|1. What are the current rates for Profits Tax?
Profits Tax rates as from 2004/05 onwards:
(1) Normal rate
Corporations (businesses/companies incorporated according to the Companies Ordinance e.g. limited company):
Unincorporated Businesses (businesses/companies NOT incorporated according to the Companies Ordinance e.g. sole-proprietorship or *partnership):
(*If one of the partners in a partnership is a corporation, the profit tax rate on that partner is 17.5%)
(2) Concessionary rate
A tax rate at 50% of the normal profits tax rate will be applied to trading profits and interest income received or derived from qualifying debt instruments issued in Hong Kong , and to the offshore business of professional reinsurance companies.
2. What are "assessable profits"? How to interpret the "basis period" for Profits Tax purposes?
The term "profit" is not clearly defined in the Inland Revenue Ordinance. In general, the assessable profits (or adjusted loss) are calculated by normal accounting principles with further reference to the statutory allowable income/receipts and deductions for the basis period. The basis period is not necessary the same as the year of assessment (1 April to 31 March of the following year).
The basis period of your business can be either:
- the year ended 31 March during the relevant year (i.e. same as the year of assessment);
- where the annual accounts are made up to any day other than 31 March, the year ended on that day in the relevant year (e.g. if your company's annual A/C closed on 31 May every year, the account you have to submit in the year of assessment 2005/06 will be from 1/6/2004 to 31/5/2005);
- where the accounts are made up for each lunar year, the lunar year ended in the relevant year;
- where you commence a new business, please refer to the following :
"Basis period" for Profits Tax in the case of a new business
Suppose your business commenced on 1 July 2004 and your company's accounting period ends on 31 December every year (i.e. the first accounting period ends within the year of assessment 2004/05), the basis periods would be:
- Year of assessment 2004/05: 1 July 2004- 31 December 2004;
- Year of assessment 2005/06: 1 January 2005- 31 December 2005
If your business commenced on 1 July 2004 but the accounting period ends on 31 May every year (i.e. the first accounting period does not end within the year of assessment 2004/05), the basis periods would be:
- Year of assessment 2004/05: Nil
- Year of assessment 2005/06: 1 July 2004- 31 May 2005
- Year of assessment 2006/07: 1 June 2005- 31 May 2006
(Note: For cessation of business , the basis period for your tax return depends on whether or not the business commenced on or after 1 April 1974. It involves complex calculation rules so you should seek advice from the Inland Revenue Department or a certified accountant.)
3. Is there any difference in the reporting requirements for a sole-proprietorship business and a partnership business?
The reporting requirements are basically the same but the relevant tax returns are different:
4. I run a business on my own and need to declare "assessable profits" in the tax return. Must I engage a professional accountant to prepare the accounts?
- For a sole proprietorship business, the proprietor should declare the profit / loss in Part 5 of the Tax Return- Individuals (B.I.R. 60).
- For a partnership business, the precedent partner should complete and sign a Profits Tax Return - Persons Other Than Corporations (B.I.R. 52).
- When there is a change from sole-proprietorship to partnership during the accounting year or vice versa, the profit / loss for the full year should be reported in the Profits Tax Return - Persons Other Than Corporations (B.I.R. 52).
There is no requirement under the law for engaging any professional service for the preparation of accounts for sole-proprietorships or partnerships . If you possess the necessary accounting and taxation knowledge, you may prepare your own accounts. You may also employ a bookkeeper to do so.
Since the calculation of accessible profits always involves the use of accounting principles, you may find it both helpful and safer to hire an accountant/auditor to handle your taxation matters.
5. If I have not appointed any accountant to handle my company's taxation matters, are there any calculation aids available to help me compute the "assessable profits"?
The "assessable profits" are the net profits (or losses) for the basis period , arising in or derived from Hong Kong and calculated in accordance with the Inland Revenue Ordinance.
The Inland Revenue Department has provided samples of Proforma Tax Computation Form (Form IR 957A(e)) (for sole-proprietorship business ), and Pro forma Profits Tax Computation Form (Form IR957)(for partnership business ). You may use these forms to make the necessary adjustments to your net profit in your accounts in order to arrive at the amount of profit you will be assessed on.
If you have further queries about the computation method, please seek professional advice from a certified accountant.
6. Can I apply for paying less tax, or for the holding over (deferring payment) of Provisional Profits Tax?
There are some grounds for the holdover of Provisional Profits Tax as stipulated in section 63J of the Inland Revenue Ordinance. To highlight a few, they include:
- Your assessable profits for the year of assessment are, or are likely to be, less than 90 per cent of the assessable profits for the preceding year; or
- You have ceased, or will before the end of the year of assessment cease, to carry on your trade, profession or business.
Your application must be made in writing and received by the Inland Revenue Department not later than 28 days before the due date for payment of the provisional tax, or 14 days after the issue of the demand note concerned, whichever is the later.
7. The gross income of my sole-proprietorship business during the year was below $500,000. Do I need to retain this year's business records, and if so, for how long? Do I need to attach the Balance Sheet and Profit & Loss Accounts to my Tax Return?
As the gross income of your sole-proprietorship business did not exceed $500,000, you are not required to submit the Balance Sheet, the Profit and Loss Accounts and the supporting schedules with your tax return.
However, according to section 51C of the Inland Revenue Ordinance, any person carrying on a business in Hong Kong must keep sufficient business records of income, expenditure, assets and liabilities, in English or in Chinese, to enable his/her assessable profits to be readily ascertained. Records relating to any business transaction must be retained for at least 7 years after the completion of the transactions, acts or operations to which they relate.
Failure to keep sufficient records may result in a fine of up to $100,000, and estimated assessments being raised on your business.
8. If not every receipt/income from my business is taxable, which is taxable and which is not?
Receipts arising from day to day business operations are normally your operating income and are taxable.
Proceeds from the sales of fixed / capital assets are capital receipts and are usually non-taxable.
Income closely connected with your business operations is also taxable, including:
- rental income received from sub-letting part of your business premises;
- rebates received from trade associates; and
- the forfeiture of trade deposits or compensation money from customers arising from the cancellation of ordinary business contracts.
Sale proceeds arising from the sale of your business entity as a going concern or of your fixed assets are normally of capital nature and are non-taxable. You should however keep in mind the specific provisions in the Inland Revenue Ordinance which relate to the treatment of stock and machinery and plant under such circumstances (seek advice from a practicing lawyer or accountant if required).
The following income/receipts are also taxable :
- trade debts that were claimed irrecoverable, and deducted from the previous years' assessable profits, but which have subsequently been recovered from customers;
- grants and subsidies (unrelated to capital expenditures) you received from the Government or other parties;
- rental/charges for the hiring of your computers, equipment and machines;
- sums for the use or right to use in Hong Kong of a patent, design, trademark, copyright material or a secret process/formula etc. received by you; and
- sums received for the transfer of a right to receive income.
The following income/receipts are non-taxable :
- proceeds from the sale of fixed/capital assets;
- proceeds from the sale of business interests/goodwill;
- compensation for early termination of business tenancies;
- dividends from corporations subject to Profit Tax separately;
- amounts already included in the assessable profits of other persons chargeable to Profits Tax;
- interest on Tax Reserve Certificates;
- interest on, and any profit made in respect of a bond issued under the Loans Ordinance (Cap. 61 of the Laws of Hong Kong) or the Loans (Government Bonds) Ordinance (Cap. 64), or in respect of an Exchange Fund debt instrument or in respect of a Hong Kong dollar-denominated multilateral agency debt instrument;
- interest income and trading profits derived from long term debt instruments; and
- sums received or accrued in respect of a specified investment scheme by or to a person :
- in relation to a mutual fund, unit trust or similar investment scheme that is authorized as a collective investment scheme under section 104 of the Securities and Futures Ordinance (Cap. 571); or
- in relation to a mutual fund, unit trust or similar investment scheme where the Commissioner is satisfied that the mutual fund, unit trust or investment scheme is a bona fide (truly and honestly) widely held investment scheme which complies with the requirements of a supervisory authority within an acceptable regulatory regime.
9. If not every expense/outgoing is deductible from the assessable profits, which ones are deductible?
Business expenses related to your day to day operations are normally deductible as your operating expenses, such as:
- rents paid on business premises/quarters for employees;
- light, water and telephone charges for business premises;
- salaries, wages, allowances, bonuses for the hiring of employees;
- employer's mandatory and voluntary contributions to MPF schemes or MPF-exempted Recognized Occupational Retirement Schemes (but the deduction is limited to 15% of the total emoluments of the employee for the period to which the payments relate);
- MPF mandatory contributions as a self-employed person for the sole proprietor or partner, not exceeding $12,000 per year per person;
- severance or long service payments paid at the termination of employment;
- interest on funds borrowed for normal business operations, such as for the purchase of stock (but must satisfy the conditions laid down in section 16(2) of the Inland Revenue Ordinance);
- bad or doubtful debts (i.e., sales duly recognized as your turnover but for which you cannot collect payments from customers);
- costs of repairing articles, premises, machinery and plant used in producing profits; and
- approved charitable donations of not less than $100, but not exceeding 25% (as from the year of assessment 2004/05) of your assessable profits.
There are also some allowable deductions by way of tax incentives which include:
- registration costs of a trademark, design or patent for use by the business;
- expenditures on the purchase of patent rights or rights to any know-how for use in Hong Kong in the production of assessable profits (However, the relevant patent rights or rights to any know-how must not be purchased from an associated or related person. ) ;
- expenditures for scientific research including: any systematic, investigative or experimental activities for the purpose of any feasibility study in relation to any market, business or management research; and the costs of machinery and plant for such purposes;
- payments for technical education subject to certain rules;
- 100% write-off of cost in the year of purchase of a "prescribed fixed asset", which includes: machinery or plant used specially and directly in any manufacturing process, computer hardware (other than that which is an integral part of any machinery or plant), and computer software and computer systems, but does not include any leased item or item acquired under hire-purchase terms;
- capital expenditures incurred on the renovation or refurbishment of buildings by 5 equal deductions over 5 successive years of assessment;
- industrial building allowance;
- rebuilding allowance for commercial buildings.
Expenditure on Building Refurbishment
A person who incurs capital expenditure on the renovation or refurbishment of business premises (including hotels and guesthouses) is allowed to deduct that expenditure over a period of 5 years in equal installments commencing in the year in which the expenditure is made.
10. Which expenses/outgoings are NOT deductible from the assessable profits?
Expenses not deductible include (this is not an exhaustive list):
11. Apart for those allowable deductions mentioned in the above Q&A, are there any other allowances available under Profit Tax assessments?
- any loss of capital;
- withdrawals by the sole proprietor/partners;
- any withdrawal of capital;
- any expenditure of a capital nature (e.g. purchase fixed assets);
- the costs of any improvements;
- rent or expenses relating to premises not occupied for the purpose of producing assessable profits;
- any sum recoverable under insurance or contract of indemnity;
- taxes paid under the Inland Revenue Ordinance, except Salaries Tax paid in respect of employees' remuneration;
- any remuneration or interest on capital or loans payable to:
for a sole proprietorship - the proprietor or the proprietor's spouse,
for a partnership - the partners or their spouses;
- domestic or private expenses, including:
medical expenses, insurance premiums, birthday celebration expenses for the sole proprietor/partners and their family members, etc., and
costs of travelling between residence and place of business;
- traffic penalty incurred during the delivery of goods to customers (this is a fine for breaking the law);
- any sum not expended for the purpose of producing assessable profits.
- contributions made to a mandatory provident fund scheme in respect of the proprietor (except mandatory contributions) or the proprietor's spouse or, in case of a partnership, to its partners (except mandatory contributions) or their spouses.
The tax payers may also enjoy "depreciation allowances" as follows:
a) Industrial Building Allowances on Industrial Buildings and Structures
- Initial allowance: 20% on the cost of construction of the premises.
- Annual allowance: 4% on the cost of construction of the premises.
- Balancing allowance or charge will be due upon disposal of the premises.
b) Commercial Building Allowances on Commercial Buildings and Structures
- Annual allowance: 4% on the cost of construction of the premises.
- Balancing allowance or charge will be due upon disposal of the premises.
c) Plant and Machinery
- Initial allowance: 60% on the cost.
- Annual allowance: at rates of 10%, 20% or 30% as prescribed by the Board of Inland Revenue in the Inland Revenue Rules, on the reducing value of the asset. Items qualifying for the same rate of annual allowance are grouped under one "pool".
- A balancing allowance is available only on cessation of a business to which there is no successor. A balancing charge can, however, arise whenever the disposal proceeds of one or more assets exceed the reducing value of the whole "pool" of assets to which the disposed items belong.
12. What is the effect on my liability for Profits Tax if I did not make any profit, but incurred a loss in my business?
The loss can be carried forward for setting off against the future profits of your business. ( NOTE: Losses incurred in a partnership are apportioned between the partners in accordance with their agreed profit/loss sharing ratio. These losses are then dealt with according to whether each partner is an individual or a corporation. Special rules are applicable to limited partnerships, i.e. p artnership with more than 20 partners, as per section 22 B of the Inland Revenue Ordinance.)
Alternatively, if you have other income (e.g. salary income) for the same year of assessment, you can select the Personal Assessment option on your tax return. This will enable you to set off the business loss against your other taxable income. Any unutilized loss can be carried forward for setting off against your taxable income in future years.
You are warned not to falsify your accounts to show a loss in order to evade tax liability. The Inland Revenue Ordinance contains contains anti-avoidance provisions to punish people who evade tax.