A short guide to corporate taxation in Hong Kong
administered by the Inland Revenue Department
Hong Kong Profit Tax
The Scope of the Charge
Corporations, partnerships, trustees and bodies of persons carrying on any trade, profession or business in Hong Kong are chargeable to tax on all profits (excluding profits arising from the sale of capital assets) arising in or derived from Hong Kong from the trade, profession or business they conduct.
In Hong Kong Tax law there is no distinction between residents and non-residents:
- A resident may derive profits from abroad without being charged to tax.
- A non-resident may be charged to pay tax on profits arising in Hong Kong.
The questions of whether a business is carried on in Hong Kong and whether profits are derived from Hong Kong are largely questions of fact. However, some guidance on the principles applied can be found in cases which have been considered by the courts in Hong Kong and in other common law jurisdictions.
The territorial principle of taxation
Hong Kong has a territorial tax principle, i.e. only that profit is received from a source located in the country. Profits earned outside Hong Kong are not subject to income tax.
I. FUNDAMENTALS OF TAXATION PROFIT IN HONG KONG
The territorial principle of taxation of profits earned as a result of trading, professional or other business activities in Hong Kong applies. This tax is taxable only on profits generated or earned in Hong Kong. This means that a person who carries out commercial activities in Hong Kong, but makes a profit outside of it, is not a tax payer for this profit in Hong Kong.
II. PREREQUISITES FOR THE INCOME OF THE TAX OBLIGATION ON THE PROFIT TAX
According to Inland Revenue Ordinance, a person or company is subject to income tax in the following cases:
- It carries out trading, professional or other business activities in Hong Kong.
- Activity is profitable.
- Profits generated or made in Hong Kong.
The first two conditions are quite clear. The third condition requires further clarification.
III. BASIC PRINCIPLES OF DETERMINING THE SOURCE OF PROFIT
For many years, the issue of the source of profit has been considered in judicial practice. According to authoritative court decisions, the following principles are highlighted.
The issue of localization of profits in fact is very difficult in practice. There is no general rule. Whether or not the profit is actually generated or made in Hong Kong depends on the nature of the profit and the transaction as a result of which the profit was made.
The actions of the taxpayer related to the receipt of the considered profit, as well as where these actions were performed, are checked. In this case, it will be correct to determine the transactions that led to the receipt of the corresponding profit, and to establish where these transactions were carried out territorially.
Gross Transaction Profit
The difference between the profit generated or received in Hong Kong and the offshore profit is determined according to the gross profit arising from individual transactions. When determining the source of profit, only those processes of economic activity are taken into account, as a result of which the direct formation of gross profit occurs. Activities related to general management are generally not considered.
Place of decision making
The place where investment/business decisions are made daily is just one of the factors that must be considered when determining the source of profit.As a rule, it is not a decisive factor.
Presence of business abroad
A business can have a representative office abroad and make a profit outside Hong Kong. However, the absence of such representative offices does not in itself mean that all business profits in Hong Kong are invariably generated or received in the country.
However, in most cases, when the main activity of the business is concentrated in Hong Kong and there is no presence of the business abroad, the profits derived from this business are likely to be taxed in accordance with the Hong Kong Income Tax.
The factor determining the source of profit from trade in goods, as a rule, is the place where the contract of sale enters into force, which includes both legal registration of the contract and negotiations, conclusion of the contract and fulfillment of obligations under it.
Totality of facts
Correct will be to assess the totality of facts. In other words, all relevant facts should be considered, and not just the purchase and sale of goods.
• How was the purchase and storage of goods?
• How were sales requested?
• How were applications processed?
• How was the product shipped?
• How were financial issues resolved?
• How was the payment made?
Consideration of significant facts
When considering significant facts, the nature and quality of transactions are more important than their number. The decisive factor is the cause and effect of such activities in relation to profit.
Facts that are not directly related to trading activities are considered insignificant in relation to the determination of the source of profit (rental of premises, hiring staff, arrangement of an office, etc.)
- If the sales contract is executed in Hong Kong, profits are taxable in Hong Kong.
- If the sales contract is executed outside Hong Kong, profits are not taxable in Hong Kong.
- If at least one of the contracts (either purchase or sale) is executed in Hong Kong, it is initially understood that profits are taxable in Hong Kong. However, in this case, it is necessary to analyze the totality of facts in order to determine the source of profit.
- If the sale is to a buyer from Hong Kong, the contract is generally considered to be performed in Hong Kong.
- If it is not required to leave the borders of Hong Kong to execute the sales contract, but it is carried out in Hong Kong using telephone or other electronic means, including the Internet, the contract is considered to be executed in Hong Kong.
- Trading profits are either fully taxed or not taxed at all. Proportional distribution is not provided.
V. PROFIT OF A PRODUCTION ENTERPRISE
Place of production
In the case of a manufacturing enterprise, the source of profit is the place where the goods are produced. Profits from the sale of goods made in Hong Kong are fully taxed. If the goods were partially produced in Hong Kong and partially outside, part of the profits attributable to goods produced outside Hong Kong is not considered to be received in Hong Kong.
The place where manufactured goods are sold does not matter.
Production in accordance with an assembly or processing agreement concluded with a plant located in mainland China:
A common feature of Hong Kong manufacturers is the conclusion of an assembly or processing agreement with a factory operating in mainland China. According to this agreement, a Hong Kong manufacturer provides raw materials, technical development, management, manufacturing skills, design, skilled labor, training, control etc. The plant, in turn, provides factory premises, land and labor for the processing, production or assembly of goods. Strictly speaking, a plant located in mainland China is a separate subcontractor that should be distinguished from a Hong Kong manufacturer, so there should be no question regarding the proportionate distribution of the latter’s profit.
Inland Revenue Department takes a practical approach, allowing for a commensurate distribution of profits from the sale of goods in the proportion of 50/50: only 50% of the profits are estimated as received in Hong Kong. Thus, the role of the Hong Kong manufacturer in the production activities of the plant located on the mainland is recognized.
Production by an independent subcontractor operating in mainland China
If production, according to the contract, is transferred to an independent subcontractor that operates in the territory of mainland China, its activity is paid on an ongoing basis and is carried out with minimal involvement of the Hong Kong company in the production process, production in the mainland is not considered the activity of a Hong Kong enterprise. Thus, the profits of a manufacturing subcontractor are not taxable in Hong Kong. However, profits made by a Hong Kong-based company from the sale of goods are fully taxed in Hong Kong.
VI. COMMISSIONS FOR SALE OR PURCHASE
In the case of the commission that the business receives for providing intermediary services that ensure the security of the transaction for the buyer or seller of goods, the activity aimed at obtaining a commission fee is to create the necessary conditions for the transaction between principals.
The source of income is the place where the commission agent provides services
If this activity is carried out in Hong Kong, Hong Kong is considered the source of income.
Factors such as the place of activity of the principals, their identification by the commission agent, and also the places where random events take place before or after receiving the commission, as a rule, are not significant in determining the source of the commission fee.
In the event that a commission is received by a person carrying out business activities in Hong Kong, but activities resulting in a commission are carried out completely outside Hong Kong, the commission is not taxed in Hong Kong.
VII. OTHER SOURCES OF PROFIT
Profit Tax liability
• Property rental. • Taxed if property is located in Hong Kong.
• Property for sale. • Taxed if property is located in Hong Kong.
• Buying or selling listed shares. • Taxed if the exchange on which shares are sold/bought is in Hong Kong.
• Profit earned by a business (other than a financial institution)
from the sale of securities issued outside Hong Kong
and not listed on the exchange. • Taxed if the sales contract is executed in Hong Kong.
• Service fee. • Taxed if services resulting in remuneration are provided in Hong Kong.
• The royalties received from the business. • Taxable if the relevant business activities are carried out in Hong Kong.
• Royalty for the use of intellectual property obtained from Hong Kong
by a non-resident. • Taxed if intellectual property is used in Hong Kong.
• Interest accrued to a business (other than a financial institution/ • Taxed if the lender provides funds to a borrower in Hong Kong.
Viii. PROPORTIONATE DISTRIBUTION OF PROFIT AND LOSS
In the case of profit from production activities and income from fees for services, which include real activities both in Hong Kong and abroad, there is a commensurate distribution of profits. As a rule, a proportional distribution in the proportion of 50/50 is used everywhere.
In the case where a proportionate distribution is applicable, the question may arise how to allocate indirect costs. If costs relate to both Hong Kong and offshore profits, they should be allocated according to the principle used for total profit.
IX. PRELIMINARY REGULATIONS
In order to ensure the clarity of the territorial taxation principle, the Inland Revenue Department may provide preliminary decisions regarding the source of income applicable to income tax. The service involves the payment of a fee. Before obtaining preliminary orders, complete information must be provided.
Funds are surely deemed to be derived from Hong Kong
The following funds are considered to be receipts arising in or derived from Hong Kong from a trade, profession or business carried on in Hong Kong:
- Funds received from the exhibition or use in Hong Kong of cinematograph or television film or tape, any sound recording or any advertising material connected with such film, tape or recording.
- Funds received for the use of or right to use in Hong Kong a patent, design, trademark, copyright material, *layout-design (topography) of an integrated circuit, *performer’s right, *plant variety right, secret process or formula or other property of a similar nature. Sums received for the use of, or right to use, such property outside Hong Kong is also taxable, if the sum is allowable for deduction in the hands of the payers. (Items marked in asterisk (*) are applicable to sums paid or accrued on or after 29 June 2018).
- Funds received by way of hire, rental or similar charges for the use of movable property in Hong Kong or the right to use movable property in Hong Kong.
The Hong Kong profits tax rates
With effect from the year of assessment 2018/19, the tax rates for the first 2 million HKD of assessable profits for corporations and unincorporated businesses eligible for two-tiered tax rates are 8.25% and 7.5% respectively.
The profits tax rates for corporations and unincorporated business above 2 million HKD of assessable profits are 16,5% and 15% respectively.
Businesses subject to Profits Tax will enjoy a reduction of 75% of the final tax for the years of assessment 2012/13 to 2017/18, subject to the ceiling of. $10,000 per case for 2012/13 and 2013/14, $20,000 per case for 2014/15 to 2016/17, and $30,000 per case for 2017/18.
The Basis of Assessment
Tax in Hong Kong is charged on the assessable profits for a year of assessment.
The assessable profits for a business which makes up annual accounts are calculated on the profits of the year of account ending in the year of assessment. In the year of assessment itself, a provisional tax is to be paid based on the profits assessed for the preceding year. The provisional tax paid is applied in the first instance against Profits Tax payable on the assessable profits for that year of assessment when assessed in the following year. Any excess is then applied against the provisional Profits Tax payable for that succeeding year.
On cessation of a business (subject to certain circumstances, where special treatment would apply), the assessable profits are generally based on the profits for the period from the end of the basis period for the previous year of assessment to the date of cessation.
On the end of a business in Hong Kong (subject to certain circumstances, where special treatment would apply), the assessable profits are generally based on the profits for the period from the end of the basis period for the previous year of assessment to the date of cessation.
Non-Residents and Agents dealing with Non-Residents
A non-resident is chargeable to tax either directly or in the name of his agent in respect of all his profits arising in or derived from Hong Kong from any trade, profession or business carried on here, whether or not the agent has the receipt of the profits, and the tax may be recovered out of the assets of the non-resident or from the agent. The agent is required to retain from the assets sufficient money to pay the tax.
Resident consignees are required to furnish quarterly returns to the Commissioner of Inland Revenue (Commissioner) showing the gross proceeds from sales on behalf of their non-resident consignors and to pay to the Commissioner a sum equal to 1% of such proceeds, or such lesser sum as may have been agreed.
Where a non-resident carries on business with a resident with whom he is closely connected and the business is so arranged that it produces to the resident either no profits or profits less than the ordinary profits that might be expected to arise to an independent concern, the business may be treated as carried on in Hong Kong by the non-resident through the resident as agent.
Where the true profits of a non-resident from a trade, profession or business carried on in Hong Kong cannot be readily ascertained, they may be computed on a fair percentage of the turnover in Hong Kong.
Where the accounts of a non-resident (other than a financial institution) whose head office is outside Hong Kong do not disclose the true profits of a Hong Kong permanent establishment, the profits of the branch in Hong Kong for tax purposes are taken to be the amount which bears to the taxpayer’s total profits in the same proportion as his turnover in Hong Kong bears to his total turnover.
Special provisions are made in the IRO for non-resident ship owners and non-resident aircraft owners whose vessels call at locations within Hong Kong waters or whose aircrafts land at a Hong Kong airport. Further details may be obtained from the Inland Revenue Department (IRD).
Dividends received from a corporation which is subject to Hong Kong Profits Tax, as well as amounts already included in the assessable profits of other persons chargeable to Profits Tax (e.g. shares of profits from joint ventures) are excluded from the assessable profits of the recipient.
Generally, all expenses, to the extent to which they have been incurred by the taxpayer in the production of chargeable profits, are allowed as deductions including:
(1) Interest on funds borrowed (provided certain conditions are satisfied) and rent of buildings or land occupied for the purpose of producing the profits.
(2) Bad and doubtful debts (any recoveries to be treated as income when received).
(3) Repairs of premises, plant, machinery or articles etc. used in producing the profits.
(4) Expenditure for registration of a trade mark, design or patent used in the production of profits.
(5) Expenditure on the purchase of specified intellectual property rights for use in the production of chargeable profits. 100% deduction for the expenditure incurred on patent rights or rights to any know-how will be allowed in the year of purchase. 20% deduction for the expenditure incurred on copyrights, *performer’s economic rights, *protected layout-design (topography) rights, *protected plant variety rights, registered designs or registered trade marks will be allowed for 5 consecutive years starting from the year of purchase. No deduction is, however, allowable in respect of intellectual property rights purchased by a person wholly or partly from an associated or related person. (Items marked in asterisk (*) are applicable with effect from the year of assessment 2018/19)
(6) Expenditure on research and development (R&D) including market, management and business research, design-related expenses and payments for technical education subject to certain rules. With effect from the year of assessment 2018/19, foe qualifying expenditure incurred on domestic R&D the first $2 million is entitled to a 300% tax deduction and the amount beyond $2 million is entitled to a 200% deduction.
(7) An employer’s annual contribution to a fund under a recognized occupational retirement scheme, or annual premium payment in respect of a contract of insurance under such a scheme, or regular contributions paid to a mandatory provident fund scheme, or regular contributions paid to a mandatory provident fund scheme, or any provision for these purposes, but limited in respect of any one employee to 15% of his total emoluments for the relevant period.
(8) Any mandatory contributions paid by a sole proprietor in a partnership in respect of his liability to pay such contributions as a self-employed person under the Mandatory Provident Fund Schemes Ordinance (Chapter 485) not exceeding the maximum allowable deduction in a year of assessment, taking into account deductions already allowed under any other sections in the IRO. However, contributions made for spouses are not deductible. The maximum allowable deduction for each year of assessment is:
Year of Assessment Maximum Deduction HKD
2015/16 onwards 18,000
(9) Donations of an aggregate not less than $100 made to recognized charities with the restriction that such donation shall not exceed 35% of the adjusted assessable profits.
When deduction is specifically prohibited
When deduction is specifically prohibited
In computing the assessable profits, deduction is specifically prohibited in the following:
(1) Domestic or private expenses and any sums not expended for the purpose of producing the profits.
(2) Any loss or withdrawal of capital, the cost of improvements and any expenditure of a capital nature.
(3) Any sum recoverable under insurance or contract of indemnity.
(4) Rent of or expenses relating to premises not occupied or used for the purpose of producing the profits.
(5) Taxes payable under the IRO, except Salaries Tax paid in respect of employees’ remuneration.
(6) Any remuneration of interest on capital or loans payable to of, subject to section 16AA of the IRO, contribution made to a mandatory provident fund scheme in respect of the proprietor or the proprietor’s spouse or, in case of a partnership, its partners or their spouses.
A transfer of certain allowable head office administrative expenses by means of a charge to a local branch or subsidiary in Hong Kong would be allowed as a deduction for Hong Kong tax purposes, to the extent to which they were incurred during the basis period for the year of assessment in the production of profits chargeable to tax.
There are tax incentives in specific areas where this may be necessary to enable us to compete in the region on a level playing field. They include:
(1) Immediate writing off to be allowed for capital expenditure on plant and machinery specifically related to manufacturing, and on computer hardware and software.
(2) Capital expenditure on refurbishment of business premises to be allowed to be written off over five years of assessment.
(3) Tax concessions for gains derived from qualified debt instruments. For certain debt instruments issued on or after 1 April 2018, tax exemption is allowed.
(4) Concessionary tax rate for offshore business of reinsurance companies and authorized captive insurance companies (with effect from the year
of assessment 2013/14 for the latter).
(5) Exemption from payment of tax on interest derived from any deposit placed in Hong Kong with an authorized institution (not applicable to interest received by or accrued to a financial institution).
(6) Exemption from tax for offshore funds (non-resident individuals, partnerships, trustees of trust estates or corporations) in respect of profits derived from transactions in securities, futures contracts, foreign exchange contracts, etc. in Hong Kong, which are carried out by corporations and authorized financial institutions licensed or registered under the Securities and Futures Ordinance (Chapter 571). The non-resident entity must not carry on any other business in Hong Kong. Tax exemption for offshore funds is extended to offshore private equity funds (provided that certain conditions are satisfied) in respect of profits derived from specified transactions carried out from 1 April 2015 onwards.
(7) Exemption from tax for onshore privately offered open-ended fund companies (provided that certain conditions are satisfied) in respect of profits derived from qualifying transactions.
(8) Accelerated deduction for capital expenditure on specified environmental protection facilities. For machinery of plant, 100% deduction will be allowed for the capital expenditure incurred. For installations forming part of a building or structure, 20% deduction will be allowed for each year in five consecutive years. With effect from the year of assessment 2018/19, 100% deduction for capital expenditure incurred on the installations.
(9) 100% deduction for capital expenditure on environment-friendly vehicles.
(10) Concessionary tax rate on qualifying profits of a qualifying corporate treasury centre derived from specified lending transactions, or from specified corporate treasury services or transactions, and accrued on or after 1 April 2016.
(11) Allowing a corporation carrying on in Hong Kong an intra-group financing business deduction of interest payable on or after 1 April 2016 on money borrowed from a non-Hong Kong associated corporation in the ordinary course ‘of such business under specified conditions.
(12) Concessionary tax rate on qualifying profits of a qualifying aircraft lessor derived from its qualifying aircraft leasing activity, or a qualifying aircraft leasing manager derived from its qualifying aircraft leasing management activity. In computing the qualifying profits, sums received by or accrued to the corporation before 1 April 2017 are not to be taken into account.
Losses made in an accounting year are to be carried forward and set off against fare profits of hat trade but a corporation carrying on more than One trade made have losses in one trade offset against profits of the other. An individual who incurs a trading loss and who elects for Personal Assessment will have the loss allowed as a deduction from his total income.
For gains or losses which are subject to concessionary tax rate, there are special provisions on the adjustment of losses between concessionary trading activities and normal trading activities.
- Industrial Buildings and Structures.
In Hong Kong special allowances are given in respect of capital incurred on the construction of industrial buildings and structures used in certain trades such as transport, dock, water and electricity undertakings, the manufacture, processing or storage of goods and trades carried on in mills and factories and in farming. An initial allowance of 20% of such capital expenditure is given in the year of expenditure and an annual allowance of 4% of the expenditure is given until the total expenditure is written off. When the asset is disposed of, a balancing allowance or balancing charge is made based on the difference between the disposal price and the written down value on disposal.
- Commercial Buildings and Structures.
A building or structure which is not an industrial building or structure but is nevertheless used for the purposes of a trade, profession or business (other than as stock in trade) can qualify for an annual “commercial building allowance” of 4% of the capital expenditure incurred on the construction of such building or structure. When the asset is disposed of, a balancing allowance or balancing charge is made based on the difference between the disposal price and the written down value on disposal.
- Plant and Machinery.
The following allowances on capital expenditure incurred on the provision of plant and machinery for the purpose of producing chargeable profits, except those assets referred to under “Tax Incentives” above, are deducted in arriving at the assessable profits:
(1) An initial allowance at 60% on the cost of plant and machinery.
(2) Annual allowances at rates prescribed by the Board of Inland Revenue reducing value of the asset. The rates are 10%, 20% and 30% according to the estimated working life of the particular category of plant or machinery. Items qualifying for the same rate of annual allowance are grouped under one “pool”.
(3) A balancing allowance based on the unallowed expenditure compared with moneys received on disposal of the plant and machinery is available on cessation of a business to which there is no successor. A balancing charge can, however, arise whenever the disposal proceeds of one or more assets exceed the reducing value of the whole “pool” of assets to which the disposed items belong.
- Books and Records.
All persons carrying on business in Hong Kong are required to keep sufficient records, in English or Chinese, of their income and expenditure to enable their assessable profits to be readily ascertained. There are statutory requirements to record certain specified details of every business transaction. Business records must be retained for at least 7 years after the completion of the transactions to which they relate. Any person who fails to keep sufficient records can be subject to a fine of $100,000.
Order a preliminary decision of your specific tax issue at the Hong Kong tax authority
In order to ensure the clarity of the territorial taxation principle, the Inland Revenue Department may provide preliminary decisions regarding the source of income applicable to income tax.