How the two-tiered profits tax rate works

How the Two-Tiered Profits Tax Rate Works

The two-tiered profits tax rate charges a reduced rate on the first HK$2,000,000 of assessable profits and the standard rate on the remainder. Only one entity in a group of connected entities is eligible for the lower tier. This system applies to both corporations and unincorporated businesses.

The Two Tiers and Their Thresholds

Two-tiered rates apply separately to the first HK$2,000,000 of assessable profits and to any amount above that threshold. The threshold applies to each business entity for a year of assessment, subject to the connected entity restriction.

For a corporation, the rates are: - 8.25% on the first HK$2,000,000 of assessable profits - 16.5% on assessable profits above HK$2,000,000

For an unincorporated business, the rates are: - 7.5% on the first HK$2,000,000 of assessable profits - 15% on assessable profits above HK$2,000,000

Assessable profits are the net profit after allowable deductions but before loss relief. If assessable profits are less than HK$2,000,000, only the lower rate applies.

Hong Kong Two-Tiered Tax Explained

The Inland Revenue Department introduced the two-tiered system for the year of assessment 2018-19. The policy reduces the tax burden on small and medium enterprises while maintaining the standard rate for larger profits.

The lower rate applies only to the first HK$2,000,000 of assessable profits, not total turnover. A company with HK$5,000,000 in assessable profits pays HK$165,000 (8.25% on the first HK$2,000,000) plus HK$495,000 (16.5% on the remaining HK$3,000,000), totalling HK$660,000.

The same structure applies to unincorporated businesses at their respective rates. A sole proprietor with HK$3,000,000 in assessable profits pays HK$150,000 (7.5% on the first HK$2,000,000) plus HK$150,000 (15% on the remaining HK$1,000,000), for a total of HK$300,000.

Two-Tiered Profits Tax Calculation

Calculate the tax by first determining assessable profits for the year of assessment. Follow these steps:

1. Identify the assessable profits before any loss relief.
2. Apply the lower rate (8.25% for corporations, 7.5% for unincorporated businesses) to the first HK$2,000,000 of assessable profits.
3. Apply the upper rate (16.5% for corporations, 15% for unincorporated businesses) to any assessable profits above HK$2,000,000.
4. Add the two amounts to arrive at the total profits tax payable.

If a loss is carried forward from a prior year, deduct it from assessable profits before applying the two-tiered rates. A business with assessable profits of HK$2,500,000 and a HK$600,000 carried forward loss has net assessable profits of HK$1,900,000, so the lower rate applies to the full amount.

Connected Entity Two-Tiered Rate Hong Kong

Only one entity in a group of connected entities may use the two-tiered rates. A connected entity is defined broadly and includes: - An associated corporation, meaning one that controls or is controlled by the taxpayer, or where both are controlled by the same person - A partnership in which the taxpayer or a connected person is a partner - A sole proprietorship carried on by the taxpayer or a connected person

This restriction applies per year of assessment. If a group of connected entities all have assessable profits, only one may elect to use the two-tiered rates. The others are charged at the standard rate (16.5% for corporations, 15% for unincorporated businesses) on all their assessable profits.

Make the election in the profits tax return. If no election is made, the Inland Revenue Department will apply the upper rate to all assessable profits. This rule prevents a business owner from splitting a single operation across multiple companies to claim the lower rate more than once.

The election is irrevocable for that year of assessment. Review your group structure and assess which entity will benefit most from the lower rate before making the election.