Why does the HK Government continue prosecuting civil servants and educators for maximising their remuneration by claiming rental allowances which, if they didn't own the property, they would be entitled to anyway? Surely people should be paid what they are worth to an employer, not based on what they own. We also look at the tax loophole which incentivises rental allowances in the first place.

The Housing Lark
9 December 2006

Barely a month goes by without reading in the HK press about some teacher or civil servant who has been prosecuted, and his or her career wrecked, for claiming rental allowances from their employer on a property in which the employee, or his family, had a financial interest, against a rule of the rental allowance scheme.

Two weeks ago, there were adjacent headlines in a local paper: "Surveyor jailed over rent scam" and "Academic guilty of fraud over flat". In the first case, a senior surveyor in the Buildings Department of the Government was jailed for 8 months for claiming rental reimbursement on a property which he had bought in the name of a nominee. In the second story, the associate dean of a university arts faculty was found to have rented a flat from a company owned by his family. In 2000, the acting chief of the Inland Revenue Department was convicted of a similar offence, and there have been numerous other examples.

The real economic point here has been missed by the Government and the media. Why is the pay of our civil servants and teachers based not on the market value of the work they do, but on whether or not they own their home? Under such schemes, if two people of equal ability and experience are working in the same job, but one of them owns his home and the other rents a home from a third party, then the employee who rents a home is paid more, and costs the employer more, than the one who owns his own home. Faced with such a remuneration structure, any employee would rationally seek to maximise his income by renting a home and claiming the maximum allowance. Indeed, if we assume (perhaps wrongly) that the Government is not overpaying its employees, then anyone who doesn't claim a rental allowance is paid below their market value.

To see how silly the rule is, consider that instead of breaking the rule, an academic or civil servant can put himself in the same financial position by finding two similar flats, one to buy and one to rent. He would buy the first property, and rent it out on the open market to an independent third party. He would then rent the second property from another independent third party at the same rent, and claim reimbursement from the Government or university. He would break no rules. This, in essence, is what many educators and civil servants do to comply with the rules while at the same time receiving a rental allowance and owning a property. When they retire, they can stop renting and move into the property they always owned.

So, since the rule against having a financial interest in your residence can easily be avoided, why have the rule at all? Just to prosecute those who are too stupid to avoid it?

Secondly, why do we have such rental reimbursement schemes in the first place? Why not just pay cash and let the employees choose whether to rent or own a home? The reason for that can be found in a giant loophole in our taxation system. As we have noted before, if an employer reimburses housing expenses, including, rent, then for salaries tax purposes that payment is deemed to be worth only 10% of the employee's other cash remuneration. For example, an employee receiving a cash salary of $80,000 per month and a rental reimbursement of $40,000 per month is taxed on only $88,000 of income (before personal allowances) rather than the $120,000 of value received, while a colleague of equal rank who gets straight cash of $120,000 will be taxed on the whole amount. Same job, same total remuneration, different tax.

Some of the biggest beneficiaries of this tax loophole are civil servants themselves, thousands of whom are housed in quarters owned by the Government or in private tenancies for which they are reimbursed. No wonder then, that they have not moved to close the loophole.

In the commercial, market-driven sector, unlike the Government or educational institutions, employers seldom attach ownership prohibitions to such rental reimbursement schemes, because all they are interested in is the total cost of employment of the individual. Many are happy to structure the remuneration to reduce the overall tax of the employee, because what matters to the employee is his net income after tax. It is not unusual, then, for an employee to own a private company established to purchase a home. The private company takes out a mortgage to buy the home, rents it out to the employer (or the employee who is reimbursed), and deducts the interest and other expenses against the rental income received from the employer, ensuring that it pays little or no profits tax. It's one reason why we have over 567,000 companies registered in Hong Kong, or about 1 for every 10 adults.

The Government should eliminate the tax loophole by taxing all employment benefits, whether in cash or kind, on their full market value. In the case of housing, whether rented from third parties or related parties, or owned by the employer, that would be either the rent paid or the rateable value, whichever is higher. Taxing all benefits would remove the tax incentive for rental schemes in the first place, so most employers would just pay cash and scrap the schemes. Closing the loophole would, or course, result in an increase in tax revenues, which should be offset by a reduction in tax rates to neutralise the effect.

© Webb-site.com, 2006

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