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  2. A Guide to Reducing Taxable Income for Small Businesses

A Guide to Reducing Taxable Income for Small Businesses

Just because Hong Kong is an attractive place to start a small business due to its low tax regime, doesn’t mean that you do not have to pay any tax. As a business owner, you can’t escape paying taxes. But what kind of taxes would you have to pay, and how are you taxed?

For small business owners who are planning or have already started a business in Hong Kong, it’s important to have a plan to make sure you are paying the most efficient tax possible. You wouldn’t want to pay more tax than what you are supposed to. In this article, we will provide an overview of taxable income, tax deductions, and a list of tax reliefs that will benefit your company.

What Is Considered As Taxable Income for

Hong Kong SME?

The main taxable incomes for Hong Kong SMEs are from:

  • Profit earned as a business
  • Salary drawn as an employee of the business

Every company in Hong Kong has to pay corporate tax, which is also known as, profits tax. This means small business owners are required to pay tax on profits, and not on revenue.

So what’s the difference? Revenue is defined as income generated from the sale of goods and services that your company sells. In simpler terms, revenue is considered as sales. For instance, you sell ice cream and the income you earn each month is HK$1000. This will be your revenue.

On the other hand, profit is defined as the income you have after you take your business expenses, debts, additional income streams and operating costs into account. Let’s use the ice cream business as an illustration again. To determine if you have made a profit or loss at the end of the month, you use your daily revenue of HK$1,000 and deduct it with your operating cost of HK$200 and employees’ salaries of HK$500. Here is the calculation:

HK$1000 – HK$500 – HK$200 = HK$300

HK$300 will be your net profit.

Salary tax is charged on an individuals’ wages. If you also receive wages as an employee of the company, director fee or bonus from the Company, you are required to file an Individual tax return and pay Salaries Tax.

What Is the Current Small Business Tax Rate?

Currently, Hong Kong works on two types of small business tax rates – Single Tier Corporate Tax System and Two-Tier Corporate Tax system.

For the single-tier corporate tax system, companies will be taxed at 16.5% on assessable profits.

But the two-tier corporate tax system functions differently. Companies will be taxed at 8.25% on their first HK$2 million. Subsequently, their remaining profits will be taxed at 16.5%. The purpose of this tax system is to lower the tax burden of most tax-paying Hong Kong’s small businesses.

Tax Deductible Expenses vs Non-Tax-Deductible Expenses

In Hong Kong, tax-deductible expenses are expenses you incur during the production of your business. So what does that mean? One good example is purchasing IT software. It has expired, and it’s time to get a new one. When customers place their orders, you utilise this software to fulfil the order effectively. As long as your expenses help you to produce profits and it’s not capital in nature, it is considered tax-deductible.

However, expenses that are not used for business purposes are generally not deductible. The government has allowed certain expenses to be tax-deductible and non-tax-deductible. It is good for you to familiarise yourself with them. Here are some of the expenses that are tax-deductible and non-tax-deductible:

Tax Deductible Expenses Non-Tax-Deductible Expenses
  • Interest expenses, such as any interest paid on a loan
  • Rental for business purposes
  • Foreign taxes paid on income. This will be subject to foreign tax
  • Bad debt that has been written off
  • Technical education
  • Building refurbishment
  • Capital expense on prescribed fixed assets and environmental protection machinery
  • Research and development expenses
  • Royalties and service fees to foreign affiliates
  • Expenses incurred in the purchase of patents, registration of trademarks, copyrights, and registration of designs
  • Retirement scheme contributions. This will be subject to certain limitations.
  • Charitable donations
  • Domestic or private expenses that are not business-related
  • Capital losses
  • The cost incurred from improving your property
  • Any sum recoverable under insurance or contract of indemnity
  • Rental income or expenses that are not business-related
  • Taxes paid on corporate profits
  • Interest expenses paid to an overseas recipient
  • Organisational and start-up expenses
  • Cost of acquisition of goodwill
  • Fines and penalties

Are There Any Tax Reductions for Hong Kong’s Small Businesses?

Yes.

In May 2021, the Financial Secretary proposed a one-off reduction of profits tax, salary tax and tax under the personal assessment for the year of assessment 2020/2021 by 100%, subject to the ceiling of HK$10,000.

This means small businesses will get to qualify for tax reductions on their profits. For salaries tax, this ceiling will be applied to each taxpayer. Best of all, business owners who are charged separately for salaries tax and profits tax will get to enjoy tax reduction under each of the tax types.

Regency Laundry Co has an assessable profit of HK$500,000 for the year of assessment 2020/2021. Given that they have fulfilled all the conditions in the two-tier tax system, they will be taxed at 8.25% under the first HK$2 million. Here is the calculation:

HK$500,000 – 8.25% = HK$41,250

HK$41,250 x 100% = HK$41,250 (one-off reduction of profit tax)

HK$41,250 – HK$10,000 = HK$31,250 (subject to the ceiling of HK$10,000)

In this case, HK$31,250 should be the final tax amount Regency Laundry Co has to pay for the year of assessment 2020/2021.

This tax reduction will relieve your tax amount payable for the year of assessment 2020/2021. Just remember to file your profits tax returns and tax returns! Do bear in mind that this tax reduction is only applicable to the final tax for the year of assessment 2020/2021.

How Do I Reduce My Taxable Income for My Small Business?

Here are some ways you can reduce your taxable income:

  • Calculate your total assessable profits
  • Deduct your deductible expenses
  • Deduct your unutilised items
  • Deduct your donations
  • Deduct your capital allowances

Total assessable profits refer to the net profits you received at the end of the financial year. This source of income should derive from any trading in Hong Kong, rental from leasing movable property, interest income, and grants and subsidies.

Likewise, deductible expenses include expenses that incur during the refurbishment or repairing of your property, equipment and machinery, and research fees.

Unutilised items refer to the loss incurred as you run your business. As much as some of us might not like to think about losses, it’s important to think about deductible losses. It can be deducted from the company’s income in the current assessment year or the subsequent year.

Charity donations to tax-exempt charities can be deducted from your assessable profits. You can claim up to 35% of your assessable profits in the year of assessment. The amount should not be less than HK$100.

Neptune Hardware Company has an assessable profit of HK$200,000. The deductible expenses are HK$10,000. To determine the amount claimable for his donation, here is the calculation:

HK$200,000 – HK$10,000 = HK$190,000

HK$190,000 x 35% = HK$66,500

In this case, the maximum approved donation amount Neptune Hardware Company can claim is HK$66,500.

Capital allowances, also known as depreciation allowance, refer to any plant and machinery you use for your business. The value of your equipment is likely to depreciate as you run your business. This is where your annual depreciation allowances will come in.

It is crucial to know your assessable profits, deductible expenses, donations and capital allowances. These components play a huge part in reducing your taxable income.

How Does Tax Relief Help My Small Business?

At this point, you may know tax relief helps small businesses to save a considerable amount of money during the tax season. Furthermore, it helps your company to expand its profit margin and strengthen your business. So utilising these reliefs will benefit your company in the long run.

Summing Up

Find out More

Here's how to reduce your taxable income as a small business.

Nobody likes to pay taxes. But in Hong Kong, there are tax reductions for small businesses to relieve their financial burden. We know as a small business owner, you may have plenty of things to worry about. If you still have questions about taxable income and tax reductions, do approach our experienced accountants today, and we are ready to assist you!

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