What is dividend tax?
Dividend refers to the part of after-tax profits of a company for distribution to its shareholders in proportion to the number of shares they hold. With dividend tax imposed, part of companies’ dividend distribution will be taxed by a certain percentage.
Hong Kong does not levy taxes on dividends. Dividends repatriated to Hong Kong, paid by a Hong Kong company to its shareholders are not subject to Hong Kong tax. Nor is there withholding tax on the dividends paid to shareholders outside Hong Kong.
Previous discussion in Hong Kong
Hong Kong has long enjoyed the reputation of its simple tax system and low tax rate, where the taxpayers are subject to only profit tax, salary tax and property tax. As important as the simple tax system is to maintain the position of an International Financial Centre, discussions on broadening the tax base emerged from time to time in past decades. Among the possible tax options is dividend tax, which was first advocated by the then Financial Secretary Sir John Cowperthwaite as early as 1964 and proposed by Sir Philip Haddon-Cave in 1975, both failed to introduce the tax as a result. The passion to discuss dividend tax reignited in the early 2000s when the government formed a committee to consider the suitability of new types of broad-based taxes for Hong Kong.
In the past years, some members of the legislative council argued that labour income could not truly reflect one’s ability to pay, leaving some rich earning a big buck from other sources of nontaxable income. They suggested introducing a dividend tax to Hong Kong to promote social equity and boost the public coffers, providing a margin for the government to reduce the profits tax rate in order to enhance tax competitiveness.
Motivations for introducing dividend tax
As an International Financial Centre coupled with a sophisticated stock exchange, Hong Kong serves as a base for international and mega-cap companies that create a broad base of shareholders and make dividend tax a viable avenue for the government to raise revenue. With concerns about population ageing and economic shocks from time to time, it is in the Hong Kong government’s interest to broaden the tax base in a bid to pile up fiscal reserves whenever possible. The progressive characteristics of dividend tax also shine in the eyes of the advocates for social equity, as it may help achieve the horizontal and vertical equity of tax by taxing more on the rich and taxing the same amount on the people with the same income. Horizontal equity suggests people with the same ability to pay should be taxed equally and vertical equity suggests those with higher income should pay more taxes.
Problems with dividend tax in Hong Kong
In the past discussions on dividend tax, some concerns were raised about its adverse impact on the investment climate and its revenue-generating ability. Double taxation is one of the most notorious problems, which means the government tax a corporation twice by first taxing on profit at the corporate level before distributing dividend and then taxing on the dividend again after the distribution at the individual level.
Some doubted the ability of dividend tax in providing stable revenue for the government. As companies have full control over their dividend policies, the introduction of dividend tax will create incentives for companies to allocate profits in other ways but distributing dividends, such as share buyback or investing in overseas companies. Besides, the amount of dividend tax also depends on the company’s profitability. Amid the economic downturn where the government needs money the most, it is expected that the government’s revenue from dividend tax will decrease following the downturn in companies’ profits.
In addition, a simple tax system is one of the most valuable features of Hong Kong that attract investment worldwide. Not only would introducing dividend tax add to the complexity of Hong Kong’s tax system, but also discourage investment due to the double taxation concern. Even though introducing a dividend imputation system could solve or alleviate the problem of double taxation, the government-established Advisory Committee on New Broad-based Taxes claimed that the implementation of a dividend imputation system was potentially complex to legislate and difficult to administer.
Last but not least, the territory source principle in Hong Kong suggests that only assessable profits which arose in or are derived from within Hong Kong are taxable. The introduction of the dividend tax might drive the investment overseas to avoid the tax. Meanwhile, the tax only apply to dividends paid by Hong Kong companies, but not to that repatriated to Hong Kong.
Dividend tax in selected places, Research Office Legislative Council Secretariat