Hong Kong’s Two-Tiered Tax Rates Explained

Hong Kong is known for its low and simple tax system, designed to attract foreign investment and business expansion locally. In 2018, the Hong Kong government introduced a unique tax system that aimed to reinforce this tradition, the Two-Tiered Tax Rates Regime. The new system has caught the attention of many taxpayers, particularly small and medium-sized enterprises (SMEs), who have embraced it as an effective incentive for their growth.

What Is a Two-Tiered Tax Rate?

The Two-Tiered Tax Rates Regime involves two profit tax rates. Under the new system, the first HK$2 million of a company's profits are taxed at a lower profits tax rate of 8.25%, while profits above HK$2 million are taxed at the standard profits tax rate of 16.5%. Sometimes, this kind approach is called a "progressive tax system."

The introduction of the Two-Tiered Tax Rates Regime in Hong Kong is bringing the city's tax system on leaps and bounds. It helps small and medium-sized enterprises (SMEs) by design, providing them with a lower tax rate on their first HK$2 million of profits. That’s valuable extra cash that canl help SMEs to reinvest in their businesses and grow the economy as a whole.

But Two-Tiered Tax Rates Regimes aren’t a new concept. Many countries around the world, including the United States, have been using progressive tax systems for decades. The aim of a progressive tax system is to ensure that everyone pays their fair share — those who earn more pay a higher percentage of their income in taxes, while those who earn less pay a lower percentage.

The Two-Tiered Tax Rates Regime is also a benefit to larger companies. While they will still pay the standard profits tax rate on profits above HK$2 million, the lower tax rate on their first HK$2 million of profits reduces their overall tax bill. This frees up more funds for research and development, hiring new staff, and expanding their operations.

All in all, the Two-Tiered Tax Rates Regime is a step in the right direction for Hong Kong's economy. By providing a lower tax rate for SMEs, the government is helping to promote entrepreneurship and innovation, while keeping larger companies happy too, by making sure they’re not unfairly burdened with high tax bills. Who could turn their nose up at that? It’s a win-win situation for everyone involved.

What’s So Important About the Two-Tiered Profit Tax?

As we cleared up earlier, the Two-Tiered Profit Tax has been implemented to support small and medium-sized enterprises. SMEs are vital for any economy, and Hong Kong's new system aims to provide them with the necessary support to thrive.

One of the key benefits of the Two-Tiered Profit Tax is that it encourages SMEs to reinvest their profits back into their business — and gives them more money to do just that. The more a company invests in its operations, the more it can grow and generate even greater profits in the future. This, in turn, helps to stimulate the local economy and create new jobs for the community. Everyone lifts where they stand, and everyone rises up together.

Another benefit of the Two-Tiered Profit Tax is that it helps to level the playing field for SMEs. In the past, larger corporations with deeper pockets and greater resources were able to take advantage of tax loopholes and pay lower rates of tax. Now, with the new system in place, SMEs can benefit from a more equitable tax system that allows them to compete more effectively with larger companies. And competition breeds innovation.

The Two-Tiered Profit Tax is a more favorable tax system for SMEs, and it’s a sign that Hong Kong is creating a more vibrant and dynamic economy that benefits everyone.

Who Qualifies For the Two-Tier System?

All corporations, partnerships, and sole proprietorships, apart from those that are already exempt from tax, qualify for the Two-Tiered Tax Rates Regime. This means that businesses of all sizes and industries can benefit from the tax relief that the system offers.

However, to be eligible for the lower profits tax rate, businesses must meet certain criteria. For example, the total gross income of the business must be below HK$500 million. This keeps the tax relief targeted towards SMEs, which are generally considered to be businesses with a lower turnover.

Businesses also need meet certain conditions related to their business activities:

1. They can’t carry out any activities that are not considered to be "trade, profession, or business" under Hong Kong law. Sounds fair enough.
2. They also can’t gain any income from outside of Hong Kong. There’s always exceptions to this, though.

The Main Rules of the Regime

The Two-Tier System is a web of regulations that governs how companies are charged for their use of resources in Hong Kong. If you want to stay compliant and avoid stacking up a wad of penalties, make sure you understand the rules of the regime. Like many places, Hong Kong is big on its tax evasion penalties.

One of the key rules of the Two-Tier System concerns companies that are jointly charged — when multiple people have teamed up to open a company. That means they’re all in it together when it comes to paying taxes, so no one can opt-out or cherry-pick what they pay. So make sure every member of the venture shares the responsibility for the tax you’re liable to pay.

Let’s say you’re operating outside of Hong Kong, but you’re based there, you’re still eligible for the Two-Tier System — as long as you meet the criteria, that is. It’s like a business using the roads and resources of a country without contributing anything towards the upkeep costs — it doesn’t seem quite right. So, this Two-Tier System is designed to avoid that, and make sure companies operating in Hong Kong are paying their fair share for the resources they use, no matter where their business operations are based.

The Two-Tier System in Hong Kong covers a variety of resources like electricity, gas, water, and waste disposal. So, businesses need to keep a close watch on their usage to dodge any surprise charges.

Though it may seem tricky, the Two-Tier System is crucial for businesses in Hong Kong to follow. By getting a grip on the rules and keeping tabs on their resource usage, companies can be both eco-friendly and good corporate citizens who pay their way.

Main Restrictions of the Regime

The regime might offer an enticing 50% reduction of profits tax liability, but companies should keep the specific restrictions in mind when opting for this tax plan.

One limitation that stands out about the Two-Tiered Tax Rates Regime is that the eligibility requirements often change from one year to the next. So, if you’re thinking about applying for the regime, familiarise yourself with the latest criteria and stay agile to make sure you meet it whenever it changes.

The Two-Tiered Tax Rates Regime also follows Hong Kong's transfer pricing rules, so make sure you're playing by the book to avoid any penalties or legal hiccups.

Also, this tax plan is mainly designed for local Hong Kong SMEs. If your company's tax residence is elsewhere, you might not get the benefits. This being said, foreign companies with a subsidiary or a permanent establishment in Hong Kong can still reap the rewards.

Remember, this regime only applies to assessable profits, not capital gains or profits from selling capital assets. So, if this is where the majority of your company's profits have come from during the year, you won’t feel the full benefit of the Two-Tiered Tax Rates Regime.

Why not speak to Osome to see if the Two-Tiered Tax Rates Regime is the best fit for your business? It's great for tax savings, but it might not suit everyone, depending on your unique goals and circumstances. We’ll help you sort out your cash flow and budgeting to make sure it’s right for you.

Connected Entities

In Hong Kong, businesses can join forces in different ways, like partnerships or joint ventures. These connections bring perks, such as shared know-how and a broader business reach. But, there are tax challenges too.

In the Two-Tiered Tax Rates Regime, connected entities share the same tax rate reduction limit. So, if they're linked in any way, they get the same tax treatment as a single entity. This keeps the tax system fair and prevents any potential for exploitation.

For instance, if two companies are in a joint venture, they're treated as one for tax purposes. With shared profits up to HK $4 million, they'd be taxed at 8.25%. But, if profits go beyond HK $4 million, a 16.5% rate kicks in for the extra amount.

So, when thinking about teaming up with other businesses, keep these rules in mind. This will help you stay compliant, dodge any penalties, and keep your business sailing smooth.

Can More Entities Use Two-Tiered Profit Tax Rates?

Absolutely. More businesses can enjoy the perks of the Two-Tiered Tax Rates Regime, as long as they meet Hong Kong's inland revenue authority's criteria. This tax relief measure is crafted to boost Hong Kong SMEs' competitiveness and growth, so more companies can benefit and help strengthen the country's financial stability.

Could the Two-Tiered Tax Rates Regime Be for You?

Hong Kong's Two-Tiered Tax Rates Regime offers an excellent tax saving incentive for small and medium-sized businesses. Take a look at Osome’s Profits Tax Return guide to make sure you’re doing everything you need to to stay compliant.

And remember to follow the transfer pricing rules. Even with that small restriction, it's a chance for SMEs to grow, innovate, and create local jobs. This tax regime plays a key role in making Hong Kong the shining financial hub of Asia.