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The Ultimate Guide to Reduce Taxable Income for Startups and SMEs

By FastLane Team, September 22, 2022 (10 mins)

Introduction


Hong Kong’s tax system is one of the most simple and tax-friendly in the world, allowing businesses and individuals to save a significant amount of money. Although the taxes in hong kong are relatively lower compared to other locations and countries, there are still taxes charged in Hong Kong.

 

Even though there’s no VAT, withholding tax, or capital gains tax, as a small business owner,  you’re still required to pay taxes in hong kong. But how will you be taxed and what kind of taxes in hong kong would you have to pay? It is critical for small company owners who are thinking about or have already established a firm in Hong Kong to prepare a strategy to ensure that they are spending the minimum amount in taxes in hong kong.

 

In this article, we will explain taxable income, hong kong tax deductions, and other tax benefits that may benefit your organization in detail.

 

What you will learn:

1. What Items are Regarded as Taxable Income for Hong Kong Startups and SMEs?

2. What is the Tax Rate for Startups and SMEs in Hong Kong?

3. What are the Tax Benefits for startups and SME Owners?

4. How to Reduce your Business’ Taxable Income?

5. What are the Tax Deductible and Non-Tax-Deductible Expenses?

6. How does Tax Deduction Help your Business?

7. Key takeaways

What Items are Regarded as Taxable Income for Hong Kong Startups and SMEs?


The following are the 2 major items of taxable incomes:

  • Profits generated as a company
  • Salary received as an employee of the company

 

Profits generated as a company

Corporate tax, also known as profits tax, is levied on every company in Hong Kong. This implies that small company owners are taxed on profits rather than revenue. But what is the difference? Revenue, also called income, is the money your company receives from selling products and services, which can be considered sales. On the contrary, profit is your income remaining after you account for business expenses, debts, additional sources of revenue and operating costs. 

 

This infographic outlines the major differences between revenue and profit:

Profits VS Revenue | FastLane

 

Salary received as an employee of the company

The individual’s earnings are taxed by means of a salary tax. If you work for the firm and receive a director’s fee or bonus from it, you must file an Individual tax return and pay salary tax.

What is the Tax Rate for Startups and SMEs in Hong Kong?


Hong Kong currently has two small business hk tax rates:

 

1. Single Tier Corporate Tax System

Companies will be taxed at 16.5 percent on taxable income under the single-tier corporate tax system.

 

2. Two-Tier Corporate Tax System

Both unincorporated companies and Hong Kong corporations can be taxed under the Two-Tier Profits Tax Regime. The first $2 million of taxable earnings is taxed at a reduced rate. The two-tier profits tax rates system went into effect for the year of assessment 2018/19 (i.e., on a taxpayer’s financial year that ended between 1 April 2018 and 31 March 2019). It’s intended to reduce the tax burden of most small and medium-sized enterprises (SMEs) by a significant degree. The hk tax rate for corporations is set at one-half of the existing rate, or 8.25 percent, for the first HK$2 million in earnings; after that, companies must pay a 16.5% tax on all profits.

 

On the other hand, unincorporated small enterprises are governed differently. The first HK$2 million in profits will be taxed at one-half of the current rate (7.5%), with the remaining amount subject to a tax rate of 15%. It’s worth noting that only one entity within a group of connected things can qualify for the two-tier pricing. Because of this, the group must decide which entity will benefit and make the pick accordingly.

 

The following table shows hk tax rates for startups and SMEs:

Tax Rate
Assessable profits Corporations Unincorporated Businesses
First HK$2 million 8.25% 7.5%
Over HK$2 million 16.5% 15%

 

What are the Tax Benefits for Startup and SME Owners?


1. Deductions for Income Tax and Profit Tax

To start, let’s explore hong kong tax deductions. As a small business owner, it is important to understand that you will need to pay taxes in hong kong on your profits and not just on your revenue. As a result, any expense that aids you in making a profit can be subtracted from your taxable income. The Inland Revenue Department Ordinance’s Section 16 covers the following deductions:

 

  • Cost of renovating a building
  • Hardware and machinery expenses for IT and production
  • Installation of environmental protection machinery
  • Allowances for depreciation

 

Cost of renovating a building

You can deduct the cost of renovating or refurbishing your business premises from your taxes in hong kong. Some examples of office costs are renovating, buying new furniture, and updating hardware. While these expenses may not result in direct profits, they are necessary for employees to be able to carry out their regular work duties. The expenses are broken up into 5 parts and subtracted from the income bit by over 5 years, which includes the year they were initially paid.

 

Hardware and machinery expenses for IT and production

SME spending refers to all company expenditures related to technology, from buying laptops for employees to investing in a new production line. These expenses are 100% deductible in the year they were made.

 

Installation of environmental protection machinery

Companies that take precautions to reduce their carbon footprint, whether by buying energy-saving equipment or retrofitting factories to emit less harmful pollutants, can enjoy this tax deduction. You can deduct the whole amount from your income in the year you paid it. Not only that, but eco-friendly vehicles purchased by your small business are also tax deductible.

 

Allowances for depreciation

Companies can also deduct depreciation allowances, but there are certain rules that must be followed. 

 

  • If you build a factory, you can deduct 20% of the cost of construction of the premises in the first year.
  • You can deduct 4% of the cost of construction for your business premises on a yearly basis until the entire amount is paid off.

 

On the other hand, when you choose to sell a property, there are certain regulations that apply to businesses.

 

  • If what you’re paid for the item is more than its residual value, you’ll have to pay a profits tax on the surplus. This surcharge is called the balancing charge.
  • If the order is reversed, the seller will receive less than the residual value. This is a deductible cost that is known as the balancing allowance.
  • When building commercial buildings, it’s beneficial to know that 4% of the construction cost can be deducted annually from the income. Plus, there will either be a balancing charge or allowance.

 

The Ultimate Guide to Reduce Taxable Income for Startups and SMEs | FastLane

 

2. Tax reduction measures passed by Legislative Council

Finally, you should be aware of the Tax Mesure of Budget 2022-23 listed on the website of The Inland Revenue Department (IRD). The Financial Secretary proposed the following measures in his 2022-23 Budget:

 

  • Tax reductions on profits, salaries and taxes levied against individuals in 2021/22 (Passed by the Legislative Council)
  • Waive business registration fees for the upcoming 2022-23 year (Passed by the Legislative Council)
  • Hong Kong Tax deductions for domestic rental expenses are being introduced (Passed by the Legislative Council)

3. Relief from double taxation

Under the terms of a Double Taxation Agreement (DTA), double taxation may be relieved in one of two ways: by tax legislation or through the agreement. There are four primary methods of double taxation relief in Hong Kong:

 

  • Tax credit relief: A taxpayer’s foreign tax is applied to their domestic tax on the same income under the credit system. Under the credit approach, the source country’s tax credit is required to be granted in the destination country.
  • Tax exemption: You may not have to pay taxes on the income you earned from foreign sources. The exemption might cover all of the income from abroad.
  • Reduced tax rate: These benefits usually apply to interest, dividends, and royalties.
  • Relief by deduction: After deducting the foreign taxes paid, domestic tax applies to the remaining foreign income.

 

Double taxation is avoided by the provision of a tax credit, according to treaties and double taxation accords concluded between Hong Kong and other nations.

The Ultimate Guide to Reduce Taxable Income for Startups and SMEs | FastLane

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How to Reduce your Business’ Taxable Income?


There are four stages in which you may lower your taxable income:

  • Calculate your total assessable profits
  • Deduct business expense
  • Subtract unused items
  • Add balancing charges

 

Calculate your total assessable profits

To determine the entire taxable profits, you must first understand that Hong Kong is taxed on a territorial basis. Profits originating in or resulting from Hong Kong are subject to corporation income tax.

 

You should then double-check the company’s revenue source. The IRD employs a variety of approaches to find out where profits originate. A comprehensive assessment demands an analysis of the sources of revenue and the transactions/operations that lead to those profits.

 

Deduct business expense

Keep in mind that many of the expenses associated with business profit are tax deductible in Hong Kong. Some deductible expenses include interest, rent, repairs, research and development costs and employees’ contributions to funds. More examples will be mentioned in the next session.

 

Subtract unused items

Furthermore, deduct items that have not been used. To start, consider deductible losses. These can be deducted against future profits and they come from business conducted in Hong Kong. 

 

Capital allowances allow businesses to deduct the costs of certain assets, like machinery and production plants, from their taxable income. The annual rate of depreciation for these assets can be anywhere from 10% to 30%. If you donate more than $100 to a registered charity, you can deduct the amount from your taxes. However, this deduction cannot be higher than 35% of your total assessable profits.

 

Add balancing charges

Finally, make sure there aren’t any excessive claims for small company tax relief. You can include charges, but you should increase the assessable profit. If the money made from selling a capital asset is more than its original value, then these charges apply. If you want to reduce your taxable income, use unutilized items and small business expenses more. 

The Ultimate Guide to Reduce Taxable Income for Startups and SMEs | FastLane

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What are the Tax Deductible and Non-Tax-Deductible Expenses?


In Hong Kong, business expenses that are tax deductible come from the production process of your company. For instance, you might need to buy new software when the current one expires. This software enables you to process customer orders quickly and efficiently. All expenses that help you make a profit and are not of a capital nature, can be tax-deducted.

 

However, non-business-related expenditures are generally not deductible. The government has established a distinction between tax-deductible and non-tax-deductible costs. 

 

Here are some of the expenses that may be deducted or not deducted:

 

Tax Deductible Non Tax Deductible 
  • Interest expenses e.g. Interest paid on loans
  • Rent paid for your business
  • Foreign taxes paid on income
  • Bad debts that have been written off
  • Expenses for repairing, renovation and replacement of equipment
  • R&D expenses
  • Technical education
  • Royalties and service fees paid to foreign affiliates
  • Patents, trademarks, copyrights, and registration of designs costs
  • Contributions to retirement scheme
  • Capital expenditure on fixed assets and environmental protection equipment
  • Charitable donations
  • Non-business-related domestic or personal costs
  • Capital losses
  • Cost of property or asset improvement
  • Rent that is non-business related
  • Corporate taxes on profits
  • Any amount that can be recovered through insurance or an indemnity agreement
  • Interest expenses paid to foreign recipients
  • Acquisition cost of goodwill
  • Fines and penalties
  • Administrative and start-up costs

How does Tax Deduction Help your Business?


Hong Kong tax deductions help small businesses to reduce an amount from their taxable income and save tax. When you claim an income tax deduction, it reduces the amount of your income that is subject to tax. This saves your business money during the tax season so that you can invest the saved money in other areas to strengthen and improve your business operations. In the long term, it might help your company to expand its profit margin.

 

Key Takeaways


With the simple and tax-friendly system in Hong Kong, the business environment of Hong Kong will remain stable and appealing for SME owners. Hopefully, after reading this article, you are now aware of all the major tax benefits available to startups and small and medium-sized enterprises in Hong Kong, and also the way to reduce your taxable income. 

 

If you still have questions about taxable income and tax reductions or regarding this topic, feel free to approach FastLane and our experienced accountants today for help, and we are ready to assist you and your Hong Kong startup and SME along the journey.



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