Profits tax in Hong Kong
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.
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. 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
|“||One looks to see what the taxpayer has done to earn the profit in question and where he has earned it.||”|
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. 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.
|Types of Profits||Applicable Tests||Explanation|
|Trading profit||Operation test||
No apportionment of Hong Kong sourced profits and offshore profits is allowed.
|Manufacturing profit||Operation test||Manufacturing 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
|Rental Income / Sales of immovable properties||Situs test||Determined by the location of properties|
|Service Income||Activity test||Determined by the location where services are performed|
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
- A person carries on a trade, a profession or a business in Hong Kong
- There are profits arising in or derived from (trade, profession, business). Profit is not from the sales of capital assets
- The profits must be arising in or derived from Hong Kong
- Contract effected test
- Operation test
- Provision of credit test
- Development test or registration test
Badges of Trade
Any trade may be subject to profit tax unless a reasonable man can provide 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:
- the taxpayer's intention of profit (one acquisition of the commodity)
- Subject Matter of the commodity disposal (If enjoyment can be assume on original acquisition, e.g. rental)
- the length of ownership,
- frequency of similar transactions,
- reason for disposal,
- 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 period||Year of assessment||"Code"|
|1 January 2014 to 31 December 2014||Year of assessment 2014/15||"D Code"|
|1 April 2014 to 31 March 2015||Year of assessment 2014/15||"M Code"|
|1 July 2014 to 30 June 2015||Year of assessment 2015/16||"N Code"|
Purchases of industrial building, commercial building and plant and machinery are not deductible because they are capital in nature. Yet, capital expenditure may be deductible if they are categorised into following:
- Capital expenditure on plant and machinery for research and development;
- Capital expenditure on renovation or refurbishment on buildings other than domestic ones;
- Capital expenditure on prescribed fixed assets (excluding lease or hire-purchase);
- Capital expenditure on environmental protection facilities (excluding lease or hire-purchase).
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.
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.
|Summary - Depreciation allowance on buildings|
|Types||Industrial building allowance||Commercial building allowance|
|Initial allowance||20% on capital expenditure||Not available|
|Annual allowance||4% on capital expenditure||4% 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. 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)
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. 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.
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. 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). 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.
- Inland Revenue Ordinance Cap 112, s.2 Interpretations
- Inland Revenue Ordinance Cap 112, s.14
- http://www.bailii.org/uk/cases/UKPC/1990/1990_42.html, BAILII, retrieved 7 February 2015
- http://www.bailii.org/uk/cases/UKPC/1992/1992_21.html, BAILII, retrieved 10 February 2015
- Departmental Interpretation and Practice Note no. 21
- Inland Revenue Ordinance Cap 112, s.17(1)(c)
- Inland Revenue Ordinance Cap 112, s.16B
- Inland Revenue Ordinance Cap 112, s.16F
- Inland Revenue Ordinance Cap 112, s.16G
- Inland Revenue Ordinance Cap 112, s.16H
- Inland Revenue Ordinance Cap 112, s.16I
- Departmental Interpretation and Practice Note no. 2, Inland Revenue Department, retrieved on 23 February 2015
- Inland Revenue Ordinance Cap 112, s.33A
- Inland Revenue Ordinance Cap 112, s.34
- Inland Revenue Ordinance Cap 112, s.35(3)
- Inland Revenue Rule Cap 112A, First Part of rule 2
- Inland Revenue Rule Cap 112A, Second Part of rule 2
- Inland Revenue Ordinance Cap 112, s.16(1)(f).
- Inland Revenue Ordinance Cap 112, s.39B
- Inland Revenue Ordinance Cap 112, s.19C
- Inland Revenue Ordinance Cap 112, s.64
- Departmental Interpretation and Practice Note no. 8
- Inland Revenue Ordinance Cap 112, s.60