According to the Basic Law of Hong Kong, the taxation system of mainland China is not applicable to Hong Kong, which essentially means that Hong Kong enjoys an independent taxation system. Because the city only imposes three direct taxes, Hong Kong has one of the simplest tax systems in the world. There are also generous allowances and deductions to reduce the burden of taxpayers. Apart from direct taxes, certain indirect taxes are also collected, such as stamp duty and betting duty.
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One thing to be noted is that Hong Kong doesn’t have any turnover taxes, including sales tax or value added tax, making it a favorable location for various business activities.
We first introduce the unique features of Hong Kong’s taxation system and then concentrate on its three direct taxes, which constitute a major part of the government’s fiscal revenue. Tax administration is charged by the Inland Revenue Department (IRD). The tax assessment year usually runs from April 1 to March 31 each year. A company may also choose its fiscal year at its own discretion.
The three direct taxes are:
- Salaries tax
- Profit tax
- Property tax
Apart from direct taxes, certain indirect taxes are also collected, such as stamp duty and betting duty.
Hong Kong doesn’t have any turnover taxes, making it a favorable location for profit shifting and conducting re-invoicing activities. Here are taxes that Hong Kong does not impose:
- No sales tax or value-added tax (VAT)
- No withholding tax on dividends and interest
- No capital gains tax
- No tax on dividends
- No estate tax
Hong Kong’s tax administration is charged by the Inland Revenue Department. The tax assessment year usually runs from April 1 to March 31 each year. A company may also choose its fiscal year at its own discretion.
Key features of Hong Kong’s taxation system
Compared to the taxation systems of other jurisdictions, Hong Kong’s tax system has some special features.
Firstly, taxes in Hong Kong are only levied on a territorial basis, unlike most countries which apply both residential jurisdiction and territorial jurisdiction in determining tax liability. That is to say, only income arising in or derived from Hong Kong is taxable, whereas worldwide income is not taxable, irrespective of the residence status of the taxpayers.
Secondly, there is no comprehensive system of income taxation in Hong Kong. Instead, a taxpayer is liable for tax on three different types of income. If an income fails to fall within any of the three specific tax provisions, then it shall not be subject to tax.
Any party, including corporations, partnerships, trustees and organizations involved in any trade, profession or business in Hong Kong, is subject to tax on all profits arising in or derived from Hong Kong (excluding profits arising from the sale of capital assets).
Profits tax is levied based on assessable profits, which is determined by excluding deductions and tax-exempt incomes. It is further reduced by the tax reduction, subject to a maximum.
The property tax is one of the most significant additional taxes that people living in Hong Kong must pay. Property tax is levied on income arising from the letting of immovable property in Hong Kong, which is payable by the owner(s) at the standard rate of the year of assessment on “net assessable value” (NAV). Under the provisions of the Inland Revenue Ordinance, each and every joint owner or owner in common is responsible for reporting rental income on tax returns and paying property tax as if he/she is the sole owner.
Under Hong Kong’s territorial system of taxation, resident and non-resident enterprises are treated alike and are liable for tax on profits arising in or derived from Hong Kong.
When a Hong Kong entity makes payments to a non-resident enterprise or individual for services rendered in Hong Kong, part of the amount must be withheld and paid to Hong Kong’s Inland Revenue Department. The percentage of amount withheld is the withholding tax.
Individual Income tax – Salaries tax
All individuals earning income arising in or derived from Hong Kong from an office, employment or pension are subject to salaries tax in Hong Kong. Tax payable is calculated at a progressive rate on the “net chargeable income” or at a standard rate on the “net income” (before deduction of the allowances), depending on which is lower. It is further reduced by the tax reduction, subject to a maximum.
Transfer pricing is charged when a transferring goods, services, and intangible property between a Hong Kong company and a related entity. The Inland Revenue (Amendment) (No. 6) Ordinance 2018 (“the Amendment Ordinance”), which was gazette on July 13, 2018, established a comprehensive transfer pricing regime in Hong Kong. It codified the transfer pricing principles, implemented certain measures under the Base Erosion and Profit Shifting (BEPS) package and aligned the provisions in the Inland Revenue Ordinance (Cap. 112) with international tax requirements. Hong Kong transfer pricing legislation is an important contribution to prevent tax avoidance in cross-border transactions.
In September 2014, Hong Kong indicated its support for implementing automatic exchange of financial account information (AEOI) on a reciprocal basis with appropriate partners, with a view to commencing the first exchanges from 2018.
[tips title="Important Tip"]Under the AEOI standard, financial institutions are required to identify financial accounts held by tax residents of reportable jurisdictions or held by passive non-financial entities whose controlling persons are tax residents of reportable jurisdictions in accordance with due diligence procedures. [/tips]
Required information of these accounts must be collected and furnished to the Department. Such information will be exchanged on an annual basis.
Audit and compliance
Limited liability firms in Hong Kong are required by law to fulfil all compliance processes or risk fines. The secretary is responsible for managing compliance efforts under the company ordinances, and it is the obligation of the company director(s) to ensure that the secretary is performing their duties. Annual returns to the Inland Revenue Department and the Companies Registry, as well as the upkeep of business information and the filing of company modifications, are all part of the compliance requirements.
As one of the two SARs of China, Hong Kong enjoys the rights to develop its own accounting standards, rather than applying the relative standards of mainland China. The Hong Kong Institute of Certified Public Accountants (HKICPA) is the only organization authorized by law to promulgate financial reporting and auditing standards for professional accountants in Hong Kong.
The accounting standards of Hong Kong are known as the Hong Kong Financial Reporting Standards (HKFRS), which have been fully converged with International Financial Reporting Standards (IFRS) since January 1, 2005. According to the HKICPA, HKFRS are designed to apply to general purpose financial statements and other financial reporting of all profit-oriented entities.