Hong Kong: Domestic Corporate Taxation
Calculation of Taxable Base
A number of factors including the territorial principle have created an extremely attractive fiscal regime exempting categories of income which in most other jurisdictions would normally be subject to a profits tax:
- Dividend income received by a Hong Kong parent company from either a resident or foreign subsidiary is not deemed income in the holding company's hands and is thus not subject to an assessment to profits tax.
- There is no separate schedule of capital gains tax in Hong Kong. Nor does the territory follow the practice of other jurisdictions and tax capital gains as trading income which is subject to profits tax. However by way of exception a business whose activities is to trade in capital assets is assessed to profits tax on any profits made on the sales of those capital assets as if these gains were trading income. Likewise if the asset is deemed a revenue asset as opposed to a capital asset then any profits made on its disposal are deemed trading income and assessed to profits tax. The absence of capital gains tax (often together with other factors) has had a number of fiscal consequences:
- Profits remitted to a Hong Kong parent which represent the profitable disposal of its shareholding in a resident or non resident subsidiary are not assessed to tax in the territory both because the gains are capital gains and because (in the case of a non resident company) income arising outside jurisdiction is exempt from tax under the principle of territoriality.
- The profitable disposal by a Hong Kong entity of foreign real estate is not assessed to tax in the territory both because the gains are capital gains and because of the principle of territoriality. This includes a disposal effected by means of the Hong Kong entity selling 100% of the shares in a company whose sole asset is the foreign real estate.
- Since currency gains and losses are considered to have a capital nature they are neither taxable profits nor deductible losses.
- The transfer by a Hong Kong entity of capital assets to a foreign or resident subsidiary or branch at market value and at a profit is considered a capital gain and thus does not attract tax in Hong Kong (unless the assets are classified as revenue assets).
- Rental income from foreign real estate is not assessable income in Hong Kong for profit tax purposes. (However depreciation & interest payments on loans made to finance the real estate tax are non deductible in the territory).
- The profits and losses of the foreign branch or subsidiary of a Hong Kong company are neither taxable profits nor deductible losses in Hong Kong owing to the territoriality principle.
- Interest income received by a resident or non resident business entity on deposits lodged with a financial institution are exempt from profits tax (By way of exception if the deposit was made by a "financial institution" then any interest received by the financial institution is deemed trading income for profits tax purposes and taxed accordingly).
- The tax treatment of loan interest payments and receipts requires a special mention. 3 situations apply:
- Loan interest repayments made by a Hong Kong borrower to a foreign lender are only tax deductible in Hong Kong if the foreign lender is a "financial institution". If the foreign lender is not a financial institution but is the parent or subsidiary of the Hong Kong borrower the interest payments are not tax deductible in the territory unless the parent or subsidiary is a connected company and is subject to Hong Kong profits tax on the loan interest receipts.
- Loan interest repayments received by a Hong Kong company on a loan made to a 3rd party are not taxable income in the hands of the Hong Kong lender if the loan was advanced to the borrower from a foreign jurisdiction such as Gibraltar. If the loan was advanced to the borrower from Hong Kong then the loan interest repayments are taxable in the territory.
- A Hong Kong parent company which borrows money to set up a subsidiary or a branch in a foreign country cannot deduct the cost of the loan for profit tax purposes since the income earned by the borrower has a foreign source. Therefore the loan should always be sourced by the foreign subsidiary or the foreign branch in the foreign jurisdiction in which it will be tax deductible.
- Owing to the principle of territoriality there is no controlled foreign company legislation under which the profits and capital gains of non resident subsidiaries can be taxed as if they were the profits of a resident parent company.(The converse applies in both the United States and the United Kingdom).
- Consolidated group accounting under which the profits of one company in the group can be set off against the losses of another company in the group so as to reduce the over all profit subject to profits tax does notexist in Hong Kong.
- Losses can be carried forward indefinitely. This compares favorably with other jurisdictions which only allow losses to be carried forward for a fixed period of time (usually 5 years).
- Since there are no debt/equity thin capitalization rules in Hong Kong a foreign parent can set up a resident subsidiary with a minimum of share capital and a maximum of loan capital and thereby reduce taxable profits arising in Hong Kong through excessive interest payments.
- The repayment by a foreign subsidiary to its Hong Kong parent of the principal of loan capital or share capital is free of tax in the territory including where the repayment is by way of a capital reduction or a final dividend distribution in a liquidation.
- The following sources of trading income are exempted from profits tax:
- Interest received or capital gains made on the purchase, retention or sale of a Government bond issued under the Loans (Government Bonds) Ordinance;
- Exchange fund debt instruments;
- Hong Kong dollar denominated multi – agency debt instruments;
- Specified investment schemes which comply with the requirements of a government supervisory authority are exempt from tax. Specified investment schemes include investments in unit trusts and mutual funds.
Profits Tax Deductible Allowances
The following allowances are deductible from assessable profits for profits tax purposes.
- A deduction is allowed for a contribution (or provision for a contribution) by an employer amounting to not more than 15% of the employee's annual salary into a recognized retirement scheme registered under the Occupational Retirement Schemes Ordinance. (It is in any event an offence for an employer to operate a pension scheme that is not registered under this Ordinance). Since the Mandatory Provident Fund Scheme came into effect on 1st December 2000 allowable deductions are either 5% of an employee's gross salary or a maximum of US$2,560 per month.
- Charitable donations made to approved charitable institutions or trusts of a public character or to the government of the Hong Kong Special Administrative Region, amounting in aggregate not less than HKD100 but not exceeding 35% (10% for years of assessment up to and including 2002/03; and 25% for years of assessment 2003/04 to 2007/08) of the adjusted assessable profits before deduction of donations, are allowable for deduction in computing the assessable profits.
- Hong Kong tax paid on foreign income which by law is chargeable to profits tax in Hong Kong is an allowable deduction for profits tax purposes. (N.B. foreign source income is not normally subject to tax in the territory).
- Any property tax already paid is deductible from income for profits tax purposes;
- Depreciation allowances for capital equipment are as follows:
- 60% of the cost of all other plant and machinery can be written off in the first year with a rate of 10-30% written off thereafter.
- 20% of the cost of construction of an industrial building can be written off in the 1st year with 4% per annum thereafter.
- Expenditure incurred refurbishing or renovating business premises can be written off in 5 equal installments.
- In May, 2004, LEGCO expanded the scope of deduction for research and development expenses under profits tax to cover design-related expenses.