Hong Kong Corporate Profit Tax Guide

Why does Hong Kong attract thousands of international businesses each year? What makes its tax system so advantageous, and how is it structured? We explore these questions and more in this article. 

Hong Kong is recognized as one of the world’s leading financial centers. This status is historically rooted in its strategic location and unique financial system, which is unmatched in most other countries. These factors make Hong Kong an appealing destination for nearly all global enterprises. 

The key to Hong Kong’s appeal lies in its distinctive tax framework, which operates on a two-tier tax system combined with a territorial source basis. This system allows companies registered in Hong Kong, whether conducting business locally or internationally, to optimize their tax obligations, significantly reducing—or even entirely eliminating—the corporate profit tax. 

Hong Kong offers taxpaying entities favorable conditions, lower tax rates for small business, profit tax exemption for profits sourced elsewhere, flexible deductions, and a transparent tax administration system. In this article, we will examine the main aspects of Hong Kong’s tax system and explain how businesses can minimize or completely avoid tax liabilities in this Special Administrative Region (SAR) of China. 

Historical Factor in Hong Kong tax system 

The Hong Kong tax system was initially shaped under the influence of the British colonial administration, which laid the groundwork for tax legislation in the region as far back as the 19th century. From its inception, Hong Kong adhered to the principle of low taxation, which played a crucial role in its early transformation into an international financial center. 

Following the transfer of Hong Kong to China in 1997, the Special Administrative Region (SAR) retained its autonomous tax system and fundamental principles, including territorial taxation. This continuity has allowed Hong Kong to remain an attractive destination for investors and international companies, despite the change in political status. 

Hong Kong territorial source principle 

The appealing foundation of Hong Kong’s tax system is the territorial principle of taxation. This means that profits tax is only levied on profits earned from sources within Hong Kong. 

The main advantage of this system is the lawful reduction of tax liabilities for activities not connected to Hong Kong sources. Companies engaged in international business but registered in Hong Kong can completely avoid paying taxes on profits earned outside of Hong Kong. 

To benefit from this principle, a company must prove that its profits were earned outside of Hong Kong. Key factors to consider include: 

• The place where the contract was signed 
• The location of negotiations 
• The place where contractual obligations are fulfilled 
• The jurisdictions of the clients and suppliers 

Examples of the territorial principle of taxation 

Trading business: export and/or import 

The primary factor in determining the source of profits for a trading company is where the sales contract is concluded. Other important variables include the location of trade negotiations and where obligations are performed. 

Example: If the sales contract is concluded in Hong Kong, the profit from the transaction will be subject to mandatory tax. 

Manufacturing Business 

If a company has production facilities in Hong Kong, all profit from the sale of products manufactured in these facilities will be taxed. 

Example: If some goods are manufactured outside of Hong Kong, only the profit from the sale of these goods will be taxed. 

Intermediary activities 

For companies providing intermediary services, the location where these services are provided is crucial. If the services are provided in Hong Kong, the profits derived from such transactions will be taxed, regardless of where the clients or partners are located. 

Two-tier corporate Profit tax system in Hong Kong 

Hong Kong’s two-tier corporate profit tax system is designed to support small and medium-sized enterprises (SMEs) by offering a preferential tax rate on the initial portion of their profits. Here’s how it works: 

Profit tax rates in Hong Kong for businesses and unincorporated business 

*Unincorporated businesses are sole proprietorship and partnership 

Hong Kong tax system in comparison with other jurisdictions 

Singapore 

Hong Kong’s tax system is often praised for its convenience, especially when compared to Singapore’s tax system, which also applies the territorial principle but has certain disadvantages. Key points of the Singapore tax system include: 

• Profits earned outside of Singapore are not taxed. 
• Profits sourced from within Singapore are taxed at a rate of 17%. 
• Profits earned outside of Singapore but transferred to Singapore bank accounts are taxed at 17%. 

Singapore offers partial tax exemptions for certain small amounts of income and other tax incentives, but the overall tax burden can be higher compared to Hong Kong and to administer a company cost usually more expensive due to the need to hire a local director. 

United Arab Emirates (UAE) 

In the UAE, the standard corporate tax rate is 9% for companies with an annual net profit of AED 375,000 (approximately €95,000) and above. Companies with a net profit of less than AED 375,000 per year are exempt from taxation. The tax is levied on profit earned both in the UAE and outside the UAE. Therefore, the overall tax burden can be higher compared to Hong Kong if the company is well operational. Additionally, administering a company in the UAE can be more expensive due to higher state fees. 

Offshore Jurisdictions 

Jurisdictions like the British Virgin Islands and the Cayman Islands are attractive to many companies because they completely exempt businesses from taxes. However, opening an offshore company can be risky due to potential issues with international reputation and limited access to global financial markets. 

In contrast, Hong Kong combines low tax rates, a high international reputation, and access to the world’s largest financial markets. 

Tax incentives and deductions in Hong Kong 

Hong Kong offers a wide range of tax incentives and deductions, which can significantly reduce the taxable base depending on the size and type of your company. These incentives support investments, business development, environmental protection, and modernization of production. 

Let’s consider the main points in which it is possible to reduce the tax rate, as well as cases when it will not be possible to do so. 

General rules regarding taxation of profit in Hong Kong 

Deductible operating expenses in Hong Kong 

As a general rule, business expenses related to the day-to-day operations of a company are usually deductible from operating expenses and reduce the company’s taxable base. What exactly these expenses are, we will discuss below. 

Rent and utilities 

• Rent for the company’s office space. 
• Payment of utilities (electricity, water, telephone) for the company’s office. 

Wages and contributions 

• Wages, allowances and bonuses to employees. 
• Mandatory and voluntary employer contributions to the pension fund (Mandatory Provident Fund – MPF). 
• Payments for years of service upon dismissal. 

Interest and Legal Costs 

1. Interest and other costs on borrowed funds for the company’s business needs. 
2. Repair and Replacement of Equipment 
   • Expenses for the repair of office space, equipment and machines directly related to the company’s activities. 
   • Costs of replacing inventory and equipment involved in generating profits. 
3. Charitable donations.  

Approved donations of at least HKD780 (approximately $100) and no more than 35% of adjusted taxable profits. 

Tax incentive deductions in Hong Kong 

There are categories of tax incentive deductions in Hong Kong to encourage contributions to various purposes. These include: 

Copyrights and trademarks 

Expenses on copyrights, registered designs and trade marks. 

Environmental projects 

Capital expenditure on environmental projects. 

Fixed assets 

100% write-off in the year of acquisition of fixed assets for the company’s operations, including production equipment, computer equipment and software. The exemption does not apply to equipment purchased on lease or rental. 

Reconstruction and repairs 

Capital expenditure on the reconstruction or repair of buildings (with a regular deduction for 5 years). 

Industrial building construction 

Industrial and commercial building construction exemptions. 

Non-deductible expenses in Hong Kong 

As a general rule, expenses that are not related to the day-to-day running of a business or its activities aimed at generating profits are not deductible. 

Personal expenses 

• Travel expenses between home and work, international travel (except for business travel, business trips), holidays, birthdays, medical expenses, home or private meals 
• Entertainment expenses not related to business purposes. 

Utilities 

• Utilities of a personal nature not related to the functioning of the company. 

Capital expenditures or losses 

• Costs of acquiring commercial premises, improvements to premises not related to the business. 
• Rent or expenses related to premises not used for generating profits. 

Mandatory Provident Fund (MPF) contributions 

• Mandatory MPF contributions for owners/partners in excess of the norm. 
• Voluntary MPF contributions for owners/partners and their spouses. 

Taxes and penalties 

• Taxes paid under the IRO, excluding employee payroll tax. 
• Penalties/fines for non-compliance with the law 

Taxable and non-taxable profits and expenses are in Hong Kong 

Handling losses in Hong Kong 

Hong Kong’s tax policy has another undeniable advantage – loss carryforward for correct depreciation of business activities. Thus, if necessary, companies can carry forward losses to future tax periods against future profits. How this works is described below. 

Loss carryforward 

Losses for one financial year can be carried forward to subsequent years against future profits. This will help reduce tax liabilities during a difficult financial situation in order to restore the company’s condition after the crisis. 

Separate accounting of losses for different types of activities 

In cases where a company has several registered types of activities, losses from one of them can be offset against profits from another. But it is worth keeping in mind that in Hong Kong there are regulations that separately regulate the carryforward of losses between types of activities within one company. 

Financial Year in Hong Kong 

In Hong Kong, a financial year, or accounting year, is a 12-month period used for accounting purposes and the preparation of financial statements. Unlike a calendar year, a financial year may end on any date as long as it covers a continuous 12-month period. 

A Hong Kong company’s first financial year usually begins on the date of incorporation and ends no more than 18 months from that date. Each subsequent financial year ends 12 months after the end of the previous year. 

Determining the financial year end date: 

• By the director: The director of the company can set the financial year end date. If this is the case, the company must promptly notify the Inland Revenue Department to issue a relevant profit tax return. 
• Automatically by the Inland Revenue Department: If the director does not set a date, the Inland Revenue Department will automatically assign one. The profit tax return is then sent to the company’s registered office with the filing date already set. 

Common financial year end dates: 

• December 31: in accordance with the calendar year. 
• March 31: corresponds to the Hong Kong government’s financial year. 

However, a company may set a different financial year end date if necessary. 

Profit Tax Return of a Hong Kong company 

The Profit Tax Return (PTR) is a mandatory annual filing for companies operating in Hong Kong. It is used to report the company’s taxable income and calculate the amount of profit tax owed to the Inland Revenue Department (IRD). 

Standard filing deadline: the PTR must be submitted within 30 days from the date stated on the tax return issued by the IRD. 

Extensions: companies may request an extension of the filing deadline under certain conditions, subject to the IRD’s approval. 

Documents required for filing a profit tax return 

Companies are required to prepare a complete set of original documents and attach them to the completed Profit Tax Return provided to IRD. Such documents include: 

1. The company’s financial statements, usually consisting of: 
   • balance sheet; 
   • profit and loss statement; 
   • cash flow statement; 
   • statement of capital movements; 
   • statement of changes in equity. 
2. An auditor’s report with regards to the financial statements. 
3. A tax calculation reflecting the total amount of profit or loss. 
4. The completed and signed annual tax return itself. 

Consequences for not filing of a Profit Tax Return 

The Hong Kong government requires strict compliance with the deadlines for filing any documents. Thus, late filing of a profit tax return may entail serious consequences, including litigation and criminal prosecution. 

Let’s consider the main consequences of late filing of a declaration with the Hong Kong Inland Revenue Authority. 

The penalty for late filing of a declaration (Profit Tax Return, PTR) is HK$10,000. However, that’s not all. 

Various sections of the Hong Kong Inland Revenue Ordinance provide for additional penalties. In particular, undeclared income established by the tax authority may entail a requirement to pay tax in triple the amount. The presence of such a penalty will also negatively affect tax deductions. 

In addition, liability is provided for in the framework of criminal prosecution together with other sanctions to limit or even completely suspend the company’s activities. 

As a manager, your job is to conduct your business as transparently as possible and be extremely responsible in declaring all your income. Hong Kong offers some of the best legal business conditions in the world, so if you want your company to thrive, you should not neglect its requirements. 

One of the most serious consequences of failure to pay taxes on time in Hong Kong is criminal prosecution. The company is subject to measures that may imprison the CEO and the entire board of directors for up to three years. However, a criminal term does not imply exemption from paying the principal debt, sanctions and fines. 

Compliance with deadlines and all procedures established by Hong Kong legislation is necessary for the correct and uninterrupted operation of your business. It is important to strictly follow state regulations, observing all deadlines and procedures for providing data.