What is Profits Tax (Hong Kong)?

**What is Profits Tax?**

Hong Kong Profits Tax is the principal direct tax on businesses operating in or from Hong Kong. It is administered by the Inland Revenue Department (IRD) and assessed annually. Critically, HK operates a territorial basis of taxation: only profits arising in or derived from a trade, profession, or business carried on in Hong Kong are taxable. Offshore profits are exempt.

**Two-tier regime (since 1 April 2018)**

The two-tier Profits Tax rates were introduced to benefit SMEs: - First HKD 2 million of assessable profits: 8.25% (corporations) or 7.5% (unincorporated businesses) - Assessable profits above HKD 2 million: 16.5% (corporations) or 15% (unincorporated businesses) - Only ONE entity in a group of connected entities can elect to use the lower rate. If a company forms part of a group, it should check whether a related entity has already claimed the preferential rate.

**Source of profits rule**

The territorial basis means the source of profits is the critical question. The IRD uses the 'operations test': where were the profit-generating activities performed? For trading, the key question is where contracts were negotiated and concluded. For service companies, where were the services performed? An offshore profit claim is strongest where all activity occurred outside HK and no HK staff or offices were used.

**Key deductions**

- Computer hardware and software and specified manufacturing plant and machinery can be written off in full in the year the cost is incurred (unlike most jurisdictions that spread deductions). Other plant and machinery gets a 60% initial allowance. Annual allowances of 20%/30%/10% apply to separate asset pools thereafter. - Commercial buildings: initial allowance 20% + annual allowance 4%. - Renovation costs for commercial premises: 20% per year over 5 years. - Research and development: 300% enhanced deduction for qualifying payments to qualifying R&D institutions. - Group loss relief: since 2018, losses can be surrendered between HK group members (75%+ common ownership).

**Assessable profits computation**

Start with accounting profit, then: 1. Add back disallowed expenses (domestic/private expenses, capital expenditure expensed, and any entertainment not incurred to produce chargeable profits). 2. Deduct additional allowances (initial allowances, R&D enhanced deductions). 3. Apply any loss carry-forward from prior years (losses can be carried forward indefinitely; cannot be carried back).

**Payment**

Profits Tax is payable in two instalments: first instalment (75% of the previous year's tax, 'provisional tax') and a balancing payment when the assessment issues. Provisional tax is assessed and demanded alongside the current year return.