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Hong Kong Company Formation: Profits Tax

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Hong Kong Company formation and Profits Tax

The Scope of the Charge

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. There is no distinction made between residents and non-residents. A resident may therefore derive profits from abroad without being charged to tax; conversely, a non-resident may be chargeable to tax on profits arising in Hong Kong. The questions of whether a business is carried on in Hong Kong and whether profits are derived from Hong Kong are largely questions of fact. However some guidance on the principles applied can be found in cases which have been considered by the courts in Hong Kong and in other common law jurisdictions.

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:

1. 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.
2. Sums received for the use of or right to use in Hong Kong a patent, design, trademark, copyright material, secret process or formula or other property of a similar nature. Effective from 25 June 2004, sums received for the use of, or right to use, such property outside Hong Kong is also taxable, if the sum is allowable for deduction in the hands of the payers. 2
3. 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.

The profits tax rate for corporations is increased from 16% to 17.5% with effect from year of assessment 2003/04 and reduced to 16.5% from 2008/09. For unincorporated businesses, the profits tax rate is increased from 15% to 15.5% in the year of assessment 2003/04, to 16% with effect from 2004/05 and reverted back to 15% from 2008/09.

Businesses subject to Profits Tax will enjoy a reduction of 75% of the final tax for the year of assessment 2007/08, subject to a ceiling of $25,000 per case.

The Basis of Assessment

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 payment is applied in the first instance against Profits Tax payable on assessable profits for that year of assessment when agreed 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.

Non-Residents and Agents dealing with Non-Residents

A non-resident is chargeable to tax either directly or in the name of his agent in respect of all his profits arising in or derived from Hong Kong from any trade, profession or business carried on here, whether or not the agent has the receipt of the profits, and the tax may be recovered out of the assets of the non-resident or from the agent. The agent is required to retain from the assets sufficient money to pay the tax.

A non-resident who receives sums described in sub-paragraphs (1) and (2) on page 1 is chargeable to tax in the name of any person in Hong Kong who paid or credited the sums to him; so is a non-resident who receives sums or derives profits directly or indirectly (including the payment of taxes to the Government) from the performance in Hong Kong of an activity by a non-resident entertainer or sportsman in his character as entertainer or sportsman. The person who pays or credits such sums is required at the time he makes the payment or credit to deduct from those sums an amount sufficient to meet the tax due.

Resident consignees are required to furnish quarterly returns to the Commissioner of Inland Revenue showing the gross proceeds from sales on behalf of their non-resident consignors and to pay to the Commissioner a sum equal to 1% of such proceeds, or such lesser sum as may have been agreed.

Where a non-resident carries on business with a resident and the business is so arranged that it produces to the resident either no profits or profits less than the ordinary 3 profits that might be expected to arise to an independent concern, the business may be treated as carried on in Hong Kong by the non-resident through the resident as agent.

Where the true profits of a non-resident from a trade, profession or business carried on in Hong Kong cannot be readily ascertained, they may be computed on a fair percentage of the turnover in Hong Kong.

Where the accounts of a non-resident whose head office is outside Hong Kong do not disclose the true profits of a Hong Kong permanent establishment, the profits of the branch for tax purposes is taken to be the amount which bears to the taxpayer’s total profits the same proportion as his turnover in Hong Kong bears to his total turnover.

Special provisions are made in the Ordinance for non-resident ship owners and non-resident aircraft owners whose vessels call at locations within Hong Kong waters or whose aircrafts land at a Hong Kong airport. Further details may be obtained from the Department.

Exemptions and Deductions

Dividends received from a corporation which is subject to Hong Kong Profits Tax, as well as amounts already included in the assessable profits of other persons chargeable to Profits Tax (e.g. shares of profits from joint ventures) are excluded from the assessable profits of the recipient.

Generally, all expenses, to the extent to which they have been incurred by the taxpayer in the production of chargeable profits, are allowed as deductions including:

1. Interest on funds borrowed (provided certain conditions are satisfied) and rent of buildings or land occupied for the purpose of producing the profits.
2. Bad and doubtful debts (any recoveries to be treated as income when received).
3. Repairs of premises, plant, machinery or articles etc used in producing the profits.
4. Expenditure for registration of a trade mark, design or patent and expenditure on the purchase of patent rights or rights to any know-how for use in Hong Kong in the production of chargeable profits. No deduction is, however, allowable in respect of patent rights or rights to any know-how purchased by a person wholly or partly from an associated or related person.
5. Expenditure on research and development including market, management and business research, design-related expenses and payments for technical education subject to certain rules.
6. An employer’s annual contribution to a fund under a recognized occupational retirement scheme, or annual premium payment in respect of a contract of insurance under such a scheme, or regular 4 contributions paid to a mandatory provident fund scheme, or any provision for these purposes, but limited in respect of any one employee to 15% of his total emoluments for the relevant period.
7. Any mandatory contributions paid by a sole proprietor or a partner in a partnership in respect of his liability to pay such contributions as a self-employed person under the Mandatory Provident Fund Schemes Ordinance (Cap. 485) not exceeding $12,000 in a year of assessment, taking into account deductions already allowed under any other sections in the Ordinance. However, contributions made for spouses are not deductible.
8. Donations of an aggregate not less than $100 made to approved charities with the restriction that such donation shall not exceed 35% (25% for years of assessment 2005/06 to 2007/08) of the adjusted assessable profits.

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