Hong Kong’s corporate tax regime is called ‘Profits Tax’. Persons, including 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 such trade, profession or business.
Hong Kong operates a territorial basis of taxation, with tax levied only on income arising in or derived from Hong Kong. Branches of foreign companies are taxed in the same way as Hong Kong companies. This low, predictable and uniform corporate tax regime provides certainty for commercial undertakings.
The Inland Revenue Ordinance (IRO) makes no distinction between resident companies and those incorporated overseas. Whether an overseas company is liable to profits tax depends on the nature and extent of its activities in Hong Kong. A resident business may therefore derive profits from abroad without suffering tax; conversely, a non-resident (foreign) business may suffer tax on profits arising in Hong Kong.
The question of whether a business is carried on in Hong Kong and whether profits are derived from Hong Kong is largely one of fact, but some guidance on the principles applied can be found in cases considered by the Hong Kong Courts and the Privy Council. No tax is levied on profits arising abroad, even if they are remitted to Hong Kong.
Two-tiered Profits Tax rates
Under Hong Kong’s two-tiered profits tax rates regime, the profits tax rate for the first HKD2 million (c. USD255,000) of assessable profits will be lowered to 8.25% (half of the rate specified in Schedule 8 to the Inland Revenue Ordinance (IRO)) for corporations and 7.5% (half of the standard rate) for unincorporated businesses (mostly partnerships and sole proprietorships).
Assessable profits above HKD2 million will continue to be subject to the rate of 16.5% for corporations and standard rate of 15% for unincorporated businesses.
All entities with profits chargeable to Hong Kong Profits Tax would qualify for the two-tiered profits tax rates, except those with a connected entity that is nominated to be chargeable at the two-tiered rates.
If, at the end of the basis period of the entity for the relevant year of assessment, the entity has one or more connected entities, the two-tiered profits tax rates would only apply to the one that is nominated to be chargeable at the two-tiered rates. The others would not qualify for the two-tiered profits tax rates.
Further, a corporation will not qualify for the two-tiered profits tax rates if it has made an election under one of Hong Kong’s preferential tax regimes to encourage specific industries or activities.
In respect of Profits Tax, an entity is:
- A natural person
- A body of persons
- A legal arrangement, including:
- a corporation
- a partnership
- a trust.
If a natural person carries on more than one sole proprietorship business, that person is taken to be a separate entity in respect of each sole proprietorship business.
For partnership, Profits Tax will be chargeable on the first HKD2 million of assessable profits at the lower rate of 7.5% or 8.25% (for a corporate partner’s share of assessable profits). Assessable profits above the threshold will be subject to the higher rate of 15% or 16.5% (for a corporate partner’s share of assessable profits). Where applicable, the threshold of HKD2 million will be apportioned amongst the corporate partners and non-corporate partners in accordance with their profit sharing ratios.
Preferential tax regimes
The Hong Kong SAR has introduced a number of preferential regimes that seek to encourage specific industries or activities by offering a reduced tax rate, including:
- Enhanced deduction for research and development (R&D) expenditure.
- Tax exemption for onshore and offshore investment funds.
- Concessionary tax rate for corporate treasury centres.
- Tax exemption for gains from qualified debt instruments.
- Concessionary tax rates for reinsurance and captive insurance businesses, direct insurers of selected general insurance business and general reinsurers of a specified insurer and concessionary treatment to selected insurance brokerage businesses.
- Concessionary tax rates for aircraft leasing businesses, ship lessors and ship leasing managers.
To qualify for these preferential tax regimes, there are threshold requirements for the level of activity in Hong Kong. These thresholds are based on various indicators such as the number of full-time employees in Hong Kong engaged in the activity and the amount of associated operating expenditure incurred in Hong Kong.
The tax concession regimes generally include a ‘main purposes test’ as an anti-avoidance provision. The Hong Kong Inland Revenue Department (HKIRD) has clarified that the main purposes test will not operate to deny tax concessions for the vast majority of genuine businesses with ‘core income generating activities’ carried out in Hong Kong.
The HKIRD has said that, in general, it will not consider obtaining tax concession in a normal course as the main purpose and hinder potential investors from setting up businesses in Hong Kong.
Scope of Profits Tax charge
Any Hong Kong-source income – excluding profits arising from the sale of capital assets – is subject to profits tax. In determining the source of profits, Hong Kong generally applies the ‘operations test’, which involves identifying the activities that are effective in generating the profits and the location where these activities are carried out.
Gains on the disposal of assets may be subject to profits tax if the disposal constitutes a transaction in the nature of trade.
The following sums are deemed to be receipts arising in or derived from Hong Kong from a trade, profession or business carried on in Hong Kong:
- Sums 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.
- Sums received for the use, or the right to the use, in Hong Kong of any patent, design, trade mark, copyright material, layout-design (topography) of an integrated circuit, performer’s right, plant variety right, secret process or formula or other property or right of a similar nature. Sums received for the use, or the right to the use, of such property outside Hong Kong is also taxable, if the sum is allowable for deduction in the hands of the payers.
- Sums received for the use, or the right to the use, outside Hong Kong of any intellectual property or know-how generated from any R&D activity in respect of which a deduction is allowable under section 16B in ascertaining profits of the recipient.
- Sums 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.
Deductions and Losses
Expenses generally are deductible to the extent they are incurred in the production of profits that are chargeable to tax. However, expenditure of a capital nature generally is not deductible.
Specific rules govern the deduction of interest expenses. No deduction is allowed for interest paid to a non-financial institution if the recipient is not subject to tax in Hong Kong on the interest, except where the interest is paid to an overseas associate by a taxpayer that carries on an intragroup financing business.
Tax losses can be carried forward indefinitely and offset against future taxable profits of the same taxpayer. Losses may not be carried back or transferred to other taxpayers.
Basis of Assessment
Profits Tax 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.
Hong Kong Profits Tax Filings
If you carry on a trade, profession or business in form of a corporation or partnership business, or if a non-resident person is chargeable to profits tax in your name, you should complete the Profits Tax return and file to the HKIRD by the due date.
Supplementary forms to Profits Tax returns were introduced to report information on preferential regimes and tax incentives. The supplementary forms, being part of the return, should be filed together with the return.
Generally, a newly registered business will receive its first Profits Tax return some 18 months after the date of commencement of business or the date of incorporation. Subsequently, the annual exercise to issue Profits Tax returns in bulk takes place on the first working day of April each year.
If a taxpayer fails to comply with the requirements, the Commissioner is empowered under the relevant punitive provisions to compound, institute prosecution and assess additional tax in respect of the offence.
The maximum penalty for non-compliance is HKD10,000, plus three-times the amount of tax undercharged. If taxes have been underpaid, the HKIRD may impose an additional 5% of the taxable amount as a penalty.
General Anti-Avoidance Rules (GAARs)
The IRO contains a General Anti-Avoidance Rule (GAAR) – section 61A – which allows the HKIRD to disregard a transaction or counteract the tax benefit conferred by a transaction if the sole or dominant purpose of entering into such a transaction is to obtain a tax benefit.
Another GAAR in IRO section 61, allows the HKIRD to disregard a transaction that reduces or would reduce the amount of tax payable by any person if that transaction is considered artificial or fictitious.
Transfer Pricing
Hong Kong introduced specific transfer pricing (TP) provisions into the IRO in 2018, primarily to implement the minimum standards of OECD’s base erosion and profit shifting (BEPS) package.
The TP provisions require income or loss from transactions between associated person to be computed on an arm’s length basis. The HKIRD is empowered to impose TP adjustments to either income or loss arising from non-arm’s length transactions between related parties that create a potential Hong Kong tax benefit.
The arm’s length principle applies to all taxpayers even if they are not required to prepare TP documentation, but related party transactions are specifically exempt from this rule if the transaction is domestic in nature, does not create any actual tax difference and was not employed for tax avoidance purposes. For this, arm’s length pricing documentation should be put in place.
In addition, the TP provisions impose further requirements for MNE groups in respect of preparing specified TP documentation under the OECD’s standard three-tiered approach, including:
- Country-by-country reporting (CbCR), which contains information relating to the global allocation of income and taxes paid together with certain indicators of the location of economic activities of a MNE group.
- Master file, which contains a high-level overview of the group of enterprises, including the global business operations and TP policies.
- Local file, which contains detailed transactional TP information specific to the enterprise in each jurisdiction, including details of transactions undertaken by the enterprise and associated enterprises involved, amounts involved in those transactions and TP analysis with respect to those transactions.
Foreign Source Income Exemption (FSIE)
Hong Kong committed to amend its Foreign-sourced Income Exemption (FSIE) regime by 31 December 2022 after the European Union deemed that the non-taxation of foreign-sourced passive income was not accompanied by adequate substance requirements or anti-abuse rules.
In particular, the EU considered that corporations without substantial economic activity in Hong Kong and that were not subject to Hong Kong tax in respect of certain foreign sourced passive income – such as interest and royalties – could lead to situations of ‘double non-taxation’.
The Inland Revenue (Amendment) (Taxation on Specified Foreign-sourced Income) Ordinance 2022 was based on the legislative building blocks confirmed by the EU Code of Conduct Group (Business Taxation). Due regard was given to the EU’s promulgated Guidance on Foreign Source Income Exemption Regimes and its parameters.
The new FSIE regime upholds Hong Kong’s territorial source principle of taxation such that determination of the source of profits will not be affected. Under the regime, taxpayers can still be exempted from tax in respect of the specified foreign-sourced passive income received in Hong Kong, provided they have a substantial economic presence in Hong Kong.
Taxpayers that benefitted from the previous preferential tax regimes generally fall outside the scope of the new FSIE regime. It allows tax exemptions for specified foreign-sourced passive income – namely interest, dividends, disposal gains in relation to shares or equity interests (disposal gains) and intellectual property (IP) income – received in Hong Kong by relevant multinational enterprise entities (MNEs) subject to certain conditions.
Only MNEs carrying on a trade, professions or business in Hong Kong are subject to the new FSIE regime. Individuals and local companies are not affected. Foreign-sourced interest, dividend and disposal gains generated by regulated financial entities from the carrying on of their regulated businesses are also not chargeable to tax under the regime.
An MNE wishing to claim a tax exemption is required to meet the economic substance requirement by employing an adequate number of qualified employees and incurring adequate operating expenditures in Hong Kong.
An MNE that is a pure equity-holding company is subject to a reduced economic substance requirement involving only the holding and managing of equity participations and complying with the corporate law filing requirements in Hong Kong.
For foreign-sourced IP income, taxpayers need to comply with the nexus requirement set out by the OECD in respect of preferential tax regimes for IP under which tax exemption must be substantially tied to the qualifying research and development (R&D) expenditures that are attributable to a qualified IP asset.
To mitigate possible double taxation, a range of enhancement and mitigation measures were introduced:
- A participation exemption regime as an alternative to the economic substance requirement to enable taxpayers that receive foreign-sourced dividends and disposal gains to claim tax exemption. The taxpayer must be a Hong Kong resident person (or a non-Hong Kong resident person that has a permanent establishment in Hong Kong) that holds at least 5% of the investee company’s shares or equity interest for at least 12 months immediately prior to the accrual of the relevant dividends or disposal gains.
- Tax credits for taxpayers who have paid taxes outside Hong Kong in respect of the specified foreign-sourced income, including taxes paid in jurisdictions that have not entered into a tax treaty with Hong Kong.
To minimise the compliance burden and enhance tax certainty, a business-friendly four-pronged approach is taken:
- Simplified reporting procedures requiring only essential, high-level information and declarations in the tax return to demonstrate compliance with the economic substance requirement.
- Advance rulings by the HKIRD on compliance with the economic substance requirement, valid for up to five years, to provide more tax certainty.
- Administrative guidance with illustrative examples is available on the HKIRD website to help ascertain tax liabilities and provide more tax transparency.
- A dedicated unit within the HKIRD provides technical support to taxpayers and respond to enquiries.
Appointing Sovereign as your Tax Representative in Hong Kong will ensure compliance with all relevant requirements and minimise your costs. Our Tax Compliance services include:
- Identifying the best approach to satisfy the IRD and acting as the Tax Representative of the company in all dealings with the IRD
- Preparing the relevant tax returns together with the supporting tax computations (if applicable) for the company’s review and approval
- Claiming tax exemptions (no tax is levied on profits arising abroad)
- Preparation / submission the tax returns, tax computations and audited financial accounts to the IRD and obtaining the IRD tax assessment.
- Responding general IRD tax queries
Sovereign Tax Compliance Services
Appointing Sovereign as your tax representative in Hong Kong will ensure compliance with all relevant requirements and minimise your costs. Our Tax Compliance services include:
- Identifying the best approach to satisfy the HKIRD and acting as the Tax Representative of the company in all dealings with the HKIRD
- Preparing the relevant tax returns together with the supporting tax computations (if applicable) for the company’s review and approval
- Claiming tax exemptions (no tax is levied on profits arising abroad)
- Preparation / submission the tax returns, tax computations and audited financial accounts to the HKIRD and obtaining the HKIRD tax assessment.
- Responding to general HKIRD tax queries
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Please contact us if you have any questions or queries and your local representative will be in touch with you as soon as possible.
