In Hong Kong, profits tax is an income tax chargeable to business carried on in Hong Kong. Applying the territorial taxation concept, only profits sourced in Hong Kong are taxable in general. Capital gains are not taxable in Hong Kong, although it is always arguable whether an income is capital in nature.
The persons chargeable to profits tax includes corporations, partnerships, trustees, and sole proprietors.
Chargeable scope
As a general rule, Hong Kong profits tax is levied on any persons who carries on a trade, profession or business in Hong Kong and assessable profits arising in or derived from Hong Kong for a year of assessment. The profits tax rate applied is 15% for individuals and 16.5% for corporations (a.k.a. the standard rate) on their net assessable profits for the year of assessment 2014/15.
Source of profits
To argue whether profits arising in or derived from Hong Kong, case law judgments are often referred. The fundamental source rule was laid down by the landmark case The Commissioner of Inland Revenue ("CIR") v. Hang Seng Bank Ltd Co. (1991) 1 AC 306. Lord Bridge of Harwich of Privy Council held that the source of profits is a question of fact depending on the nature of transaction and stated the broad guiding principle in determining the source is that
The statement is widely retrieved in the context of Taxation in Hong Kong and other jurisdictions and reconfirmed in subsequent cases, such as HK-TVB International Limited v. CIR (1992) 2 AC 397. However, while applying the broad guiding principle, it should not be distracted by the antecedent and incidental matters.
To reduce the complexity in determining the source of profits, the Inland Revenue Department of Hong Kong ("IRD") issued Departmental Interpretation and Practice Note No. 21 - Locality of profits ("DIPN no. 21") to provides potential taxpayers a guideline on the source of income. Following the guideline in DIPN no, 21, the taxpayers may first determine what kinds of profits do their business earn and make reference to the IRD's views in respect of the particular type of profits.
Tax computation
The formula is:
HK profits tax payable = Net assessable profit × Profits tax standard rate
Net assessable profit = Assessable profit − Loss brought forward (if any) + Loss transferred from partnership (if any)
Assessable profit = Profit or (Loss) per financial account + (Disallowable expenses charged in account − Non-taxable income credited in account) − Depreciation allowances − Approved charitable donations
Approved charitable donations
The Approved charitable donations are limited to 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, per section 16D of the IRO. Such aggregate must not be less than $100.
Section 14
A person carries on a trade, a profession or a business in Hong Kong
There are profits arising in or derived from (trade, profession, business). Profit is not from the sales of capital assets The profits must be arising in or derived from Hong Kong Contract effected test Operation test Provision of credit test Development test or registration test
Badges of Trade
Any trade may be subject to profit tax unless one can provide reasonable evidence to prove that there is not any revenue profit. In Hong Kong, capital profit is not subject to tax.
In order to prove the nature of a trade, the badges of trade are to be considered: the taxpayer's intention of profit (one acquisition of the commodity) Subject Matter of the commodity disposal (If enjoyment can be assume on original acquisition, e.g. rental) the length of ownership, frequency of similar transactions, reason for disposal, supplementary work and so on.
Basis period and year of assessment
The year of assessment of each year starts from 1 April and ends on 31 March in the next year. For example, the year of assessment for 1 April 2014 to 31 March 2015 is "Year of Assessment 2014/15". However, no adjustment is required to align the financial information with the end-date of year of assessment. On the contrary, IRD accepts the profits assessed in accordance with the accounting year-end date. In the context of tax law, this is also referred as basis period.
Tax depreciation
Purchases of industrial building, commercial building and plant and machinery are not deductible because they are capital in nature. Yet, capital expenditure may be deductible if they are categorised into following: