Hong Kong’s Two Tier Tax Rates Explained

Hong Kong’s Two Tier Tax Rates Explained

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The Two Tier Tax Rates Scheme of Hong Kong acts as a game-changer for SMEs. The first HK$2 million of profits are taxed at 8.25% rate with the intent of encouraging businesses to grow and succeed. Read the article below to find more about the advantages and necessary requirements of this tax system.

Hong Kong’s tax system has been kept low and simple to encourage more foreign investment and to expand the business locally. In 2018, the Hong Kong government capitalized on the existing tax regime to foster the heritage culture by introducing the Two Tier Tax Rates Regime. This system has therefore come to be the center of attraction of many taxpayers, especially small and medium-sized enterprises (SMEs), who see it as an effective mechanism for their growth.

What Is a Two Tier Tax Rate?

Two Tier Tax Rates model implies two tax rates for profit tax. The new system established for profits tax applicable in Hong Kong, profits of a company up to HK$2 million are taxed at 8.25% and profits above HK$2 million are taxed at the standard profits tax rate of 16.5%. In some cases, this form is called a “progressive tax system“.

Two Tier Tax Rates System has been implemented in Hong Kong and bring the city’s tax system on an upward trajectory. It assists SMEs through design, it allows them to get a lower tax rate on their first HK$2 million of profit. Those are very useful extra funds that SMEs can use to reinvest back into their businesses and thus contribute to the expansion of the economy.

However, Two Tier Tax Rate Regimes is not a new concept. There are a number of countries worldwide that have been using the progressive tax systems for years, including the United States. The goal of progressives is that rich people pay more of their income in taxes than poor people do.

Two Tier Tax Rates Regime is also very advantageous to larger corporations. They will still pay the standard profits tax rates on profits over HK$2 million but with the lower tax rates on the first HK$2 million, the overall tax bill is reduced. This creates more room for funds allocation for research and development, hiring new personnel, and increasing the size of their operations.

In the end, the Two Tier Tax Rates Regime will be a milestone for Hong Kong in terms of the economy. Hong Kong government has used the way of lowering tax rate for SMEs to promote entrepreneurship and innovation, and also to make sure that larger companies won’t be suffering from high tax burdens. It’s a two-way support for all the parties.

Related Article: 2024 Tax Filing Season: Tax Deadline 2024 in Hong Kong You Need To Know About

What’s So Important About the Two Tier Profit Tax?

The Two-Tiered Profit Tax has been introduced for promoting small and medium enterprises. SMEs are integral to any economy and Hong Kong’s new system that strives to offer them the required support to grow and become successful.

Among the major advantages of the Two-Tiered Profit Tax is that it pushes SMEs to re-invest their profits right back into the business and leaves more money for the same. The more money the company invests into its business, the more it will grow and subsequently generate even higher profits in the future. Doing this can also act as a stimulus for the local economy and provide new opportunities for the community.

The Two-Tiered Profit Tax also plays a vital role in enabling small businesses to compete on a fair basis. Previously, the big organizations with a lot of money and the better facilities were able to use the tax loopholes and pay lower rates of tax. The new system has been introduced and now SMEs can enjoy an equal taxation system which gives them a possibility to compete equally with the larger companies.And competition breeds innovation.

The Two-Tiered Profit Tax is more flexible to SMEs, which suggests that Hong Kong is generating a more dynamic and diverse economy that is good for everyone.

Who Qualifies For the Two Tier Tax System?

Every corporation, partnership, and sole proprietorship, except those already exempt from tax, qualifies for the Two Tier Tax Rates Regime. In this case, businesses whether they are large or small in any of the industries that are eligible can enjoy the tax relief that the system provides.

But to benefit from the lower profits tax, businesses must meet certain requirements. As for instance, the total gross income of the business must not be above HK$500 million. So the tax relief is limited to SMEs is as they are generally considered to be businesses with a lower turnover.

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

  • They can’t perform any activities that are not regarded in accordance with Hong Kong law as “trade, profession, or business”.
  • They can’t engage in any remunerated activities outside of Hong Kong. However, there’s always exceptions.

The Main Rules of the Regime

The Two Tier Tax 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 Tax 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.

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Imagine you’re operating from out of Hong Kong, but you’re based in Hong Kong, you can still make use of the Two-Tier System, as long as you meet the certain requirements. Free-riding is like a business that uses roads and resources of a country but doesn’t pay anything for the maintenance costs — it seems unfair. Thus, the aim of that Two-Tier System is not to punish companies based on their operations, but to ensure that companies engaged in business in Hong Kong pay their fair share for the resources they use, no matter where they operate in.

The Two-Tier System in Hong Kong comprises power, gas, water, and waste management resources. Therefore, companies have to monitor closely how much data they use to avoid unpleasant surprises.

Indeed, it may appear difficult but the Two-Tier System is essential for firms in Hong Kong to be compliant with. The ability to understand and follow the rules, together with the regular checks on the resources usage, will allow companies to be both eco-friendly and responsible businesses that pay their way.

Main Restrictions of the Regime

The government usually promotes this tax regime by offering the investors attractive 50% exemption from the profits tax, however, there are certain restrictions to be careful about when the taxpayers consider this tax system.

The one drawback that is most apparent about the Two Tier Tax Rates Regime is that the qualifying conditions often change from one year to another. Therefore, if you’re out there contemplating applying to the regime, keep yourself up to date with the latest criteria and stay nimble so that you can always meet it when it changes.

Adopting the Two Tier Tax Rates Regime, many offshore jurisdictions strictly follow the rules of transfer pricing set by Hong Kong, therefore, ensure that you play by the book in order to avoid penalties or legal issues.

The other thing is that this plan of taxation is basically made for SMEs in Hong Kong. If your company’s tax residence is elsewhere, you wouldn’t be able to enjoy the benefits. It is noteworthy that Global firms with a subsidiary or a permanent establishment in Hong Kong may still enjoy its various perks as well.

Note that this regime is limited to taxable profits, whereas capital gains and profits from selling capital assets are not subject to it. Therefore, if profits in most of your company have happened here at the end of the year, you won’t feel the real benefit of the Two Tier Tax Rates Regime.

Let’s have a talk with FastLane Group and analyse whether the Two Tier Tax Rates Regime is your best option. It is also good for a tax reduction, but it may not be suitable for you, depending on your specific goals and situation. We’ll support you in the cash-flow and budgeting process to ensure it is suitable for you.

Connected Entities

In Hong Kong, business entities may cooperate in alternative ways such as partnerships or joint ventures. These networks are beneficial that they give you access to a wealth of know-how and an extended business reach. However, there are tax hurdles as well.

Under the Regime of the Two-Tiered Tax Rates, entities are connected, and they share the same limit on the rate of tax reduction. That means, if they are linked to each other, all of them are taxed as a single entity. This ensures that the tax system will remain fair and no loophole will be exploited.

For example, if two businesses are in a joint venture, they’re considered one in tax issues. They will be eligible to profit share of HK $4 million and to be taxed at 8.25%. However, if profit goes beyond $4m, the 16.5 % is payable on the excess amount.

Consequently, take into account these rules when you are thinking about the teamwork with other businesses. This will help you keep the business compliant, avoid any fines, and cruise through it.

Can More Entities Use Two-Tiered Profit Tax Rates?

Absolutely. Entrepreneurs can take more advantage of the Two-Tiered Tax Rates Regime, provided that their businesses comply with the inland revenue authority’s requirements. This measure of tax relief was created to promote the growth and competitiveness of the small and medium size enterprises in Hong Kong which will help more firms to benefit, and thus, strengthen the country’s financial stability.

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

Hong Kong’s Two-Tiered Tax Rates System is an incredibly attractive tax-saving incentive for Small and Medium-sized Enterprises. Browse through FastLane Group’s Profit Tax Return guide now to see if you’re on the right track in terms of compliance.

Bear in mind to comply with transfer pricing rules too. The restriction, even a small one, gives a chance for SMEs to grow, innovate and to create local jobs. The tax regime also has the biggest impact on Hong Kong being the most outstanding financial hub in the Asia.

How FastLane Group can Help?

If you are lost in the maze of Hong Kong’s Two Tier Tax Rates System, then read on. People should not let tax complexity to be the cause of their business growth slowing down. FastLane Group is the leading provider of accounting services in Hong Kong, and we can simplify the tax rates system for you. The team of CPAs and tax specialists at our company is highly experienced in the local regulations and requirements and this way we guarantee that all your tax matters are resolved quickly and in compliance with the law. 

When you hire us, you can concentrate on what you do best – which is to run and grow your business. Leave us to take care of tax compliance and management while you can steer your business with confidence knowing that tax matters are taken care of. Contact us now.

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