Hong Kong : Taxation by Entity Type
Hong Kong maintains a status as one of the most business friendly locations in the world, due in no small part to its corporate taxation regime. Corporate tax, also known as profit tax, is only levied on income sourced within Hong Kong. This makes Hong Kong a very attractive destination for offshore companies. Additionally, the tax code for businesses is straightforward and requirements are limited relative to other advanced economies.
Hong Kong is a single tier corporate tax jurisdiction as profits are taxed only once. The corporate tax levied on profits is the final tax and, as such, there is no tax on dividends (neither paid, credited, or distributed to shareholders) derived from profits that have already been taxed.
- Profit Tax for Corporations Incorporated entities pay a flat tax rate of 16.5% on assessable profits.
- Profit Tax for Unincorporated Businesses Unincorporated businesses (such as sole-proprietorships) pay 15% on assessable profits.
- Taxation of Non-resident Entertainers and Sportsmen Non-resident entertainers and sportsman pay 15% on profits. For performances given through a corporate agent, the tax rate is 16.5%.
Hong Kong and Territorial Source Principle of Taxation
Hong Kong follows the territorial source principle of taxation, meaning that only profits sourced in Hong Kong are taxable.
Determining the Source of Profits Not one method of determining the source of profits can be universally applied. This depends on the nature of the profits and the operations that generate them. To prevent unlawful reductions in taxable income, Hong Kong authorities rely on a number of official principles in determining the source of profits:
- The Operations Test This approach simply involves determining the location of the operations that leads to profits. Under this principle, if the relevant operations were based in Hong Kong, any profits earned would be subject to profit tax.
- Incidental Activities The investigator must clarify which activities are relevant and which are not. Incidental and antecedent activities should be treated as distinct from profit producing transactions.
- Location of Decision-Making The investigator may take into account the location in which decision-making governing profit-generating operations takes place. This is treated as only one of multiple relevant factors and is rarely the determining factor.
Profit Tax in Hong Kong : Industry-Specific Considerations
Determining the source of profits for trading companies depends on where contracts are legally executed and negotiated, and where the actual terms are executed. According to general practice, the profits are assessable in Hong Kong when the purchase and sale are effected in Hong Kong. When the customer is a Hong Kong business (including the Hong Kong buying office of an overseas customer), the sale contract will usually be taken as having been effected in Hong Kong and, therefore, profits are to be considered subject to profit tax. If the purchase and sale contracts do not require travelling outside of Hong Kong in order to be effected (even if carried out in Hong Kong by use of IT and electronic communications) the contracts will likely be considered as having been effected in Hong Kong.
For profits derived from the manufacturing of goods, authorities will usually consider the location of manufacturing to be the source location of profits. Therefore, profits based on the sale of goods manufactured in Hong Kong (assuming the sale is conducted by the same entity that sells it) will be considered subject to profit tax. Note that only the percentage of value-added in Hong Kong will be taxed. The sale location for a manufacturing company is usually not a relevant factor in determining the source location of profits.
In determining the source of rental income, the location of the property is the most relevant (also known as the situs test). For example, if a real estate company is managed in Hong Kong, but the majority of their properties are located in Southeast Asia, profits from rental income are unlikely to be taxable.
The location of the performance of the services will be considered the source location. However, determining the source of profits can often become much more complex with services companies operating internationally. For example, if an advisory firm’s clients are located outside of Hong Kong and only some of the work is performed at the client’s site, it less clear how much of the income in considered Hong Kong sourced. As there is no one-size-fits-all solution, it is best to seek the assistance of a Hong Kong Certified CPA to determine total taxable profits.
Other than profits sourced oversees, there are a number of other income categories considered non-taxable.
- Dividends Due to the single-tier taxation system, dividends are non-taxable.
- Exchange Reserve Certificates Interest earned from Exchange Reserve Certificates is non-taxable.
- Select Financial Instruments Earning from long term debt instruments, Hong Kong dollar-denominated debt instrument for a multilateral institution, bonds issued under the Loans Ordinance, or from Exchange Fund debt instrument are non-taxable.
The basis period is the year ending March 31st.
The Internal Revenue Ordinance states that any misleading transactions intended to reduce the amount of payable tax constitutes an offence subject to fines and penalties.
Relief from Double Taxation
The territorial system of taxation ensures that residence rarely suffers from double taxation. Hong Kong allows for a deduction of foreign tax paid on turnover basis for income, which is also subject to Hong Kong profit tax. Hong Kong, nonetheless, maintains an extensive network of Double Taxation Treaties. Such agreements promote investment as they give certainty to investors on the taxing rights of contracting parties and enable accurate assessment of potential tax liabilities of prospective investments.
Profit Tax in Hong Kong : Filing Requirements
The Inland Revenue Department issues profit tax returns on April 1st, immediately following the end of the year of assessment. The tax return should be filed within one month of the date of receipt. The profit tax return must include the following:
- The tax return form issued by the Inland Revenue Department
- Official form containing tax and financial data
- Official copies of report of audited accounts and balance sheet
- Report of the computation of assessable profits
New Businesses: Newly registered businesses will receive their first profit tax return 18 months after the date of incorporation.