Accounting firms urged Hong Kong to reform its e-commerce tax regime and embrace artificial intelligence (AI) in public services as the city faces a snowballing deficit ahead of its February budget.

Deloitte on Tuesday proposed the Hong Kong government offer tax certainty to Chinese mainland e-commerce platforms by allowing them to claim half their profits as offshore income.

Many mainland e-commerce companies and software developers have set up Hong Kong entities for international sales via overseas platforms, with these units mainly handling international payments and settlements with mainland parent companies, according to Polly Wan, lead partner of the Hong Kong budget team at Deloitte China.

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Tax uncertainties loom over these online shopping firms, particularly regarding whether their Hong Kong entities' profit shares are reasonable compared to their entire cross-border operations, and whether these profits should be taxed in Hong Kong, Wan said.

To “encourage cross-border e-commerce companies to relocate some operations to Hong Kong and establish the city as their overseas headquarters and digital hub”, the advisory firm proposed a “safe harbor” rule that would allow e-commerce firms to claim 50 percent of the profits as offshore income if they voluntarily declare earnings to the Hong Kong tax authorities.

The proposal comes as residents’ and visitors’ shopping habits undergo a sea change, with online shopping in full swing. The government has launched multiple initiatives to subsidize local retailers’ digital transformation.

Ernst & Young Global Ltd (EY) noted that consumer preferences have shifted from brick-and-mortar stores to digital platforms. The firm warned that platforms operating outside Hong Kong might avoid profits tax despite earning revenue from local customers.

“To create a fairer environment for Hong Kong’s retail industry and digital platforms, the government should review whether current tax legislation effectively captures income from nonresidents providing digital services in Hong Kong,” said Paul Ho, EY financial services tax leader for Hong Kong.

Accounting firms also suggested the government adopt artificial intelligence in administrative operations to boost efficiency and address fiscal challenges as the city is doubling down on innovation and technology to diversify its economy.

KPMG China Tax Partner Stanley Ho suggested the government focus on leveraging technology to maintain service quality while trimming public expenditure. “Converting research into practical applications is crucial,” he said.

Wilson Chow, PwC China’s artificial intelligence (AI) and global technology, media and telecommunications industry leader, echoed Ho. Chow said, “AI adoption in public services is essential for streamlining processes and achieving operational efficiency. … The government should spearhead AI deployment through pilot programs, such as automated immigration clearance systems using facial recognition in collaboration with Shenzhen.”

Partnerships between Cyberport, the Hong Kong Science and Technology Parks Corporation, and Guangdong-Hong Kong-Macao Greater Bay Area AI incubators could establish Hong Kong as a regional AI startup hub, Chow added.

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Hong Kong faces its third year of deficit, which Financial Secretary Paul Chan Mo-po expects to be under HK$100 billion this fiscal year — still more than double the initial HK$48 billion estimate.

“It’s a structural problem as Hong Kong will face larger expenditure from an aging population and welfare, while the potential growth rate will likely be lower than in past decades,” said Gary Ng Cheuk-yan, senior economist with Natixis Corporate and Investment Bank.

“Hong Kong will need to rely more on external financing and fine-tune its tax regime. However, the focus should extend beyond the fiscal deficit to the government’s role and efficiency in resource allocation,” Ng added. “While raising debt and taxes moderately would be acceptable if proposed projects bring long-term economic benefits, the lack of vision and careful planning could further widen the fiscal deficit.”

Contact the writer at tianyuanzhang@chinadailyhk.com