SECRET
Annex 4
Removal of Withholding tax
At present withholding tax of 10% is levied on interest paid on Hong Kong dollar deposits. The rate was reduced in the 1982 budget from 15% to 10%, when a similar tax was removed altogether from foreign currency deposits held in Hong Kong; the latter move was designed to enhance Hong Kong's attractiveness as a funding centre - the government made no distinction between deposits held off or on on-shore - in relation to Singapore where the Asian Dollar Market was growing rapidly at the time.
2. It is argued that by keeping a withholding tax in place on HK dollar deposits only, with a differential (cet par) against local currency deposits, the government has encouraged the growth of a distinct US dollar-based economy in Hong Kong (eg exporters tend to keep earnings in US dollar accounts, even if held with local banks).
3.
The US dollar transactions between Hong Kong companies have become commonplace some companies keep their books entirely in US dollars but it is debatable whether this trend has really been accentuated by the tax differential. Indeed as the differential is only equivalent to 1% of the value of a deposit (on an annual basis, where prevailing deposit rates are at 10%) a 1 percentage point different between nominal rates on US dollar and HK dollar deposits would be expected to compensate; the actual difference is currently of the order of 5 percentage points. This suggests that the benefit to the exchange rate would be, as the Governor argues, at best marginal. Banks may be discouraged from taking HK dollar deposits in the guise of US dollar deposits a purely artificial book- keeping exercise to avoid the payment of withholding tax - but this is not likely to effect the volume of flows across the exchanges. Local dollar deposits would be recorded as such; any switching of these funds by the banks would have occurred whether or not the
withholding tax were applied.
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