Profits tax in Hong Kong

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In Hong Kong, profits tax is an income tax chargeable to business carried on in Hong Kong. Applying the territorial taxation concept, only profits sourced in Hong Kong are taxable in general. Capital gains are not taxable in Hong Kong, although it is always arguable whether an income is capital in nature.

Hong Kong East Asian city

Hong Kong, officially the Hong Kong Special Administrative Region of the People's Republic of China and commonly abbreviated as HK, is a special administrative region of China on the eastern side of the Pearl River estuary in southern China. With over 7.4 million people of various nationalities in a 1,104-square-kilometre (426 sq mi) territory, Hong Kong is the world's fourth-most densely populated region.

An income tax is a tax imposed on individuals or entities (taxpayers) that varies with respective income or profits. Income tax generally is computed as the product of a tax rate times taxable income. Taxation rates may vary by type or characteristics of the taxpayer.

Contents

The persons chargeable to profits tax includes corporations, partnerships, trustees, and sole proprietors. [1]

Corporation Separate legal entity that has been incorporated through a legislative or registration process established through legislation

A corporation is an organization, usually a group of people or a company, authorized to act as a single entity and recognized as such in law. Early incorporated entities were established by charter. Most jurisdictions now allow the creation of new corporations through registration.

Partnership Arrangement in which parties agree to cooperate to advance their mutual interests

A partnership is an arrangement where parties, known as partners, agree to cooperate to advance their mutual interests. The partners in a partnership may be individuals, businesses, interest-based organizations, schools, governments or combinations. Organizations may partner to increase the likelihood of each achieving their mission and to amplify their reach. A partnership may result in issuing and holding equity or may be only governed by a contract.

Trustee person who holds property, authority, or a position of trust or responsibility for the benefit of another

Trustee is a legal term which, in its broadest sense, is a synonym for anyone in a position of trust and so can refer to any person who holds property, authority, or a position of trust or responsibility for the benefit of another. A trustee can also refer to a person who is allowed to do certain tasks but not able to gain income. Although in the strictest sense of the term a trustee is the holder of property on behalf of a beneficiary, the more expansive sense encompasses persons who serve, for example, on the board of trustees of an institution that operates for a charity, for the benefit of the general public, or a person in the local government.

Chargeable scope

As a general rule, Hong Kong profits tax is levied on any persons who carries on a trade, profession or business in Hong Kong and assessable profits arising in or derived from Hong Kong for a year of assessment. [2] The profits tax rate applied is 15% for individuals and 16.5% for corporations (a.k.a. the standard rate) on their net assessable profits for the year of assessment 2014/15.

Source of profits

To argue whether profits arising in or derived from Hong Kong, case law judgments are often referred. The fundamental source rule was laid down by the landmark case The Commissioner of Inland Revenue ("CIR") v. Hang Seng Bank Ltd Co. (1991) 1 AC 306 . Lord Bridge of Harwich of Privy Council held that the source of profits is a question of fact depending on the nature of transaction and stated the broad guiding principle in determining the source is that

The statement is widely retrieved in the context of Taxation in Hong Kong and other jurisdictions and reconfirmed in subsequent cases, such as HK-TVB International Limited v. CIR (1992) 2 AC 397. [4] However, while applying the broad guiding principle, it should not be distracted by the antecedent and incidental matters.

To reduce the complexity in determining the source of profits, the Inland Revenue Department of Hong Kong ("IRD") issued Departmental Interpretation and Practice Note No. 21 - Locality of profits ("DIPN no. 21") to provides potential taxpayers a guideline on the source of income. Following the guideline in DIPN no, 21, the taxpayers may first determine what kinds of profits do their business earn and make reference to the IRD's views in respect of the particular type of profits. [5]

Types of ProfitsApplicable TestsExplanation
Trading profitOperation test
  • Both sales and purchases contracts are effected in Hong Kong, fully taxable;
  • Either sales or purchases contract are effected in Hong Kong, presumably fully taxable, subject to totality of fact analysis;
  • Both sales and purchases contracts are effected outside Hong Kong, fully non-taxable

No apportionment of Hong Kong sourced profits and offshore profits is allowed.

Manufacturing profitOperation testManufacturing operation is done in Hong Kong, fully taxable.

For manufacturing operation done by Hong Kong Company in China, depends on whether the manufacturing process is

  • Contract processing; or
  • Import processing
Rental Income / Sales of immovable propertiesSitus testDetermined by the location of properties
Service IncomeActivity testDetermined by the location where services are performed

Tax computation

The formula is:

HK profits tax payable = Net assessable profit × Profits tax standard rate
Net assessable profit = Assessable profit − Loss brought forward (if any) + Loss transferred from partnership (if any)
Assessable profit = Profit or (Loss) per financial account + (Disallowable expenses charged in account − Non-taxable income credited in account) − Depreciation allowances − Approved charitable donations

Approved charitable donations

The Approved charitable donations are limited to 10% of the amount after deducting of the Depreciation allowances, per section 16D of the IRO. And after the amendment recently, it is changed to 25% of the amount after deduction of Depreciation allowances

Section 14

Badges of Trade

Any trade may be subject to profit tax unless one can provide reasonable evidence to prove that there is not any revenue profit. In Hong Kong, capital profit is not subject to tax.

In order to prove the nature of a trade, the badges of trade are to be considered:

  1. the taxpayer's intention of profit (one acquisition of the commodity)
  2. Subject Matter of the commodity disposal (If enjoyment can be assume on original acquisition, e.g. rental)
  3. the length of ownership,
  4. frequency of similar transactions,
  5. reason for disposal,
  6. supplementary work and so on.

Basis period and year of assessment

The year of assessment of each year starts from 1 April and ends on 31 March in the next year. For example, the year of assessment for 1 April 2014 to 31 March 2015 is "Year of Assessment 2014/15". However, no adjustment is required to align the financial information with the end-date of year of assessment. On the contrary, IRD accepts the profits assessed in accordance with the accounting year-end date. In the context of tax law, this is also referred as basis period.

IRD Convention on "basis period"
Reporting periodYear of assessment"Code"
1 January 2014 to 31 December 2014Year of assessment 2014/15"D Code"
1 April 2014 to 31 March 2015Year of assessment 2014/15"M Code"
1 July 2014 to 30 June 2015Year of assessment 2015/16"N Code"

Tax depreciation

Purchases of industrial building, commercial building and plant and machinery are not deductible because they are capital in nature. [6] Yet, capital expenditure may be deductible if they are categorised into following:

  1. Capital expenditure on plant and machinery for research and development; [7]
  2. Capital expenditure on renovation or refurbishment on buildings other than domestic ones; [8]
  3. Capital expenditure on prescribed fixed assets (excluding lease or hire-purchase); [9]
  4. Capital expenditure on environmental protection facilities (excluding lease or hire-purchase). [10] [11]

If the capital expenditure is not deductible at any of the above provisions, the following depreciation allowances may be granted as an alternative deduction.

Industrial building and commercial building allowance

As derived from its name, the industrial building allowance is only available for buildings used, generally, for the purpose of manufacturing of goods and products. Buildings which are used to carry out other businesses may be qualified for commercial building allowance. [12]

Industrial building allowance is more beneficial to the taxpayer because at the year of purchase, 20% of "initial allowance" on the capital expenditure can be deducted. Such benefit is not available for commercial buildings. For every year, 4% of the capital expenditure can be deducted as "annual allowance", until 25 years after its first use. [13] [14]

On the contrary, the amount which the proceeds received at the time of sales over the allowance claimed will be taxable as "balancing charge". [15]

Summary - Depreciation allowance on buildings
TypesIndustrial building allowanceCommercial building allowance
Initial allowance20% on capital expenditureNot available
Annual allowance4% on capital expenditure4% on capital expenditure

Depreciation Allowance on Plant and Machinery

Types of plant and machinery that are tax-depreciable and their respective rates (for annual allowance only, see below) are set out in a prescribed schedule. [16] The definition of plant and machinery does not include any implement, utensil and article. Instead, they can be fully deductible for profits tax purpose on replacement basis (i.e. the initial purchase of which is not deductible) [17] [18]

For assets purchased during that year of assessment, an initial allowance of 60% will be granted. Thereafter, the assets sharing the same rates of annual allowance are transferred into a pool, classified by the prescribed schedule in the Rule 2 and annual allowance of either 10%, 20% or 30% will be granted for the entire pooled assets. [16] [19] For example, a motor vehicle, which is 30% pooled, can be first granted a 60% initial allowance and 30% of annual allowance on the remaining 40% asset value. Therefore, 72% (i.e. 60% + 30% x 40% = 72%) of the value of motor vehicle can be deducted from tax in the year of purchase.

Tax loss

Tax losses can be carried forward to set off the profits in the future years until fully absorbed but not backward. [20] Group loss relief is not available in the taxation in Hong Kong.

Taxpayer bears no rights to object a loss determined by IRD because loss is not an assessment in accordance to the definition of Ordinance. Until the time when profits are assessed which affects the tax loss (e.g. offsetting of previous tax loss), the taxpayer may apply for an objection to the CIR. [21] [22] It also implies that a statement of loss, which grants no objection option to the taxpayer, has a different status with the notice of assessment.

An assessment cannot be re-opened after being final and conclusive after 6 years (or 10 years in the case of willful tax evasion). [23] On the contrary, a case of tax loss, even agreed by the CIR in previous year, can be re-opened at any time in the future since it is technically not an assessment. [22]

See also

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Expenditure is an outflow of money to another person or group to pay for an item or service, or for a category of costs. For a tenant, rent is an expense. For students or parents, tuition is an expense. Buying food, clothing, furniture or an automobile is often referred to as an expense. An expense is a cost that is "paid" or "remitted", usually in exchange for something of value. Something that seems to cost a great deal is "expensive". Something that seems to cost little is "inexpensive". "Expenses of the table" are expenses of dining, refreshments, a feast, etc.

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A capital gains tax (CGT) is a tax on capital gains, the profit realized on the sale of a non-inventory asset that was greater than the amount realized on the sale. The most common capital gains are realized from the sale of stocks, bonds, precious metals, and property. Not all countries implement a capital gains tax and most have different rates of taxation for individuals and corporations.

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The schedular system of taxation is the system of how the charge to United Kingdom corporation tax is applied. It also applied to United Kingdom income tax before legislation was rewritten by the Tax Law Rewrite Project. Similar systems apply in other jurisdictions that are or were closely related to the United Kingdom, such as Ireland and Jersey.

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Salaries tax

Salaries tax is a type of income tax that is levied in Hong Kong, chargeable on income from any office, employment and pension for a year of assessment arising in or derived from the territory. For purposes of calculating liability, the period of assessment is from April 1 to March 31 of the following year.

Inland Revenue Department (Hong Kong) department of the Hong Kong Government

The Inland Revenue Department (IRD) of Hong Kong Government is one of Hong Kong government departments which is responsible for the administration of the following Hong Kong ordinances on taxes and duties and the related rules and regulations:

Inland Revenue Ordinance Ordinance of Hong Kong

The Inland Revenue Ordinance is one of Hong Kong's Ordinances. It regulates the inland revenue of Hong Kong.

Estate Duty Ordinance

The Estate Duty Ordinance is one of Hong Kong ordinances. It regulates the HK estate duty which was a tax imposed on capital asset - the net value of property situated in Hong Kong at the date of the taxpayer's death. It is chargeable irrespective of whether the deceased was a resident of Hong Kong.

Commissioner of Inland Revenue v George Andrew Goepfert, also known as the Goepfert case, is a leading Hong Kong tax case, affecting jurisprudence relating to the territory's salaries tax.

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The oil depletion allowance in American (US) tax law is an allowance claimable by anyone with an economic interest in a mineral deposit or standing timber. The principle is that the asset is a capital investment that is a wasting asset, and therefore depreciation can reasonably be offset against income.

References

  1. ↑ Inland Revenue Ordinance Cap 112, s.2 Interpretations
  2. ↑ Inland Revenue Ordinance Cap 112, s.14
  3. ↑ http://www.bailii.org/uk/cases/UKPC/1990/1990_42.html, BAILII, retrieved 7 February 2015
  4. ↑ http://www.bailii.org/uk/cases/UKPC/1992/1992_21.html, BAILII, retrieved 10 February 2015
  5. ↑ Departmental Interpretation and Practice Note no. 21
  6. ↑ Inland Revenue Ordinance Cap 112, s.17(1)(c)
  7. ↑ Inland Revenue Ordinance Cap 112, s.16B
  8. ↑ Inland Revenue Ordinance Cap 112, s.16F
  9. ↑ Inland Revenue Ordinance Cap 112, s.16G
  10. ↑ Inland Revenue Ordinance Cap 112, s.16H
  11. ↑ Inland Revenue Ordinance Cap 112, s.16I
  12. ↑ Departmental Interpretation and Practice Note no. 2, Inland Revenue Department, retrieved on 23 February 2015
  13. ↑ Inland Revenue Ordinance Cap 112, s.33A
  14. ↑ Inland Revenue Ordinance Cap 112, s.34
  15. ↑ Inland Revenue Ordinance Cap 112, s.35(3)
  16. 1 2 Inland Revenue Rule Cap 112A, First Part of rule 2
  17. ↑ Inland Revenue Rule Cap 112A, Second Part of rule 2
  18. ↑ Inland Revenue Ordinance Cap 112, s.16(1)(f).
  19. ↑ Inland Revenue Ordinance Cap 112, s.39B
  20. ↑ Inland Revenue Ordinance Cap 112, s.19C
  21. ↑ Inland Revenue Ordinance Cap 112, s.64
  22. 1 2 Departmental Interpretation and Practice Note no. 8
  23. ↑ Inland Revenue Ordinance Cap 112, s.60
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