Some-Buyer's Stamp Duty
30th October 2012

First it was the "HK land for HK Permanent Residents" policy on new residential land leases. Now the Government is proposing a discriminatory form of taxation - a "Buyer's Stamp Duty" of 15% on any person who is not a Permanent Resident (PR) and buys a home in HK. That is a status that most new arrivals can only get after 7 years of residency.

This marks a dangerous precedent - for the first time, the amount of tax you pay depends on your immigration status in Hong Kong. You can come here to work, and you must then pay salaries tax, but you can't spend your earnings on a home without paying more tax than the permanent resident sitting next to you. If the proposal is passed, then it lays the path for other possible discriminatory taxes - for example, the Government might propose that non-Permanent Residents pay salaries tax at higher rates, claiming that they are "taking jobs" from PRs, or they might charge higher stamp duty on tenancies with non-PR tenants, because they are putting upward pressure on rents for apartments that PRs might rent.

This is at odds with the often-stated Government goal of social harmony and its calls for Acceptance of New Arrivals in HK. The video opens with "No matter where we came from, or how long we've been here, we are all part of the Hong Kong family". Yeah, right. By telling PRs that they are special, the Government strengthens the "them and us" mentality. And yet, if you are a "foreigner" like Google, and want 2.7 hectares of cheap land for a data centre, creating fewer than 10 permanent jobs per hectare (25 in all), then no problem! At a plot ratio of 5, a site of that area could produce  135,000 sq.m. (1.45m sq ft) of floor area, or about 2,400 homes. Google paid about HK$102.6m for the site, assuming they sealed the deal after premiums went up on 24-Aug-2011. A residential site of that size in Tseung Kwan O would cost about $4k per sq ft of floor area, or around HK$5,800m. Have we got our priorities right? Anyone for a new industrial estate, Cyberport, or Science Park?

Another possible discriminatory tax would be a selective sales tax on all things, not just apartments, to deter mainlanders from crowding into our shops and buying things to take home. We could have a sales tax for which PRs (on production of their ID card) are exempt, but non-permanent residents (who have no vote) and non-ID card holders pay, let's say (picking a number out of thin air), 15%?

Who are they trying to protect?

Ironically, by erecting a prohibitive barrier to home ownership by non-PRs, the new tax will ensure that when the bubble bursts, fewer non-permanent residents, and more PRs, will lose money. It's the Government's way of saying to non-PRs, "beware of our property market" while encouraging locals to believe that the market is "healthy and stable" for them. But surely buying property is a mistake that anyone should be allowed to make for themselves. Meanwhile, if you are a PR who owns property, the only real way out is now to sell to another PR.

The Basic Law

Through BSD, the Government proposes, in effect, to prohibit anyone other than a PR from buying your property. Shouldn't you be free to sell to whomever you like? After all, it is your property, isn't it? Article 105 of the Basic Law says in part:

"The [HKSAR] shall, in accordance with law, protect the right of individuals and legal persons to the acquisition, use, disposal and inheritance of property..." (emphasis added)

That is "property" in the legal sense of the word, including immovable property, i.e. real estate. The "legal persons" phrase is in there to be specific that the Basic Law protects not just individuals (humans), but also companies, partnerships and other organisations, and it doesn't say "HK passport holders", or even "permanent residents", it says "individuals". Yes, it says "in accordance with law" (meaning common law and local legislation), but when you start making unequal laws that financially favour one class of individual over another based on their immigration status, and favouring that class over "legal persons", then you are on very shaky ground.

The Government may argue that this is not a prohibition, merely a financial deterrent - well alright then, at what level of duty does it become at least partially prohibitive? How about 20%, 100%, or 1,000%? The Government may also argue that BSD falls within its power of taxation under Article 108 of the Basic Law. That says:

"The [HKSAR] shall...enact laws on its own concerning types of taxes, tax rates, tax reductions, allowances and exemptions, and other matters of taxation."

But there is a thin line between taxation and penalty. Penalties are for the courts to impose, subject to a fair trial, and a penalty which restricts a Basic Law right would surely be unconstitutional. It would be one thing to deter all purchases, as a matter of (ill-conceived) policy, by charging very high rates of stamp duty (we already do some of that, by charging up to 4.25% on all residential transactions, a measure introduced in the 2010 budget). But to do this only when the buyer is a non-permanent resident or a company, raising the charge to 19.25%, seems a lot more like a penalty than a legitimate form of taxation. Is there really a policy objective that can turn this into a legitimate tax, or just a political desire to be popular with voters, who are all PRs?

Bubble? What bubble?

As usual, the Government speaks of "maintaining a healthy, stable property market" - but to maintain something, it has to be there already. If it is healthy and stable, then why do they think these measures are needed? They cannot bring themselves to admit that we are in a bubble. Instead they say "the risk of a property bubble forming is increasing". In fact, the phrases "healthy and stable" and "risk of a property bubble" in Government press releases goes back at least 32 months to the budget speech of 24-Feb-2010, and prices are up about 40-50% since then.

The main cause of this is record low, and persistently low, interest rates, not demand from foreigners (for which, read, "mainlanders"). As Financial Secretary John Tsang said on Friday, the proportion of residential property transactions by "non-local" buyers was only 6.5% in 2011. The current Chief Executive, C Y Leung, was quoted in a Government press release on 19-Jun-2012 (only 4 months ago):

"He said that although non-Hong Kong residents are still coming to the city to purchase properties, they are not doing so in numbers that affect resident Hong Kong buyers."

If anything, there has been a downtrend in such activity since the mainland economy began to cool. So the Government has failed to demonstrate any policy objective for this taxation. And note that the original plans in Mr Leung's manifesto related to HK land for all residents, not just PRs - but then he remembered that only PRs have a vote.

Waving his hands in the general direction of the sky, Mr Tsang said on Friday:

"this [BSD] is an extraordinary measure introduced under exceptional circumstances. We shall consider withdrawing this measure when the market regains its balance"

"Regains its balance" - what on earth does that mean? When the market has fallen enough? When it stops going up? When it stops going down? How can a market be imbalanced and yet "healthy and stable"? In economic terms, the market is always "balanced" at a price which reflects supply and demand - so he can only mean that he wants to reduce demand and shift the price downwards.

Killing the redevelopment market

If BSD takes effect, or until LegCo rejects the necessary legislation, redevelopment of residential buildings (other than by existing owners of whole buildings) will grind to a halt, because companies who would normally buy up old apartments and consolidate them for redevelopment will now face a prohibitive 15% purchase tax. That is bound to have a negative impact on supply in about 3 years' time, offsetting some of the supply increases that the Government has introduced. Perhaps the Government will seek to introduce a BSD rebate scheme for redevelopers - but that would be controversial in itself. How do you define a redeveloper? How quickly must they redevelop a site to qualify for BSD exemption or rebate?

Even if a rebate scheme existed, a developer embarking on a consolidation project would have to pay the BSD on each purchase and take the risk that it cannot get 100% ownership. Then the developer would have paid all that BSD without being able to recover it. The developer might get to the 80% or 90% threshold at which (depending on the building age) they can trigger an auction of the site under the Land (Compulsory Sale for Redevelopment) Ordinance, but then they would take the risk that a second developer would win the auction and the first one would have no rebate of the BSD. On the other hand, if there is no BSD exemption for bidders in such an auction, then third-party bidders would be hopelessly uncompetitive unless they could get credit for the BSD already paid by the majority owner. It would result in single-bid auctions by the majority owner, disadvantaging the minority owners in the auction.

All of this would leave the Government's Urban Renewal Authority in an even more dominant position in the redevelopment market - not only because of its existing statutory powers of compulsory purchase (which are not subject to any ownership threshold) but because any stamp duty it has to pay to buy out owners of old buildings goes straight back to the URA's owner, the Government, so the URA in essence is exempt from stamp duty. This takes the redevelopment market even further away from free-market principles.

SSD 2.0

We won't spend much time repeating our criticism of Special Stamp Duty (SSD). It is unconstitutional because it penalises owners who sell their properties within a certain time frame, in other words, for exercising their right of disposition of property under Basic Law Article 105, and it doesn't fall within Article 108 because it is not a legitimate form of taxation. It is not a legitimate tax because its stated purpose is to inhibit a form of behaviour without demonstrating that this behaviour harms society (unlike, say, the public cost of treating cigarette-related illnesses and the associated lost productivity), and because even if it could be shown that investing or trading in properties is bad (rather than good) for society, the tax is unfocussed and hits too many people who could not by any stretch be called speculators.

Now, by moving the cut-off from 2 years to 3 years, and doubling the rate from 5% to 10% for resales after 1 year, the SSD is bound to capture even more unintended victims. How many people, other than civil servants who implement such policies, could be sure of having an income in 3 years time, with which to pay their mortgage? Watch as the law catches more people who have only ever owned one home at a time, but now need to sell, for whatever reason - job relocation, divorce, death of an income-producing spouse or just the knowledge (when it happens) that the market is heading down and they are headed for negative equity. There is an SSD exemption for bankruptcy and foreclosure - but that's a Catch-22. Either take the SSD hit, or wait for the bank to foreclose - either way, the homeowner faces financial ruin.

And by the way, even though Mr Tsang says that "resale within 12 months has virtually disappeared", he is increasing the rates on that from 15% to 20% (on resales within 6 months) and from 10% to 15% (within 6-12 months). Like putting a few more bullets in the corpse. What does he expect to achieve from this, other than looking tough? He also cites statistics on resales within 12-24 months, noting that they have increased from 83 cases in Mar-2012 to 218 cases in Sep-2012. That's about 0.02%, or 1 in 5,000 private-sector homes per month. Hardly a menace to society.

SSD 2.0 only applies to transactions after last Friday. We'll bet him a can of Pringles that if he gets legislative approval for SSD 2.0 then he (or his successor) will have to repeal it within the next 3 years.