Calculating Taxable Income for Hong Kong Companies
- Dec 31, 2024
- 5 min read
Updated: 7 days ago
Hong Kong's Profits Tax System
Hong Kong operates a territorial tax system. This means that only profits that arise in or are derived from Hong Kong are subject to profits tax. Income sourced from outside Hong Kong is generally not taxable, regardless of whether it is remitted to Hong Kong.
This territorial approach makes Hong Kong particularly attractive for international businesses and holding companies. However, calculating taxable income correctly requires a clear understanding of what counts as Hong Kong-sourced income, what deductions are permitted, and how the two-tier tax rate applies.
The Two-Tier Profits Tax Rate
Since the 2018/19 tax year, Hong Kong has applied a two-tier profits tax rate for corporations:
8.25% on the first HKD 2 million of assessable profits
16.5% on assessable profits above HKD 2 million
Only one entity within a group of connected companies can benefit from the reduced 8.25% rate on the first HKD 2 million. If a company is connected to other entities, the group must nominate which entity will claim the lower rate.
What Are Assessable Profits?
Assessable profits are the starting point for calculating profits tax. They are defined as the net profits arising in or derived from Hong Kong from a trade, profession, or business carried on in Hong Kong.
In practice, assessable profits are calculated as follows:
Start with the accounting profit (or loss) per the audited financial statements
Add back any non-deductible expenses that were charged in the accounts
Deduct any amounts that are exempt from profits tax (such as offshore income or capital gains)
Apply any available depreciation allowances
Deduct any brought-forward tax losses
The result is the net assessable profit, to which the applicable tax rate is then applied.
Allowable Deductions
The Inland Revenue Ordinance specifies which expenses are deductible for profits tax purposes. Broadly, an expense is deductible if it is incurred in the production of taxable profits and is not capital in nature.
Commonly deductible expenses include:
Staff salaries, wages, and bonuses
Rent for business premises
Interest on borrowings used to produce assessable profits
Professional fees (legal, accounting, audit)
Repairs and maintenance of business assets
Bad debts that are specifically identified and written off
Contributions to recognised retirement schemes (up to prescribed limits)
Expenses that are not deductible include domestic or private expenses, capital expenditure, income tax paid in Hong Kong or elsewhere, and provisions that are not specific and measurable.
Capital vs Revenue Distinction
Hong Kong profits tax applies only to revenue receipts and revenue expenditure. Capital gains are not taxable, and capital expenditure is generally not deductible as an expense, though depreciation allowances may apply.
The distinction between capital and revenue is not always clear-cut and has been the subject of considerable case law. Key factors that indicate a capital nature include the one-off or infrequent nature of a transaction, the purpose for which an asset was acquired, and the length of time the asset was held. When in doubt, professional tax advice is advisable before filing.
Offshore Income Claims
A company that earns income from sources outside Hong Kong can claim that income as offshore and exclude it from taxable profits. This is one of the most significant features of the Hong Kong tax system and is widely used by trading companies and holding companies with cross-border operations.
To successfully claim offshore status, a company must be able to demonstrate that:
The contracts were negotiated and concluded outside Hong Kong
The goods or services were sourced and delivered outside Hong Kong
Decision-making and control over the relevant transactions took place outside Hong Kong
The Inland Revenue Department scrutinises offshore claims carefully, particularly for companies that have significant management presence in Hong Kong. Since 2023, Hong Kong has also introduced a Foreign-Sourced Income Exemption (FSIE) regime that imposes substance requirements on certain types of passive offshore income (dividends, interest, royalties, and disposal gains) received by companies with a nexus to Hong Kong. Professional advice is essential for companies relying on offshore claims under the current regime.
Depreciation Allowances
Capital expenditure on plant and machinery, and on industrial and commercial buildings, qualifies for depreciation allowances rather than an immediate expense deduction.
The main categories are:
Initial allowance: 60% of the cost of new plant and machinery in the first year
Annual allowance: applied to the reducing value of the pooled assets, at rates of 10%, 20%, or 30% depending on the asset category
Industrial buildings allowance: 4% per year on qualifying industrial building expenditure
Commercial buildings allowance: 4% per year introduced for qualifying commercial building expenditure from 2023
Depreciation charged in the accounts is added back in the tax computation and replaced by these statutory allowances.
Tax Losses
If a company incurs a tax loss in a given year, the loss can be carried forward indefinitely and set off against future assessable profits of the same company. There is no time limit on loss carryforward in Hong Kong.
Losses cannot be carried back to prior years, and group relief (transferring losses between related companies) is not available under Hong Kong tax law. Each company within a group is assessed separately.
Related Party Transactions
Transactions between related parties, such as intercompany loans, management fees, or the licensing of intellectual property, must be conducted on arm's length terms. Hong Kong's transfer pricing rules, introduced in 2018, require that the terms and pricing of related party transactions reflect what independent parties would have agreed in comparable circumstances.
Companies that do not comply with the arm's length standard may have their taxable income adjusted upward by the IRD. Documentation requirements apply to larger taxpayers.
Frequently Asked Questions, Calculating Taxable Income in Hong Kong
Is there a minimum tax in Hong Kong?
No. Hong Kong does not impose a minimum tax or alternative minimum tax. If a company has no assessable profits, or if its allowable deductions and loss carryforwards eliminate all taxable income, no profits tax is payable.
Does Hong Kong tax dividends received from subsidiaries?
Dividends received from a subsidiary are generally not subject to profits tax in Hong Kong, provided the subsidiary is a corporation. Dividends from partnerships or sole proprietorships may be treated differently. Under the FSIE regime introduced in 2023, dividends received from non-Hong Kong entities may be subject to tax if the receiving company does not meet the applicable substance requirements.
How does the offshore claim work for a trading company?
A trading company that buys goods from one country and sells to another, with all negotiations and logistics handled outside Hong Kong, can typically claim that the resulting profit is offshore and therefore not taxable. The key is that Hong Kong should not be the place where the value is created. Companies must maintain documentation to support their offshore position.
Can a Hong Kong company deduct management fees paid to a parent company?
Yes, in principle, provided the fees are genuinely incurred for services actually rendered and are charged at arm's length prices. The IRD will scrutinise management fee deductions closely, so contemporaneous documentation showing the nature and value of services received is essential.
What records must be kept for tax purposes?
Companies must retain sufficient records to enable the preparation of accurate tax returns and audited accounts. Records should be kept for at least seven years from the end of the relevant tax year. These include accounting records, invoices, bank statements, and documentation supporting any offshore claims or deductions.
Are there any tax incentives in Hong Kong?
Yes. Hong Kong offers specific tax concessions for qualifying ship operators, aircraft leasing, corporate treasury activities, and certain professional reinsurance businesses. A patent box regime also provides a reduced profits tax rate of 5% on qualifying profits derived from qualifying intellectual property. These incentives are subject to specific eligibility conditions.
ASC Consulting can assist with profits tax planning, offshore claims, and compliance for Hong Kong companies. Get in touch to discuss your specific situation.
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