- Introduction to Hong Kong Taxation System
- Legal Obligations of Taxpayers
- Objection to a Tax Assessment
- Handling Enquiries from IRD
- “Error or Omission” in Tax Assessment
- Power of IRD’s assessors
- The Burden of Proof – in case of tax dispute or evasion
- Rights to Objection and Appeal
- Advance Tax Ruling by IRD
- Tax Penalty
- Tax Recovery
- Personal Assessment (PA)
- Double Taxation Relief (DTR) in Hong Kong
- IRD’s viewpoint on Tax Avoidance and Tax Evasion
Introduction to Hong Kong Taxation System
The only 3 direct income taxes in Hong Kong are as follows:
- Salaries Tax
- Profits Tax
- Property Tax
Apart from the income taxes mentioned above, there are also a number of government charges, fees, rates, duties … etc. Overall, the tax system in Hong Kong is simple and low, below are noticeable points for overseas entrepreneur:
- Only the income and profit arising in and derived from Hong Kong are taxable (The Territorial Source Principle of Taxation).
- Corporation’s profits tax rate is 16.5% (from 2008/09 onward).
- For most of medium to low income individual taxpayer who is a resident in Hong Kong, he may elect for Personal Assessment as a effective tax relief so all of his income under the assessment of above 3 direct income taxes are computed like Salaries Tax in overall.
- Individuals’ salaries tax rate does not exceed 15%, low to medium income earners are taxed at lower rates under a progressive-rate system starting at 2% (from 2008/09 onward).
- When individual taxpayers’ total income is lower than their total personal allowances, they are exempted from tax on their personal income.
- The tax law in Hong Kong is stipulated in the Inland Revenue Ordinance (IRO), Chapter 112, and its supplementary Inland Revenue Rules and different orders made by Chief Executive under the Ordinance. As Hong Kong has been adopting common law as well as the IRO originates from tax law in UK, the court may follows tax cases of the UK and other countries adopting common law for reference of interpretation about the Hong Kong law of similar wordings when tax cases are going to courts occasionally.
- Zero tax on capital gains, dividends or interest.
- The anti-avoidance law is well-established since Hong Kong tax rate is reasonably low.
- Capital expenditure is not deductible from income. However, generous allowances are granted for expenditure from the direct production of profits.
Legal Obligations of Taxpayers
Never game the tax authority (i.e. Inland Revenue Department), anyone who breaks the tax law has price to pay from money fines to criminal prosecution. Here are advice for every taxpayer:
- Keep business and accounting records for 7 years, make sure every material is true.
- File the tax return correctly, deceive the return leading to criminal prosecution.
- File the tax return on-time, apply for extension of submission before deadline if you are unable to finish it on time.
- Ensure all the information and material you provided to IRD is correct, if the required one is unavailable, be honest to reply.
- Pay tax on time. (Beware: the surcharge on unpaid tax is very high, much more than the market interest rates).
- Inform IRD if you:
- cannot receive the tax return from IRD (within 4 months after the year of assessment).
- found any error in the submitted documentation (immediately).
- no longer have a Hong Kong-sourced income (within one month).
- leave Hong Kong for a period (at least one month before your departure).
- change your registered address (within one month).
Objection to a Tax Assessment
If you disagree to the assessment, you can reply to IRD within one month of the issues date of the notice. Here is the steps to lodge your request:
- have a written notice of objection signed by you to IRD
- send it to IRD within one month from the date of assessment
- state your reasons of objection clearly in the objection
- file a tax return if you have not done so.
If you miss the deadline of objection, it is still possible to ask IRD to accept your late objection by the grounds and supporting document as follows:
- absent from Hong Kong, or
- serious sickness or medical condition, or
- any causes that stopped a taxpayer to lodge the objection
Usually, after your objection is submitted, you should expect the follow-up as follows:
- If the estimated assessment is done without your tax return submission, the taxpayer must complete tax return in support of his objection.
- When an objection is filed in IRD (i.e. valid objection), IRD will order the amount of tax to be held over until the result of objection (i.e. hold-over order) . Taxpayers will be informed in the form of a standard letter. Unless IRD stated the otherwise, the taxpayer should pay the full amount of tax that is state in the Notice of Assessment on time although part of the amount is in dispute. If the undue delay in IRD dealing with the objection, the surcharge generated by the late tax payment will be waived.
- The taxpayer will have to pay the tax plus interest for the tax being held over if the taxpayer finally lose the objection, interest rate is based on the prevailing court-judgment rates. If IRD orders “no hold-over of tax in dispute” and the taxpayer wins the case at last, then only the overpaid tax will be refunded without gain of interest.
- For objection against an additional assessment, no revision will be made to the original assessment.
- For objection again a Personal Assessment (PA), no revision will be made to all of its composite assessments.
- When an assessment is under processing of objection, it will be subject to overall revision and affect the grounds of objection.
Please pay attention to the procedure of IRD to handle objection, the IRD usually request the taxpayer and relevant parties to supply information in connection to the claim of objection, taxpayers are always required to provide accounting books. Then, IRD may allow the objection, or revise the assessment, or ask for withdrawal of objection. In case no agreement from the taxpayer is made, the case will be submitted to the Commissioner who will make decision to the objection by assessment confirmation, reduction, or raising on the the assessment.
If the taxpayer disagrees with the Commissioner’s decision, he can appeal to the Board of Review, the taxpayer must bear all the burden of proof that the assessment is excessive. the Board will decide on the case after investigate on the information from the taxpayer and IRD. If no agreement is made between after the Board’s decision is made, either party can request the Board to refer the case to the court.
On the other hand, taxpayer can log your case to Revenue’s Complaint Officer if you are dissatisfied with the service provided by IRD.
Handling Enquiries from IRD
The IRD assessor is required to questions the unclear items found in your tax returns, when you receive IRD letters of enquiries, you are advised to handled them promptly and seriously, careless taxpayer’s answers can lead them to troubles afterwards.
From experience, neglect or reluctance is bad handling to the queries, the taxpayers must suffer penalties and unfavorable assessment from the IRD; Giving false answers or deceitful material is the worst, they must be facing in-depth investigation and liable to even criminal prosecutions.
Most importantly, seeking advice from a tax consultant can save much effort than your cost paid to the professionals.
“Error or Omission” in Tax Assessment
An assessment is deemed as final and conclusive when it fit either one of the situation:
- no filed objection or appeal has been lodged before deadline;
- the objection has been withdrawn by taxpayer, or dismissed by the Board of Review or the Court;
- a revised assessment has reached agreement; or
- an assessment is determined by the Board of Review for not referring this dispute to court in a point of law.
However, IRO enforces IRD’s assessors to make an additional assessment on matters that have not been determined under the objection within 6 years after the end of the year of assessment, the max time limit is extended to 10 year in case of tax evasion. Assessors can revise the assessment to correct “error or omission” within 6 years after the year.
There is no definition of ‘error or omission’, that is to look to their ordinary and literal meaning. Practically, the words “error or omission” may be defined as follows :
- an arithmetical error,
- an omission to claim an expense or deduction or allowance,
- an error or omission of fact, or
- an error of law.
The case of typical examples of ‘error or omission’ are as follows:
- An individual taxpayer included compensation for loss of an employment as assessable income in salaries tax return or Personal Assessment
- An individual taxpayer did not include personal allowance such as married person allowances, child allowances or dependent parent allowance in salaries tax return or Personal Assessment.
- An individual taxpayer did not include deductions such as Home Loan Interest (HLI), charitable donation, contribution to recognized retirement scheme in salaries tax return or Personal Assessment.
- A corporate taxpayer has included an tax computation with error in profits tax return.
- A corporate taxpayer wrongly reported offshore profits in his profits tax return without supporting as respective tax proof from offshore tax authorities.
- A corporate taxpayer did not include depreciation allowances in his profits tax return.
- A corporate taxpayer wrongly included an item which should be a deductible.
- An assessor made mistakes on salaries tax assessment because of incorrect employer return.
- An assessor made arithmetical mistake in computing the assessable profit.
Power of IRD’s assessors
As mentioned above, IRO empowers an IRD’s assessor to make judgment on taxpayers’ assessments based on existing information available and previous assessments. Most of the cases, the assessor judgment is based on the information of a tax return as well as their supplementary documents.
For a taxpayer’s advantages, the tax return and IRD’s inquiries must be completed and returned on time for less trouble. However, if the tax payer failed to complete the tax return, assessors make judgment to give estimated assessment, they can disregard tax return by solely reviewing on the available information.
- a honest and reasonable judgment by assessors should give a 3-fold profits estimation of a local small business which produced steady profits over the years. That judgment is apparently unreasonable based on the available information and previous assessments. The taxpayer can disagree with the estimation and lodge a formal objection to the assessment.
- a individual taxpayer has ceased his sole proprietorship business two years ago but he never report this to IRD or file a tax return about it. The assessor provides an estimated assessment of assessable profits in the years of assessment after the cessation of business for the taxpayer. As a result, these estimated assessments are invalid because of the cessation of trading. Remark to this case, the taxpayer is liable to penalty because of late notice to IRD for change of his business.
The Burden of Proof – in case of tax dispute or evasion
Provided that the assessor’s judgment on the assessment is reasonable and honest, the taxpayer must quote evidence to prove that the assessment is excessive thus incorrect. Since the case related to tax dispute (i.e. not prosecution) which is a civil proceeding, in which the required proof provided by the taxpayer will be considered based on a legal concept named as “a balance of probabilities” – a dispute to be decided in favor of the party whose claims are more likely to be true.
This burden of proof on the taxpayer is written on IRO, the burden is always heavy.
On the other hand, prosecution of tax evasion is a criminal proceeding since tax evasion is crime and is an offence against the public at large and the penalty on conviction may lead to imprisonment. The burden of proof is on IRD. The IRD must collect evidence to prove that the taxpayer had deliberately committed an offence “beyond reasonable doubts” than to prove on “the balance of probabilities” – the jurors are told they can only find the taxpayer guilty if they are convinced “beyond a reason-able doubt” of his guilt.
Since the burden of prove on IRD for a criminal prosecution is much heaver, there are just a few prosecution cases of tax evasion every year. As a result, IRD is inclined to impose penalty prescribed on IRO to the taxpayers.
Rights to Objection and Appeal
As mentioned above, IRO empowers the IRD’s assessor to make an honest assessment according to his judgment, IRO grants taxpayers rights to objection and appeal if he thinks he is aggrieved by the assessment, the steps to initiate an objection and appeal are as follows:
- it is in writing letter (the letter should be signed by the taxpayer or his representative.)
- it is made within one month of the date on the notice of assessment (late objection will normally with ground.)
- it states the grounds of objection (such as excessive assessable income.)
If IRD does not allow or cannot settle a taxpayer’s objection, he will issue a determination on the objection. The taxpayer has the right to disagree with the determination, he can lodge an appeal to the Board of Review within one month after the determination setting out with the grounds.
Board of Review (Inland Revenue Ordinance)
The Board of Review is part of the judicial system for hearing and determining tax appeals. It is an independent statutory body comprising legal experts and prominent public figures appointed by the Chief Executive.
Any taxpayer disagreeing with the IRD’s determination can lodge an appeal to the Board. In order to ensure the effective services, the Board may impose a fee on the appellant taxpayer as measure to screen out trivial appeals. The decision by the Board are final. However, both parties can ask the Board to refer the case to High Court on a point of law, common questions includes one involving a mixture of law and facts.
Advance Tax Ruling by IRD
For companies and individuals, an advance ruling is a IRD’s written interpretation of a transaction which a taxpayer is going to be done according to the current tax law, this possibly minimizes future dispute between the taxpayers and IRD.
Any taxpayer can make a request to IRD for the services of advance tax ruling. However, the ruling will not make any interpretation on the following:
- Tax Recovery;
- The correctness of a taxpayer’s tax return;
- To determine or establish a question of facts;
- To make assumption on a future event;
- Tax return which has been already filed with IRD;
- The matters for an objection or appeal;
- To form an opinion to a generally accepted accounting principle or a commercial practice;
- The interpretation of a foreign law or the application of an Agreement for Avoidance of Double Taxation;
IRD may refuse to provide the ruling when IRD holds and states opinion on the taxpayer or the case:
- not seriously contemplated by the taxpayer;
- frivolous or vexatious;
- the taxpayer has not provided all the relevant information;
- requires excessive resources; or
- a subject of the Revenue’s tax audit or tax investigation.
IRD is able to withdraw the ruling at any time, and the ruling is done based on current tax legislation. In other words, is ruling is obsolete when the new ruling come.
Service fee for application and service charge are applied, the starting price is HK$30,000 and non-refundable. The cost is relatively heavy for low to medium income taxpayers, it is feasible to seek help from tax consultation profession before the transactions take place.
Hong Kong’s simple tax system with low tax rates cannot function without a high degree of compliance by taxpayers. A tax penalty may be imposed on a taxpayer if he fails to comply with the requirements under IRO.
However, IRD may accept some cases of non-compliance if the taxpayers have a reasonable ground prove as a proof, IRD may exempt or partially reduce the penalty substantially.
A taxpayer may be liable to penalty without reasonable excuse under requirements of IRO as follows:
- fail to file a tax return within the specified time limit.
- fail to keep sufficient business record of his income and expenditure.
- fail to keep sufficient record of his rental income.
- fail to inform IRD of his imminent departure from Hong Kong for more than one month
- fail to inform IRD of his cessation of business within one month
- fail to inform IRD of change of his correspondence address.
- fail to inform IRD of his tax liability within 4 months of the end of year of assessment if he does not receive IRD’s notice of tax return
- fail to pay tax within the specified time limit.
- supply incorrect information.
- make incorrect return.
- omits to disclose any particulars in a tax return that are required.
- make a false statement or entry in a tax return.
- make a false statement in connection with a claim for any deduction or allowance deliberately.
- sign an incorrect tax return or account deliberately.
- give an incorrect answer to IRD inquiries.
- maintain incorrect books of accounts.
- use a fraudulent act to evade tax.
Subject to the court decision, the tax penalty may be ordered on the non-complying. In additional to fine and tax undercharged, imprisonment may be ordered if the non-comply is proved to be involving tax evasion. Other than than, the penalty on late submission or tax payment is fine with the tax undercharged.
Below are the common cases of non-compliance to tax law and possibly leading to tax evasion.
Failing to Keep Sufficient Business Records
The purpose of keeping business records is to assess a taxpayer’s tax liability. For a business, apart from keeping records of bank statements, cheque stubs, daily income and expenditure sheets, vouchers and the cash register tapes, the taxpayer should also prepare and maintain proper accounts for its receipts and payments and for its assets and liabilities. Practically, the daily income and expenditure sheets kept were not regarded as sufficient business records for taxation requirements.
False claim of business expenses
False claim in tax return is a serious crime, and may result in imprisonment no matter the taxpayers or the owners of businesses. For example, Limited Company of sole-director and shareholder is a common business entity for consultation services, the business owner is able to fully deduct the business expense from the business assessable profit. However, the director of this company is fully required to comply with the IRO and liable to penalty personally.
False provision of receipts record
The taxpayer should be also provide correct and sufficient receipt records for income assessment, false provision of receipts record is a serious crime and may result in imprisonment to the taxpayer. For the business involving frequent cash transaction in operation, they should pay extra attention to the receipts records.
Non-disclosure of assessable profits
The director and beneficial owner of a Limited Company is ultimately liable to tax compliance even a 3rd person is abetted to sign the false tax return for hiding profits.
False claim of allowances from salaries income
Most of the individual tax payer in Hong Kong are chargeable to Salaries Tax on their income and benefit from employment. Since their employers must inform IRD for the employee salaries income and benefit, individual taxpayer usually fill in the same assessable income from an employment in their tax return. Apart from that, a taxpayer should carefully examine their ground to claim for allowance. False claim of allowance for salaries tax purpose is an act of tax evasion.
The taxpayer is liable to pay surcharge in addition to the outstanding tax for the tax default. If IRD take legal actions against the tax defaulter, the tax defaulter is liable to pay court fee plus interest on the judgment sum to IRD. IRD takes immediate action to issue Recovery Notices to third parties including defaulter’s employer, bank, or debtor whoever owe money to the tax defaulter, ordering them to pay the outstanding tax. Moreover, IRD is able to apply to court for disallow the defaulter from leaving Hong Kong.
Installments for tax payment
Tax payer is liable to the surcharge which are not advantageous to tax payers comparing to tax loan offered the financial market. Tax payer must apply for installment payment before due date of tax payment and subjects to IRD decision.
Common procedures for tax recovery
Tax payment is deemed to be in default when it is not paid on or before the “due date”. IRD take immediate tax recovery action against tax defaulter. Without prior notice, surcharge of 5% on unpaid tax is imposed and it is immediately due, if tax is still unsettled, further surcharge of 10% is imposed on the total unpaid amount (i.e. included surcharge of 5%) after the expiry of 6 months from the due date. IRD the send recovery notice to a third party including the defaulter’s bank, employer or debtor.
If IRD still cannot be recovered, it may proceed to legal action for the outstanding tax and surcharge. In some cases, bankruptcy proceedings may also be taken against the taxpayer.
If the tax payer has installments payment approved by IRD, the second installment will become immediately due and recoverable when the first installment of provisional tax is in default.
Personal Assessment (PA)
For individual taxpayer, Salaries Tax, Profits Tax and Property Tax are chargeable on all his personal income arising in or derived from Hong Kong from employment, from business and from premises. For most of the low-to-middle income taxpayer who is chargeable of such income above, he is recommended to elected for PA since all such incomes are assessable under the assessment of salaries tax enjoy progressive tax rate and those deductions and/or allowances which are not offered under the assessment of Profits Tax and Property Tax. In brief, election for PA Assessment is a tax relief measure to lessen the tax burden on major low-to-middle income taxpayers who are liable to such 3 direct income taxes.
Although taxpayer is free to elect for PA, it is not always advantageous comparing to separate assessments. After a numerous computation from cases, a taxpayer is better elect for PC when he meets either one of condition in a tax year as follows:
- has income generated from property (premise) only
- has income generated from business only
- is owner of a let-out property with expense on interest from mortgage of this property
- has losses uncured from business and income from salaries and property
- has income generated from property and/or business but salaries, while:
- makes approved charitable donations
- has expense on recognized self-eduction, residential care, or home loan interest
On the contrary, PA is not a feasible solution of tax relief for taxpayer in the condition as follows:
- has income generated from employment only (e.g. salaries, director remuneration)
- is high employment income earner so that its marginal income is charged in marginal tax rate
- is high business and/or property income earner so that it is more feasible to be charged in standard tax rate
The deadline of election of PA is post-assessment since IRD allowed the taxpayer to elect for PA within 2 years after the end of the year of assessment or 2 months after issue of any assessment for that year, whichever is the later. Furthermore, if objection to the assessment is made by the taxpayer, the election deadline will be extended. As a result, individual taxpayer in Hong Kong is in a advantageous position to compute the most tax efficient assessment.
Double Taxation Relief (DTR) in Hong Kong
For oversea entrepreneur, double taxation relief is one of the headline on their business portfolio. When the same income is chargeable to tax of Hong Kong and to be taxed of a jurisdiction outside Hong Kong, the same income is under Double Taxation Relief (DTR) is the relief granted to certain taxpayers suffering from double taxation provided by a variety of Double Taxation Agreements (DTA) which are signed by the Hong Kong government between with other jurisdictions.
Double Taxation Relief (DTR) is never a choice for those middle-to-low income taxpayer as a approach for tax efficiency, they are advised to seek for the means of generous deductions and allowances offered in Hong Kong tax system. Indeed, this relief is usually applicable to to those “big names” in transportation business such as international airlines and shipping corporations because of the strict requirement.
For the taxpayers who are liable to salaries tax, they see part of or total of their assessable income is NOT derived from Hong Kong employment, seeking for partial or total exemption from assessment due to visiting Hong Kong less than 60 days or no services in Hong Kong is commonly acceptable approach for tax relief.
General profit tax payers who see non-Hong Kong sourced profit should seek for tax exemption on the ground of overseas business operation.
IRD’s viewpoint on Tax Avoidance and Tax Evasion
Since Hong Kong adopts the common law from UK, every taxpayer has a right to arrange his affairs legally to reduce his tax liability and thus tax payable in Hong Kong. In other words, the tax authority should determine the tax payable of a taxpayer bases on the accounting transactions as long as it is “visually appealing”. This idea lays the legal foundation for tax planning.
Tax evasion is a crime and thus it may lead to heavy punishment including imprisonment on the taxpayers. However, tax avoidance is legal as long as the arrangement fulfills with accounting principles and court cases (“Rule is rule”, although tax avoidance is unfavorable to the government and may be immoral to some people.)
Therefore, IRD is empowered to fight against tax avoidance and tax evasion. In practice, tax consultants see that IRD does not have hard ruling to determine if a case is tax evasion or tax avoidance, and IRD are more like to take penal actions on likely artificial or ficitious transactions. In fact, IRD’s published stance to these issues is as follows:
- A scheme can still constitute a case of tax evasion even it is not properly structured, not adequately supported by evidence or not genuinely effected.
- A transaction executed as part of an arrangement is real may not necessarily make that the total arrangement real or legal.
A criminal prosecution against tax evasion is a heavy burden on IRD to collect evidence to prove the offense and the guilty mind, there are a few prosecutions every year. At the same time, the deliberate tax evaders always avoid booking the cash receipt and banking into their accounts, this makes IRD in difficulty in proving the assessable profit as well as the criminal tax evasion.
IRD’s anti-avoidance stance
Prescribed in Inland Revenue Ordinance (IRO), the anti-avoidance provisions empowers to counteract the tax benefits of a tax avoidance scheme. IRD is more likely to rely on it rather than taking prosecutions.
For deciding the taxpayers’ purpose of obtaining a tax benefit, the IRD should consider the matters as follows:
- The perceived manner in which the transaction was entered into or carried out by the taxpayer
- The legal form and economic substance of the transaction
- The financial and legal result done by the transaction
- Change in the financial position of the subject person in an arrangement
- Change in the financial position of the other party to the transaction in an arrangement
- The rights and obligations created in a transaction in which are not likely created between subject persons dealing with each other at arm’s length
- The degree of participation in a transaction of a resident or carrying on business outside Hong Kong
IRO also provides the specific rule to counteract avoidance of tax under specific financial situation.
Against tax avoidance through “loss company”
In this case, “loss company” refers to a company that have booked accumulated loss in the previous assessment years. The amount of loss is able to be setting-off profit in the future.
Hiding profit in “loss companies”
Scenario A: A profitable company recorded considerable amount of assessable profit for the past three tax assessment years. In the middle of current assessable year, the company was forecast to record huge profit this year. In order to avoid profits tax by “hiding” the upcoming assessable profit, this company acquired a dormant “loss company” which had no valuable assets, then transfered its business operations into this company by using this for receipt of payment, the gain in transaction is off-set by the inherited loss of this company. Until all the loss was set-off, this company was wound up.
Buy and sale of “loss companies”
Scenario: Similar to scenario, a profitable company purchased a dormant “loss company”, then transfer its business by injection of business’s capital into this “loss company” until the injected capital set off the accumulated loss. Then, this company was wound up by liquidation, and all the assets were distributed to its owners company in form of dividend.
Since the profitable company’s sole intention of action to purchase a “loss company” is for avoiding taxation on its profit, IRO empowers the IRD to reject all the accumulated loss incurred in the “loss company” for setting off profit.
The profit gained from the injected business is still assessable; The injected capital does no effect on the “loss company” on liquidation.
Against tax avoidance through hiring service companies
The general understanding of taxation on personal income is that the individual income generated from employment which is derived in Hong Kong is subject to assessment of Salaries Tax. Since the expenses deduction offered by the assessment of Salaries Tax is much more strict than that by Profits Tax, an individual may want to take tax advantages by receiving “service fee” in a form of “service company”.
Disguised master-and-servant relationship
Scenario: Company “A” pays “service fee” to a service company “B” that was offered by an “individual” who was owing and controlling Company “A” and “B”. This individual is taking advantage of more generous expense deduction requirement provided by Profits Tax (i.e. income tax on corporate body) of company “B” comparing to Salaries Tax (i.e. income tax on individual) – if this individual directly receive remuneration from company “A”.
IRD can question the taxpayer and look to such factors including proof of master-and-servant relationship between the individual and companies, controlling power, company organizational structure, financial burden to determine the questions of employment or contract for service.