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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.
A number of rates apply in 2012:
Companies pay a standard rate of 16.5% on assessable profits.
Businesses other than corporate entities pay a rate of 15% on assessable profits.
These rates have applied from the year of assessment 2008/9. Prior to the that, the standard and unincorporated rates of profits tax were 17.5% and 16% respectively.
All taxpayers, whether incorporated or unincorporated, are subject to the same business tax rate irrespective of their residential status.
Special concessionary rates of profits tax which are substantially less than the standard rates apply to the following businesses or sources of income:
Trading profits and interest income derived from debt instruments issued in Hong Kong with an original maturity of up to seven years will be chargeable to tax at a concessionary rate, being 50% of the normal profits tax rate, while those with a maturity period of seven years and above qualify for a 100% concession.
The re-insurance of offshore risks is taxed at a concessionary rate, being 50% of the normal profits tax rate.
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 30% of 16.5% (4.95%, or 4.5% for an unincorporated business) 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 4.95% 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 16.5%. 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 16.5% 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 30% of 16.5% (4.95%, or 4.5% for an unincorporated business) of the payment received with all related expenses being non tax deductible.
In March 2012, the Financial Services and the Treasury Bureau launched a two-month consultation on the proposed amendments to the Inland Revenue Ordinance and Stamp Duty Ordinance to promote the development of an Islamic bond, or “sukuk”, market in Hong Kong. The Secretary for Financial Services & the Treasury, Prof KC Chan, said the amendments seek to level the playing field for common types of sukuk compared with their conventional counterparts in terms of profits tax, property tax and stamp duty liabilities. Under the legislative proposals, the government proposes “to adopt a prescriptive and religion-neutral approach, in line with that adopted by other major financial markets such as the United Kingdom, as prescriptive legislative provisions without specific reference to Shariah principles would provide more certainty in implementation to market players in Hong Kong”. It is proposed to cover the most common types of sukuk in the global market – Ijarah, Musharakah, Mudarabah and Murabahah – and to adopt a tripartite structure, comprising an originator, a bond-issuer and bond-holders, as the basis for the framework of the proposed legislative amendments. Specifically, a new term would be introduced known as an alternative bond scheme containing two arrangements – a bond arrangement and an investment arrangement. The former refers to the arrangement between the bond-issuer and the bond-holders, while the latter refers to the arrangement between the bond-issuer and the originator. Under each of the aforesaid arrangements, a set of essential features and qualifying conditions would need to be satisfied in order for the parties involved to enjoy the special tax treatment and stamp duty treatment/relief applicable to that arrangement.
In the 2012/13 budget, announced in February 2012, Financial Secretary John Tsang proposed a reduction of 75% of the final tax for the year of assessment 2011-12 in respect of profits tax, salaries tax and tax under personal assessment, subject to a ceiling of HKD12,000 per case.
To help reduce operating costs, enhance competitiveness and preserve jobs, the Financial Secretary also proposed to waive business registration fees for 2012-13 and abolish capital duty levied on local companies to encourage investors to set up companies in Hong Kong. This followed the waiver of fees for 1-year Business Registration Certificates and 1-year Branch Registration Certificates as a result of the 2010/2011 budget for the period from August 1, 2010 until July 31, 2011. Businesses were, however, still required to pay the levy for the Protection of Wages on Insolvency Fund.
Budget 2010/2011 also brought about clarification by the Inland Revenue Department of the meaning of “central management and control” in the Departmental Interpretation and Practice Notes No. 43 to address the industry’s concern about the residency requirement for directors of the management committee of offshore funds in their applications for profits tax exemption.
To encourage the business sector to purchase more electric vehicles, hybrid vehicles and other environment-friendly commercial vehicles, the Financial Secretary also decided in the 2010/11 budget to accelerate the tax deduction for capital expenditure on environment-friendly vehicles from 72% to 100% of the capital expenditure. The Inland Revenue (Amendment) (No.3) Ordinance was gazetted on 18 June 2010. The Financial Secretary also proposed in the 2010/11 budget to extend the profit tax concession on interest income derived from debt instruments to cover debt instruments with a maturity period of less than three years.
Another 2010/11 Budget measure expanded the existing regime of tax deductible capital expenditure on the purchase of patent rights and industrial know-how to cover registered trademarks, copyrights and registered designs to promote wider application of intellectual property by enterprises and the development of creative industries.
With regard to intellectual property, under Hong Kong’s existing tax arrangements, capital expenditure by enterprises to purchase patent rights and industrial know-how is deductible under profits tax. A bill introduced into the Legislative Council on March 9, 2011 sought to amend the Inland Revenue Ordinance to provide such a tax deduction (spreading over five succeeding years on a straight-line basis starting from the year of purchase) for capital expenditure incurred on copyrights, registered designs and registered trademarks. It would also remove the “use in Hong Kong” condition currently applicable to the tax deduction for capital expenditure incurred on the purchase of patent rights and industrial know-how. Those enhancement measures are also be applicable to the proposed tax deduction for copyrights, registered designs and registered trademarks.
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