The international financial system has undergone major changes in the last few decades. Among them is a huge increase in the amount of money flowing around the world. Capital controls have weakened, and cross-border trade and investment have grown in volume. Meanwhile, the technology to facilitate funds transfer has improved.
One result is that jurisdictions with high or far-reaching taxes have seen revenues decline as money moves or stays offshore. High-tax jurisdictions have criticized their low-tax counterparts as tax havens and pressured them to share information about their citizens’ financial affairs.
Perhaps the most famous example is Switzerland. Starting around 10 years ago, countries like Germany, France and Italy demanded that Switzerland do more to help them fight tax evasion. The Swiss took the moral high ground. They essentially criticized the other countries for their high-tax policies, and said the confidentiality of Switzerland’s banks was paramount. Of course, Switzerland’s banks and local governments also made money from fees and taxes on overseas account holders.
From many countries’ point of view, tax havens did not deserve the moral high ground: they were helping citizens dodge taxes back home. Public opinion in many large, higher-tax countries also became more aware of how wealthy individuals and companies could find ways to reduce or avoid taxes. Tax havens in general started to suffer an image problem.
In 2010 the United States passed the Foreign Account Tax Compliance Act – FATCA. It required foreign banks to share details about US clients. A few years later the OECD developed the Common Reporting Standard for the Automatic Exchange of Information (AEOI) on tax matters. Some 70 jurisdictions have committed themselves to adopting this system.
Hong Kong is among them. Agreements covering the first automatic exchanges of information have been signed with Japan and the UK.
What does this mean for Hong Kong’s financial institutions?
Judging from the experience with FATCA, the impact could be considerable. FATCA required Hong Kong (and other places’) financial services providers to carry out work on behalf of the US authorities. They have to identify American customers, collect details about their accounts and essentially help the US collect taxes. Penalties for non-compliance are severe.
Some Hong Kong banks and other financial companies had to ask themselves if they could afford to go through with all this. Would it actually be easier to identify all their American customers and close their accounts – thus getting rid of the extra work and the threat of penalties? Many now refuse to accept applications from new US clients.
There have been stories of particular problems for US citizens using a Hong Kong corporation to establish a mainland subsidiary. Such structures would obviously be disrupted if the corporate bank account in Hong Kong is affected. This represents a potential threat to Hong Kong’s role as a gateway.
On the other hand, some bigger institutions with global networks have absorbed the extra burden of monitoring and reporting on Americans. Being happy to accept US clients, they have possibly gained an advantage and expanded their client base.
Most of us would agree that the international community needs to monitor certain aspects of the financial system. Regulations designed to identify money laundering are part of the fight against crime and terrorism. Hong Kong is also party to the BEPS initiative designed to counter the practice of multinationals to book profits in low-tax jurisdictions.
Hong Kong officials support our role as a financial services hub. They also support international efforts against cross-border tax evasion. In practice, this means striking a balance – which means some players might have to let some opportunities go. The alternative is to be declared a “non-cooperative” tax jurisdiction, which would damage our reputation and possibly attract various other sanctions.
It is in Hong Kong’s overall interests to comply with new standards and regulations, to protect our reputation as an international financial center. Ultimately, maintaining our integrity as a financial center comes first.
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