Calculating Taxable Income for Hong Kong Companies
Corporate tax (also commonly known as profits tax in Hong Kong) is calculated on a company’s assessable profits. The assessable profits are calculated by making various adjustments to the company’s net profit and loss accounts for the taxable period.
This is a general guide on various factors that should be taken into account when determining the taxable income of Hong Kong companies. For more information on corporate taxes in Hong Kong, please refer to Income Tax Guide for Hong Kong Companies. To estimate your Hong Kong taxes and to compare those with your home country, refer to Hong Kong Tax Calculator.
A company’s profits tax liability is calculated by making certain adjustments to its net profit and loss data as shown in the following flowchart.
Under Hong Kong law, a company’s net income includes:
- Profits that arise in or are derived from carrying on a business in Hong Kong
- Royalties from intellectual property rights
- Rent from leasing movable property
- Interest income
- Grants, subsidies or other financial assistance
- Gains from bills of exchange or certificates of deposit
- Refunds of contributions to retirement schemes
- Receipts from the exhibition or use of films, tapes or recordings
The following adjustments are made to the company’s net income in order to arrive at the taxable income.
Step 1: Deduct non-assessable profits
Profits of non-assessable nature are deducted from the company’s net income. Non-assessable profits include:
- Profits not arising in or derived from Hong Kong
- Capital received from the sale of capital assets
- Certain dividends or profits for which profits tax has already been assessed
- Interest income derived from a deposit placed in Hong Kong. This does not include interest received by or accrued to a financial institution.
- Other specific exempt receipts under the provisions of the Hong Kong Inland Revenue Ordinance
Step 2: Deduct qualified business expenses
Expenses that are incurred in the production of business income are deductible. Examples of deductible expenses include:
- Expenses connected with borrowing money
- Rent paid for occupying buildings or land in order to conduct profit generating activities
- Foreign taxes paid on income that is subject to foreign tax
- Bad debts written off
- Repair, refurbishment and replacement expenses for machinery, equipment, premises or articles that are used for producing profits
- Trademark and patent registration costs
- Retirement scheme contributions (subject to certain limitations)
- R&D expenses incurred on feasibility studies, market research, product and design innovation, business or management research etc.
- Technical education fees
- Approved charitable donations
- Expenses on purchasing patents, know-how,registered trademarks, copyrights and registered designs
- Capital expenditure on prescribed fixed assets (subject to limitations)
- Capital expenditure on environmental protection machinery
Non-deductible expenses include:
- Domestic or private expenses
- Expenses not incurred in the production of profits
- Cost of making improvements to property or assets
- Sums recoverable under insurance contracts
- Any tax paid other than employees’ salaries tax
- Certain capital expenses or losses that are deemed as “non-deductible” under Sec 17 of the Hong Kong Inland Revenue Ordinance
- Payments to or for the benefit of spouses or partners
- Expenses connected with premises not occupied for profit-generating purposes
Step 3: Deduct unutilized losses
Losses incurred can either be deducted from the company’s income in the same assessment year or carried forward and deducted from income in subsequent assessment years. To be deductible, losses must have arisen from carrying of a business in Hong Kong.
Note that an adjustment factor applies when unabsorbed losses incurred from concessionary trading receipts (trading receipts that are subject to a concessionary rate of tax) are set off against normal trading receipts (trading receipts that are subject to a normal rate of tax) and vice versa.
Step 4: Add balancing charges
A balancing charge arises when the sale proceeds of a capital asset (i.e. building, structure, plant or machinery) exceeds its Written Down Value (cost of the asset minus the amount of capital allowances previously claimed).
Step 5: Deduct capital allowances
Per Hong Kong law, depreciation of a fixed capital asset and expenditure incurred on the purchase of fixed assets are not deductible for tax purposes. Instead, tax relief in the form of capital allowances is available for initial capital expenditure and annual depreciation for wear and tear. Capital allowances are available for business premises and for plant and machinery used in the production of profits. The various types of capital allowances are as follows:
- An initial allowance of 20% is available on capital expenditure incurred on the construction of an industrial building or structure.
- Each year, an annual allowance of 4% of the initial capital expenditure incurred on the construction of an industrial or commercial building is granted.
- 20% of capital expenditure incurred on the renovation or refurbishment of business premises is deductible in equal installments over 5 years, commencing with the year in which the expenditure occurred.
- An initial allowance of 60% is available on capital expenditure incurred on plant and machinery in the relevant year.
- An annual depreciation allowance is available on the reducing value of plant and machinery. The rate of depreciation can range from 10% to 30%, depending on the type of plant and machinery.
- 20% of the capital expenditure incurred on environmental protection installations to a commercial or industrial building is deductible in equal installments over 5 years, commencing with the year in which the expenditure occurred.
- Special provisions apply to plant and machinery under a sale and leaseback arrangement.
Once the above listed deductions and additions have been made, the company’s taxable income is obtained. The appropriate tax rate is applied to this income to determine the profits tax. The normalprofits tax rate for corporations stands at 16.5% on assessable profits and the tax rate for unincorporated businesses stands at 15% on assessable profits.