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6.5. Deductions

Most expenses and outgoings that have been incurred in the production of taxable profits are deductible for Hong Kong profits tax purposes, without territorial restriction.

However, capital expenses are generally not deductible aside from the expenditures and allowances covered in section 6.3.

Losses may be deducted after accounting for any compensation or insurance payments. Assets which have been written off but later recovered will be recognized as revenue.

Specific Deductible Items

The following are allowed to be deducted

Accrued expenses

Accrued expenses recognized in accordance with the GAAP are generally deductible when incurred for the production of taxable profits and are not capital in nature.

Interest Expense

Interest on funds borrowed for the purpose of producing taxable profits together with any legal fees, stamp duty and other expenses in connection with that loan is generally tax deductible. However, there are cases when interest expense is not deductible, including:

  • When a loan is secured by either a deposit or a loan on which interest income is not subject to Hong Kong tax
  • Interest incurred on loans used for financing of constructions projects or others that are capital in nature (unless the loan is used to fund the provision of machinery or plant that qualifies for depreciation allowances)
  • Other situations where interest expense deductions and the related loan arrangements are used to avoid Hong Kong tax

In respect of sums payable on or after 1 April 2016, new rules for interest deduction on intra-group financing were introduced. Under these rules, a corporate borrower carrying on an intra-group financing business in Hong Kong is allowed to deduct interest payable on money borrowed from a non-Hong Kong associated corporation, provided that:

  • The deduction claimed is in respect of interest payable by a corporation (the borrower) on money borrowed from a non-Hong Kong associated corporation (the lender) in the ordinary course of an intra-group financing business;
  • The lender is, in respect of the interest, subject to a similar tax in a territory outside Hong Kong at a rate not lower than the reference rate (standard 16.5% or 8.25% if concession specified in Section 6.7 to qualifying corporate treasury centers applies); and
  • The lender’s right to use and enjoy that interest is not constrained by a contractual or legal obligation to pass that interest to any other person, unless the obligation arises as a result of a transaction between the lender and a person other than the borrower dealing with each other at arm’s length.

For the purpose of the deduction, intra-group financing business in relation to a corporation means the business of the borrowing of money from and lending of money to its associated corporations.  

Inventory Expenses

Inventory may be stated at the lower of cost or market value (share and securities held as trading stock must be stated at market value). Cost must be determined using the first-in, first-out (FIFO) method or an average cost, standard cost or adjusted selling price basis. Last in first out (LIFO) may not be used for tax purposes.

When inventories are sold, the carrying amount of those inventories is recognized as a deductible expense in the period in which the related revenue is recognized. In addition, the amount of any write-down of inventories to net realizable value and all losses of inventories is recognized as a deductible expense in the period the write-down or loss occurs.

Any reversal of a write down will be recognized as a reduction in the deductible inventories expenses realized in the period the reversal occurs.

Rent

Rent of buildings or land occupied for the purpose of producing the profits is deductible.

Bad and Doubtful Debts

Bad and doubtful debts are tax deductible if they are proven to have become bad during the year of assessment. They must also be debts that were previously included as taxable trading receipts or loans made in the ordinary course of a money lending business.

Any bad or doubtful debt that has been allowed a deduction but ultimately recovered will be treated as taxable profits of the year in which it is recovered.

Repair and Replacement Costs

Repairs and replacement costs are tax deductible. These, may include the cost of repairing articles, premises, machinery and equipment used to produce taxable profits, and the cost of replacing implements, utensils or articles used to produce taxable profits.

IP Registration

Expenditure incurred for registration of a trademark, design or patent used in the production of profits is deductible if the IP is used in producing taxable profits.

Research & Development

Expenditure incurred on research and development including feasibility studies, market, management and business research, design-related expenses, payments for technical education, payments to approved research institutes, and other design or innovation related expenses are generally deductible.

Head Office Administrative Expenses

Head office administrative expenses charged to a local Hong Kong branch or subsidiary are allowed as a deduction if they were in relation to the production of profits chargeable to tax.

Property Tax

Any property tax already paid is deductible from income for profits tax purposes.

Foreign Tax

Whiles corporate taxes are generally not deductible, foreign taxes paid on income chargeable to Hong Kong profits tax is deductible.

Payments for Directors

Director fees or other remunerations paid by a corporation to its directors are generally deductible. However, no deduction is allowed on salaries or other remunerations paid to a sole proprietor or any partners or partners’ spouses of a partnership business.

Payments to Foreign Affiliates

Royalties and service fees paid by a Hong Kong corporation to foreign affiliates are deductible if they are incurred for the production of profits subject to Hong Kong tax.

Interest payable to a foreign affiliate is not deductible if the interest income received is not subject to Hong Kong profits tax.

Non-Deductible Items

The following expense types are not deductible for Hong Kong tax purposes:

  • Domestic or private expenses not expended for the purpose of producing taxable profits
  • Any loss or withdrawal of capital, cost of improvements, and any expenditure of a capital nature aside from those outlined above
  • Any sum recoverable under insurance or contract of indemnity
  • Rent of buildings or land not occupied or used for the purpose of producing taxable profits
  • Company formation/start-up expenses that are incurred before the commencement of a trade, profession, or business and that are for the establishment of the overall income producing structure are considered capital in nature and not tax deductible
  • Cost of acquisition or amortization of goodwill
  • Fines and penalties