China's tax crackdown piles pressure on luxury brands as US spending falters

China's tax crackdown on wealthy individuals is adding to the woes of luxury brands, which are already struggling with the aftermath of the Iran war and a slowdown in US consumer spending. This combination of issues could weigh down third-quarter results expected next week, further fueling worries that the US$350 billion luxury sector, already experiencing a three-year decline, may find it difficult to recover its former strength.

Shares of LVMH and Hermes, a maker of Birkin bags, have dropped around 40% this year and are trading close to multi-year lows. Gucci's owner, Kering, has declined 29%, reflecting mounting investor skepticism about the sector. Under China's new tax regulations, high-net-worth individuals who used offshore trusts to hide assets have until October 22 to declare and pay back taxes, potentially dampening spending in one of the industry's most crucial markets.

Chinese consumers, who contribute about a fifth of global luxury sales, have long been the growth engine for the sector. However, demand has plummeted in recent years since the Covid-19 pandemic. A 20% levy is hitting ultra-high-net-worth individuals, a group that had previously weathered China's prolonged real estate slump better than middle-class consumers impacted by the property downturn, according to Alexis Bonhomme, head of luxury consultancy Trinity Asia in Shanghai.

While some individuals may face liquidity problems before the tax deadline, it does not necessarily mean they will stop buying luxury goods altogether, Bonhomme added. Recent summer shopping mall data from mainland China suggested a significant slowdown in growth. Bernstein analysts noted in a note that overall conditions remained weak, although performance varied among brands.

Smaller "quiet luxury" labels like Brunello Cuccinelli's cashmere and LVMH's Loro Piana are outperforming more conspicuous brands such as Louis Vuitton and Gucci, according to two industry sources familiar with third-quarter mall trading in mainland China. The concerns in China coincide with a softening of demand in the US, the luxury industry's biggest market and, until recently, one of its strongest due to a tech-driven stock market rally.

US credit card spending on luxury goods tracked by Citi fell for a third straight month in August as broader consumer confidence dwindled, following surveys that showed growing unease about the US economy ahead of the midterm elections. Kering has already cautioned analysts about a further decline at Gucci, prompting brokerage firms to revise their stock price targets downward.

One of the few positive developments has been the high-end jewelry sector, with brands like Richemont's Cartier benefiting from wealthy consumers opting for gold and other precious materials, viewed as offering more enduring value. In Beijing, Deng Qi, a 51-year-old exporter of ceramic building components, projected a 20% decrease in luxury spending compared to previous years.

The offshore tax measure, he said, has sent a clear message that wealthy people who are subject to taxes on offshore trusts will not stop buying luxury items; they are not short of a few tens of thousands of yuan. Instead, the real concern is the broader impact: measures like this undermine confidence for everyone, and sooner or later, they will target the relatively wealthy.

Investors will receive their first update on the sector next week when LVMH reports results on Monday, with analysts expecting quarterly sales of €18.5 billion (US$20.7 billion), a 1.0% increase from the prior year. Kering and Hermes are scheduled to report on October 22.