Guide to Setting up a Business in Hong Kong (5) - Taxation, Duties and Fees

1. Introduction

Hong Kong taxes are essentially territorial so that, in most cases, only income which in substance arises in or is derived from Hong Kong is subject to Hong Kong tax. Domicile, nationality and residence are therefore generally immaterial in determining whether or not Hong Kong tax is payable in a particular situation. There are three taxes on income in Hong Kong:

(1) property tax

(2) salaries tax

(3) profits tax

The Inland Revenue Department is responsible for the administration and collection of these taxes and the taxation regime is set out in the Inland Revenue Ordinance.

In addition, ad valorem stamp duty is levied on transfers of shares in Hong Kong companies and on agreements for sale of residential land and conveyances of nonresidential land. Ad valorem capital fees are payable on the authorised capital of a company and on increases in capital. Estate duty is charged on the aggregated value of assets located in Hong Kong on death where the total value of such assets exceeds HK$7,500,000. Sweeping anti-avoidance provisions apply where companies are used to avoid Hong Kong estate duty.

There is no separate tax on interest in Hong Kong but in general, interest earned by financial institutions from the carrying on of banking and similar financial activities in Hong Kong and by other businesses where the interest has a Hong Kong source, is liable to profits tax. However, interest derived from deposits placed in Hong Kong with Hong Kong licenced banks, restricted licenced banks or deposit taking companies by companies or other persons (who are not financial institutions) generally will not be subject to profits tax unless the deposit secures a borrowing the interest expense of which is tax deductible.

Dividends are not subject to tax and there is no withholding tax on dividends or interest paid to non-residents. There is no capital gains tax in Hong Kong but profits arising from trading in shares, commodities or land are liable to profits tax.

The Inland Revenue Ordinance provides for a system, known as personal assessment, under which resident individuals can elect to have tax liability calculated by reference to total taxable income from all sources.

Although when compared with many taxation systems, Hong Kong tax is relatively simple in concept and application, we recommend that clients take specific tax advice when establishing operations in Hong Kong to consider the most tax effective way of structuring operations. Tax evasion is viewed as a serious matter in Hong Kong and there are various specific anti-avoidance provisions and also two general antiavoidance provisions in the legislation.

2. Property tax

Property tax is charged on the owner of land or buildings located in Hong Kong at the rate of 16% of, generally, the actual rent or other consideration received, less the amount of any rates paid by the owner and also less an allowance of 20% for repairs and maintenance. Owner occupied buildings are exempt from property tax liability.

3. Salaries tax

General

Salaries tax is charged on income arising in or derived from Hong Kong from:

(1) any office of employment or profit

(2) any pension

Income

The income which is subject to salaries tax includes wages, salary, leave pay, fees, commission, bonus, gratuity, perquisites and allowance. Examples of payments which are not subject to salaries tax include severance payments and long service payments and (up to a limit of HK$12,000) employees' mandatory provident fund contributions.

Source

The rules which have been established for determining whether income derived from employment arises in or is derived from Hong Kong can be summarised as follows:

(1) Employees with Hong Kong employment are subject to salaries tax on all their income, irrespective of where they work, except in respect of any income earned for services rendered in another territory which is taxed in that territory or unless the employee visits Hong Kong for not more than 60 days in any tax year.

(2) Employees with non-Hong Kong employment are only subject to salaries tax on that part of their income which is derived from services performed in Hong Kong.

Therefore, employees with non-Hong Kong employment who work partly in Hong Kong and partly outside Hong Kong will be subject to Hong Kong salaries tax only in respect of income attributable to the proportion of their income which relates to services performed in Hong Kong. The apportionment can be done by reference to
days in/out of Hong Kong or the value of the services performed in Hong Kong. If an employee is a visitor to Hong Kong who spends not more than 60 days on such visits in any tax year, no salaries tax will be payable in respect of services rendered during such visits.

Directors' fees

Directors' fees paid to the directors of a company which is controlled and managed in Hong Kong are chargeable to salaries tax irrespective of where the director resides. For this purpose any person holding a position similar to that of a director will be regarded as a director.

Deductions

Deductions from assessable income may be made for certain outgoings and expenses which have been wholly, exclusively and necessarily incurred in the production of the assessable income. It is, however, rare for an employee to succeed in making a claim for such a deduction. Accordingly, in Hong Kong, emphasis is placed on reducing assessable income by the use of non-taxable benefits rather than expenses in the case of salaries tax. Deductions are permitted for contributions of employees to mandatory provident fund schemes up to a limit of HK$12,000 per year.

Benefits

Non-salary benefits should be tax-deductible expenses for the employer and will, generally speaking, not be subject to salaries tax if:

(1) the benefit is not in the form of "money or money's worth"

(2) in the case of a payment made by the employer for the benefit of an employee, the employer (and not the employee) has the primary obligation to pay for the benefit and no other person has guaranteed payment

(3) the benefit is not in connection with the education of a child of the employee.

Special tax rules apply to accommodation. The taxable amount is generally restricted to a maximum of 10% of the employee's remuneration provided that certain conditions are observed.

Rates of tax

Tax is charged on a progressive scale up to 20% after generous personal allowances but this is subject to a maximum effective rate of 16% applied to gross income. The amount of personal allowances to which a salaries tax payer is entitled depends on a person's marital status and the number of children and other dependents.

Returns

Employers must file returns of remuneration paid to and benefits provided for employees and must notify the Commissioner of Inland Revenue when employees are employed or are about to leave employment. The procedure to be followed by an employer where an employee is about to leave employment is important and should be closely observed.

Provisional salaries tax

There is a system of provisional salaries tax in Hong Kong. A provisional assessment for the current year is made based on the previous year's final assessment and tax is charged accordingly. Once the actual income for the year of assessment is known, a final assessment is issued based on the actual income crediting the provisional salaries tax already paid.

4. Profits tax

General

Individuals, partnerships, corporations and other bodies carrying on business in Hong Kong are liable to pay profits tax on those profits which arise in or are derived from Hong Kong. The corporate profits tax rate is currently 17.5% of assessable profits and the rate for sole proprietors and partnerships is 16%.

Source of income

It can sometimes be difficult to determine whether or not profits have a Hong Kong source. However the broad guiding principle is "what did the taxpayer do to earn the profits in question and where did the taxpayer do it?".

By way of example the following activities would normally amount to the carrying on of business in Hong Kong which would give rise to profits with a Hong Kong source:

(1) manufacturing in Hong Kong

(2) performing services in Hong Kong

(3) selling goods in Hong Kong

(4) appointing an agent in Hong Kong with general authority to negotiate and conclude the contracts.

Certain profits, including receipts from the use of films, the use of intellectual property rights or the hire of movable property in Hong Kong, are deemed to be profits of a business carried on in Hong Kong and to be profits which arise in or are derived from Hong Kong. Profits from arm's length licensing arrangements attract tax at 5.25% thereof, provided that various conditions are satisfied. Special provisions apply to:

(1) insurance and ship and aircraft owning companies

(2) disposals of certain discounted financial instruments

(3) profits of financial institutions in respect of interest derived from financial business carried on in Hong Kong

Chargeable profits and deductions

In general, only the difference between gross Hong Kong profits and Hong Kong expenses incurred in producing profits is assessable to profits tax. Interest paid is only deductible if it is of a revenue nature and only then if various specific conditions are met. Provision is made for depreciation allowances for approved capital expenditure.

Subject to certain anti-avoidance provisions, business losses may be carried forward and set-off against future profits. There are no provisions for transferring the benefit of losses between group companies or for carrying back terminal losses.

Tax year

The tax year in Hong Kong runs from 1st April to 31st March and businesses potentially liable to profits tax are usually issued with a tax return in April or May of each year requesting that they complete the return and furnish it to the Inland Revenue Department with the relevant accounts within one month of the date of issue of the return. Profits for a particular tax year are usually based on the profits earned in the accounting period ending in the year of assessment.

Provisional profits tax

The Inland Revenue Department issues a provisional profits tax assessment for each year of assessment at the same time as it issues a final profits tax assessment for the preceding year. Provisional tax is applied first against profits tax payable on the profits of the current year of assessment. When the final assessment is calculated any underpayment of tax is added to the provisional profits tax assessment for the following year.

Who is responsible?

The secretary, managers and directors of a company are each responsible for ensuring compliance with the company's obligations under the Inland Revenue Ordinance. Where there is no one from the company resident in Hong Kong who can be so responsible, the company is obliged to appoint a "tax representative" and advise the Commissioner accordingly. The Registrar has the power to impose penalties in relation to late filing and payment of taxes so care should be taken to comply with the time limits imposed by the Registrar.

5. Stamp duty and capital fee

Share transfers

Stamp duty is levied on the transfer of shares in Hong Kong companies at an effective aggregate rate of 0.2%. (There are exemptions available for intra-group transfers and we will be pleased to provide advice about these exemptions on request). Duty is charged on the consideration for the transaction or, if higher, the market value (as assessed by the Stamp Office based on the company's most recent accounts or other supporting documentation) (see Guide to Setting up a Business in Hong Kong (2) - Hong Kong Companies).

Sale and purchase agreements and conveyances of land

Stamp duty is payable on "agreements for sale" (which is widely defined) of residential land at the maximum rate of 3.75% and on conveyances of non-residential land, at the same rate. Lower rates apply where the sale price or gift value does not exceed various thresholds which are regularly increased in line with inflation. Where ad valorem duty has been paid on an agreement for sale of residential land, a fixed duty of HK$100 is payable on the conveyance.

Capital fee

A capital fee of 0.1% is payable on the nominal value of, and on any increase in, the authorised share capital of a company and on any premium on the allotment of shares. It is capped at $30,000 per case.