Due to its geographical proximity to the mainland, modern and (until now) friendly banking system and transparent legal regime, Hong Kong has long served as a popular gateway into China for foreign businesses. Americans in particular have favored the former British colony, which retains its widespread use of the English language and Western business ideals, as a launching pad for their operations into mainland China.
However, since the Foreign Account Tax Compliance Act (FATCA) came into effect in early July, many Hong Kong based banks have been refusing to open new accounts for, and even shutting down the existing accounts of, American individuals and corporations.
Dezan Shira & Associates have been advising several of our American clients who have found themselves in this frustrating and potentially catastrophic situation. In this article, we examine the effects of FATCA on American businesses and taxpayers operating out of Hong Kong, as well as the implications for Hong Kong’s future as a means of penetrating the Chinese market.
What is FATCA?
The Foreign Account Tax Compliance Act (FATCA) is an American law approved in 2010 that has only slowly been implemented, primarily because of its complexity and because of the necessity to negotiate the cooperation of numerous foreign countries to secure its desired global reach.
The basic idea is that banks and other financial institutions (broadly defined in the law) would be compelled to assist the U.S Internal Revenue Service (IRS) in collecting taxes from U.S taxpayers abroad by reporting the details of their overseas financial accounts, including naming and identifying the account holder. Failure to comply will result in a 30 percent withholding tax on all U.S. income.
Individual Americans and corporations are also required to report the details of their overseas accounts, and the IRS will then reconcile the information received in an effort to identify unreported, taxable income.
Headache for HK financial institutions
Hong Kong authorities only signed an inter-governmental agreement (IGA) with Washington in May of this year. Widespread confusion surrounding the law meant that come the first deadline for tax reporting on July 1, which incidentally kicked in as pro-democracy protesters blocked up the city’s business district, only a couple of thousand Hong Kong financial institutions, a mere fraction of the tens of thousands operating there, had registered themselves.
Now that the IGA has been signed, FATCA is as much Hong Kong law as it is American. This means that on top of the U.S. 30 percent withholding tax, these institutions are subject to further penalties from the Hong Kong authorities. The costs do not stop there. Hong Kong banks are now scrambling to find any trace of American presence in their accounts and have to make significant process and technological changes.
The costs of locating, monitoring and reporting on a U.S. held or controlled account must be weighed against the benefits of serving the client. In short, it is often easier and more cost efficient for Hong Kong institutions to simply shut down the accounts of, or reject applications from, American clients, rather than shouldering the costs of complying with FATCA or the penalties for not doing so.
What this means for the Americans:
Key to using a Hong Kong corporation to establish a Chinese subsidiary is the ability open and maintain a corporate bank account in Hong Kong, since a Chinese subsidiary may only receive a capital injection from a bank account held in the name of the parent company.
This has left many American businesses stranded. In some cases, the subsidiary has already been established, but cannot be funded or controlled, as applications for a Hong Kong bank account are rejected. In others, long-running operations are paralyzed, as already existing accounts are shut down.
There are some 50,000 U.S citizens living in Hong Kong, not including U.S green card holders who are also required to file U.S tax returns. Law firms specializing in the area have been reporting record numbers of inquiries about relinquishing U.S citizenship or green card status.
What this means for Hong Kong:
This has implications for Hong Kong’s future as the preferred gateway into China. Singapore has already replaced Mauritius as the leading source of FDI into India, and investors have long been weighing up the advantages of the city state – its independence from China’s laws and political stability – against Hong Kong’s proximity to, and strong trade links with, the mainland. FATCA may prove to be the final straw.
By Benedict Lynn
