The new two-tiered profits tax regime, first announced by Chief Executive Carrie Lam in her Policy Address on 11th October 2017, was brought into force on 1 April 2018 by the Inland Revenue (Amendment) (No. 3) Ordinance 2018. The regime is designed to lower the tax burden for small and medium enterprises (SMEs) and will apply to both corporations and unincorporated business.
As from year of assessment 2018/19, the new profits tax will be levied at a rate of 8.25% (7.5% for unincorporated businesses) on the first HK$2 million (US$255,000) of assessable profits and at a rate of 16.5% (15% for unincorporated businesses) on the remainder of assessable profits.
The law contains restrictive provisions specifying that a group of ‘connected entities’ can only elect one of them to be eligible for the two-tier regime for a year of assessment. It also excludes corporations that have elected to be subject to the special half-rate tax regimes for profits derived from their businesses of professional reinsurers, captive insurers, corporate treasury centres, aircraft lessors or aircraft leasing managers.
Profits derived from qualifying debt instruments, which are already taxed at 8.25%, will not be included in the first HK$2 million threshold under the two-tier regime.
Business restructurings, including the amalgamation of companies, involving a transfer of business from one company to another are generally considered as normal commercial activities. As a result, tax benefits derived under the two-tier regime due to restructurings will not generally be considered as a tax avoidance arrangement.
The Hong Kong government has also introduced a new 300% tax deduction on the first HK$2 million of qualifying research and development (R&D) expenditure incurred by enterprises. Expenditure above this threshold will benefit from a 200% tax deduction. R&D expenditure that does not qualify for the enhanced deduction will continue to benefit from the existing 100% tax deduction, subject to specified conditions.
In order for expenditure on a qualifying R&D activity to be deductible, it must be incurred in relation to the taxpayer’s business and must be:
- Paid to a designated local research institution; or
- Paid to a designated local research institution that has, as an object, the undertaking of a qualifying R&D activity related to the class of business to which the taxpayer’s business belongs, where the payment is used for pursuing that object; or
- Related to an employee engaged directly and actively in a qualifying R&D activity, or a consumable item that is used directly in a qualifying R&D activity.
In the 2018 Budget Speech, Hong Kong Financial Secretary Paul Chan further announced an investment of HK$50 billion in the technology sector and set aside a dedicated provision of HK$500 million for the development of the financial services industry in the coming five years.
For more information about these very welcome developments, please contact our Hong Kong accounting team.