On 29 March 2018, the Inland Revenue (Amendment) (No. 3) Ordinance 2018 (the Ordinance) was gazetted to implement the two-tiered profits tax rates regime as announced in the Chief Executive's 2017 Policy Address (you can read our client alert on the Policy Address here).
The new regime is aimed at enhancing Hong Kong's competitiveness by reducing the tax burden on enterprises, especially small and medium-sized enterprises (SMEs).
In general, under the Ordinance, the first 2 million HKD of profits of incorporated and unincorporated enterprises will be taxed at half of the applicable standard rate. For corporations, the profits tax rate for the first 2 million HKD of profits will be reduced to 8.25%, while profits beyond the first 2 million HKD will continue to be subject to the standard rate of 16.5%. For unincorporated businesses such as sole proprietorships, the profits tax rate for the first 2 million HKD of profits will be reduced to 7.5%, while the standard rate of 15% will continue to apply to profits above 2 million HKD. These new rules will apply for the years of assessment commencing on or after 1 April 2018. The benefit will be available universally to all businesses, subject to the limit on connected entities as discussed below.
Where there are two or more "connected entities", only one of them will be eligible to the reduced tax rate, as the intended target of the tax benefits is primarily SMEs. This restriction is intended also to avoid possible abuse of the regime by splitting businesses.
Under the Ordinance, the lower tax rate will not apply to an entity if, at the end of the basis period of the year of assessment in question, the entity has any connected entity. However, the Inland Revenue Department (the IRD) may apply the reduced tax rate for a specified year of assessment to an entity if the entity has elected in writing to receive the reduced tax rate, and no other connected entity has received the reduced tax rate for that year of assessment. We expect that the IRD will provide more guidance on how enterprises should make this election.
The term "entity" in "connected entity" means any natural persons, bodies of persons, or legal arrangements including corporations, partnerships, and trusts. In general, entities are considered as "connected entities" if: (i) one of them has control over the other; (ii) both of them are under the control of the same entity; or (iii) in the case of the first entity being a natural person carrying on a sole proprietorship business, the other entity is the same person carrying on another sole proprietorship business. The term "control" is generally defined as more than 50% of issued share capital, voting rights, capital or profits of the controlled entity, held directly or indirectly.
Under the new section 14AAB(4) of the Inland Revenue Ordinance, it would be necessary to trace the ultimate owner through successive layers of interposed companies in order to determine which entities are connected.
No double benefits
The regime will not apply to enterprises that already benefit from an existing preferential tax regime (e.g., professional reinsurance companies, captive insurance companies, corporate treasury centres, and aircraft leasing companies).
Additionally, the regime excludes assessable profits earned on qualifying debt instruments as interest, gain, or profit, which are already taxed at half-rate (i.e., 7.5% or 8.25%, as the case may be).
Transitional provisions regarding provisional profits tax
The Ordinance provides for transitional arrangements in relation to the charging of provisional profits tax for the year of assessment 2018/19. A taxpayer who is liable to pay provisional profits tax in respect of the year of assessment 2018/19 may apply to the IRD for a lower provisional payment if the taxpayer is likely to have lower taxes as a result of the Ordinance. An application must be made no later than: (i) the 28th day before the day by which the provisional profits tax is to be paid; or (ii) the 14th day after the date of the notice for payment of provisional profits tax, whichever is later. The IRD has the discretion to postpone this deadline if satisfied that it is appropriate to do so.