhat by retaining stamp duty on the transfer of shares and market securities (charged at 0.1%) although it is the intention of the government to eventually phase out stamp duty altogether.

Personal income taxes are also low by world standards and constitute a major draw for foreign residents. Income tax, known in the SAR as ‘salaries tax,’ is based on the previous year's income and is charged at progressive rates to 20% (Aug 2006). The territorial nature of Hong Kong’s tax system means that there is much scope to reduce taxation on various forms of income derived from foreign jurisdictions.

Hong Kong until 2006 levied an estate tax, charged at a maximum of 15% on estates valued over US$1,350,000 (HK10.5 million).

However, the Revenue (Abolition of Estate Duty) Ordinance 2005 came into effect on 11 February 2006. No estate duty affidavits and accounts need to be filed and no estate duty clearance papers are needed for the application for a grant of representation in respect of deaths occurring on or after that date.

The estate duty chargeable in respect of estates of persons dying on or after 15 July 2005 and before 11 February 2006 with the principal value exceeding $7.5 million was reduced to a nominal amount of $100.

Residence

Hong Kong owes much of its success to international input, and its colonial past means that British influences abound. English can still be heard as the territory’s official language alongside Chinese. However, the overwhelming majority of Hong Kong’s densely packed 6.95 million (July 2006) population are of ethnic Chinese origin, with the major non-Chinese elements coming from the British Commonwealth, the US, Japan and Portugal.

All foreign nationals attempting to gain entry into Hong Kong must obtain a visa. The one exception to this rule is for British citizens, who may remain in the territory for up to six months before having to acquire a visa. However, the visa rules in Hong Kong are complex, and have become especially so since 1997. As a general rule those seeking to reside or work in Hong Kong who do not already have the right to abode or ownership of land in the territory need a visa. Whilst it may also be possible to arrive in Hong Kong on a tourist visa and obtain employment, it is becoming increasingly difficult for employers to obtain residential visas via this method, and is therefore not the recommended path.

Employers will find the transfer of specialised staff or management posts within a firm is usually a straightforward business in Hong Kong, although the SAR government’s policy on importing labour makes recruiting specialised staff more difficult, and procedures are in place to ensure that local workers have ample opportunity to fill a vacancy ahead of foreign candidates.

Real estate

People looking to buy property in Hong Kong will find that real estate prices have begun to recover after a long slump which began amid the Asian financial crisis of 1997/1998. Prices were up approximately 30% in 2004 and were around 40% above their historic low reached in 2003.

As of September 2004, rents in the city equalled HK$20 to HK$25 per square foot per month for a typical apartment, climbing to between HK$30 and HK$40 for flats at the luxury end of the rented market. Sales prices ranged from HK$5,000 to HK$6,000 per square foot.

Closer Economic Partnership

As mentioned, Hong Kong’s unique relationship to China allows it to serve as a convenient base for international manufacturers and investors with plans to tap into the Chinese market place. Beijing and Hong Kong have sought to oil the wheels of the trading machinery that exists between the two jurisdictions by agreeing to the Closer Economic Partnership Arrangement (CEPA), which came into effect on 1st January 2004. This set in motion a process of trade liberalisation in goods and services between the SAR and China and has cemented Hong Kong’s position as the conduit for investment into the mainland.

By 1st January 2005, the CEPA II deal had removed tariffs on 1087 categories of goods exported from Hong Kong to the Chinese mainland. It also removed or reduced geographical, financial and ownership constraints on 18 services sectors including professional services, communications and media, financial services and trade related services. Importantly, these apply to companies of any nationality provided the firm is incorporated in Hong Kong, has operated there for a minimum of three years, is liable to pay tax in the territory, and employs at least 50% of staff locally.

However, overseas firms without a presence in Hong Kong can still take advantage of the CEPA provisions by outsourcing to, or partnering with, a qualified Hong Kong-based manufacturer or service provider. Foreign manufacturers can achieve this by satisfying rules of origin requirements which essentially means that goods must be ‘substantially changed’ in Hong Kong to qualify. Overseas service providers meanwhile, can partner with or invest in a CEPA-qualified firm to gain greater access to the mainland market.

Under the ‘building block’ approach to CEPA adopted by the decision makers of Hong Kong and the mainland, in January 2005 there was a further round of consultations on additional products that will benefit from preferential tariff treatment.

In June 2006, China's State Council revealed that it would ease restrictions on the trading of the Chinese currency, the renminbi, in Hong Kong under an agreement to expand the scope of the Closer Economic Partnership Arrangement.

Under the proposals, Hong Kong importers could be allowed to settle direct import trades from the Mainland in renminbi, while

inancial institutions in the Mainland could issue renminbi financial bonds in Hong Kong on a pilot basis.

Additional new measures under CEPA would also cover goods and services, and enhanced cooperation on intellectual property protection.

In the services sector, 10 areas would see new liberalisation measures. They are legal services, construction, information technology, convention and exhibition, audiovisual, distribution, tourism, air transport, road transport, and individually owned stores.

Both sides are committed to encouraging mutual recognition of professional qualifications as part of the services rules under CEPA. Accordingly, a mutual recognition agreement between Mainland construction supervising engineers and Hong Kong building surveyors was signed on June 27, 2006 in Beijing, bringing the number of mutual-recognition agreements or arrangements under CEPA to 10 at that time.

Hong Kong travel agents would be allowed to set up wholly-owned or joint-venture operations in Guangdong Province, to apply to operate group tours to Hong Kong and Macau for residents of Guangdong Province on a pilot basis.

Hong Kong air-transport sales agencies may set up wholly-owned agencies in the Mainland. The registered capital requirement will be the same as that for Mainland enterprises.

All these measures will take effect starting from January 1, 2007.

Since January 1, 2006, the Mainland has granted all products of Hong Kong origin tariff-free treatment if applications by Hong Kong manufacturers met the CEPA rules of origin. Manufacturers may apply to include products that did not meet the agreed rules of origin in discussions that will be held twice a year.

Recovery

Economically speaking, Hong Kong hasn’t had an altogether easy ride in recent years, and has had to deal with a long period of deflation; the widespread impact of 9/11 and the SARS epidemic in early 2003, which joined with cyclical factors to slow economic growth considerably.

However, the government is determined to avoid a repeat of the SARS crisis which virtually shut down the city for a number of weeks in 2003, in the process crippling the economy across all sectors and eventually claiming the lives of 300 people.

Realising that there is much at stake if another epidemic were to occur, Hong Kong in 2003 earmarked some HK$1.3 billion (US$100 million) to be spent on various public health projects whilst laws have been changed to strengthen and enforce hygiene standards and promote a more hygiene-conscious culture among the city’s population.

Fortunately, 2003 proved to be the nadir of Hong Kong’s recent economic woes - GDP growth in 2005 was estimated at 7.3%.

So, in summary, Hong Kong holds an enviable position as the conduit for global investment into China, and with its economy built firmly on a foundation of low taxation and decades of expertise as a financial services hub, it seems that prospects for the former British colony appear bright, and the jurisdiction is likely to remain popular both as a place to do business, and a place where foreigners can take advantage of an attractive tax regime, for some time to come.