Unpacking Hong Kong’s taxation system for SME owners | Article – HSBC VisionGo
Hong Kong’s tax system lives up to its reputation for ease and transparency, but there are still many details that SME owners much understand to stay
One significant drain on business bottom lines are taxes – to pay, as well as to manage. Not only do you have to contend with the compliance requirements and the paperwork you also have to part with a significant part of your profits. But not if your business is based in Hong Kong!
The Hong Kong tax system is one of the easiest, cheapest and most transparent in the world and is truly a pleasure to deal with. It just has two broad tax categories for businesses – Profits Tax and Property Tax. Here is a look at the finer details of both
The Profits tax in Hong Kong (similar to international norms) is calculated as a percentage of the profit a company makes in a year.
However, not all of your company profits are taxed. In Hong Kong, the tax system follows the territorial source principle to determine which income is subject to taxation.
What is the territorial source principle?
In a nutshell, this means that only profits that you make in Hong Kong are taxed. This is only for 40+ countries with which Hong Kong has a Double Taxation Agreement. Under this principle, if you have an office in HK and if the main profit-generating activities are carried out in HK, then the profits from these activities will be taxed in Hong Kong regardless of where the products are sold.
To find out where your tax liabilities lie, you can take this small test devised by the Inland Revenue Department (IRD). You can also answer the following questions to understand your situation better:
- Is your main office or the office that does all the work to make a profit located in Hong Kong?
- Is the profit-generating work done in Hong Kong?
- Are the business decisions for profit generation made in Hong Kong?
- Do your main earnings come from Hong Kong entities?
If you answered “yes” to any of the questions above, it’s most likely that you will be taxed in Hong Kong.
Income Tax rates in Hong Kong
Hong Kong uses a two-tiered system for calculating profits tax depending on the annual revenue of the company. These are – 8.25% on first HK$2 million and 16.5% on any amount after the first HK$2 million. For example, if company A earns HK$1 million, then they will fall under the 8.25% bracket. Company B with HK$3 million will pay 8.25% on HK$2 million and 16.5% on the rest HK$1 million.
If an individual or a company is the majority shareholder in more than one Hong Kong business, then the entities are considered connected through them. In this case, only one firm can use the two-tiered system.
What Are the Income Tax deductions SME owners can count on?
The deductions offered by the IRD are covered by section 16 of the Inland Revenue Ordinance. Here are some details:
1. Building Refurbishment Expenses
Any amount spent on renovating your office, buying new furniture and similar activities are considered business expenses and can be split into 5 parts and deducted from the income over 5 years including in the year they were incurred.
2. IT hardware and plant and machinery expenses
All spending related to technology, whether it is buying a work laptop or installing a new assembly line in your manufacturing unit, are eligible to be deducted from your income in full the year they were incurred.
3. The expense of installation of environmental protection machinery
Any amount spent on buying and installing energy-saving equipment or rebuilding your plant to reduce harmful air emissions can be deducted from your taxable income.
The entire amount can be deducted in the year it was spent. Eco-friendly vehicles for business activities also fall under this heading.
All depreciations are also deductible, but there are some rules for them:
Cost of Construction
- Factory buildings
20% of the cost of construction of the premises can be deducted in the first year. Thereafter, 4% of the cost of construction is deducted annually until the whole sum is covered.
- Commercial buildings
4% of construction cost can be deducted annually from the income.
- Plant and Machinery depreciation
60% can be deducted in the year you buy it. Thereafter, the expense can be written off at a rate of 20% a year, throughout its useful life period.
If you sell the building
- Factory buildings
If you get paid more than the residual value of the building, then you will have to pay profits tax on the difference (this is called the balancing charge). If you get less than the residual value, it’s a deductible expense (called the balancing allowance).
- Commercial buildings
The balancing charge or allowance is similar to factory buildings.
- Plant and Machinery depreciation
If the equipment is sold for more than its residual cost, IRD charges a profits tax on the difference. If you get less for your equipment, then the difference is deducted from the income.
The Property Tax is charged as a percentage on the income generated from real estates such as rent and any deposits received from the tenants. This income is taxed at a rate of 15%.
The taxable income for applying the property tax is based on the Rating and Valuation Department (RVD), which evaluates the value of the property and the estimated annual revenue you can generate from renting it.
The RVD publishes its findings on its website, and this information is updated annually. Changes in the evaluation are communicated to property owners, and they have 28 days to challenge the findings by justifying revaluation such as the actual rent received from tenants.
Deductions - Property owners are allowed a 20% allowance (of annual rental value) for renovation purposes.
Other indirect taxes - The Government Rate (5%) and the Government Rent (3%) are two indirect taxes that property owners have to pay regardless of whether they have tenants.
How To Pay Taxes In Hong Kong?
As a new company, you will get a breather for the first 18 months and only start getting tax forms from the IRD after that. The tax form will reach you on the first day of the Year of Assessment (April 1st).
You have to fill in all the relevant data in these forms and submit it – we strongly recommend you turn over tax matters to professional accounting agencies such as Osome who deal with these matters daily.
You will get three kinds of returns:
- Employer’s return – this form is to collect information about employees of the company in Hong Kong.
- Profits Tax return
- Property Tax return (if the business rents out any real estate in Hong Kong)
After you get the relevant forms, you have a month to fill them out. 2-3 months after submitting the way you will get a demand note from the IRD which will lay out the amount of taxes you have to pay.
In the demand note, you will be asked to pay double the amount – this is because it adds something called “provisional tax”, which is the tax you pay in advance for the next year of assessment. Next year, this amount will be deducted from your tax amount. You will have to make the current year’s tax payment to IRD within a month, but provisional tax is paid in two instalments spread over the year of assessment.
Here is the tax filing timeline in brief
Date: April 1st
What happens: You get a Profits Tax return, Employer’s Return, and Property Tax return forms
Date: May 1st
What happens: The completed forms are filed with the IRD
Date: July – August
What happens: Demand notes come in for Profits and Property taxes
Date: August – September (a month after you get the letters)
What happens: Taxes should be paid
The IRD hosts an exhaustive set of guidelines on their website to help entrepreneurs manage their tax obligations. These guidelines also contain examples of case studies that cover all situations that taxpayers could face. And of course, you always have the option of contacting them directly via phone, e-mail or even in person.
However, if you want to take the easy and safe way out, then it is best to engage a professional tax agency, like ours, to do you tax filings. Our experienced team will provide personal and professional attention to your tax issues, making it a hassle-free and error-free process.
Get in touch with Osome to know more!