The 3 Tax Benefits Essential for SME Owners
10 minute read
Hong Kong takes pride in its simple, comprehensive, and favorable tax system. However, even though taxes there are considerably lower compared to some other parts of the world, it doesn’t mean that they are non-existent.
There isn’t VAT, withholding tax, or capital gains tax, but as a small business owner, you still have to pay taxes. If this sounds good, you will be pleased to read about three key tax benefits if you are an SME owner looking to set up a small business in Hong Kong.
Profit Tax/ Income Tax Deductions
First of all, let’s take a look at small business tax deductions. As a small business owner, you will have to pay tax on your profits and not on your revenue. Hence, every expense that helped you acquire a profit is deductible from the taxable income.
Section 16 of the Inland Revenue Department Ordinance covers the following deductions:
- Refurbishing building expenses
- IT hardware and plant and machinery expenses
- Installation of environmental protection machinery
- Depreciation allowances
Refurbishing building expenses
This deduction applies to expenditure on renovation or refurbishment of business premises.
These include office renovations, buying new furniture, office hardware, and so on. These spendings do not result in profits directly, but are used by employees for their regular work duties.
The expenses are split into 5 parts and deducted from the income over 5 years including the year they were incurred
IT hardware and plant and machinery expenses
This category covers all SME spendings that are related to technology, including the money spent on company desktop computers, laptops, copiers, all the way to the money you spend on a new production line at your local plant.
These expenses are deducted from the income in full in the year when they were made.
Installation of environmental protection machinery
Companies that buy energy-saving equipment or companies that rebuild a plant to reduce harmful air emissions can enjoy this specific deduction. The complete amount can be deducted from the income in the year it was spent.
Eco-friendly vehicles are covered too, so if your small business buys them, their cost is a deductible expense too.
For companies, Depreciation allowances are deductible too. However, also keep in mind that you need to follow certain rules.
- Firstly, if you build a factory, you can deduct 20% of the cost of construction of the premises in the first year.
- In addition, you can deduct 4% of the cost of construction of the premises on a yearly basis until the whole sum is covered.
On the other hand, there are specific rules that apply to companies once you decide to sell the building.
- If the amount you get paid for it is higher than its residual value, you will have to pay profits tax on the difference. This is called the balancing charge.
- If the process is reversed, the seller gets less than the residual value. This is a deductible expense and it is called the balancing allowance.
- Moreover, if you plan on building commercial buildings, it is good to know that 4% of their construction cost can be deducted annually from the income and there will either be a balancing charge or a balancing allowance.
Tax reduction measures passed by Legislative Council
Finally, you should learn about The Inland Revenue Department (Amendment) (Tax Concessions) Bill 2019, which was passed by Hong Kong’s Legislative Council in 2019. It grants a one-time 100% tax reduction for profits tax, salaries tax, and tax under personal assessment for the year of assessment 2018/19, in all cases subject to a ceiling of HKD 20,000.
Hong Kong has a special corporate tax regime called the two-tier profits tax rates regime, which became effective in 2018/19 (Year of Assessment).
As a Hong Kong SME, you have two options for profit tax rates:
- Single-Tier Corporate Tax System
- Two-Tier Corporate Tax System
According to the Single-Tier Corporate Tax System in Hong Kong, corporations are taxed at 16.5% on assessable profits, while unincorporated companies are taxed at 15%.
The Two-Tier Profits Tax Regime can apply to both Hong Kong corporations and unincorporated businesses. It lowers the tax rate for the first $2 million of assessable profits.
The two-tier profits tax rates system became effective in the year of assessment 2018/19 (i.e., on a taxpayer’s financial year which ended anywhere between 1 April 2018 and 31 March 2019). Its goal is to significantly reduce the tax burden of most taxpaying small and medium-sized enterprises (SMEs).
When it comes to corporations, the first HK$2 million of profits will be taxed at one-half of the current tax rate (8.25%) and the remaining profits will continue to be taxed at the existing 16.5% tax rate.
On the other hand, unincorporated small businesses follow different rules. The first HK$2 million of profits will be taxed at one-half of the current tax rate (7.5%) and the remaining profits will be taxed at the existing 15% tax rate.
Bear in mind that only a single entity within a group of connected entities can enjoy the two-tier rates. Due to this, the group has to identify which entity will benefit and make the selection accordingly.
Here are the applicable small business tax rates:
A one-off reduction of 75% of the profits tax for the year of assessment 2017/18 is applied, applied to a maximum of HKD 30,000 per case.
In the Budget for 2019/20, a one-off reduction of 75% of the profits tax is proposed for the year of assessment 2018/19, applied to a maximum of HKD 20,000 per case.
However, bear in mind that various enterprises need to be excluded from the two-tiered profits tax regime in order to avoid double benefits.
Relief from double taxation
The relief from double taxation is either prescribed by tax laws or under the specific DTA.
Generally, there are four ways of relieving double taxation in Hong Kong:
- Tax credit relief. Under the credit system, a taxpayer’s foreign tax is credited against their domestic tax on the same income. Under the credit method, the residence jurisdiction is required to grant a tax credit for tax payable in the source jurisdiction.
- Tax exemption. Foreign income is exempt from domestic tax. The exemption may apply to the entire part of the foreign income.
- Reduced tax rate. These benefits usually apply to interest, dividends, and royalties.
- Relief by deduction. Domestic tax applies to the foreign income but after deducting foreign tax suffered.
According to treaties and double taxation agreements concluded by Hong Kong, double taxation is eliminated by an allowance of a tax credit.
How can I reduce my taxable income?
There are four steps that should be taken to reduce the taxable income:
- Figure out total assessable profits
- Deducting business expenses
- Deducting unutilized items (losses, capital allowances, and donations)
- Adding balancing charges
To determine the total assessable profits, you should know that Hong Kong relies on its territorial basis of taxation. Only profits arising in or derived from Hong Kong are subject to corporate taxation.
You should then verify the source of profits. The IRD uses a range of methods to determine the source of profits. A good assessment requires an examination of the nature of the profits and the transactions and operations resulting in those profits.
Bear in mind that a lot of expenses incurred in the production of profits are deductible in Hong Kong. These usually include interest, rent, repairs, intellectual property, research development, employee fund contributions, and director fees.
Also, make sure to deduct unutilized items. Firstly, think about the deductible losses. These arise from business conducted in Hong Kong and they can be deducted against future profits.
When it comes to capital allowances, annual depreciation allowances are permitted for the depreciation of machinery and production plants. The annual rate of depreciation can range between 10% and 30%.
Donation sums, each exceeding HK$100 made to registered charities are deductible. These may not exceed 35% of total assessable profits.
Finally, ensure that there are no excessive claims for small business tax relief. Balancing charges may be added, but you should increase the amount of assessable profit. These charges occur when the earnings from the sale of a capital asset exceed their written-down value.
Clearly, in order to reduce the taxable income, you should make greater use of unutilized items and small business expenses. No tutorial will be provided, but think about how you can increase these two and you will figure out how they can help with the reduction.
What can you write off as a small business owner?
Solely expenses which are incurred for the production of business income are tax-deductible. However, this definition leaves some grey area regarding what expenses can be deducted in Hong Kong.
Additionally, some people have difficulty understanding what expenses may be personal and what may be considered business-related.
For instance, a director of the small business in Hong Kong takes a trip overseas for working purposes but happens to meet up with a friend. In this situation, it is down to the small business to determine whether the expenses are legitimately business-related or not.
All in all, expenses that are linked to business operations can be considered tax-deductible.
The table below should make this issue clearer:
How do tax breaks help businesses?
It should be a high priority for every entrepreneur to take advantage of various tax incentives that Hong Kong offers. For instance, profits tax exemption for eligible onshore and offshore funds operating in Hong Kong is quite attractive.
Other prominent tax incentives a proprietor can look for include:
- 100% write-off for new expenditure on plant and machinery specifically related to manufacturing and on computer hardware and software (owned by the end-users).
- 5-year write-off for capital expenditure on the renovation or refurbishment of the workspace.
- 100% deduction of capital expenditure on environment protection machinery and eco-friendly vehicles.
- Tax concession for captive insurers. It comes in the form of a 50% reduction of the profits tax on offshore risk insurance business, taking effect from the year of assessment 2013/14.
- 100% profit tax deduction for capital expenditure incurred in connection to environmental protection installations, where the expenditure is incurred in a year of assessment starting on or after 1 April 2018.
- 100% profit tax deduction for capital expenditure on eco-friendly vehicles in the year of purchase, with effect from the year of assessment 2010/11.
- Profit tax deductions for capital expenditure which are incurred by enterprises when purchasing intellectual property rights (e.g. copyrights, patents, know-how, copyrights, registered trademarks and designs, rights in plant varieties, in performances, etc.).
Hong Kong anti-epidemic relief measures
The world is currently facing a viral outbreak that hinders some small businesses more than others. However, the Hong Kong government takes great care of businesses, both local and foreign-owned.
In response to this situation, the authorities issued The Exemption from Salaries Tax and Profits Tax Order (anti-epidemic fund). This was issued in May 2020 following the release of considerable stimulus packages to support small businesses and individuals negatively impacted by the COVID-19 outbreak.
This order came into effect on May 29, 2020 and it applies from the year of assessment 2019/2020.
It provides tax exemptions for most of the financial assistance as well as subsidies granted under the Anti-Epidemic Fund (AEF) to individuals and businesses.
Hopefully, you are now familiar with all the important tax benefits for SME in Hong Kong. SME owners can rest assured that the business climate in the region will stay quite positive and attractive.
If you have any questions about this topic, feel free to contact us. Reach out to Sleek for help and our experts will be there for you and your Hong Kong SME every step of the way.