Futu Research | Hong Kong's Dividend Tax Lowered, Long-Term Benefits Benefit Hong Kong Share Valuation

COMPREHENSIVE ADJUSTMENT OF HONG KONG STOCK DIVIDEND TAX

In recent days, the market has been rumored that a comprehensive adjustment will be made through the purchase of Hong Kong stocksHong Kong stocksDividend tax. Prior to this, the National Representative and Chairman of the Hong Kong Securities and Exchange Commission, Lei Tsing Liang, proposed a continuous expansion and improvement of the existing interconnection mechanism during two meetings, strengthening Hong Kong's role as a bridge connecting the Mainland to overseas capital markets and further enhancing Hong Kong as the preferred foreign market location for Mainland enterprises. Important status.

One of the proposals is to impose a tax on dividend income on individual investors under Hong Kong shares, which affects the attractiveness of the Hong Kong stock market to individual investors in the Mainland, and the proposal that the State Administration of Taxation and the Securities Regulators of the two localities actively study improving the relevant tax system to reduce dividends for individual investors in Hong Kong equities. The level of dividend tax makes it level with the A-share market.

This article will discuss in detail the different systems of dividend tax on Hong Kong stocks and A shares and what impact the proposal would have on the Hong Kong stock market if implemented.

Different tax rates affect the actual rate of return on high dividends

The purchasing power of Hong Kong equity capital slowed slightly after 2021, but it still constitutes an important part of the Hong Kong stock market. As of the end of 2023, Hong Kong equity capital traded over HK$7 trillion over the year, accounting for more than 28% of major market transactions. The total market value of Hong Kong joint-stock companies is HK$45 trillion and the share market capitalization of Hong Kong stocks accounts for 86% of the total market value of Hong Kong stocks.

Figure: Hong Kong Equity Capital Flows

Source: Wind

HOWEVER, MAINLAND INVESTORS' PREFERENCE FOR UNDERVALUED, HIGH-DIVIDEND STOCKS IS DIFFICULT TO CONVEY TO THE HONG KONG STOCK MARKET. THERE IS A MARKED DIFFERENCE IN DIVIDENDS AND VALUATIONS BETWEEN HONG KONG STOCKS AND A HIGH-DIVIDEND SEGMENTS, SUCH AS SHENHUA CHINA LISTED IN BOTH COUNTRIES, CHINA SHENHUA DIVIDEND TTM OF 6.6% AND HONG KONG SHARES TTM This is 9.7% and the A/H premium rate is 43%. Similarly, for the high-dividend indices in both countries, the dividend yield of the A-share CID is 5.4% and the Hang Seng High Yield Index has a dividend yield of 7.6%.

In addition to the liquidity premium, there is also an important factor behind this: the excessive dividend tax on Hong Kong shares, and the dividends received by Mainland individual investors through the HK share mechanism are actually required to pay far more than the Mainland dividend tax, which significantly reduces the actual return on holding high-dividend stocks.

What is the system of paying taxes on Hong Kong shares?

Companies on the Hong Kong market can be divided into Chinese-owned stocks (income mainly from the Mainland of China), Hong Kong local shares (income mainly from Hong Kong), foreign equity shares (income mainly from overseas), and Chinese-invested shares can be further advanced depending on the place of registration and the nature of the company. It is divided into H shares (enterprises registered in the Mainland of China), red chips (state-owned enterprises registered overseas) and Chinese citizen shares (private enterprises registered overseas).

According to the Notice Concerning Tax Policy on the Pilot of the Shanghai Stock Market Interconnection Mechanism and the Notice Concerning Tax Policy on the Pilot of the Hong Kong Stock Market Interconnection Mechanism, there are different requirements for the dividend tax regime for different types of enterprises:

FOR INDIVIDUAL INVESTORS IN THE MAINLAND WHO RECEIVE DIVIDENDS RECEIVED BY INVESTING IN HONG KONG SHARES LISTED ON THE HONG KONG STOCK EXCHANGE, H SHARES SHALL APPLY TO THE CHINA SECURITIES REGISTRATION LIMITED LIABILITY COMPANY (HEREINAFTER REFERRED TO AS CHINA SETTLEMENT) TO BE MADE AVAILABLE BY THE CHINESE SETTLEMENT TO H SHARE COMPANY, THE MAINLAND REGISTER OF PERSONAL INVESTORS, H SHARES The Division deducts personal income tax at a 20% tax rate; dividends received from investments in non-H shares listed on the Hong Kong Stock Exchange are settled by China at a 20% tax rate to deduct personal income tax.

That is, regardless of the stock, interest tax is levied uniformly on investors in Hong Kong accounts of 20%.

The above tax policy is a tax method for Hong Kong share-level investors. Since H-shares are based in the country and Hong Kong's general users are also mainland residents, dividends are not distributed abroad, so the normal 20% dividend tax is payable according to the regulations. For non-H shares, corporate income tax of 10% for overseas investors of Chinese companies is also involved. The specific tax rate depends on whether the corporate income tax has been calculated on a 10% corporate income tax.

In the case where dividend income tax is not deducted in advance, red chip companies are required to deduct 10% corporate income tax in accordance with the standard for corporate investors, and the remaining dividends will be deducted from the dividend income tax of 20%, and the actual tax rate is 28% on the accrual of both dividends. This is due to the fact that HK common stock investors are registered on the register of shareholders of the Hong Kong Central Clearing Company (agent). Currently, in practice, RDI investors cannot distinguish between private investors and legal investors on a technical level. Therefore, all investors from Hong Kong Central Clearing Companies are not technically able to distinguish between private investors and legal investors All are subject to a 10% corporate income tax deduction.

Figure: Acquisition of Shanghai Stock Income Tax in China Oil 2023 Dividend Announcement

Source: Company Announcement

So for individual investors, it means that the dividends received are repeatedly levied on income tax twice, corporate income tax once and personal income tax once. This involves the duplication of taxes. According to Document No. 81 of Property Tax [2014], individual investors may apply for tax credits to the domestic competent tax authority with a valid deduction certificate in their possession. However, due to the cumbersome application process and costs, it is difficult for Hong Kong equity investors to actually enjoy the tax credit.

In contrast, Property Tax [2015] 101 provides for a differentiated dividend income tax policy for individual investors in A shares (halved for more than 1 month and exempted from holding for more than one year), resulting in a much higher effective tax rate on Hong Kong common stock dividends than A shares. Taking the example of China's Shenhua, the actual returns available to Hong Kong investors after dividends are deducted will fall to 6.9%, significantly narrowing the gap compared to 6.6% for A-shares.

THE ACTUAL DIVIDEND TAX PAID BY HONG KONG EQUITY INVESTORS IS MUCH HIGHER THAN INVESTORS IN THE HONG KONG LOCAL AND A-SHARE MARKETS. Not only does this fail to generate reasonable returns for investors, but it is also detrimental to a good value for a good company that distributes high dividends in a stable manner.

If the proposal can be implemented, what impact will it have?

Can the current tax on individual investors in Hong Kong stocks be reduced. What are the main obstacles behind it?

The current HCAC mechanism involves two agents for China Clearing and Hong Kong Central Clearing. Compared to corporate investors in the Mainland, Mainland corporate investors are legally exempt from corporate income tax on dividends earned by investing in Hong Kong-listed shares for 12 months in Hong Kong listed shares. So the main reason for Mainland corporate investors and Mainland individual investors on tax rates may be that corporate accounts are relatively easier to track holding time. Tax relief for individual investors is also possible if the impediments can be cleared both systemically and technically, and given the small amount the Chinese government collects from dividend taxes each year.

If the tax rate on Hong Kong shares is equal to that of A shares, “10% dividend tax is charged for holding for a period of one month or less than one year; personal income tax is exempt from holding for a period greater than one year”. This means that for investors in Hong Kong stocks, the overall tax rate will decrease by 10%. The decrease in the tax rate will make the dividend rates of HK corporations more attractive, and the high dividend segment within HK equities will benefit first. As mentioned above, the market capitalisation of Hong Kong stocks has accounted for 86% of the total HK share market value. The higher valuation of Hong Kong stocks is expected to lead to a subsequent increase in the valuation of the overall HK stock market, focusing on the telecom operators, transport, water services, and Hong Kong domestic utilities sectors.

Investors are advised to actively deploy at the beginning of the announcementHigh Dividends on Hong Kong StocksThe segments in which the most noteworthy filtering stock criteria are:

Continuous EPS growth+higher dividend rates+willing to repay shareholders with higher dividends for many years.

This type of company is expected to be accompanied by a decrease in the Hong Kong share tax rate in the medium to late period, providing investment opportunities that continue to increase in valuation.

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