Taxationi Income tax for employees
Hong Kong salaries tax is chargeable on employment income that arises in or is derived from Hong Kong. In determining whether income arises in Hong Kong, the location of the employment must be examined. The most important factors are whether the employment contract was negotiated and executed in Hong Kong, whether the employer is resident in Hong Kong and whether the remuneration is paid to the employee in Hong Kong.
If the employment is located in Hong Kong, the income from such employment will be chargeable to salaries tax, although an exemption is available if an employee renders no services in Hong Kong during this employment, or if the employee is physically present in Hong Kong for no more than 60 days in total in the year of assessment; however, even for employment that is not located in Hong Kong, if the employee is physically present in Hong Kong for more than 60 days and renders any services during that period, the income arising from the services rendered in Hong Kong will still be subject to salaries tax, albeit on a day-in-day-out basis. The salaries tax charge therefore applies to all employees, regardless of their nationality or residency. Salaries tax is charged at progressive rates, with the maximum rate being 17 per cent, but the total tax payable is capped at a standard rate of 15 per cent of the net assessable income.Share options
Salaries tax will be charged upon the exercise of share options. The tax is levied on the gain realised by the exercise of the option, and this gain is calculated as the difference between the fair market value of the shares at the time of exercise and the consideration paid for the grant of the shares.Restricted stock
If there is no vesting period for restricted stock, salaries tax is charged on the fair market value of the shares at the time of grant. Discounts may be made in determining their fair market value depending on the restrictions applicable. Any distributions arising from the shares during any restriction period will not be taxable, as they are investment income. If a vesting period applies, salaries tax is charged on the fair market value at the time of vesting. Distributions that arise from the shares during the vesting period will also be taxable as employment income.Restricted stock units
The legal position on restricted stock units (RSUs) is uncertain, but where they are settled completely in cash, they are most likely regarded as phantom share plans, and no salaries tax will be charged at the time the shares are allocated if no value is passed on to the employee. Salaries tax will be charged when the cash is paid. If RSUs are completely settled using shares, they would most likely be regarded as stock awards, and salaries tax would be charged when the shares vest in the employee. If an RSU is to be settled with a mixture of cash and shares, the tax treatment would depend on the particular terms of the RSU.ii Social taxes for employees
In Hong Kong, employers and employees are each required by law to participate in a mandatory provident fund (MPF) scheme and to each contribute an amount equivalent to 5 per cent of the employee's relevant income (exclusive of severance or long service payments paid under the Employment Ordinance) to the scheme. The employee's relevant income is currently capped at a maximum of HK$30,000 per month for the purposes of calculating the contribution. Accordingly, the maximum mandatory contribution amount required by both employer and employee is HK$1,500 per month.
The requirement to make contributions will apply in relation to all Hong Kong employment, regardless of the nationality or the residence of an employee. An executive director receiving a salary under a contract of employment, for example, will be required to join an MPF scheme; however, a director who receives directors' fees by virtue of being an office holder is not an employee and therefore not required to participate in an MPF scheme. There are, however, some limited exceptions for employees who enter Hong Kong on an employment visa.
Alternatively, an employer may also operate an Occupational Retirement Schemes Ordinance-exempted scheme instead of participating in an MPF scheme. The contributions for such a scheme will be governed by the relevant Occupational Retirement Schemes Ordinance-exempted scheme's governing rules.
Remuneration in the form of share options and other compensation that is not expressed in monetary form is excluded from the employee's income for the purposes of making MPF contributions.iii Tax deductibility for employers
Employee remuneration is generally deductible by the employer for the purposes of profits tax, including regular contributions to an MPF scheme (up to a limit of 15 per cent of the total remuneration); however, only remuneration that can be shown to be an expense incurred in the production of profits subject to tax in Hong Kong will be deductible and therefore some payments to employees may not be deductible.
Remuneration will generally be deductible during the year of assessment in which it is incurred, but it should be noted that the Hong Kong Inland Revenue Department considers that the issue of shares by an employer to employees in fulfilment of share options or stock awards is not an expense but a movement in the equity reserve account of the employer, and therefore no tax deduction is allowed. Payments to a third party (e.g., a listed parent) for the issuance of shares may be deductible under normal rules in relation to deductibility. Where an employer is recharged for shares issued or acquired by another group entity, if there is a written recharge agreement in place, the recharge in relation to both new issues of shares and acquisition of shares from the market by a group entity is allowable for deductions under the current guidelines published by the Hong Kong Inland Revenue Department. However, the employer can claim a deduction for the recharge only at the point of exercise of stock options or the point of vesting of share awards, and the amount claimed must not be excessive.iv Other special rules
Payments made to employees in connection with a change of control will generally not be deductible for the profits tax purposes of the employer, unless it can be shown that the payments are current expenses incurred for the production of profits.
Benefits provided by an employer to an employee in return for services rendered will generally be chargeable to salaries tax if they are convertible into cash. A benefit can be convertible by sale but also by other means: for example, an arrangement whereby the employee can elect to surrender the benefit and accept extra salary instead. Housing and vehicles are frequently provided to employees in Hong Kong on a tax-favoured basis. This is permissible provided that the rules in relation to such benefits are properly followed.