Hong Kong Company Formation- Company Formation, offshore company formation, offshore company, limited company
Hong Kong Company Formation: A Simple Guide on The Territorial Source Principle of Taxation
- Index Company Formation Kong Kong
- Tax planning via a network of international tax advisers and attorneys
- Offshore Company Formation: Tax haven rankings
- Examples for the legal reduction of corporate taxes
- DTA permanent establishment concept
- Our services and fees
- Parent companies and their subsidiaries in the European Union
- OECD: Articles of the Model Convention with Respect to taxes on income and on capital
- Beware of cheap founders!
- Information about the company formations in English
- Worldwide Registries
- Table of Fees: International Business Formations
- Basic considerations within the framework of international taxation
Hong Kong Company Formation: A Simple Guide on The Territorial Source Principle of Taxation
Hong Kong adopts a territorial source principle of taxation. Only profits which have a source in Hong Kong are taxable here. Profits sourced elsewhere are not subject to Hong Kong Profits Tax. The principle itself is very clear but its application in particular cases can be, at times, contentious. To clarify the operation of the principle, we have prepared this simple guide on the territorial source principle of taxation. It gives a brief explanation of how the principle operates and provides simple examples for illustrative purposes of the tests applied to different types of businesses. If you wish to explore the subject in greater depth, we recommend that you consult your professional advisers.
Hong Kong’s basis of taxation on profits from businesses
Hong Kong adopts a territorial basis for taxing profits derived from a trade, profession, or business carried on in Hong Kong. Profits Tax is only charged on profits which arise in or are derived from Hong Kong. In simple terms this means that a person who carries on a business in Hong Kong but derives profits from another place is not required to pay tax in Hong Kong on those profits. Many places levy tax on a different basis. Unlike Hong Kong, they tax the world-wide profits of a business, including profits derived from an offshore source.
Pre-conditions for liability to Profits Tax
Under the Inland Revenue Ordinance, a person is chargeable to Profits Tax under the following conditions
- he carries on a trade, profession or business in Hong Kong;
- the trade, profession or business derives profits;
- and the profits arise in or are derived from Hong Kong. The first two conditions are straightforward. Some elaboration is necessary for the third. Let us have a brief look at the basic principles for determining the source of profits.
Basic principles for determining the source of profits
The Courts have over the years considered the subject of the source of profits. The following principles have emerged from authoritative court decisions
Matter of fact
The question of locality of profits is a hard, practical matter of fact. No universal rule can apply to every scenario. Whether profits arise in or are derived from Hong Kong depends on the nature of the profits and of the transactions which give rise to such profits.
The operations test
The broad guiding principle is that one looks to see what the taxpayer has done to earn the profits in question and where he has done it. In other words, the proper approach is to identify the operations which produced the relevant profits and ascertain where those operations took place. The source of profits must be attributed to the operations of the taxpayer which produce them and not to the operations of other members of the taxpayer’s group.
Antecedent or incidental activities
The relevant operations do not comprise the whole of the taxpayer’s activities. The focus is on establishing the geographical location of the taxpayer’s profit-producing transactions as distinct from activities antecedent or incidental to those transactions.
Place where decision is made
The place where the day-to-day investment/business decisions take place is only one factor which has to be taken into account in determining the source of profits. It is not usually the deciding factor.
Gross profits from transactions
The distinction between Hong Kong profits and offshore profits is made by reference to the gross profits arising from individual transactions.
Business presence overseas
A business may maintain a presence overseas which earns profits outside Hong Kong but the absence of a business presence overseas does not, of itself, mean that all the profits of a Hong Kong business invariably arise in or are derived from Hong Kong. However, in the vast majority of cases where the principal place of business is located in Hong Kong and there is no business presence overseas, profits earned by that business are likely to be chargeable to Profits Tax in Hong Kong.
Profits of trading firms
Contracts for purchase and sale The factor that determines the locality of profits from trading in goods and commodities is generally the place where the contracts for purchase and sale are effected. “Effected” does not only mean that the contracts are legally executed. It also covers the negotiation, conclusion and execution of the terms of the contracts. Following the Court of Appeal judgement (Magna Industrial Co. Ltd v CIR) it is now clear that a wider approach is necessary. The proper way is to look at all the relevant operations carried out to earn the profits, not simply the purchase and sale of the goods. In Magna Industrial Co. Ltd. v CIR, the Court of Appeal noted that: “Obviously the question where the goods were purchased and sold is important. But there are other questions: For example: How were the goods procured and stored? How were the sales solicited? How were the orders processed? How were the goods shipped? How was the financing arranged? How was payment effected?”
How relevant facts are considered
In considering the relevant facts the nature and quality of the activities matter more than their quantity. It is the cause and effect of such activities on the profits that is the deciding factor.
Facts not directly related to the trading activities are considered irrelevant in determining the locality of profits. For example, renting office premises, recruiting general staff, setting up office, etc.
Where the contracts of purchase and sale are effected in Hong Kong, the profits are taxable here.
- Where the contracts of purchase and sale are effected outside Hong Kong, the profits are not taxable here.
- Where either the contract of purchase or the contract of sale is effected in Hong Kong, the initial presumption is that the profits are taxable here. However, other relevant facts will have to be examined to determine the source of profits.
- Where the sale is made to a Hong Kong customer (including the Hong Kong buying office of an overseas customer), the sale contract will usually be taken as having been effected in Hong Kong.
- Where the effecting of the purchase and sale contracts does not require travelling outside Hong Kong but is carried out in Hong Kong by use of telephone, or other electronic means including the Internet, the contracts will be considered as having been effected in Hong Kong.
- Trading profits are regarded as being either wholly taxable or wholly non-taxable here. Apportionment is not appropriate.
Profits of manufacturing businesses
The place of manufacture
The source of profits for a manufacturing business is the place where the goods are manufactured. The profits arising from the sale of goods manufactured in Hong Kong are fully taxable here. Where goods are manufactured partly in Hong Kong and partly outside Hong Kong, that part of the profits which relates to the manufacture of goods outside Hong Kong will not be regarded as arising in Hong Kong. The place where the manufactured goods are sold is not relevant.
Manufacturing under a processing or assembling arrangement with an entity in the Mainland of China
In the Mainland, two types of processing trade normally involve Hong Kong companies: contract processing and import processing.
In contract processing, the document that governs the contractual relationship among the parties is the processing agreement. It sets out the rights and responsibilities of the Hong Kong company and the Mainland processing enterprise. The Hong Kong company is responsible for the supply of raw materials and machinery without consideration and to provide technical know-how while the Mainland processing enterprise is responsible for the provision of factory premises, utilities and labour force. In return for the processing service, the Hong Kong company pays a subcontracting charges to the Mainland enterprise. The legal title to the raw materials and finished goods remains with the Hong Kong company. Strictly speaking, the Mainland processing enterprise is a separate sub-contractor distinct from the Hong Kong company and the question of apportionment in respect of the latter’s profits should not arise. In the Department’s view, the Hong Kong company’s operations in the Mainland complement its operations in Hong Kong. Recognising the operations of the Hong Kong company in the Mainland, an apportionment of profits on a 50:50 basis is usually accepted.
In import processing, the manufacturing operations are carried out by a foreign investment enterprise (FIE) incorporated in the Mainland and related to the Hong Kong company. The Hong Kong company sells raw materials to the FIE and buys back the finished goods from the FIE. The Hong Kong company engages in the trading of raw materials and finished goods whilst the FIE manufactures the finished goods. The legal title to the raw materials and the finished goods passes to/from the FIE. The Departments holds the view that the profits which accrued to the Hong Kong company from “trading transactions” carried out in Hong Kong cannot be attributed to the manufacturing operations of the FIE carrying on business in the Mainland. The source of the trading profits must be attributed to the operations of the Hong Kong company which produced them. Apportionment of profits is not appropriate.
Manufacturing by an independent sub-contractor in the Mainland of China
In cases where the assembly work is contracted to various contractors in the Mainland, the jobs are numerous, small in value and of short duration and the Hong Kong company has minimal involvement in the assembly work, then the manufacturing in the Mainland is not regarded as having been carried out by the Hong Kong company. Given that the Hong Kong company does not carry out any manufacturing operations outside Hong Kong, its profits should be fully chargeable to profits tax without any apportionment.
Sale or purchase commissions
The place where service is performed
When a business earns commission by securing buyers for products or by securing suppliers of products required by customers, the activity which gives rise to the commission income is the arrangement of the business to be transacted between the principals. The source of the income is the place where the activities of the commission agent are performed. If such activities are performed in Hong Kong, the income has a source in Hong Kong. Factors such as the place where the principals are located, how they are identified by the commission agent, and the place where incidental activities are performed prior or subsequent to the earning of the commission are not generally relevant in determining the source of the commission income. In the event that the commission income is earned by a person carrying on a business in Hong Kong but the activities which give rise to the commission are performed entirely outside Hong Kong, the commission is not taxable in Hong Kong.
Company formation Hong Kong: Setting Up a Company in Hong Kong
BRIEF OUTLINE OF HOW TO SET UP A COMPANY IN Hongkong:
- DTA facts: Hong Kong only has a double-taxation agreement with Belgium and Luxembourg, that is, as a rule the shielding effect of a DTA is not present.
- Legal form: limited company
- Bearer shares: No, only registered shares (and these are published)
- Trade register open to public inspection: Yes
- Taxes:16.5%. Exempt companies (companies that only operate with foreign-based businesses) remain totally exempt from taxation. Income from abraod likewise remains exempt from tax.
- Turnover tax: No
Setting Up a Company in Kong Kong and the Services of Our Legal Firm
- tax advice on setting up a company in Hong Kong and associated companies
- setting up a company in Hong Kong, entry in the register, translation of the registration documents into the language where the client is domiciled, apostille
- registered office in Hong Kong, head office (proper place of business) up to and including an office.
- bookkeeping and annual accounts on behalf of the limited company in Hong Kong
- on request and insofar as required:
- appointment of a trust director or full-time director in Hong Kong (cf. “Location of the senior management of the business” as the location of the business premises, provided there is no production facility, no facility for the exploitation of mineral resources or any construction work being carried out in Hong Kong for longer than 6-9 months, in which case the business premises are always in Hong Kong, irrespective of the location of the senior management of the business)
- opening of an account on behalf of the limited company in Hong Kong, including online banking, cheques and credit card. In the case of a trust director the beneficiary/client will obtain sole authority over the account
Further services for medium-sized enterprises:
- search for suitable offices, storage depots or production sites
- staff in Hong Kong: visa matters,registration for tax purposes, wage accounts.
- Setting Up a Company Hong Kong and Legal Form
The private limited company, that is, a limited company that is not listed on the stock exchange, is the most popular form of company in Hong Kong and is also, almost without exception, the one chosen by all foreign companies that have set up in business here.
The statutory minimum requirements are:
- Share capital amounting to 2 Hong Kong dollars (approx. 0.20 euros). The liability of the partners is limited to the amount of the share capital.
- one shareholder as well as two directors; the shareholders and directors can be one and the same (this is also often the case with small companies) and may be both legal and natural persons who do not have to be resident in Hong Kong.
- a company secretary (clerk). He must be resident in Hong Kong and is responsible inter alia for sending reports to the trade register (e.g. on the re-appointment of directors etc.).
- a head office in Hong Kong.
- A set of articles of association for the company which are, in most cases, couched in very broad terms and regulate the powers of the directors as well as the purpose of the business. The object of the business may be production and distribution, trading (locally or in the import/export business) as well as the most widely varying services. Particular conditions for admission (similar to those in Germany) only exist in some sectors, such as in the case of banks, the stock exchange, finance and insurance.
The share capital, the head office of the company, the above-mentioned persons as well as the articles of association are noted in the Hong Kong trade register which can be inspected by everyone. By contrast, in the case of the balance sheet and the profit & loss account, which must be produced (and certified) annually, there is no obligation to publish them.
Setting Up a Company in Hong Kong and General Advice
In view of the ease with which companies can be set up in Hong Kong for not a lot of money, it is hardly surprising that many foreigners want to have a piece of the cake. However, anyone who thinks that the requirements for doing so are met with the purchase of a Hong Kong letter-box company will quickly have his eyes opened:
Admittedly, the authorities on both sides of the border have some flexibility in all issues relating to this. However, it is essential that it actually involves a company actively engaged in business in Hong Kong with its own management that was neither set up only on the day before the concession applications were submitted nor one which, in comparison with the ostensible scope of the business has a ridiculously low level of capitalisation and/or has its address (together with a hundred others) under the bell push of a local lawyer, an auditor etc..
On the other hand, with a little sense of proportion the requirements can, in most cases, be fulfilled really easily : huge offices and business premises are not expected. Rather, as opposed to this, it is about having a telephone of one’s own that is also answered when people ring. The manager should, in this case, reside locally (a wish that can be fulfilled by means of trust solutions) and should also be credibly shown in the profit & loss account of the company under the item “salaries”.
This definition can be departed from if a production facility is set up in Hong Kong, a facility for the exploitation of mineral resources or construction work which will go on for more than 12 months. In that case the business premises are always in Hong Kong (in the same way as the 5 OECD agreement), irrespective of the “location of the senior management of the business”.
However, anyone who purchases his company from one of the many discounters, who often do not even ask about the intended use, must subsequently have the situation put right with a great deal of effort and expense with professional help.
Company formation Hong Kong: Professional Services
Incorporation of Hong Kong Companies
- Memorandum & Articles of Association
- Statutory Register
- Share Certificate
- First Board Minute
- Metal Common Seal
- Rubber Stamp
Company Secretarial & Compliance
- Acting as Company Secretary
- Annual Return
- General Meeting
- Board Meeting
- Increase of Capital
- Transfer of Shares
- Allotment of Shares
- Appointment of Directors
- Resignation of Directors
- Change of Company Name
- Change of Registered Address
- Presence in HK without actual Office
- Mail Forwarding
- Fax Forwarding
- Bank Account Opening
- Office Space Sourcing
Accounting & Auditing
- Accounting & Book-keeping
- Year end Auditing
- Tax Computation and Return
- Profit Tax Return
- Taxation and Accounting Issues
Hong Kong Scope of Profits Tax
Profits tax is levied under the Inland Revenue Ordinance on the “assessable profits” of corporate entities, partnerships, trusts and sole proprietorships. It is levied according to the “territorial principle” meaning that it is the source of the income rather than the residential or non-residential status of the entity that determines whether or not trading income is or is not subject to Hong Kong profits tax.
The territorial principle means that only income which meets the following 3 preconditions is subject to Hong Kong profits tax:
- The entity must trade in Hong Kong
- The income must arise from such a trade
- The income must arise in or be derived from Hong Kong
The residential or non-residential status of the entity is irrelevant as is the fact that the income is or is not exempt from tax in a foreign jurisdiction. Advance tax rulings are available in the SAR and are particularly favored and recommended on the question of whether or not for profits tax purposes trading income is deemed onshore and taxable or offshore and tax exempt.
“Source of income” for profits tax purposes has been defined as the geographical location of the operation which substantially gave rise to the income, but the Inland Revenue’s Practice Note No 21 adds more precise criteria:
The establishment of an office in Hong Kong: does not of itself render a company liable to profits tax where that office is not generating profits from within the territory.
Place where the contract was negotiated and executed: A key criterion is the place where the contract was negotiated and signed. Income relating to a sale contract negotiated by the seller from the territory by way of facsimile or telephone where the negotiation did not require travel outside the territory is deemed Hong Kong source income for profit tax purposes. Likewise if the contract is negotiated and signed outside the territory and the goods sold are not sourced from within the territory then any income arising is not deemed Hong Kong source income for profits tax purposes. This is often achieved by utilizing an offshore company which re-registers in the territory as a foreign company but whose directors both remain non resident and negotiate and execute the contract from the offshore jurisdiction.
Booking Center: Where the Hong Kong entity is merely a booking center in the sense that it does not negotiate or draft the sale agreement (which is carried out abroad) but merely issues an invoice on instructions, operates a bank account and maintains accounting records covering the transaction then the income from such a transaction is not deemed Hong Kong source income for profits tax purposes.
Shares & Securities : Gains from shares and securities purchased and sold on the territory’s stock exchange are deemed Hong Kong source income for profit tax purposes (assuming the entity is subject to profit tax on such an activity).
Cross Border Land Transportation: Income from cross-border land transportation is deemed Hong Kong source income if the passengers or goods are normally uplifted in Hong Kong.
Loans : Loan interest on a loan made available to the borrower within the jurisdiction of Hong Kong is deemed to be Hong Kong source income for profits tax purposes and taxable in the hands of the Hong Kong lender whereas loan interest on a loan made available to the borrower in a foreign jurisdiction is not deemed Hong Kong source income and is therefore not taxable.
Hong Kong Profits Tax Rates
A number of rates apply:
- Companies pay a standard rate of 17.5% on assessable profits.
- Businesses other than corporate entities pay a rate of 16% on assessable profits.
- Special concessionary rates of profits tax which are substantially less than the standard rates apply to the following businesses or sources of income:
- Interest or capital gains made on qualifying maturity debt instruments are taxed at 8%.
- The re-insurance of offshore risks is taxed at 8% of assessable profits.
- Life insurance businesses are assessed at 5% of the value of the premiums arising in Hong Kong.
- An entity whose business is to grant rights to use a trademark, copyright, patent or know how pays a flat profit tax of 1.75% (or 17.5% on 10%) of the payment received with all related expenses being non tax deductible. If the recipient of the payment is a related offshore licensing company the Hong Kong company must withhold and hand over 1.75% of the fee paid over.
- Income from the international operations of shipping companies is exempt from tax unless the ships are operating in Hong Kong waters or proximate to the same in which case only that proportion of income earned in Hong Kong is subject to local tax of 17.5%. Shipping profits meeting the conditions of the double taxation agreement with the USA are exempt from profits tax in Hong Kong.
- Irrespective of whether or not the company is managed and controlled from Hong Kong assessable profits are the proportion of income arising within Hong Kong (from the uplift of passengers and freight locally) to the proportion of worldwide income. Under a number of international aircraft double taxation agreements the government has agreed to include income arising abroad for taxation in Hong Kong where that income is exempted abroad under the agreement. Likewise profits meeting the conditions of the double taxation agreements are exempt from profits tax locally. The rate is 16% of assessable profits.
- The sale of goods on consignment from Hong Kong on behalf of a non resident is subject to a tax of 1% of the turnover without any deductions unless the non resident can produce accounts to show that he would have paid less profit tax than consignment tax in which case a normal rate of tax will apply .The selling of goods on consignment is deemed to be the equivalent of creating a permanent establishment.
- An entity whose business is to rent out a film, tape or sound recording for use in any cinema or television program pays a profit tax of 1.75% (or 17.5% on 10%) of the payment received with all related expenses being non tax deductible.
Hong Kong 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 not exist 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.
- Full deduction is allowed for charitable donations not exceeding 10% of annual assessable profits after deduction of depreciation allowances but prior to losses carried forward being added in.
- 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:
- 100% first year allowances for manufacturing plant and machinery;
- 100% first year allowances for computer equipment;
- 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 instalments.
- In May, 2004, LEGCO expanded the scope of deduction for research and development expenses under profits tax to cover design-related expenses.
Hong Kong Property Tax
Property tax is levied annually on the owner or occupier of real estate located in Hong Kong. Since ownership may be split (eg an entity with a 100 year lease may grant a 50 year sublease to a 3rd party) separate assessments may be made on the same parcel of land. Property tax which is governed by the provisions of the Inland Revenue Ordinance has the following characteristics:
- The annual assessment to property tax is based on 100% of the annual rental income of the property less any rates paid, any bad debts, a repairs and outgoings allowance constituting a maximum of 20% of the annual rental income (irrespective of whether or not more was actually spent) and other allowable deductions. In determining “rental income” the Inland Revenue will include any premiums, service charges, management fees, rates, repairs and outgoings paid by the tenant either to the owner or on behalf of the owner under the terms of the lease. In order to assist the inland revenue to assess the rental income the owner is obliged to keep records for up to 7 years and inform the tax authorities of the actual sums received.
- Property tax is based on the territorial principle and is levied on buildings, parts of buildings, wharves, piers and other structures located in Hong Kong. The fact that the owner is non resident, non domiciled or a national of a foreign country is completely irrelevant and does not exempt him from having to pay this tax.
- The tax rate is 15% of the assessed annual rental income .
- Property tax is levied on a provisional assessment basis which takes into account the previous year’s rental income with a tax credit being granted where the previous year’s rental income exceeds the current year’s rental income. Relief is also given where part of the assessed rental income is a bad debt.
- The following types of property are exempted from this tax:
- The properties of foreign governments;
- Charitable bodies exempted from taxation;
- Business entities who derive profits from and pay profits tax on rental income derived from ownership of real estate are entitled to a set-off of property tax against profits tax with a tax credit being granted where the property tax exceeds the profits tax;
- A corporation which purchases a property for its own occupation does not pay property tax on the deemed rental income which it could have earned if it had rented out the building.
- It is advisable for properties to be owned by Hong Kong corporate entities since property tax does not make allowances for either depreciation or interest costs on a loan to finance the purchase, while such costs are deductible for corporate profits tax purposes. A foreign company cannot own real estate in Hong Kong unless it is registered as a foreign company under the provisions of the Companies Ordinance.
Hong Kong Stamp Duty
The laws on stamp duty are set out in the Stamp Duty Ordinance. Stamp duty is either a fixed fee or is calculated ad valorem depending on the nature of the transaction. It is payable on:
- Leases, assignments and conveyances of immovable property.
- The transfer of shares or marketable securities
- The transfer of bearer instruments (being instruments under which ownership is transferred through physical delivery).
Immovable Property Stamp Duty Rates
2 separate rates of stamp duty are payable on immovable property:
- The Conveyance of a Freehold or the Assignment of a Leasehold: The rate of stamp duty is progressive and varies from US$13 if value of the transferred interest is less than US$128,000 to a maximum rate of 2.75% where the property is valued at more than US$565,875 .
- The Granting of a Short-Term Lease: The stamp duty rate is progressive and varies between .25% and 1% of the annual rental value depending on whether the lease is for less than one year or more than 3 years. Any agreement which increases the rent reserved by a chargeable stamped lease is itself chargeable to stamp duty in respect of the additional rent which it makes payable.
Immovable Property Transactions Exempted from Stamp Duty:
The following immovable property transactions are exempt from stamp duty:
- Non-Residential Property: Instruments transferring “non residential property” are exempt from stamp duty. Non-residential property is defined as property which may not by law be used at any time for residential purposes.
- Gifts to Charitable Institutions or Public Trusts: Instruments transferring immovable property by way of gift to a charitable institution or public trust are exempt from stamp duty.
- Approved conveyances on sale to diplomatic or consular bodies.
- A transaction conveying an interest in immovable property between “associated corporate bodies”. Entities are defined as associated corporate bodies when one entity holds over 90% of the share capital of the other or when a 3rd entity holds over 90% of the share capital of both entities. The association must remain for 2 years after the transfer in default of which the full level of stamp duty must be paid over retrospectively. The financing of the transaction cannot come from an unassociated body.
- Mortgages: Mortgages are free of stamp duty.
Immoveable Property Stamp Duty Anti-Avoidance Provisions
There are elaborate anti avoidance provisions in place aimed at deterring speculation. Thus where the beneficial owner of real estate executes an instrument in favor of a third party under which he undertakes to hold the real estate on trust for the third party duty is payable on this instrument as if a conveyance had taken place. Likewise stamp duty is payable where under an uncompleted contract of sale the vendor is deemed by law to hold on trust for the purchaser.
Stamp Duty Payable on Shares & Marketable Securities
Stamp duty of .225% is payable on the transfer of shares or marketable securities whereas .1% stamp duty is payable on the issued share capital of a company up to a maximum stamp duty fee of HK$30,000. In the long-term stamp duty on shares and securities is to be phased out completely.
Securities Transactions Exempted from Stamp Duty
The following transactions are exempt from stamp duty:
- Loan capital transactions, bills of exchange, promissory notes, certificates of deposit, exchange fund debt instruments and Hong Kong multilateral agency debt instruments.
- Transactions involving debentures, loan stocks, funds bonds or notes that are not denominated in Hong Kong currency except to the extent that they are redeemable in that currency.
- Stock donated to charitable bodies or public trusts which are exempt from taxation in Hong Kong.
- A transaction conveying stock between “associated corporate bodies”. Entities are defined as associated corporate bodies when one entity holds over 90% of the share capital of the other entity or when a 3rd entity holds over 90% of the share capital of both entities. The association must remain for 2 years after the transfer, in default of which the full level of stamp duty must be paid over retrospectively. The financing of the transaction cannot come from an unassociated body.
Stamp Duty Payable on Bearer Instruments
The amount of stamp duty payable is 3% of the value of the instrument transferred.
Hong Kong Filing Requirements and Payment of Tax
The tax year starts on 1st April. The assessment to profits tax is provisional and is based on the previous year’s assessable profits with 75% of the assessment being due by the 3rd quarter and the final 25% being due at the year-end. Tax payments delayed less than 6 months are subject to a 5% non-deductible surcharge whereas payments overdue by more than 6 months are subject to a 10% non-deductible surcharge. A tax credit is granted where the previous year’s assessment exceeds the currents year’s assessable profits.
Hong Kong Withholding Tax
There are no withholding taxes in Hong Kong as such, but there are certain circumstances in which a company making a payment to a foreign associate (subsidiary or holding company) which is deemed to be Hong Kong source income needs to needs to withhold the tax.
For instance, when a Hong Kong entity pays royalties for the use of intellectual property to its own offshore licensing affiliate, then tax is due of 10% of 16% = 1.6% and this must be withheld by the Hong Kong paying company.