Calculating a Businesses Taxable Income in Hong Kong
Every person (including corporations, partnerships, and sole proprietorships) conducting business in Hong Kong is subject to taxation on profits derived in Hong Kong. The corporate taxation regime is widely regarded as relatively simple and clear. Tax returns are sent to the Inland Revenue Department within one month of their issue. They are usually issued on April 1st, as the tax year ends on March 31st.
Hong Kong’s profit tax for corporations is at a flat rate of 16.5%. Unincorporated entities (such as sole-proprietors) as well as non-resident entertainers and sportspersons not working through an agency or corporation pay a rate of 15% on profits.
Calculating Taxable Income Step-by-step
Step 1: Determine Total Assessable Profits
Step 2: Deduct Business Expenses
Step 3: Deduct Unutilized Items (losses, capital allowances, donations)
Step 4: Add Balancing Charges
Determining Total Assessable Profits
Hong Kong’s Basis of Taxation on Corporate Profits
Hong Kong’s territorial basis of taxation means that only profits that arise in or are derived from Hong Kong are subject to corporate taxation. Therefore, an individual running a business in Hong Kong that derives its profits from another country, is not required to pay tax in Hong Kong on these profits.
Verifying the Source of Profits
The Inland Revenue Department relies upon a number of methods for determining the source location of profits (see the IRD website). This should be done on a case-by-case basis, as an accurate assessment requires an examination of the nature of the profits and the transactions and operations leading to said profits.
Other Exempted Income
- Dividends from a corporation (even those subject to Hong Kong Profits Tax)
- Interest from Tax Reserve Certificates
Income from bonds issued under the Loans Ordinance, with respect to an Exchange Fund debt instrument, or with respect to a Hong Kong dollar-denominated debt instrument for a multilateral institution
- Earnings from long-term debt instruments
Though capital gains are not taxable in Hong Kong, the capital nature of income can be contentious. Companies that fraudulently cause profits to appear as capital in nature solely for the purposes of reducing taxable income may be subject to penalties upon conviction.
Deductible Business Expenses
The vast majority of expenses incurred in the production of profits are deductible. This includes (but is not limited to):
- Interest Interest payments on funds borrowed to finance a company’s operations and expansion are deductible.
- Rent Payments on rent for facilities and offices used for the purpose of profit-making activities are deductible.
Repairs Any costs incurred to repair facilities, equipment, or other items in the production of profits may be deducted.
Intellectual Property Expenses for use or registration of patents, trademarks and other intellectual property assets are deductible. Expenditures on intellectual property must be for the use of chargeable profits, or they will not be considered deductible. Deductions on the expenditures related to IP (copyrights, registered designs or registered trade marks) are permitted for 5 consecutive years from the time of purchase.
IP from Related Parties No deduction is permitted for expenses incurred in the purchase of IP rights from a wholly or partly related entity such as a parent company, subsidiary, or branch office.
Research and Development Expenses for research and development are deductible. This includes expenses related to product development, design, studies, and market research.
Employee Fund Contributions A company’s contributions to an occupational retirement scheme, annual premium payments with respect to contract of insurance under such a scheme, regular contributions paid to the Mandatory Provident Fund scheme, or any other provisions for related purposes are deductible expenses. However, such deductions are limited with respect to any one employee to 15% of his or her total emoluments for the given period.
- Director Fees Remuneration expenses for directors are generally deductible.
Restrictions on Deductions
Companies should remain aware of the following restrictions on expense deductions:
- Expenditures not included for the purpose of profit producing activities.
- Capital losses or withdrawals.
- Sums that may be recovered under the indemnity clause of an insurance agreement.
Any taxable payable under the Inland Revenue Ordinance other than the Salary Tax on employees’ compensation arrangements.
- Cost of acquiring goodwill and amortization of goodwill are not deductible.
- Salaries and remuneration for sole proprietors or partners.
- Fines and Penalties
Deducting Unutilized Items (losses, capital allowances, donations)
Deductible losses must have arisen from business conducted in Hong Kong. Losses may be carried forward and deducted against future profits.
Annual depreciation allowances are permitted for the depreciation of machinery and production plants. The annual rate of depreciation depends on the type of plant, but can range from anywhere between 10% and 30%.
- An annual allowance of 4% of the initial capital expenditure is allowed for industrial or commercial premise.
- An initial allowance of 20% on capital expenditure is made available for the building of industrial premises.
20% of the capital expenditure on the renovation of a commercial or industrial facility (such as office, manufacturing plant, or distribution center) is deductible. This can be made in equal installments over 5 years, commencing with the year in which the expenditure occurred.
20% of the capital expenditure for environmental protection efforts in an industrial premise is deductible in equal installments over 5 years.
Donation sums, each exceeding HK$100, that are made to registered charities, are deductible. Donations may not exceed 35% of total assessable profits.
To ensure that there are not excessive claims for tax relief, balancing charges may be added, by increasing the amount of assessable profit. Such charges occur when the earnings from the sale of a capital asset exceed their written down value.