What are the taxation policies of Hong Kong for taxpayers who have gained interest income through company incorporation HK and exemption of interest income from having bank deposits?


04 Jan

There can be different sources of income of a person or incorporation in Hong Kong. The implementation of tax policy by the Hong Kong tax department on the income obtained from these different sources is clearly defined under the tax laws. In this blog we are exploring this tax policy on different sources of income. We will discuss that how the tax policy is implemented on the interest income that is obtained by the either corporations, persons or bank deposits in Hong Kong. The interest income is considered as the sub category of the profits tax.       

Income of Interest   

The case of Orion Caribbean was the first case of court on the interest income source. It was considered by the Privy Council in this case that, the judgement of Lord Bridge in case of Hang Seng Bank with respect to only interest income which enclosed the simple situations only. For example, where the money was lent by the taxpayer from its own sources. If it was required by the taxpayer rendering Hong Kong incorporation to borrow for the purpose of financing its lending, it was not enough only to observe the place where the money was borrowed by him. At last, it was reaffirmed by the Privy Council that source of income of interest was a practical and solid matter of consideration, like some other sort of profits.           

It is shown clearly by this case that; this is not simply enough to view at the place of credit’s provision. It was stated by the Inland Revenue department in departmental interpretation and practice notes 13 that, the factors given below are non-relevant in the determination of source of interest income:

  • The place where loan was used by the debtor;
  • Where the interest is to be paid;
  • The place of domicile of creditor / debtor;
  • The funds’ location from which money is drawn by debtor for the payment of interest;
  • The place where loan is used by the debtor; and
  • Where it is concluded the loan agreement.

It appears in the light of case of Orion Caribbean and Kim Eng. Securities that, the factors that are given above cannot be ignored completely. These form the part of the totality of facts.

It was ruled by the Privy Council that, the income of interest in case of Orion Caribbean was allowable to tax under Section 14 of Hong Kong tax law. There was no requirement as such, to assume the charge under Section 15 (1) of Hong Kong tax law in that case.

It has been considered by the case D 7/84 of board of review that, allowance of credit should not be the only test. The ‘completeness of facts’ approach should be adopted by it. A financial institution was concerned by the case. In that given case, that place was regarded by the board of review where clients were requested by the taxpayer having setting up a business in HK and they made the decisions of funding to be the relevant factors.

In some of the cases, the transactions that are being carried out in Hong Kong have interest as an important part. For example, goods were sold by the Hong Kong manufacturer on increased credit terms to a foreigner buyer. In this concerned case, the interest and trading profits were obtained in Hong Kong chargeable under Section 14 (BR 20/75) of Hong Kong tax law.

The departmental interpretation and practice notes 13 was revised by the Inland Revenue department in December 2004. It was stated by the Inland Revenue department that, where the debts are not simple debts, ‘allowance of credit’ is non-applicable. It referred to the case of Orion Caribbean Ltd. in that case, it was held by the Privy Council that, the genuine test for determination of source of profit, where the profits were earned by taxpayer working in company having Hong Kong incorporation by lending or borrowing the money for the operations test. i.e. ‘one looks to observe that, what has been done by the taxpayer to earn the in question profit and where he has achieved it’. In a case of the business of moneylending, a wider range of activities would be comprised by the business of taxpayer. These activities may also include the lending and / or buying of money. For such sort of business, the operations test instead of the allowance of credit test will be applied by the Inland Revenue department for the determination of the source of interest income.


Corporations under Section 15 (1) (f) of Hong Kong tax law

It is provided by the Section 15 (1) (f) of Hong Kong tax law that, the place where

  • a corporation obtains interest income from Hong Kong; and
  • carries on a business or trade in Hong Kong,

the tax is applicable on interest income.

Due to that reason, in case of a foreigner corporation the interest obtained is not taxable, if that foreign corporation does not carry on business in the Hong Kong and obtains the interest with a source in Hong Kong.

Dormant Corporation

This type of behavior can also be observed by a corporation that it ceased all of its operations and imparted its excess funds to an affiliated person. The basic question here is that whether, the business is still carried on by the corporation in Hong Kong or not. If business is carried on by it then the interest received by it is taxable. It is usually accepted by the Inland Revenue department that, bare compliant receipt interest from deposits of bank without some other activity of business does not aggregate to a business. The reference for this statement is taken from the case of departmental interpretation and practice notes 13 (revised December 2004).

Bare compliant income’s receipt may aggregate to a business. This type of receipt of income may also include the dividend from shares in secondary branches of a company. In the case of Bartica Investments Ltd. it was observed that money was deposited by the Hong Kong open company in a bank. That money was used for the purpose of securing the offshore loan for an affiliated company in Australia. It was held by the court that, the activity was enough as alone to carry on a business in Hong Kong in a way that, the bank’s deposit interest in Hong Kong was subject to tax on profits. The activity of taxpayer was more than the compliant receipt of interest of bank deposit. The key point to note here is that, with effect from the 22 June 1998, the interest income obtained by a person from a deposit with an authorized institution or bank is exempt.

Persons other than Corporation under Section 15 (1) (G) of Hong Kong Tax Law            

The scenarios that provide interest obtained by a person other than a taxable corporation are the same as required for a corporation but there is one more condition. That condition is that; the fund must be a business’s fund. Hence, if a partner’s own funds are lent by him to another person, then the interest is not the income of partnership that is taxable.

Exemption of Income of Interest from Bank Deposits

By the reason of Exemption from the profits tax, Order 1998, any income on interest accumulated to or received by:

  • A person, not a corporation, carrying on profession, business or trade in Hong Kong, regarding the funds of that profession, business or trade; or
  • A firm carrying on profession, business or trade in Hong Kong,

On or after the date i.e. 22 June 1998 from any accumulation (not including the currency) placed in the Hong Kong with a certified institution. These certified institutions include a prohibited license bank, a company incorporation HK taking deposit authorized by the Banking Ordinance. That person described earlier (including a corporation) will be disallowed from paying the tax on profits on that income of interest, after deducting all chargeable expenses and outgoings included in the production of such income. The reference for this statement is taken from the departmental interpretation and practice notes 34. This escape from paying the profits tax was granted by the in Council Chief Executive under Section 87 of Hong Kong tax law.

That exemption from interest income granted under Section 87 of Hong Kong tax law does not apply to:

  • Interest accumulated to or received by an institution of finance; and
  • Interest used for the purpose of securing the loan on deposits.

One more key point to note here is that the currency of the deposit is non-relevant.

All affiliated expenditures are not deductible that are included in the production of income. No reconciliation in relation to the income of interest is required to disallow incidental or indirect expenditures.

On Deposits Interest used to Guard a Loan 

The exemption orders of 1998 sets free the income from the deposits of bank which is taxable otherwise under the Inland Revenue ordinance.

Where it is used the local bank deposit to protect a borrowing from the financial institution or bank, the Exemption order 1998 does not apply to the bank deposit interest (i.e., the income of interest does not remain non-taxable) in case if the borrowing:

  • Accomplishes any of Sections 16 2 (c), (d) or (e) of Hong Kong tax law.
  • Accomplishes Sections 16 1 (a) of Hong Kong tax law.
  • Section 16 2 (d) of Hong Kong tax law, (before the amendment of the Inland Revenue ordinance, i.e. 25 June 2004) or Section 16 (2A) of Hong Kong tax law (as per 25 June 2004) is not breached.

If the deposit is a type of onshore deposit, then Section 16 2 (d) of Hong Kong tax law, (pre- 25 June 2004) or Section 16 (2A) of Hong Kong tax law (post 25 June 2004) is not breached. For example, where the allowance of credit was made in Hong Kong and the deposit’s interest income would be a receipt from recipient’s business in Hong Kong. In these type of scenarios, the interest income under Section 14 or 15 of Hong Kong tax law would be allowable to tax on profits. As, the 1998 Order of exemption does not concern to these scenarios, the income of interest is subject to tax on profits. The reference for this statement is taken from the departmental interpretation and practice notes 34 (revised December 2004).

If in case the income of interest on the deposit is prominent than the expenses of interest on debt, it cannot be chosen by the taxpayer to give up the claim of expenses of interest so as to disallowed from the income of interest. The reference for this statement is taken from the departmental interpretation and practice notes 34 (revised December 2004).


An individual taxpayer or a corporation as a taxpayer who planning to start a business then they should be aware of these tax implementation policy on interest income before setting up a business in HK.


Interest on Remuneration on Trust Accounts of Client

If the interest is earned by the lawyer from the trust accounts of clients, then it is not disallowed as the funds in trust accounts of clients do not concern to the lawyer. Since, in fact they are not the funds of the business of lawyer. As being part of the profits of lawyer and being dealt as part of the service income of lawyer, the interest is taxable. The reference for this statement is taken from the departmental interpretation and practice notes 34 (revised December 2004). Also discussed in detail on this topic in these cases of Messrs Lau, Wong & Chan Solicitors.

 

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