Perhaps one of the biggest surprises of 2020 so far is how quickly the world can change. Since the virus first appeared, governments have been forced to intervene in ways that would have been inconceivable a few months ago. 

Many of these interventions have been extremely damaging for businesses – restrictions on opening, numbers of customers and international travel have all impacted large sections of the economy and in many cases consumer appetite had already been dented regardless of any legal restrictions. This in turn has led to governments looking at what relief measures they should take. 

In the first wave of responses the focus was on emergency relief measures and public safety responses, but as it becomes clear that the societal and economic effects of the virus will continue to reverberate for some time, attention is turning to the measures governments need to take to protect both the economy and their own tax raising abilities in the new business environment.

The story so far

Fiscal responses to the virus have followed a broadly similar pattern: an initial series of small-scale handouts and reliefs, followed by a much larger package of relief measures as the scale of the problem becomes more apparent. Hong Kong has followed this pattern with an initial $30 billion package on 21 February being dwarfed in succession by measures in the budget a week later and a second round of relief measures on 8 April. Similarly, the government has moved from fairly conventional responses (one-off tax reductions, rental waivers and cash payouts) to more targeted responses aimed at preserving employment (the employment support scheme) or assisting particular hard-hit sectors. 

The government has also taken action to address liquidity concerns, expanding the guarantee scheme for SMEs and amending bank lending regulations to assist struggling debtors. The employment subsidy scheme in particular is relatively generous, being available to most employers to subsidize employment costs provided they commit not to reduce headcount, although the drive for administrative simplicity means there are some unfortunate exceptions. Nevertheless, most measures announced to date are effectively sharing a degree of short-term pain to help businesses ride out the storm. The question now is whether measures are needed to reboot the economy in the post-Covid world.

Future tax challenges

As the initial response fades and businesses and individuals start to focus on their longer term response to the virus, governments will also need to consider how to set the appropriate framework both to relieve distress and to support change. From a tax perspective, in the short term the relief of distress may include more flexibility in the use of tax losses. In the longer term, though, a more detailed re-examination of Hong Kong’s tax system may be required:

ν    As remote working and digital business become more common, Hong Kong’s traditional focus on territorial taxation may become harder to sustain;

ν    Continuing restrictions on international travel may impact the planning many companies had undertaken regarding their residence and substance either within or outside Hong Kong - government will need to think what approach to take where companies are no longer able to follow their original plans;

ν    As the global financial crisis led to the first round of global coordination on tackling tax avoidance (BEPS), it is likely that to fund relief measures for Covid-19, governments around the world will need to find additional sources of revenue in the future. We can expect to see further measures designed to tackle global tax planning. Hong Kong, as a low-tax international centre, will need to be agile in addressing these.

ν  Hong Kong has traditionally derived a large proportion of its government revenue from land transactions - given that remote working makes significant CBD footprints less important, will this model remain sustainable in the future?

ν  Different business sectors are likely to face different recovery curves, with some areas, for example technology, probably benefitting from changes in behaviour, and others, for example the travel industry, probably suffering from long-term disruption. This is likely to affect the future composition of Hong Kong’s economy and government will need to consider how to use the tax system effectively both to encourage innovation in growth areas and to manage decline or stagnation in struggling sectors. Such measures might include enhancements to research and development incentives, measures to promote the digitalization of the economy and more sympathetic rules for companies facing bad debts.

Changing employment relationships

Covid is driving changes in the employer-employee relationship that could have a flow-on effect into the shape of post-Covid company and government policies. Across the globe we have consistently seen the adoption, often by necessity rather than choice, of increased work-from-home and remote working practices. In some locations, such as Hong Kong, this enforced experiment has led to a changed mindset, making such arrangements more acceptable to employers and employees. In other locations, the practice existed but has been amplified.

With more home or remote working, particularly cross-border remote working, companies are having to assess the adequacy of existing policies and face new issues, such as the definition of “home,” and the immigration, tax, employment law and regulatory compliance consequences of cross-border working. Current global mobility and agile working policies may struggle to cope with these new scenarios, yet it is likely that greater reliance will need to be placed on them in the future.

Similarly, existing tax laws may not cope well with the reversal of the “usual” mobility scenario. Instead of moving an employee to a new work location, the future may see increased remote working where the work is (digitally) moved to the location of the employee. This will raise new policy and enforcement issues for the taxation of income from labour, similar to those raised in a corporate tax context around the taxation of the digital economy. Will traditional concepts of source of personal income (often the location where the work is performed) be adequate when the employing entity, benefit of services and tax deduction for remuneration costs are all elsewhere? 

We may also see increased competition between jurisdictions to attract business and employment opportunities for local citizens. For a location like Hong Kong, where location and proximity to Mainland China has fueled employment and its choice as a regional hub, increased remote working and decreased physical mobility through business travel and inbound expatriates may present challenges to stimulating the future recovery.

Conclusion

So far the Hong Kong Government has focused on providing some welcome short-term measures to assist business through the immediate crises. As the economy starts to reemerge after its hibernation, it is now time to focus on what longer term changes are needed to enable Hong Kong to flourish in the new economy. 

Ivor Morris and Murray Sarelius, Partners, KPMG.