In this blog we will explore different aspects of expenditures in profit tax calculation as discussing about capital expenses that are not deductible such as permanent quota and postponed expenses. Then we will further discuss treatment of some different types of expenditures under different Sections of Inland Revenue Ordinance. Such expenses will include payments to employees upon termination of business, books and pre-beginning expenses and at the last of this blog we will be seeing the contribution to the mandatory provident fund scheme, as what is this scheme about and what is its relation with taxpayer. We will discuss all these in the light of how taxation policy of Hong Kong applies on these different scenarios for the calculation of profit tax in expenses category for taxpayer having business or company formation Hong Kong.

Non-Deductible Capital Expenses

Permanent Quota

In the case of Canton Industries Ltd a Hong Kong company establishment, it was observed that, T was doing the business of Textile in Hong Kong. It was not possible during the year of assessment to export the production of textiles to Europe or the USA with quota. Both temporary and permanent quota was acquired by T, as part of his business. The accounting policy of T was to carry-down permanent quota as being used on the ground of straight-line over the competent economic lives. In the balance sheet of T, the permanent quotas were grouped as non-current belongings at their written-down values (WDU) (i.e., annual utilization’s net). As a result of the membership of Mainland in the World Trade Organization, it was expected that the system of quota would come to termination on 31 December in the year 2004. The permanent quota that was gained by T over the pertinent years had a very small life period. The claims of the deduction of T in concerning of the usage of permanent quota was not allowed by the Inland Revenue Department. The board of review held for the CIR. On the appeal of the court of first instance it was considered by the Hon Royes J that, the tests given below were not mandatorily resultant:

  • Structure test that is yielding profit;
  • Continuing benefit test;
  • Circulating or fixed capital test; and
  • All test of expense.

The decision of the board of review was upheld by the judge. With the acquiring of the permanent quota, a continuing profit was obtained by the T as the capability to manage the business over the period of quota continuously. Given that the life of the quota may be short, but shortness of this type cannot be conclusive. Having accessed the permanent quota, given that it maintains the exports at a specific level. A holder of permanent quota can utilize the exclusive rights’ bundle that comes with the quota to produce the profits for its trade over the period of quota. Consequently, once acquired, the everlasting quota was included into fixed capital or profit-making structure of T. Expense on the permanent quota does not have a recurrent or circulating nature, it also doesn’t have the character of a regular cost experienced as the part of process of conducting the regular returns through garments’ trading. The permanent quota’s cost (or a part of such cost) was not only a cost attributable directly to the sale of garments of T in any stated year.

Postponed Expense

In the case of Shui On Credit Company Ltd., it was observed that, a building was owned by the company in the Shui On Group. Through a complex scheme, that building was transferred to the new secondary company of Sui On Group and the contract loan on the building was financed again. Hence the new owner was that person of other subsidiary. That subsidiary experienced the liability for the payment of interest for 8 years at the interest rate of 9.357 %. The tax was paid from a newly established offshore incorporations limited Hong Kong. It paid an amount of $600 million plus lawful fees of amount $6.2 million to access the right to obtain the income of said interest. The deduction of the said amount $606.2 million was claimed by the T in the form of postponed expenses. In order to disallow the deduction, Section 61A of Inland Revenue Ordinance was raised by the assistant commissioner. It was argued by the T on appeal that, the conditions in the Section 16 (1) were satisfied. The taxpayer T:

  • Contended that, T was an institute of finance and hence the remuneration was similar to the stock of trading.;
  • Leaned on the Myer Emporium Ltd where a remuneration obtained for the distribution of a repeated stream of income of interest was held to be revenue in nature;
  • Leaned on the Secan that, the deduction was supported by the treatment of accounting.

The court of final appeal:

  • Did not trusted that the case of T was supported by the Secan as the remuneration in any event as it was capital in nature;
  • Did not accept the argument of T that it was an institute of finance as T was a vehicle that avoided the tax;
  • Differentiated the Myer Emporium Ltd on the basis that, the instant case was regarding the tax treatment of expense by a payer and not about the remunerations’ taxability earned by a recipient;
  • Governed that, it was totally possible to apply the Section 16 and 17 of Inland Revenue Ordinance, to the case given that the assessment was made consistent to Section 61A. The function of CIR that, ‘once taxpayer made the objections, it was to build a basic review of the assessment’s correctness’. In the same way, the function of board, on hearing an appeal under the Section 68, is to observe the matter de novo. The Section 61A is not a charging section; and
  • Held that, the postponed expense was not a proper withdrawal but capital expense experienced in the accession of an asset that is capital in nature and non-permissible under the Section 17 (1) (c). As the scheme was beaten by the Section 17, so there is no requirement to utilize the Section 61A of Inland Revenue Ordinance.

It was made clear by the court of final appeal that, the Section 61A has no application if there is no benefit of tax, as what occurred in the immediate case where the remuneration was held to be capital in nature and not withdrawable for the reasons of tax by the virtue of Section 17. It is due to this reason occupant on CIR, in the cases of Section 61A, to recognize any substitutive basis on which the CIR may pursue to support an assessment whether under the Section 16 and 17 or substitutive ways of expressing the case of CIR under the Section 61A.

The illustration was also given by the court of final appeal as to whether Section 61A (2) (a) or Section 61A (2) (b) of Inland Revenue Ordinance should be raised by the assistant commissioner where Section 61A be held relevant. Where the remuneration was a profit oriented justification, for example, in case of the Tai Hing (the sale of land was for a profit oriented purpose) or Ngai Lik (the British Virgin Island companies were trading in actual), it would not be feasible for the CIR to discharge the transactions.

Treatment of different Types of Expenditures

Payments to the Employees upon the Termination of Business

In the case of Cosmotron Manufacturing Co Ltd it was observed that, a compensation payment was made by the taxpayer to his employees upon the termination of business in concerning with the Ordinance of Employment. The payment was on the basis that once a workforce is employed by a taxpayer, it experiences automatically a contingent liability to make social separation payments. Upon the termination of business, the liability was crystallized as observed in the case of Overseas Textiles Ltdas an obiter, that extensive service payments to the employee, were permissible whether made upon termination or not. A voluntary remittance to the employees for the reason of terminating the business may not be permissible.

In the case of Swire Pacific Ltd., it was observed that, remunerations made to the employees at the time of mingling the two businesses of ship-repairing were held to be permissible due to the reason that, the business was not terminated by the employer at the time the remittances were experienced.

Pre-beginning Expenditures

Expenses experienced before company setup in Hong Kong are not deductible in a correct sense, but the Inland Revenue Ordinance allows expenditures of a revenue nature of employees, by concession (for example, employees’ wages, rent of shop properties) experienced before setting up a business.


The books’ cost utilized by the professionals is capital expense but may charter for the devaluation allowance as discussed in the proceeding of the case of Munby. If the books served as utensils, implements or articles under Section 16 (1) (f), the earlier cost of the books’ purchasing is not permissible but the substitution of earlier editions will charter for deduction.

Contribution to the Mandatory Provident Fund (MPF) Scheme 

Donations by an Employer

Voluntary or mandatory contributions made to a mandatory provident fund scheme by a taxpayer company setup in Hong Kong, as an employer in the base period for an assessment year are permissible deductions under Section 16 (1), in that assessment year to the scope as they are experienced in the generation of profits that are chargeable, subject to a limitation of 16 % of the total payments of the employee for the term to which the payment was associates. The reference for this statement is taken from the Section 17 (1) (h) (iii) of Inland Revenue Ordinance. Voluntary or mandatory contributions are the contributions made at regular interims, such as weekly, monthly or daily basis and are either of same or considerably same amounts, or computed by reference to a fixed or a scale %age of salary of a person or remuneration other than that.

Special contributions are those contributions that are other than voluntary or mandatory contributions. These are unusual large payments that are paid normally at the establishment of mandatory provident fund scheme. These contributions are commanded by the Section 16A of Inland Revenue Ordinance that premises the deduction at an even rate over 5 assessment years, beginning from the assessment year in the base period of which the donations are made.


Allowances for regular donations to a mandatory provident fund scheme are deductible in the same procedure as regular donations for taxpayers Hong Kong company establishment. Where an allowance has been allowed previously as a withdrawal, such withdrawal cannot be asserted again when paid under Section 17 (1) (k) of Inland Revenue Ordinance. Allowances for the special contribution are not permissible.

Discussing an example, a well-known retirement scheme is operated by a company named as F Ltd. That scheme is a defined donation scheme. A special donation of amount $2,000,000 was paid by F Ltd. to the scheme, during the year ended 31 December in the year 2015. A deduction of amount $400,000 can be claimed by F Ltd. for each of the 5 assessment years from 2015 / 16 to 2019 / 20. If the amount of $2,000,000 was an allowance for special donation, no withdrawal will be permissible in the assessment year 2015 / 16.

Departmental Interpretation and Practice Notes 23 also provides, among other things, the following:

  • Schemes of retirement validated under ORSO have isolated legal identities from those of their financing employees. Any losses experienced on the ejection of investments held by the ORSO schemes at the hour when they are dissolved are not withdrawable in the determination of the profits that are assessable of the sponsoring employers who started the scheme. Costs experienced by a sponsoring employer in the following points will be withdrawable ordinarily:
  • Establishing a mandatory provident fund scheme;
  • Altering the rules of an ORSO scheme to observe the mandatory provident fund regulations; or
  • Winding up a scheme of ORSO.
  • The sponsoring employer donations to a scheme of ORSO repaid to the employer upon breakdown of the scheme are taxable to the employer under Section 15 (1) (h) of Inland Revenue Ordinance. Any overconsumption damages (being income of the investment of the ORSO scheme) is not taxable.
  • Retirement schemes that are recognized and the trustees of these schemes are not supposed to be subject to tax on profits on their income of investment.
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