Hong Kong Tax Tips

Chapter 2   Salaries Tax Tips    

2.0 Overview of salaries tax 

The basic rule is laid down in section 8(1): All income from an employment or an office in Hong Kong is taxable. Such income is stated in the section as “income arising in or derived from Hong Kong”.  

The general rule for determining “income arising in or derived from Hong Kong” is to determine the location of the employment. After the court case CIR v Geopfert, the Revenue usually looks to three factors: (1) Is the contract of employment executed and enforceable outside Hong Kong? (2) Is the employer a non-resident of Hong Kong? and (c) Is the remuneration paid outside Hong Kong? In general, the factors (1) and (2) are more important than (3) and if the answers are no, the employment will be regarded as “in Hong Kong”. 

If the employment is in Hong Kong, the whole income from the employment (even part of it is attributable to services outside Hong Kong) is taxable. The only exception is that the employee renders all services outside Hong Kong. In this respect, if the employee visits Hong Kong for not more than 60 days during the year of assessment (from 1 April to 31 March), he will be regarded as rendering all services outside Hong Kong.

If the employment is outside Hong Kong, all income attributable to his services in Hong Kong is still taxable. The income assessable to tax is usually computed on a time basis: assessable income = total employment income * number of days in Hong Kong in the year of assessment / 365. Nevertheless, he can still claim full exemption if he visits Hong Kong for not more than 60 days in the year of assessment. 

The above tax charge applies to a common salaries taxpayer. It does not apply to company directors, civil servants, seamen and air-crew to whom special rules are applicable.  

For large-income taxpayers, the tax is computed at 15% (standard rate from 2008/09 onward) on their net assessable income (i.e. assessable income less deductions of expenses and outgoings, home-loan interest and contribution to recognized retirement schemes). 

For low-to-medium income taxpayers, the tax is computed by applying the progressive tax-rates to the Net Chargeable Income (i.e. Net assessable income less Personal allowances). The tax computed under graduated tax rates cannot exceed the tax computed at 15% (standard rate from 2008/09 onward) on the net assessable income. 

A checklist for reduction of salaries tax

1. All your services done outside Hong Kong? If yes, you pay no tax.

2. You visit Hong Kong during the year of assessment for not more than 60 days? If yes, you pay no tax.

3. You are employed by an overseas company and work both within and outside Hong Kong? If yes, your income attributable to services outside Hong Kong is not taxable.

4. You receive from your employer a compensation which is not a reward of services? If yes, such compensation is not taxable.

5. You receive from your employer a gift on your marriage, passing of an examination, during annual dinner... etc.? If yes, such gift is not taxable.

6. Do you receive paid a lump sum on your retirement? If yes, the lump sum is not taxable.

7. You are granted a share option to purchase shares but you have not exercised the share option. In that case, the share option is not taxable.

8. You receive shares from your employer but you cannot sell the shares within a certain period. In that case, the “shares” are taxable but you can claim a very big discount from their valuation because of the restriction on sale. Furthermore, if they are private shares, you can claim a big discount for the minority shareholding and the unpopular marketability.

9. You terminated your employment and received Long Service Pay or Severance Pay under the Employment Ordinance? If yes, the pay is not taxable.

10. Your employer terminated your employment and you received payment in lieu of notice? If yes, the payment is not taxable.

11. You receive benefit-in-kind (e.g. free medical, free lunch, free transportation, free uniform ... etc.) from your employer and the benefit-in-kind is not convertible into cash? If yes, the benefit is not taxable.

12. You use company car for both business and private purpose and all the motor expenses are borne by your employer? If yes, you pay no tax for the free traveling (the expenses attributable to business are not taxable because they are not your benefit whereas the expenses attributable to private purpose are not taxable because they are benefit inconvertible into cash).

13. You use your own car for both business and private purpose and you receive reimbursement of car expenses from your employer? If yes, the reimbursement of car expenses for business purpose is not taxable because it is not a benefit. The reimbursement of expenses for private use is taxable and is usually computed by an apportionment.

14. You receive free accommodation at a flat from your employer? If yes, the accommodation is taxable at 10% of your relevant income.

15. You receive free accommodation at a hotel room? If yes, the accommodation is taxed at 8% of your relevant income.

16. Your employer has not paid you salaries? If yes, the unpaid salaries are not taxable.

17. You returned part of your salary to your employer because you failed to meet the sales target as stipulated in your employment contract? If yes, the returned salary is not taxable.

18. You wear uniform on duty and you pay laundry expenses? If yes, the laundry expenses are deductible.

19. You pay membership fee to a professional association? If the membership is a prerequisite for your employment, the membership fee is deductible.

20. Do you earn commission based on sales figures? If yes, you can claim expenses deduction.

21. You work partly in Hong Kong and partly in China and you receive hardship allowance for your working in China? If yes, the allowance is not taxable.

22. You work partly in Hong Kong and partly in China and your China income tax is paid by your employer? If yes, the income tax paid by employer is not taxable.

23. You work partly in Hong Kong and partly in China and you pay China income tax? If yes, the income attributable to your services in China is not taxable.

24. You run a small business at your home? If yes, you can claim deduction for part of your household expenses under profits tax. Besides, if you sustain a business loss, you can apply for personal assessment to reduce your tax liability.

25. You omit to claim married person allowance, child allowance, dependent parent allowance or disabled dependant allowance? If yes, you can make the claim even though this is after the one-month objection period.

26. You omit to claim your contributions to elderly residential care expenses? If yes, you can make the claim within 6 years after the year of assessment.

27. You omit to claim your contributions to MPF? If yes, you can make the claim within 6 years after the year of assessment.

28. You omit to claim your home loan interest? If yes, you can make the claim within 6 years after the year of assessment.

29. You omit to claim your self-education expenses? If yes, you can make the claim within 6 years after the year of assessment.

30. You omit to claim your charitable donation? If yes, you can make the claim within 6 years after the year of assessment.

31. Your salary has decreased lately? If yes, you can apply for hold-over of provisional tax.

32. Are you self-employed? If yes, you should be assessed under profits tax instead of salaries tax and then you will be subject to less stringent conditions of expenses deduction.

33. Read the chapter “Common topics of tax reduction” below.

The checklist is for general guidance only. Indeed the above guidelines are subject to various conditions laid down in the Inland Revenue Ordinance as well as the judgments made in court and Board of Review cases. Besides, there are exceptions to which the above guidelines do not apply. To know more, please read my tax tips below. If you are in doubt, you should consult a tax advisor. 

2.1 The basic charge  

Section 8(1) of the Inland Revenue Ordinance imposes the basic charge: to tax all the income from employment or pension which are arising in or derived from Hong Kong.

Source of employment

In deciding the charge concerning employment, it is necessary to establish the place where the employment is located. The general rule of how to determine the source is laid down in the court case CIR v. George Andrew Goefert: the chief factors to be considered are: (1) whether the employment contract was made in Hong Kong (2) whether the employer has a residence in Hong Kong, and (3) whether the employee's remuneration was paid in Hong Kong. If the employment is established as a Hong Kong employment, the whole income from the employment, even though part of it is for services outside Hong Kong, is taxable.  

Extension of charge 

In addition to the basic charge, an extension of charge is imposed by Section 8(1A) of Inland Revenue Ordinance to assess all the income in respect of the services rendered in Hong Kong. This charge, frequently called "time-apportionment," is used for taxing non-Hong Kong employments.

Time apportionment 

Time apportionment is usually done by multiplying the total income from the employment by a fraction: number of days in Hong Kong / number of days of employment period in the year of assessment. The "number of days in Hong Kong" includes "the leave periods outside Hong Kong attributable to Hong Kong services." Normally, all the days in Hong Kong, irrespective of whether they are related to services or not, are counted. But in special cases, for example an employee resides in Hong Kong and he frequently leaves Hong Kong to work at a Shengzhen factory at 9:00 a.m. and then return to Hong Kong on the same day at 7:00 p.m. => in such circumstances, his stay in Hong Kong on that day was purely for residential purpose => he can claim to have that day in Hong Kong to be completely excluded from the "number of days in Hong Kong" for the time apportionment. But in general, part of a day in Hong Kong (e.g. the day of arrival in or the day of departure from Hong Kong) is counted as half day (that is 0.5).

Queries by IRD on time-apportionment claim 

The IRD will usually ask for the following information.

     About the employer: name, address, nature of business and place of residence. If taxpayer is assigned to an associated company in Hong Kong: (a) the terms of assignment to Hong Kong, (b) the name, address, nature of business of the Hong Kong associated company (c) whether the employer or the Hong Kong associated company has control over the taxpayer's work in Hong Kong. 

     About the employment contract: the date and the place where the contract of employment was negotiated and concluded and enforceable and copy of the contract of employment 

     About the remuneration payment: (a) where is the place of the payment? (b) how the payment is effected? and (c) whether it is paid into a Hong Kong bank account or elsewhere?

     About the taxpayer's stay within and outside Hong Kong: a travel schedule for the year of assessment setting out all the dates of arrival in and departure from Hong Kong, all the places visited and the purpose of such visits. 

An example showing how to do time apportionment 

Mr Simons, an American resident, was assigned by his employer, Manhattan Incorporation, to assist his employer's branch in Hong Kong to set up the information system. During 2005/06, he stayed in Hong Kong for 200 days and in USA for 165. His stay in USA included 30 days annual leave. His total remuneration in the year of assessment was HK$2,000,000.      

Year of assessment 2005/06

No. of days in Hong Kong：200

No. of days in USA：165 – 30 = 135

No. of leave days attributable to H K service：30 * 200 / (200 + 135) = 17.9

Adjusted no. of days in Hong Kong：200 + 17.9 = 217.9

No. of days in 2005/06：365

Assessable income：$2,000,000 * 217.9 / 365 = 1,193,973  

All work done outside Hong Kong

If an employee (other than a government servant), irrespective of whether he is under a Hong Kong employment or not, performs all his services outside Hong Kong, he will be exempt from Salaries Tax.

What are “services” rendered by an employee?

The Revenue takes the view that services include:
1. supervising junior staff,
2. attending business meetings,
3. reporting duties to supervisors, and
4. taking part in training of staff (whether as a trainer or a trainee).

If the employee undertakes any of the above activities in Hong Kong during the year of assessment, the IRD will generally reject his claim for the exemption. 

In practice, to find out whether or not all the services of a claimant are done outside Hong Kong, the IRD will look to the following points:  

1.    What the duties of the claimant? Say, if he is a production manger responsible for the day-to-day runing of a factory in mainland, his claim will be more acceptable. On the other hand, if he is a product designer and travels frequently to and back from mainland during office hours, the IRD will usually challenge the claim. To support the claim, the taxpayer has to supply copy of the employment contract as well as a written confirmation from his employer certifying “no services in Hong Kong” throughout the year of assessment.  

2.    The number of days the employee stays in Hong Kong during the year of assessment. If he spends less than 60 days, his claim will generally be accepted, even though his claim may fail the 60-day-visit rule because the stay in Hong Kong is not accepted as “visit”. The IRD will usually obtain the facts from the Immigration Department. 

3.    The timing of his stay in Hong Kong. If he often leaves Hong Kong before 9:00 am and returns after 6:00 pm, he will have a strong case to argue such stay in Hong Kong not involving services in Hong Kong. This information is also ascertainable form Immigration Department.  

4.    The nature and size of the Hong Kong's and mainland's establishments. If the Hong Kong establishment is very small and its functions are limited as compared to the mainland's establishment, the employee will have a stronger case to argue “no services in Hong Kong'.   

From Board of Review cases, a taxpayer bringing work samples from the mainland factory to his Hong Kong employer does not constitute “services in Hong Kong”. Neither was his attending at a training course organized by Productivity Council sponsored by his employer regarded as “services in Hong Kong”.  

The Board's decision was based on the taxpayer's testimony of the following:

1.    She worked in Shenzhen during the day but had to return to Hong Kong to look after her children. Her husband and her father-in-law were both residing in Hong Kong.

2.    She attended training courses in Hong Kong on her own volition in order to equip herself to handle the anticipated change of Shenzhen's computer system in 2000. She did not attend these courses pursuant to directions of her employer. She had to make use of her own leave entitlements for such attendance.

3.    The entire production department was in Shenzhen. She did not render any service in Hong Kong.

4.    The Appellant is a sincere and down-to-earth witness. 

Author's advice: Put forward the above four points if you have a similar case. 

Queries by IRD on claim for all services outside Hong Kong  

To determine whether or not all the services of a claimant are done outside Hong Kong, the Revenue may raise the following queries:  

1.  What the duties of the claimant? Say, if he is a production manger responsible for the day-to-day running of a factory in mainland, his claim will be more acceptable. On the other hand, if he is a product designer and travels frequently to and back from mainland during office hours, the IRD will usually challenge the claim. To support the claim, the taxpayer has to supply copy of the employment contract as well as a written confirmation from his employer certifying “no services in Hong Kong” throughout the year of assessment.  

2.  The number of days the employee stays in Hong Kong during the year of assessment. If he spends less than 60 days, his claim will generally be accepted, even though his claim may fail the 60-day-visit rule because the stay in Hong Kong is not accepted as “visit”. The IRD will usually obtain the facts from the Immigration Department.  

3.  The timing of his stay in Hong Kong. If he often leaves Hong Kong before 9:00 am and returns after 6:00 pm, he will have a strong case to argue such stay in Hong Kong not involving services in Hong Kong. This information is also ascertainable form Immigration Department. 

4.  The nature and size of the Hong Kong's and mainland's establishments. If the Hong Kong establishment is very small and its functions are limited as compared to the mainland's establishment, the employee will have a stronger case to argue “no services in Hong Kong”.  

From a Board of Review case, a taxpayer bringing work samples from the mainland factory to his Hong Kong employer does not constitute “services in Hong Kong”. Neither was his attending at a training course organized by Productivity Council sponsored by his employer regarded as “services in Hong Kong”.

Visit Hong Kong not exceeding 60 days

If a person visits Hong Kong for not more than 60 days during the year of assessment, he will be exempt from Salaries Tax. In counting the days of visit, all days in Hong Kong are counted, irrespective of whether they are in relation to services or not and part of a day is counted as one whole day.

The extension of the exemption only applies to a “visit”. If an employee's stay in Hong Kong does not constitute a “visit”, the exemption will not be granted. Regrettably, the word “visit” is not defined in the IRD. Without the definition, its meaning is determined in accordance with the basic rules of interpretation of tax law, in particular the Literal Rule. In practice, the IRD adopts the definition of the shorter Oxford Dictionary: a visit is a short or temporary stay.

What constitutes a visit?

There is no hard and fast rule for determining whether a period of stay in Hong Kong qualifies a visit. In practice, the IRD adopts a liberal approach if the taxpayer travels frequently in and out of Hong Kong during the year of assessment. Generally speaking, an overseas purchasing clerk coming to Hong Kong to solicit orders for his overseas employer qualifies the exemption. However, a foreign professor employed by a local university under a short-term contract to teach a short course in Hong Kong lasting for less than 60 days is not entitled to the exemption --- this is because the professor performs all relevant services in Hong Kong and he is not required to travel out of Hong Kong during the employment period.

In general, if an employee is assigned to work outside Hong Kong, his casual returns to Hong Kong will be regarded as “visits”.

Nowadays, a number of people work in the Mainland and they return to Hong Kong only for family reunion purpose. If they can prove, usually by production of a employer's written confirmation, that they render all the services in the Mainland, then they will be exempt from salaries tax.

The beginning or the ending of an employment in a year of assessment do not usually constitute visit. Therefore, if an employee leaves Hong Kong in the middle of May, his income for 1 April up to his date of departure will be assessable, notwithstanding the total number of stay in Hong Kong in that year of assessment does not exceed 60 days.

In counting the number of days for “visits”, part of a day is taken to be one whole day. In other words, the day of arrival and the day of departure are counted as two days. Furthermore, all days in Hong Kong are counted irrespective of whether they are for services or not. This method of counting is established in the court case CIR v. So Chak Kwong, Jack 2 HKTC 174. The court made clear that the words “not exceeding a total of 60 days” in section 8(1B) qualify the word “visits” and not the words “services rendered”.

Since the So Chak Kwong case, there have been a number of Board of Review cases concerning how to count the number of days for the 60-day rule. Among them, the Board case D27/03 summarizes all the previous cases and made the following comments:  

" (a) In determining whether a taxpayer has rendered his services outside Hong Kong, no account can be taken of services rendered by him during visits to Hong Kong totaling not more than 60 days under section 8(1B) of the IRO which reads as follows: ' In determining whether or not all services are rendered outside Hong Kong for the purposes of subsection (1A) no account shall be taken of services rendered in Hong Kong during visits not exceeding a total of 60 days in the basis period for the year of assessment.'  

(b) In section 8(1B), a 1986 High Court decision held that the word 'days' qualifies 'visit', and not 'services rendered'. But this was recently queried. (i) The question is: should the days visiting Hong Kong refer to (a) only visits spent rendering services in Hong Kong; or (b) all the visits to Hong Kong irrespective of whether services were rendered. This question was answered by the High Court in CIR v So Chak Kwong, Jack 2 HKTC 17. It was held that the words 'not exceeding a total of 60 days' qualify the word 'visit' and not the words 'services rendered'. Mortimer J at page 188 said: 'The words “not exceeding a total of 60 days” qualify the word “visits” and not the words “services rendered”. Were it otherwise the Section would be expressed differently. In order to take the benefit of the Section therefore a Taxpayer must not render services during visits which exceed a total of 60 days in the relevant period.' (ii) This was queried in D37/01, IRBRD, vol 16, 326 where the Board there said at page 329: 'With respect, that will give rise to extraordinary results. For example, someone spending 61 days of holidays or weekends in Hong Kong will not qualify for exemption if he so much as spent half an hour on an ad hoc assignment for his employer in Hong Kong. Such an absurd result could not possibly be the intention of the legislature.' And at page 330: 'It may be that the words “services rendered” should be construed to mean regular work  contemplated by the contract of employment and exclude any work done on an ad hoc or an informal basis. Be that as it may, we are bound by the decision in the So Chak Kwong, Jack case. All that we can say is that it is perhaps time for the legislature to review this subsection to clarify precisely what is the true intention of this subsection.' 

(iii) We are bound by the So Chak Kwong Jack case. Our interpretation of the current status of the law is that, in counting the 60 days, days visiting Hong Kong include any visits to Hong Kong irrespective of whether services have been rendered in Hong Kong during those visits. By extension of this principle, since 'days' refer to any visit, it cannot be argued that 'days' must be 'work days'. However D37/01 queried whether in the interpretation of 'services rendered', work done on an ad hoc or informal basis should be excluded from 'services rendered'. In a similar way, we have raised this question but in a different context under section 8(1A)(b) in paragraph 9(c).   

(c) There is controversy in interpreting the word 'visit'. Can a person with a home in Hong Kong be considered as 'visiting' Hong Kong although he may have been living outside Hong Kong? (i) The interpretation of the word 'visits' has been taken to mean that residents of Hong Kong who for all intent and purposes are outside Hong Kong for most of a year of assessment can never 'visit' Hong Kong. This was the interpretation adopted in D29/89, IRBRD, vol 4, 340 where the Board in that case decided that section 8(1B) was inapplicable to a Hong Kong resident employed in Hong Kong but whose working place was essentially outside Hong Kong. The reason was that the taxpayer in that Board decision was normally a Hong Kong resident working in China. This was despite the fact that the taxpayer was in Hong Kong for only 107 days (taking fractions of a day to be one whole day) and according to the taxpayer's calculations he was in Hong Kong for 27 'working' days (viz excluding weekends, public holidays and unpaid leaves). D29/89 decided as he was resident in Hong Kong and not in China, he could not be taken as having 'visited' Hong Kong within the meaning of section 8(1B). As obiter, the Board in D29/89 was of the view that even if the taxpayer could have been considered as 'visiting' Hong Kong, he could not have met the 60 day grace period requirement as the Board had adopted the interpretation of 'day' to include fractions of a day.  

(ii) Another Board in D11/97, IRBRD, vol 12, 147 queried this interpretation of 'visits'. The Board stated that: 'The meaning of the word must of course be construed in its context. The context of section 8(1B) is that the person is ex hypothesi outside the jurisdiction for most of the year and the word “visit” may not be inapposite to describe a period of short stay. It seems to us somewhat precarious to hang on that single word an intention, not otherwise expressed, on the part of the legislature to exclude from the beneficial application of section 8(1B) all persons who have their home in Hong Kong.'  (iii) We agree with the approach in D11/97. We are not persuaded by the rationale in D29/89 or the arguments put forward by the Revenue in this appeal. We will not deprive a taxpayer of the benefit of section 8(1B) purely on the ground that the taxpayer is a Hong Kong resident or has a home in Hong Kong. First, the Board will have to look at whether a taxpayer was rendering outside Hong Kong all of his services. Then the Board will decide whether the 60 day rule in section 8(1B) applies in favour of the taxpayer so that any services that he did render in Hong Kong for visits totalling less than 60 days will not be used against the taxpayer when determining whether he did render all his services outside Hong Kong.  

(d) The word 'day' in section 8(1B) has been the subject of two types of queries: (i) Does 'day' include any day irrespective of whether it is a working day, non-working day, weekend, midweek, public holiday or paid leave or unpaid leave? Or does it include only the 'working' time or day element? (ii) Should fractions of a day be taken to be one whole day so that arrival and departure dates are each included as a day (assuming arrival and departure did not take place within the same day)? Or should they be taken as exactly what they are; fractions only? (i) D37/01 favoured, obiter, the exclusion of non-working hours in the calculation of the 60 days. But given the High Court decision in the So Chak Kwong, Jack case and in the context of circumstances envisioned in section 8(1B), we believe that this is untenable. Services can be rendered irrespective of whether the time in Hong Kong were working days or not. Under the same rationale in the So Chak Kwong, Jack case, 'days' include any visit and not only just visits in which services were rendered or visits which were working days or had working hours. (ii) On the question of whether a part day should be considered as a whole day, the legal position is not so clear. From the cases to which we have been referred, this issue was first raised in D29/89 which mentioned as obiter that fractions of a day was to be considered as one day. This principle was applied in D12/94, IRBRD, vol 9, 131, D11/97, D107/99 unpublished and D20/00, IRBRD, vol 15, 297. D20/00 considered this issue with benefit of reasoned and detailed submissions on the law on this issue from the representatives of both the taxpayer and Revenue in that case. It applied the fraction day = whole day approach. But this approach has been queried in other Board cases D54/97, IRBRD, vol 12, 354 and D37/01. The fraction = whole approach contradicts the rule of interpretation of tax law that ambiguities should be resolved in favour of taxpayers. Thus we disagree with the fraction = whole approach. (iii) Should fractions of a day be considered as one whole day when calculating the 60 days? The Revenue answers yes. Taxpayers answer no and point to the inherent unfairness to the Revenue's approach. A taxpayer entering Hong Kong in the evening of one day and leave Hong Kong the next day within 24 hours of arrival is taken to have visited Hong Kong for two days. In the context of Hong Kong residents working in China returning home for the weekend, this can work especially harshly. A taxpayer returns to Hong Kong in the afternoon or evening of Saturday after his workweek in China and leave Hong Kong on the Sunday evening to be ready for work in China on Monday will have spent 104 days (excluding midweek holidays) in Hong Kong. But we must remember that the 60 day grace period works only if the taxpayer has rendered some services in Hong Kong during his 104 days in Hong Kong. If he had not rendered any services at all in Hong Kong during those 104 days, his salary is still exempt from tax under section 8(1A)(b). The harshness comes from the fact that he is then effectively deprived of the benefit of the 60 day grace period if he performs any services under his  employment contract should he need to perform some services during those weekends in Hong Kong or should he need to return to Hong Kong during mid-weekdays to perform such services. Compare his situation with that of a taxpayer who does not have a home in Hong Kong or does not have to come home to Hong Kong during the weekends. This 'non-Hong Kong' taxpayer can take advantage of the 60 day grace period to allow him to perform some of his services in Hong Kong so long as his visits do not total 60 days. In short, a Hong Kong resident with a family in Hong Kong and who regularly returns to Hong Kong to spend quality time with his family cannot avail himself of the 60 day grace period afforded to a complete non-Hong Kong person. (iv) If the fraction of a day = whole day formula is said to work harshly against taxpayers or against rules of interpretation of tax statutes, what are the alternatives? There are the following: 

(1) There is the sum-of-all-parts approach where all the fractions of any part day are simply totaled to give whole days. This approach gives maximum benefit to taxpayers but is unreasonable since stays in Hong Kong of less than 24 hours should as a matter of common sense be considered as at least one day.  

(2) Alternatively, a day can be divided into two parts of 12 hours each commencing with twelve o'clock with any hours in Hong Kong less than 12 hours being counted as half a day. By giving half days, the harshness of the whole day approach may be mitigated.  

(3) The third approach is more complicated; but it also mitigates the harshness of fraction = whole approach and the other extreme of sum-of-all-parts approach. Each trip to Hong Kong in which the stay in Hong Kong is 24 hours or less is to be counted as one day. For each stay over 24 hours, the total hours in Hong Kong will be divided into 24 hours to count as whole days with the remaining fraction of 24 hours being totaled up using the sum-of-all-parts approach. In essence, this approach treats every trip to Hong Kong lasting less than 24 hours as one day and every trip more than 24 hours will have any additional hours beyond the initial 24 hours treated as fractions of a day. Of course, if there were two or more trips to Hong Kong within the same day, all the trips added together should be counted as only one day.  

(v) None of the suggested alternatives have any legal basis. But then again neither did the fraction = whole approach have any legal basis when it was first considered by the Board in D29/89. We believe that the Revenue and the Board should adopt a flexible approach by looking at the circumstances of each case. Did the taxpayer have a family in Hong Kong? Is he a Hong Kong resident with close connections with Hong Kong? Is he a foreigner with no connections whatsoever? What was the principal reason for the visit to Hong Kong? How long was each visit? How frequent were the visits? Are there any records of entry and departure times and dates? There may be other questions which need to be considered depending on the facts of each case. "

Author's comment: Although the So Chak Kwong Jack case lays down the basic principle on counting the days of visiting Hong Kong, don't forget to put forward the actual circumstances of your case and ask for a flexible approach based on the above Board's ruling.

Queries by IRD on claims for visiting Hong Kong not more than 60 days

To determine whether or not all the services of a claimant are done outside Hong Kong, the Revenue may raise the following queries:

1.  a copy of the employment contract

2.  a written confirmation from employer regarding the taxpayer's place of employment, post title and nature of work in Hong Kong

3.  a travel schedule setting out dates of arrival in or departure from Hong Kong and the purpose of the visits to Hong Kong

4.  copy of passport

2.2 Basis period  

Salaries Tax is charged on the assessable income earned by an employee or an office holder in a year of assessment that runs from 1 April to 31 March. A final assessment will not normally be made before the end of the year of assessment (save the taxpayer is about to leave Hong Kong). Instead, a provisional assessment is made on the basis of the last final assessment. The tax demanded by the provisional assessment is to be paid by two installments: 75% in January to March within the year of assessment and 25% in the coming April to June. In other words, tax is payable on the earned “provisional income”. If the actual income is 90% of the provisional income or less, the taxpayer can ask for a revised assessment of provisional income. The time limit for such application is 28 days before the pay day of the provisional tax.

When the final assessment is raised, the provisional tax charged will be deducted from the tax payable for that year. Normally, in the year of assessment with a commencement of employment, the first tax payable will be a final assessment without a deduction for provisional tax plus a provisional tax for the following year of assessment.

Only the salary received by the employee is taxable. Unpaid salary is not taxable. On the other hand, if salary is returned by the employee to the employer because of failing to meet certain conditions in an employment contract, such salary returned will be accepted as a deduction from the taxable income by way of concession. When accrued salary is received at last, it is taxable in the year of assessment to which it accrues, not in the year of assessment of receipt.

Salary is deemed to be received by an employee if is made available to him or if it has been dealt with by the employer on behalf of the employee or according to his direction. In other words, if the employer pays the employee's salaries tax according to a recovery notice of tax issued by the IRD, the payment of taxes will be treated as taxable income because it is income dealt with on behalf of the employee. Furthermore, income accrued to an employee is defined as when he can claim payment thereof legally.

A taxpayer can apply for relating back a lump sum payment or a gratuity that is paid upon retirement or termination of any office or employment or any contract of employment to enjoy lower tax rates. Besides, he can also apply for relating back of the deferred pay (usually called back pay) of his remuneration to the related period. The effect of the application is that such lump sum, gratuity or deferred pay is treated as income accruing evenly throughout the relevant employment period subject to a maximum of 3 years. The application can be made in the taxpayer's his tax return for the relevant year of assessment. If he fails to do so, he can write to apply within 2 years after the relevant year of assessment.

Hold-over of provisional tax

If the actual income is 90% of the provisional income or less, the taxpayer can ask for a revised assessment of provisional income. The time limit for such application is 28 days before the due date of the provisional tax.

Besides, a taxpayer can ask for hold-over of the provisional tax on the grounds that he is eligible to claim a new allowance, e.g. he married a wife in mainland China, or his employment has ceased or he has objected to an assessment which forms the basis of the provisional tax.

2.3 What are taxable income and benefit?  

Section 9 defines taxable income and benefit to include: salary, wages, leave pay, fee, bonus, commission, gratuity, perquisite or allowance whether or not they are derived from employer. Special provisions are laid down in the IRO to tax special perks such as subsidized accommodation, retirement benefits, share options, holiday benefits and children's education subsidies.

The leading Hong Kong court case on taxable emoluments is David Hardy Glynn v The Commissioner of Inland Revenue 3 HKTC 245. In this case, the employee arranged so that his children's expenses were solely borne by his employer. He argued that because such benefit could not be converted into cash and only his employer had the liability to pay, the free education benefit should not be taxable. On appeal, the Court of Appeal ruled that the UK tax cases were irrelevant in taxing of employment benefits for Hong Kong salaries tax and all benefits, whether they were convertible into cash or not, derived from an employment were taxable.

This ruling widened the scope of taxable benefits too much. On further appeal, the Privy Council ruled that the UK tax cases on taxation of perquisite were still applicable to taxing of employment benefits in Hong Kong, thus reversing the decision of Court of Appeal, and that all benefits having cash value are taxable including the provision of free education to an employee's children. 

After the Glynn's case, Section 9 was amended so as to restore the old rules for taxing of employment benefits. In short, a benefit is taxable if it is of money's worth. A benefit is regarded as of money worth if it is convertible into money (e.g. by sale) or if it is involved in the discharge of the employee's personal liability (e.g. payment of the employee's credit card liabilities). Furthermore, the provision of free education to an employee's children is taxable in whatever arrangements.

Under Section 9, all kinds of cash allowances arising from an employment are wholly taxable. They include housing allowance, living-cost allowance, transportation allowance, baggage allowances, medical allowance, clothing allowances, tips … etc. So, to make the benefits non-taxable, the employer should be made solely liable to pay the benefits --- in that case, these benefits will be inconvertible into cash or have no cash value. Caution: Such arrangement does not work for subsidized accommodation, retirement benefits, share options, holiday benefits and children's education subsidies because they are subject to special provisions of the IRO.

The allowance paid to an employee to cover the employer's expenses is not taxable because it is not income to the employee. Moreover, the transportation allowance paid to enable the employee to discharge his duties (for example the motor expenses from one work site to another) is not taxable either. 

In the case CIR versus Humphrey 1 HKTC 451, a civil servant who worked in Tai Po and lived in Kowloon was given a monthly allowance to cover the traveling expenses from his home to the workplace and vice versa. It was held that the allowance was taxable because the expenses involved were of a private and domestic nature. Author's comment: If the allowance was to cover the expenses between one work place and the other workplace of the employment, such allowance will not be taxable.

A benefit is taxable if it is of money's worth. A benefit is regarded as of money worth if it is convertible into money (e.g. by sale) or if it is involved in the discharge of the employee's personal liability (e.g. payment of the employee's credit card liabilities). Furthermore, the provision of free education to an employee's children is taxable in whatever arrangements.

All kinds of cash allowances arising from an employment are wholly taxable. They include living-cost allowance, transportation allowance, baggage allowances, medical allowance, clothing allowances, tips … etc. So, to make the benefits non-taxable, the employer should be made solely liable to pay the benefits --- in that case, these benefits will be inconvertible into cash or have no cash value.

Nevertheless, only emoluments for the services rendered by employee are taxable. This principle is laid down in a number of tax cases including Hochstrsser v Mayes (38 TC 673), Reid v Seymour (11 TC 635) and Mairs v Haughey (3 WLR 393). So, if the payment is paid as a gift on a special occasion (e.g. marriage, death, passing an examination… etc.), it is not taxable.

Besides, the following receipts are not taxable:

·    compensations for work injuries

·    compensation or payment for sickness 

·    compensation for loss of employment

·    compensation  for damages in legal disputes

·    compensation on redundancy

·    compensation for wrongful dismissal of an employee

·    legal settlement / compensation for sexual harassment

·    legal settlement / compensation for breach of employment contract

·    compensation arises from a dispute between an employer and an employee

·    payment by a new employer for inducement of an employee to leave his existing employment

·    payment for a leaving employee not to compete with his employer within a certain period of time

·    payment of employee's relocation expenses from a foreign country to Hong Kong on commencement of employment

·    payment of employee's relocation expenses from Hong Kong to a foreign country on cessation of Hong Kong employment

·    severance payment

·    long-service payments

·    certain payments from retirement schemes

·    free medical services, free lunch, free training, free transportation, free house-keeping services... etc.  

·    reimbursement of self-education expenses (not exceeding the statutory limit)

·    salary not yet received by the employee

·    certain payment made by a new employer to induce an employee to leave his existing employment: vide Pritchard v Arundale  (47 TC 680)

·    salary received by a consulate employee who is a citizen of and is representing the relevant foreign country. In practice, the exemption will be granted to the employee who holds a consulate passport.

·    salary received by the principal staff of certain International Organizations 

·    certain lump sums withdrawn from an approved retirement scheme (For details, see retirement benefit at Chapter 2.7)

·    pensions payable outside Hong Kong

·    education grants, subsidies or scholarships

·    payments relating to war service

·    alimony or maintenance payments to a spouse or an ex-spouse 

2.4 Housing benefit 

Section 9 states that rental value at 10% of the relevant income is assessed if free accommodation is provided by employer.

Relevant income means the taxable income (excluding rent refund) in respect of the period of free accommodation. Contract gratuity paid on termination of employment is not included in the relevant income for computation of rental value. But if there is no termination of employment, the gratuity will be added to the relevant income and so increase the rental value. If the contract of employment is renewed upon expiry, there will be no termination of employment. Therefore, in order to avoid the inclusion of the contract gratuity in the relevant income, it is advisable for the taxpayer to have a break, say 2 to 3 weeks, after the expiry of the first employment contract before he signs a new contract of employment with the same employer.

Free accommodation is deemed in case of rent refund by the employer. Based on Board of Review cases, the crucial point in deciding the question of Rent Refund versus Rent Allowance is whether the employer has, from time to time, exercised control over the use of the rent.

The taxpayer may elect to have the rental value be assessed at the rateable value. The taxpayer should make the election if the rental value assessed based on relevant income is greater than that based on rateable value. The rateable value is the estimated annual rent as shown in the rates bill issued by the Commissioner of Rating and Valuation. So, don't forget to check with your rates bill when you are assessed to rental value in your tax bill.   

Housing allowance v rent refund

Housing allowance is taxable in full. But rent refund is taxable at 10% of relevant income. To avoid challenge by Revenue, it is advisable for taxpayers to have the rent refund benefit stipulated in the employment contract and the rent agreement duly stamped.

If it is a rent allowance case, the allowance should be reported by the employer in the Employer's Return of Remuneration and Pensions (IR56B) under item: Any other Rewards, Allowances or Perquisites. If it is a rent refund case, the rental benefit should be reported as free accommodation under item: Particulars of Place of Residence provided.

If the free accommodation is a room at a hotel, the rental-value rate will be 4% instead of 10%. If it consists of two rooms, the rate will be 8% instead. In practice, a room means one unit of residence (that is one room number) although there may be more than one bedroom in that "room". 

Can an employee let his property to employer to obtain tax benefits? 

Yes! In law, the owning of a residence by an employee will not deprive him of receiving rent-refund benefit from his employer. In fact, this method is used by a lot of employees to reduce their tax burden.  

An employee may pay mortgage interest exceeding the limit of home loan interest: $100,000 in a year of assessment. But any excess of interest payment is not deductible under Salaries Tax. Besides, home loan interest deduction is only available for seven years of assessments. There will be no interest deduction after the seven year period. Below is a typical arrangement.   

The total remuneration is fixed. To obtain the rent-refund benefit, the employee let his residence to his employer at the market rent. Then, the cash remuneration is reduced by the rent refund. The taxable value of the rent refund is only 10% of the reduced cash remuneration. As a result, the total assessable income under salaries tax decreases. 

On the other hand, as the employee receives rental income, he has to pay property tax. But the rates paid by the employee is deductible from the rental income. Furthermore, there is a further deduction of 20% from the rental income. The tax reduction by the free accommodation under salaries tax is generally greater than the property tax. 

The tax benefit can be enhanced by election of Personal Assessment under which the employee can claim deduction for all the mortgage interest (there is no such dollar and time limits as home-loan interest under Salaries Tax). The election of Personal Assessment can generally remove or reduce the property tax. 

Caution: The Revenue may challenge the above arrangements by section 61A in the following situation:

1.     the employer is controlled by the employee,

2.     the tenancy agreement is not stamped,

3.     the rent exceeds 50% of the total remuneration, and

4.     the rent is excessive when compared to the market rent.

Queries by IRD on claims for rent refund instead of rent allowance

(a)    Copy of employment contract 

(b)    Employer's housing-benefit policy 

(c)    How the taxpayer's housing-benefit was determined? 

(d)    Did the employer exercise control over the use of the benefit and how? 

(e)    Copy of the tenancy agreement 

(f)     Copy of some rent receipts 

(g)    The relationship between the landlord and the taxpayer 

(h)    How the rent was paid to the landlord? 

(i)     Did the taxpayer make contribution for purchase of the property?

2.5 Holiday benefit

Holiday benefit granted by employer is assessable under section 9(2A)(a). The assessable amount is the actual cost incurred by the employer in providing the benefit to the employee and his family.

The law provides that the charge of tax is irrespective of the following factors: (a) Whether or not the benefit is convertible into cash, (b) Whether the employer of the employee has the primary liability to pay the benefit, (c) Whether or not the benefit will add additional cost to the employer, (d) Whether or not the benefit will cause opportunity cost to the employer (for example the lost revenue arising from the sale of discounted-price air tickets by air-liner employer to employee).

In brief, the amount taxable is the amount paid by the employer in connection with the benefit. This includes the cost of the air tickets, hotel accommodation, traveling, food, package-tour fee ... etc.

Only “holiday-journey” benefits are taxable. All expenses in connection of business journey are exempt. Business journey means the employee's traveling is required by his employer to perform his duties. If a trip is substantially for business purpose, even though part of the trip is for non-business purpose, the whole journey will be exempt. However, if the non-business portion is significant and can be clearly identified, the expenses attributable to the non-business portion will be ascertained and taxable.

Only the benefit that is provided as a reward for services rendered is taxable. Say, an employee in the lucky draw of the employer's annual dinner gets a round trip air-ticket to USA. This air ticket, although it was bought by the employer, is not taxable because it is a gift made in a social activity and not as a reward for services rendered by the employee.

According to paragraph 19 of DIPN 41, the payment for the relocation of an employee and his family to Hong Kong on commencement of employment or for the relocation of an employee out of Hong Kong is not taxable.

2.6 Granting Share Options to employees  

A share option is a right to acquire shares at a prescribed price. The gain realized on exercising or selling the share option granted by the employer is taxable. The taxable gain on exercising the option is the market value as at the date of the exercise less the price paid by the employee. Any gain or loss on sale of the shares after the exercise is ignored. So, if you don't want to take the risk of fall in market value after you get the shares, sell them quickly. The taxable gain on selling the option is the net sales proceeds less the price paid by the employee for the option. If you don't sell the option, it won't be taxed.

If the services, for which the share option is granted, are exempt from tax, then the related gain will be exempt too. The exemption is usually computed by a time apportionment.

The taxability of the share options is irrespective of: (a) Who issues the share options, or (b) Where the shares option are issued, or (c) Whether the shares acquired by exercising the options are unsold and held by the employee as capital investment. The crucial question is whether the share options are granted in respect of taxable services in Hong Kong and whether they are exercised or sold.

Employee leaving Hong Kong for good

With a view to finalizing his salaries tax before departure, the Revenue may allow, by concession, a taxpayer to elect for a notional exercise of the share option. In that case, the gain is computed as if the option were exercised on any day within 7 days before the filing of his Salaries Tax return for the last year of assessment. This election is made on a mutual understanding that no further tax liability will arise when the option is eventually exercised, assigned or released thereafter. Once the election is made, it will not be withdrawn unless that is made within the objection period --- that is one month after the issue of the relevant assessment. On the other hand, if it transpires the real gain by the actual exercise, assignment or release of the option is less than the amount assessed under the notional exercise, the taxpayer can ask the Revenue for a revised assessment adopting the real lower gain. So, it is generally advisable for the taxpayer to make the election.

Issue of shares to employees

Shares issued at a discount become taxable at the time of issue. If the shares issued are subject to a restriction, say a holding period of 2 years, then the taxpayer can ask for a discount when computing the taxable value. In fact, the discount rate can be more than 50% off the market value. So, don't forget to fight for a high discount rate if the shares offered are subject to restrictions for resale. Besides, if the shares offered are the ones listed in a stock market, there are seldom disputes as to their valuation. However, if the shares belong to a private company, the IRD will usually adopt the dividend-yield method: that is usually done by a capitalization of the average last 3-year dividend per share at a discount rate. In theory, the discount rate is the expected rate of return from the shares by a reasonable buyer. This may be the then market interest rate as adjusted upward to account for the risk associated with the shares in question. In fact, the discount rate is often disputed by the taxpayer with the IRD and it is often resolved by compromise in accordance with the objection or appeal procedures.  

2.7 Payments at the end of an employment  

As aforesaid, a compensation for loss of employment is taxable. But what is a compensation for loss of employment? Let's see what the Board of Review said: 

Author's advice 

1.  Where a lot of employees are made redundant due to downsizing or closure of certain business activities of the employer, the Revenue will generally allow the lump sum paid on termination of employments as compensation for loss of office (not taxable).  

2.  If the lump sum is already provided in the employment contract to be paid on termination of employment, the Revenue will assess the lump sum as “remuneration paid in arrear for the employee's past service”. 

3.  If the lump sum is paid to induce the employee to start a new employment, say with an associated company of the employer, the Revenue will assess the sum as “remuneration paid for future service of the employee”.

4.  The long service payment and severance payment paid in accordance with Employment Ordinance upon termination of an employment are exempt from Salaries Tax. Where there is no termination of employment, the above payments can still be exempt from tax under the Revenue's extra-statutory concession. This concession applies where the employee's salary is adjusted downward by way of a dismissal followed by a fresh immediate re-employment. In such case, if the employer pays the employee a sum representing the Long Service Payment or Severance Payment, the sum will be exempt from tax.

5.  Contract gratuity paid on termination of employment is not included in the relevant income for computation of rental value. But if there is no termination of employment, the gratuity will be added to the relevant income and so increase the rental value. If the contract of employment is renewed upon expiry, there will be no termination of employment. Therefore, in order to avoid the inclusion of the contract gratuity in the relevant income, it is advisable for the taxpayer to have a break, say 2 to 3 weeks, after the expiry of the first employment contract before he signs a new contract of employment with the same employer.

6.  In your tax return you can state the cessation of employment and  ask for no charge or reduced charge of provisional tax for the following year of assessment.

7.  If your actual income is 90% or less than the provisional income assessed, you can ask for a reduced charge of the provisional tax. The time limit for such application is 28 days before the due date of the tax payment. 

Queries by IRD on claims for money received on termination of employment not taxable 

(a).  Copy of employment contract

(b).  Date of termination of employment

(c).  Date of commencement of employment

(d).  What caused the termination? Was the termination due to redundancy or resignation or completion of contract? 

(e).  Nature of the payment: was it bonus, accrued leave-pay, or payment in lieu of notice? 

(f).  How the payment was computed? Was it severance payment or long service payment in accordance with Employment Ordinance?

(g).  Why is it not taxable?

2.8 Retirement benefit  

As far as salaries tax is concerned, retirement benefit may be classified into two types: a lump sum payment on retirement and a regular monthly payment after retirement. In general, a lump sum payment on retirement from a recognized retirement scheme is exempt and a regular monthly payment (i.e. pension) is taxable. 

What is retirement? 

Retirement is defined in section 8(3) of IRO as: (a) a retirement from the service of the employer at a specified age not less than 45 years; or (b) a retirement after a period of service of not less than 10 years; or (c) an attainment of a specified age of retirement or the age of 60, whichever is the later.  

Termination of employment by death or by incapacity to work 

For tax purpose, a termination accords the same treatment as a retirement. 

Retirement schemes 

With the enactment of Mandatory Provident Fund Schemes Ordinance in December 2000, almost all retirement schemes in Hong Kong are subject to regulation by Mandatory Provident Fund Schemes Authority. As such, almost all retirement schemes operating in Hong Kong are recognized for tax purpose. There are two categories of recognized retirement schemes: (a) ORSO Scheme and (b) MPF Scheme.   

What is an ORSO scheme? 

It is a scheme defined in the Occupational Retirement Schemes Ordinance (ORSO). In fact, most ORSO schemes operated before MPFSO. 　

What is a MPF scheme? 

A MPF scheme is a defined contribution retirement scheme managed by an approved trustee as defined in the Mandatory Provident Fund Schemes Ordinance “MPFSO”.  MPF schemes are applicable to employees aged 18 to 65 whether they work full-time or part-time for 60 days or more. It also covers casual construction workers and self-employed persons below the age of 65. Nevertheless, the following persons are not covered by MPF schemes: (a) persons who have been employed for less than 60 days, (b) domestic helpers, (c) self-employed hawkers, (d) persons covered by pension (e.g. government employees), (e) persons covered by statutory provident fund schemes (e.g. teachers of subsidized schools), (f) persons to work in Hong Kong for not more than 12 months or covered by overseas retirement schemes, and (g) persons covered by recognized ORSO schemes.  

There are three types of MPF schemes: (1) Master Trust Schemes: suitable for employees of more than one employer, self-employed persons with accrued benefits transferred from another scheme, (2) Employer Sponsored Schemes: suitable for large employers, and (3) Industry Schemes: suitable for employees of industries with high labour mobility.   

Employer and employee are separately required to contribute 5% of the employee's income (total 10%). If the employee's monthly income is greater than $20,000, their contribution is restricted to: 5% of $20,000, i.e. $1,000 each. If the monthly income is less than $5,000, the employee is not required to make contribution but the employer still has to make the 5% contribution.  

A self-employed person can make contribution on a monthly or a yearly basis. He must join a registered scheme within 60 days of the commencement of self-employment.   

Termination of employment with service of 10 years or more  

The lump sum payment is not taxable. This applies to both ORSO and MPF schemes. 

Termination of employment with service of less than 10 years  

The lump sum payment attributable to employee's contribution is not taxable.  

Tax relief and exemption 

In case of an MPF scheme, the lump sum payment attributable to the employer's mandatory contribution is also exempt. The lump sum payment attributable to the employer's voluntary contribution (the accrued benefit) is exempt up to a limit called the "proportionate benefit" which is defined as: the accrued benefit * no. of completed month of service / 120. The excess of the lump sum payment attributable to the employer's voluntary contribution over the limit is taxable. 

In case of an ORSO scheme, the lump sum payment attributable to the employer's voluntary contribution (the accrued benefit) is exempt up to a limit called the "proportionate benefit" which is defined as: the accrued benefit * no. of completed month of service / 120. The excess of the lump sum payment attributable to the employer's voluntary contribution over the limit is taxable. 

Leaving Hong Kong for good 

If an employee leaves Hong Kong permanently and his employment ceases on his departure from Hong Kong, the exemption of proportionate benefit for termination of employment will apply. However, if there is no termination of service (for example he is seconded to an overseas associated company), the portion attributable to the employer's voluntary contribution is taxable in full. In other words, the exemption of "proportionate benefit" will not apply. 

Set-off of retirement benefit  

If part of the retirement benefit is used to set off the Long Service Payment or Severance Payment under the Employment Ordinance, the amount of set-off is deductible from the taxable amount.   

Contribution to a retirement scheme 

An employee can claim deduction for his mandatory contribution to a recognized retirement scheme. The maximum deduction is $12,000 per year.

2.9 Pension benefit

Under section 8(1), pension arising in Hong Kong is chargeable to salaries tax. No definition of “pension” is made in IRO. So, the Literal Rule applies so that its ordinary meaning will be adopted. In short, pension is a periodical payment to a person in consideration of his past services.

Section 9(3) extends the charge to cover a pension which is voluntary or is capable of being discontinued. This provision was to overcome the decision in Stedeford v. Beloe 16 TC 505 in which pension was held to be excluding voluntary payments.

Like employment income, only the pension arising in or derived from Hong Kong is assessable. This follows that we have to determine the location of the source of the pension. From case law, the location of the fund from which the pension is paid is the decisive factor in determining whether the pension is arising in Hong Kong or not. But this does not mean that the place where the assets making up the fund determines the location of the pension. In fact, regard should be made to the place where the fund is managed and controlled. Normally, this is situated at the place of the business that employed the pensioner. But in some special cases, it can be located at the place where the trustee has power to control the fund.

As far as Hong Kong government pensioners are concerned, all the pension based on total length of service is chargeable to salaries tax, even though part of which is attributable to services done outside Hong Kong. In all other cases, the pension attributable to services outside Hong Kong is not taxable.

2.10 Children's education benefit

This benefit is held to be taxable in the case CIR v David Hardy Glynn even though the obligation for the payment was put on the employer solely. In fact, since the case, section 9(2A)(b) has been introduced to reaffirm its taxability. The taxable amount is the amount paid by the employer.

2.11 Non taxable incomes

Payment not for services rendered is not taxable

Only emoluments for the services rendered by employee are taxable. If the payment is paid as a gift on a special occasion (e.g. marriage, death, passing an examination… etc.), it is not taxable.  

Reimbursement of employee's education expense 

If the amount reimbursed does not exceed the statutory limit, it is not taxable. 

Expenses allowance is not taxable 

If the employer pays an employee to cover the company's expenses (for example the traveling expenses for carrying out duties), the payment is not taxable.  

Benefit inconvertible into cash is not taxable 

Except those specifically provided in the law (such as housing benefit, children's education benefit, holiday benefit … etc.), the benefits which cannot be converted into cash is not taxable. Such non-taxable benefits include: free medical services, free lunch, free training, free transportation, free house-keeping services... etc.  

2.12 Deduction of expenses 

Section 12 says all outgoings and expenses, other than that of a domestic, private or capital nature, which are wholly, exclusively and necessarily incurred in the production of assessable income, are deductible. 

The tests of “wholly” and “exclusively” should not be construed narrowly. In my experience, the Revenue accepts reasonable apportionment of expenses for deduction even if the expenses are not “wholly” and “exclusively” incurred in the production of assessable income.   

Where the employer reimburses the expenses incurred by the employee, the Revenue may accept such reimbursement as non-taxable income. Or else, the employee can claim a deduction for the expenses allowance. 

Where the employee is required to wear uniform on duty, the Revenue may grant a flat rate deduction for the laundry expenses incurred by the employee. This flat rate deduction is usually proposed by the Revenue when the employee claims the deduction in a tax return or a formal objection to the assessment. The employee can get a greater deduction if he can substantiate his claim by documentary proof. 

Where the employee has part-time jobs, the Revenue may grant a flat rate deduction (about 10% of the part-time income) for the traveling expenses between the workplaces. This flat rate deduction is usually proposed by the Revenue if the employee claims the deduction in a tax return or in a formal objection to the assessment. The employee can get a greater deduction if he can substantiate his claim by documentary proof. 

Where the employee is a member of a professional body (e.g. law society) and the membership is relevant to his job, the Revenue may allow a deduction for the annual membership fee. 

Where the employee is a sales-person, the Revenue may grant a flat rate deduction for the commissions, entertainment and traveling expenses incurred by the employee. The flat rate deduction is usually proposed by the Revenue if the employee claims the deduction in a tax return or in a formal objection to the assessment. The employee can get a greater deduction if he can substantiate his claim by documentary proof.  

The following two cases illustrate the general principle of expenses deduction. 

Queries by IRD on claims for deduction of outgoings and expenses

(a) A schedule showing date, amount and purpose of each item of expenditure.

(b) Why the expenses were wholly, exclusively and necessarily incurred in the production of assessable income?

(c) Whether such expenses were reimbursed by the employer and why?

(d) Documentary evidence (such as receipts or employer's confirmation)

2.13 Home Loan Interest 

Section 26E of Inland Revenue Ordinance states that the interest paid on loan for purchase of residence is tax deductible. In brief, the qualifying conditions are:-

1.     the person is the property owner; and

2.     the property is a rateable unit in Hong Kong; and

3.     the property is used as the person's residence; and

4.     the loan is subject to mortgage from a recognized lender such as a bank.  

A car park in the same property development of the residence is accepted as part of the residence. 

There is a limit on the interest deduction. The current limit is $100,000. If the deduction is below the limit, the unused part cannot be carried forward. A person can only get the deduction for a total of 7 years of assessments. It is up to him to apply for the deduction for any year of assessment throughout his working life. 

Where the property is partly owned by the person, the interest deductible is restricted to his share of ownership. 

Where the property is jointly owned by the person and his spouse, the deduction ratio of interest is 50%. But if the spouse has no income chargeable to tax, he can get the remaining 50% deduction by spouse's nomination. If the spouse has income chargeable to tax, no nomination is allowed but that spouse can get her share of the deduction in her own assessment. If the couple elects for joint assessment, then the total interest will be allowed in their joint assessment.   

Where a re-mortgage loan is borrowed to repay the first loan, the interest on the re-mortgage loan attributable to the repayment of the first loan is deductible.

Where an additional loan is borrowed after the purchase of the property, the interest on the additional loan is not deductible.

Queries by IRD on claims for deduction of Home loan interest

(a) Location of property

(b) Owner of the property

(c) Date of purchase

(d) Purchase price

(e) Was it used for the taxpayer's residence?

(f)  Date of the loan

(g) Amount of the loan

(h)  Name of the lender

(i)  Was the property mortgaged?

(j)  Amount of interest in the year of assessment            

(k) Copy of repayment schedule / installment payment / interest receipts / bank's letter showing the interest

2.14 Self Education Expenses 

Section 12(1)(e) states that a person can get a deduction for Self-Education Expenses. In brief, the qualifying conditions are:-

1.    the expenses are paid to a recognized educational institute such as university, college, school, technical institute; and

2.    the expenses include tuition and examination fees for a course of education, and the course of education is related to employment, whether present employment or future employment; and

3.    the expenses are not reimbursed or are not to be reimbursed by employer or any other person. 

Only the actual amount paid in the year of assessment should be claimed. No spreading of the expenses throughout the period of the course is allowed. The maximum deduction is $40,000.

The Revenue may allow deduction, by concession, for examination fee of a professional examination relevant to your employment alone even though the taxpayer does not take a course of education or training. 

Courses for language proficiency or for higher level of education are acceptable.

Queries by IRD on claims for deduction of self-education expenses 

(a).  Name of the educational institution

(b).  Name of the course attended by taxpayer

(c).  Nature of the course

(d).  Date, amount and nature of the expenses, with copy receipt in support

(e).  Were the expenses reimbursed by the employer or by the government?

2.15 Donations to Charity  

A taxpayer making a donation to charity can claim tax deduction if:

1.    it is a donation of money; and

2.    it is for charitable purpose; and

3.    it is paid  to a charitable institution or a trust of a public character that is exempt from tax under Section 88 or to the Hong Kong SAR government; and

4.    the total donations in the year of assessment is not less than $100.  

A taxpayer can also claim deduction for his spouse's donations. 

The maximum deduction is 25% of his net income (assessable income less deductions).

2.16 Elderly Residential Care Expenses 

A taxpayer may claim the elderly home expenses he pays for his or his spouse's parent or grandparent subject to the following conditions:　 

1.  The parent or grandparent is at least 60; or if under 60, he is eligible to claim disabled allowance.

2.  The expenses actually paid by the taxpayer or by his spouse in the year of assessment.

3.  The expenses are paid to a recognized elderly home in Hong Kong.

4.  The expenses cover accommodation, food, nursing care and sundry expenses but exclude those of private medical care or those of a personal nature not in the nature of residential care.

5.  The expenses reimbursed by Social Welfare Department cannot be claimed.  

Even taxpayers paying tax at standard rate can get the deduction. 

Full-year expenses are allowed when the parent reaches 60 in the year of assessment. In other words, no time apportionment of the expenses is necessary. 

The maximum deduction is $60,000 for each parent. 

A taxpayer should not claim Dependent Parent Allowance and Elderly Residential Care Expenses for the same parent for the same year of assessment. If that is the case, his claim for Dependent Parent Allowance will be void and only his claim for Elderly Residential Care Expenses will take effect. So, if the conditions of both claims are satisfied, the taxpayer should decide which claim to make. Normally, if the elderly home expenses are more than $30,000, it is advisable for him to claim Elderly Residential Care Expense. Otherwise, he should claim Dependent Parent Allowance. 

No double claim for the same parent is allowed. If two or more persons claiming the deduction, they should reach an agreement as to who can get the deduction. If no such agreement is made, no one can get the deduction.

2.17 Husband and wife  

In so far as taxation is concerned, a husband and his wife refers to a couple of a lawful marriage. According to section 2, "marriage" means (a) any marriage recognized by the law of Hong Kong; or (b) any marriage, whether or not so recognized, entered into outside Hong Kong according to the law of the place where it was entered into and between persons having the capacity to do so, but shall not, in the case of a marriage which is both potentially and actually polygamous, include marriage between a man and any wife other than the principal wife, and "married" shall be construed accordingly. A wife is defined as a married woman of a marriage within the meaning of the IRO.

In short, the marriage must be a lawful marriage between a man and a woman. A marriage of the same sex (同性戀婚姻) is not acceptable for tax purpose. 

Separate assessment 

As far as tax is concerned, husband and wife are treated as separate individuals. Each party is required to complete his / her tax return, to notify the IRD of his / her chargeability to tax and to pay his / her own tax.  

Joint assessment 

Under salaries tax, if the total net income of one spouse is less than his / her total allowances, there will be unused personal allowances under his / her own assessment. In that case, the couple can elect for joint assessment to have their incomes and personal allowances combined in one single assessment so as to reduce their overall tax liabilities.   

Should the election not reduce their total tax, the IRD will inform the taxpayers so and the election will not be effected. So, it is advisable for the couple to elect for joint assessment if either spouse has low taxable income.  

The election must be signed by both spouses in a tax return or in a form specified by Board of Inland Revenue. The time limit for the election adopts the time limit of the relevant tax return or within one month after a relevant salaries tax assessment becoming final and conclusive.   

The joint election can be withdrawn within one month of the issue of the joint assessment. But once withdrawn, no re-election will be accepted. However, if there are adjustments to either spouse's original assessment rendering the tax reduction of joint assessment no longer applicable, the election will be deemed invalid and revised assessments will be issued under separation taxation basis.  

Normally, only one joint-assessment will be issued to the spouse liable to tax. This is unlike Personal Assessment where the total tax will be apportioned between the spouses so that each spouse will get an assessment. If both spouses are required to pay tax before the joint assessment, they will have to nominate one to get the joint-assessment.  

For joint assessment in case of a newly-wed couple, the marriage will be deemed to start from the beginning of the year of assessment; that is 1 April. In other words, there will be no apportionment of a spouse's income between before and after the marriage. 

2.18 Married Person's Allowance

If a taxpayer's spouse does not have any taxable income, the taxpayer need only claim Married Personal Allowances in his own tax return. In other words, no election for joint assessment is necessary. 

Full allowance is granted in the year of marriage, separation, divorce or death. No apportionment of the allowance is required. 

Whether or not the spouse is a Hong Kong resident does not affect the eligibility of the allowance. 

Where a person is living apart from his spouse, he is not entitled to the allowance unless he maintains his ex-spouse. But if his ex-spouse has assessable income, the allowance will not be granted unless they both elect for joint assessment.  

A married person may also claim Disabled Dependant Allowance in respect of his disabled spouse. The condition for the claim is that the spouse must be eligible to claim Disability Allowance from the Social Welfare Department.

2.19 Child Allowance  

A taxpayer may claim child allowance if he maintains an unmarried child who is below 18, and if 18 to 25: a full time student, or if over 25: disabled for work.

Whether or not the child is a Hong Kong resident does not affect the eligibility of the allowance. According to section 27, the word "child" is defined as any child of a person chargeable to tax or of his or her spouse or former spouse whether or not born in wedlock and includes the adopted or step child of either or both of them. Besides, the word "adopted" is defined as: adopted in any manner recognized by the laws of Hong Kong. 

Full allowance is granted in the year of assessment in which the child is born.　

No double claim of child allowance for a child. No sharing or splitting of child allowance among a couple unless the couple is living apart or divorced. If the couple has more than one eligible child, either spouse can make the claim for all the children and then the other spouse gets no child allowance at all. In general, it is advisable for the spouse with higher income to make the claim. 

A claim for living-apart has to be proved by production of court order or separation deed. A married person living apart from his spouse temporarily is not accepted as living-apart for tax purpose. 

The sharing of the child allowance between a living-apart or divorced couple is based on their contribution to the maintenance and education of the child. In practice, equal sharing is assumed unless the claimant can provide proof that he makes a greater contribution. 

A divorced or living-apart person may also claim Single Parent Allowance if he provides sole or predominant care to the child in the years of assessment after year of the divorce or separation. Whether such care exists is mainly a question of facts. In general, the Revenue looks to whether the claimant is responsible for the provision of the daily care and supervision of the child. The proof may include production of the child's student handbooks, medical record, resident card, … etc. Apportionment of the allowance between the parents on time basis may be accepted if either parent provides sole or predominant care for the child during different periods during the year of assessment.   

A taxpayer may claim Disabled Dependant Allowance in respect of his disabled child. The condition for the claim is that the child must be eligible to claim Disability Allowance from the Social Welfare Department. Full allowance is granted for the whole year of assessment in which the disability is certified.

2.20 Dependent Parent Allowance

If a taxpayer maintains his parent, he can claim the allowance. To qualify the allowance, the parent must ordinarily reside in Hong Kong and be 55 or above; or if under 55, he is disabled.

According to section 2, “parent” means: a parent of whose marriage the taxpayer or his spouse is the child; the natural father or mother of the taxpayer or his spouse; a parent by whom the taxpayer or his spouse was adopted; a step parent of the taxpayer or his spouse; or a parent of his deceased spouse.

Maintaining the parent means paying the parent at least $12,000 during the year of assessment or living with the parent "not for full consideration" for at least 6 months. The phrase "not for full consideration" means the taxpayer subsidizing the living costs of the parent; the allowance can still be granted even if the parent contributes to pay his own living expenses or some of the household expenditure.

A taxpayer may also claim Additional Dependent Parent Allowance if he lives with his parent "not for full consideration" throughout the whole year of assessment.

Full allowance is granted for the whole year of assessment in which the parent or grand-parent reaches 55. Also full allowance is granted for the year of death. No time apportionment of the allowance is required. 

No double dependent parent allowance for the same parent is allowed. If two or more persons claiming the allowance, they should reach an agreement as to who can get the allowance. If no such agreement is made, no one can get the allowance.

In addition, a person may also claim Disabled Dependant Allowance in respect of his disabled parent. The condition for the claim is that the parent must be eligible to claim Disability Allowance from the Social Welfare Department.

2.21 Dependent Brother or Sister Allowance

A person can get the allowance if he maintains his brother or sister who is single and under 18; or if over 18 and under 25: who is on full time study; or if at any age: who is disabled for work. 

Whether or not the brother or sister is a Hong Kong resident does not affect the eligibility of the allowance. 

No double allowance for maintaining the same child is allowed. In other words, if child allowance is granted to the child's parent, no Dependent Brother or Sister Allowance will be granted. 

A taxpayer may also claim Disabled Dependant Allowance in respect of his disabled brother or sister. The condition for the claim is that the brother or sister must be eligible to claim Disability Allowance from the Social Welfare Department.

2.22 Computation of salaries tax

An example of salaries tax computation 

Throughout the year ended 31 March 2006, Mr. Wong, a singleton, was employed as an accountant with a monthly salary of $50,000. In his tax return, he claimed deduction for membership fee to Hong Kong Society of Accountants $2,000, contribution to Mandatory Provident Fund $12,000 and expenses of self-education $15,500. According to his last-year tax bill, he had paid $80,000 for Provisional Tax for 2005/2006. 

In October 2006, Mr. Wong received a tax bill. Assuming the tax return was totally accepted by the Revenue, his assessment and tax payable shown in the tax bill would be as follows:      

Final tax payable for 2005/2006:

Net assessable income: $50,000 * 12 = $600,000 less membership fee $2,000 less MPF contribution $12,000 less self-education expenses $15,500 equal to $570,500.

Net chargeable income: $570,500 minus basic allowance $100,000 equal to $470,500. 

Tax payable at progressive rates (please see my CD Rom for details): $83,300

(Standard rate restriction: $570,500 * 16% = $91,280 --- not applicable)

Less: Provisional tax paid per last-year tax bill $80,000.

Balance tax payable: $83,300 minus $80,000 equal to $3,300. 

Add: Provisional tax payable for 2006/2007:

This is normally the same as the tax for 2005/2006; that is $83,300.

Total tax payable: $3,300 + $83,300 = $86,600. 

Two installments of payments:

The first installment is made up of (a) balance of tax payable for 2005/2006: $3,300 and (b) 75% of the provisional tax payable for 2006/2007, i.e. $83,300 * 75% = $62,475. Total payable for first installment: $65,775. The due date is usually in January to March 2007. 

The second installment of tax is 25% of provisional tax payable for 2006/2007, i.e. $83,300 * 25% = $20,825. The due date is usually in April to June 2007.

2.23 Hold-over of provisional tax

Mr. Wong can apply for hold-over of provisional tax for 2006/2007 on the following grounds:-

1.  The provisional income was likely to be less than 90% of the amount assessed.

2.  He was eligible to claim a new allowance, e.g. he married a wife in mainland China in the year 2006/2007.

3.  His employment has ceased in 2006/2007.

4.  He has objected to the prior-year assessment for 2005/2006.  

Application for hold-over of provisional tax must be lodged 28 days before due date or 14 days after the issue of the demand for provisional tax. It must be made in writing and lodged with this Department within the prescribed time limit.

In the aforesaid example, if an application is lodged on the ground of fallen income for 2006/07, the taxpayer should furnish a computation to demonstrate a drop of the net chargeable income by more than 10%, when compared with that for 2005/06.

As most taxpayers would have their 1st instalment of tax due in January 2007, the most appropriate time to lodge holdovers will be in November and December 2006. By that time, you should know the actual income figures for the 7 months to 31 October 2006, and you should be in a better position to estimate your income for the remaining 5 months to 31 March 2007.

2.24 Working in mainland China

If all your work is done in mainland, you are entitled to a full exemption. If you occasionally come back to the Hong Kong office to attend meetings or report duties, the exemption will fall through. So, you had better report duties to your Hong Kong boss through telephone, fax or e-mail. It is also advisable for your employment contract to stipulate your duties in mainland only.   

In general, the relief under Section 8(1A)(c) of Inland Revenue Ordinance (IRO) is greater than the double taxation relief under Section 49. In brief, the Section 8(1A)(c) relief is to exempt the income attributable to services in mainland if mainland's Individual Income Tax is paid on such income. So, you had better keep all your mainland tax bills for your claim.  

Hardship allowance for working in mainland China has been held by Board of Review as not taxable.

Individual Income Tax paid by the employer should be wholly excluded under Section 8(1A)(c). As the whole of the IIT paid by the ER is wholly attributable to the services rendered outside Hong Kong, it should be wholly excluded under Section 8(1A)(c). According to Article 3(2) of the Arrangement with the Mainland for the Avoidance of Double Taxation of Income, a resident of one side working in the other side should be taxed by the other side in respect of the remuneration of that other side. So, if a Hong Kong resident working in the mainland China and Hong Kong, the China side should only tax the part of the income attributable to the services China. In general, this is achieved by time apportionment of his total income during the year. Since the mainland's tax refers only to the services rendered in the Mainland, it should be excluded under the section 8(1A)(c) exemption. 

If you only work in Hong Kong during visits not exceeding 60 days during the year of assessment, you are entitled to a full exemption. But this exemption will not apply if your main base of work is in Hong Kong. In counting the days for this exemption, the Revenue takes the departure day and the arrival day as two whole days in Hong Kong. You'd better keep record of all your stay in Hong Kong. 

If your employment is of a non-Hong Kong source, you are entitled to claim relief under Section 8(1A)(a): that is to exempt the income attributable to your services in mainland. In practice, the exemption is computed on time basis: that is by reference to the number of days in mainland over the number of total days in Hong Kong and in mainland. From case law, whether your employment is of a non-Hong source depends on three factors: location of employment contract, location of employer's residence and place of payment of remuneration. So, you should keep record of your stay in mainland as well as the documents concerning the source of your employment.

Queries by IRD on claims for exemption on the grounds of working in China

(a) Copy of the employment contract

(b) Name, title and location of the taxpayer's supervisor

(c) Did the taxpayer report his China work to the Hong Kong company? 

(d) Did the taxpayer take instructions from his supervisor?

(e) Working hours in China 

(f)  A schedule setting out dates of arrival in or departure from Hong Kong as well as the purpose of each stay in Hong Kong

(g) A written confirmation from employer certifying the purpose of each visit to Hong Kong  

(h) A written confirmation from employer as to whether the taxpayer came to Hong Kong to attend company meetings, training, reporting or taking instruction of work

(i)  Whether the taxpayer paid Individual Income Tax in China and if no, why?

2.25 Separate employment contracts

Section 8(1) of Inland Revenue Ordinance levies tax on income from an employment in Hong Kong. From case law, an employment exists where there is a master and servant relationship in doing work. If the employment is in Hong Kong, all the income from the employment is taxable even though part of it is attributable to services outside Hong Kong. 

It is very difficult for a person to convince the Revenue that he has separate employments with the same employer on the grounds that he has separate employment contracts: one for his work in Hong Kong and another for his work outside Hong Kong. This is because such artificial division of employment contracts will usually be regarded by the Revenue as a tax avoidance measure. In other words, the Revenue will strive to impose tax on all the income from the same employer, whether or not part of such is from an employment contract with services outside Hong Kong. 

If the taxpayer's employer is not a resident in Hong Kong, it is advisable for the taxpayer to arrange for his employer contract to be negotiated, signed and enforceable outside Hong Kong. It is also advisable to have the remuneration paid into a bank account outside Hong Kong. With all these arrangements, the taxpayer can argue that his employment is not in Hong Kong and so only the income attributable to his Hong Kong services taxable. 

If the taxpayer is employed by a foreign company and he is required to work outside Hong Kong as well as work for an associated company in Hong Kong, then it is advisable for him to enter into two separate contracts of employment: one with his foreign employer for his work outside Hong Kong and one with the associated company in Hong Kong for his work in Hong Kong. As such, he can argue that they are indeed separate employments (2 different employers) and so only the income under the Hong Kong employment will be taxable. 

2.26 Employed or Self-employed

A self-employed person is subject to profits tax with expense deductions more favorable than those under salaries tax.   

If a taxpayer claims to be assessed under profits tax, he has to discharge the burden of proof. A business registration is just one of the many factors for the proof. 

An employment exists where there is a legal relationship of master and servant. An employee is under a "contract of service" whereas a self-employed person is under a "contract for services".  

In Market Investigations v. Minister of Social Security [1969] 2 QB 173 the judge said: "The fundamental test is whether the person engaged himself to perform these services performing them as a person in business on his own account? If the answer to that question is 'Yes', then the contract is a contract for services. If the answer is 'No', then the contract is a contract of service. No exhaustive list has been compiled and perhaps no exhaustive list can be compiled of the considerations which are relevant in determining that question, nor can strict rules be laid down as to the relative weight which the various considerations should carry in particular cases. The most that can be said is that control will no doubt always have to be considered, although it can no longer be regarded as the sole determining factor; and that factors which may be of importance are such matters as whether the man performing the services provides his own equipment, whether he hires his own helpers, what degree of financial risk he takes, what degree of responsibility for investment and management he has, and whether and how far he has an opportunity of profiting from sound management in the performance of his task... In order to decide whether a person carries on a business on his own account it is necessary to consider many different aspects of that person's work activity. This is not a mechanical exercise of running through items on a check list to see whether they are present in or absent from a given situation. The object of the exercise is to paint a picture from the accumulation of detail. The overall effect can only be appreciated by standing back from the detailed picture which has been painted, by viewing it from a distance and by making an informed, considered, qualitative, appreciation of the whole. It is a matter of evaluation of the overall effect of the detail, which is not necessarily the same as the sum total of the individual details. Not all details are of equal weight or importance in any given situation. The details may also vary in importance from one situation to another. The process involves painting a picture in each individual case."  

Economic reality test 

The test looks at the financial aspects to see if a person is running his business on his own account. This test was laid down in the case Fall v. Hitchen,  in which the judge said: "Is the person who has engaged himself to perform these services performing them as a person in business on his own account?'  If the answer to that question is 'yes', then the contract is a contract for services.  If the answer is 'no', then the contract is a contract of service.  No exhaustive list has been compiled and perhaps no exhaustive list can be compiled of the considerations which are relevant in determining that question, nor can strict rules be laid down as to the relative weight which the various considerations should carry in particular cases.  The most that can be said is that control will no doubt always have to be considered, although it can no longer be regarded as the sole determining factor; and that factors which may be of importance are such matters as whether the man performing the services provides his own equipment, whether he hires his own helpers, what degree of responsibility for investment and management he has, and whether and how far he has an opportunity of profiting from sound management in the performance of his task."

The test was then applied in the UK case of Market Investigations Ltd. v. Minister of Social Security. In that case a woman was engaged to do market surveys at fixed rates. She arranged her working hours, selected her interviewees. She was free to work for other organizations, without any supervision albeit subject to rigid rules, It was held that she was employed. The court ruled that a person might carry out more than one employment at the same time --- the control exercised was enough to be compatible with a contract of service --- the payment of a fixed fee could not be considered in isolation from the general test of whether she was carrying on business on her own account. Thus, she did not run her business on her own account.  

In Market Investigations v. Minister of Social Security [1969] 2 QB 173 the judge said: "The fundamental test is whether the person engaged himself to perform these services performing them as a person in business on his own account? If the answer to that question is 'Yes', then the contract is a contract for services. If the answer is 'No', then the contract is a contract of service. No exhaustive list has been compiled and perhaps no exhaustive list can be compiled of the considerations which are relevant in determining that question, nor can strict rules be laid down as to the relative weight which the various considerations should carry in particular cases. The most that can be said is that control will no doubt always have to be considered, although it can no longer be regarded as the sole determining factor; and that factors which may be of importance are such matters as whether the man performing the services provides his own equipment, whether he hires his own helpers, what degree of financial risk he takes, what degree of responsibility for investment and management he has, and whether and how far he has an opportunity of profiting from sound management in the performance of his task... In order to decide whether a person carries on a business on his own account it is necessary to consider many different aspects of that person's work activity. This is not a mechanical exercise of running through items on a check list to see whether they are present in or absent from a given situation. The object of the exercise is to paint a picture from the accumulation of detail. The overall effect can only be appreciated by standing back from the detailed picture which has been painted, by viewing it from a distance and by making an informed, considered, qualitative, appreciation of the whole. It is a matter of evaluation of the overall effect of the detail, which is not necessarily the same as the sum total of the individual details. Not all details are of equal weight or importance in any given situation. The details may also vary in importance from one situation to another. The process involves painting a picture in each individual case."  

Whether or not a person running a business on his own is largely a largely question of facts. From time to time, the courts and tribunals suggest a number of tests --- yet no one is conclusive. The choice of tests depends on the nature of that particular trade, profession or industry as well as on the facts of that particular case. In general there are three common tests: control test, integration test and economic reality test. 

A self-employed person is subject to profits tax with expense deductions more favorable than those under salaries tax.  

If a taxpayer claims to be assessed under profits tax, he has to discharge the burden of proof. A business registration is just one of the many factors for the proof. 

An employment exists where there is a legal relationship of master and servant. An employee is under a "contract of service" whereas a self-employed person is under a "contract for services". 　

In the Board of Review case D22/92, this was said: "Whether a person is an employee or not may in some cases be equivocal; whereas the answer to the question whether or not a person has embarked upon a business with all of the trappings and attributes of a business may be much clearer."  

The economic reality test may not be used in "professional people" cases. In the case of Hall v. Lorimer [1994] 1 WLR 209 --- the taxpayer was a vision mixer working for 20 or more production companies on single day assignments, in which the judge said: "In cases of this sort there is no single path to a correct decision. An approach which suits the facts and arguments of one case may be unhelpful in another. I agree with the views expressed by Mummery J. in the present case [1992] 1 W.L.R. 939, 944: 'In order to decide whether a person carries on business on his own account it is necessary to consider many different aspects of that person's work activity. This is not a mechanical exercise of running through items on a check list to see whether they are present in, or absent from, a given situation. The object of the exercise is to paint a picture from the accumulation of detail. The overall effect can only be appreciated by standing back from the detailed picture which has been painted, by viewing it from a distance and by making an informed, considered, qualitative appreciation of the whole. It is a matter of evaluation of the overall effect of the detail, which is not necessarily the same as the sum total of the individual details. Not all details are of equal weight or importance in any given situation. The detail may also vary in importance from one situation to another. The process involves painting a picture in each individual case. As Vinelott J. said in Walls v. Sinnett (1986) 60 T.C. 150, 164: 'It is, in my judgment, quite impossible in a field where a very large number of factors have to be weighed to gain any real assistance by looking at the facts of another case and comparing them one by one to see what facts are common, what are different and what particular weight is given by another tribunal to the common facts. The facts as a whole must be looked at, and what may be compelling in one case in the light of all the facts may not be compelling in context of another case...  Again the question whether the individual is in business on his own account, though often helpful, may be of little assistance in the case of one carrying on a profession or vocation.  A self-employed author working from home or an actor or a singer may earn his living without any of the normal trappings of a business.  For my part I would suggest there is much to be said in these cases for bearing in mind the traditional contrast between a servant and an independent contractor.  The extent to which the individual is dependent on or independent of a particular pay master for the financial exploitation of his talents may well be significant." 

Whether or not a person running a business on his own is largely a largely question of facts. From time to time, the courts and tribunals suggest a number of tests --- yet no one is conclusive. The choice of tests depends on the nature of that particular trade, profession or industry as well as on the facts of that particular case. In general there are three common tests: control test, integration test and economic reality test. 

Control test  

It is the traditional common-law test for an employment relationship. And it is still the most important test. 

This test was first laid down by the judge in the court case R v. Walker who said: "It seems to me that the difference between the relations of master and servant and of principal and agent is this: A principal has the right to direct what the agent has to do; but a master has not only that right, but also the right to say how it is to be done." 

Subsequently, in the case of Yewens v. Noakes, the judge said: "A servant is a person subject to the command of his master as to the manner in which he shall do his work". The control test is to consider whether the "servant" is answerable to a "master" for "what he does, how he does and when he does".           

Control by the employer may include:

·    working hours,

·    approval for leave,

·    training,

·    how to report duty,

·    duties or responsibilities, or

·    where, when and how the work is to be done.

Some judges commented that the test might be too simple in the context of modern world. Now, it is no longer a conclusive test for all cases. For example, in the case of Morren v. Swinton and Pendlebury Borough Council (1965) 2 All ER 349 at 351, the judge pointed out that when dealing with a man of some special skill and experience, the employer might not be necessary to tell the employee how to do the work; therefore the absence of control and direction in such cases might be of little use as a test.    

There may be situations where one is hired to do work which is under the strict control of the client but, nevertheless, the contract is not a contract of service. An example is Queensland Stations Pty. Ltd. v. Federal Commissioner of Taxation, the "drover" case, where the judge said: "In considering the facts it is a mistake to treat as decisive a reservation of control over the manner in which the droving is performed and the cattle are handled.  For instance, in the present case the circumstance that the drover agrees to obey and carry out all lawful instructions cannot outweigh the countervailing considerations which are found in the employment by him of servants of his own, the provision of horses, equipment, plant, rations, and a remuneration at a rate per head delivered." 

Integration test  

The "organization" or "integration" test was introduced by the judge in the case Bank voor Handel en Scheepvaart NV v. Administrator of Hungarian Property (1954) who said: "the test of being a servant does not nowadays rest on submission to orders.  It depends on whether the person is part and parcel of the organization ..." 

This test looks at whether the individual can be regarded as part of the "employer's" organization. That is whether he is an integral part of the organization or is just casually or temporarily engaged for doing a task ancillary to the employer's main activities. For example, a car repairer rendering services to a garage is more likely to be an employee more than a businessman rendering car repairing service. 

Economic reality test 

The test looks at the financial aspects to see if a person is running his business on his own account. This test was laid down in the case Fall v. Hitchen, in which the judge said: "Is the person who has engaged himself to perform these services performing them as a person in business on his own account?'  If the answer to that question is 'yes', then the contract is a contract for services.  If the answer is 'no', then the contract is a contract of service.  No exhaustive list has been compiled and perhaps no exhaustive list can be compiled of the considerations which are relevant in determining that question, nor can strict rules be laid down as to the relative weight which the various considerations should carry in particular cases.  The most that can be said is that control will no doubt always have to be considered, although it can no longer be regarded as the sole determining factor; and that factors which may be of importance are such matters as whether the man performing the services provides his own equipment, whether he hires his own helpers, what degree of responsibility for investment and management he has, and whether and how far he has an opportunity of profiting from sound management in the performance of his task." 

The test was then applied in the UK case of Market Investigations Ltd. v. Minister of Social Security. In that case a woman was engaged to do market surveys at fixed rates. She arranged her working hours, selected her interviewees. She was free to work for other organizations, without any supervision albeit subject to rigid rules, It was held that she was employed. The court ruled that a person might carry out more than one employment at the same time --- the control exercised was enough to be compatible with a contract of service --- the payment of a fixed fee could not be considered in isolation from the general test of whether she was carrying on business on her own account. Thus, she did not run her business on her own account. 　

In the Board of Review case D22/92, this was said: "Whether a person is an employee or not may in some cases be equivocal; whereas the answer to the question whether or not a person has embarked upon a business with all of the trappings and attributes of a business may be much clearer."  

The economic reality test may not be used in "professional people" cases. In the case of Hall v. Lorimer [1994] 1 WLR 209 --- the taxpayer was a vision mixer working for 20 or more production companies on single day assignments, in which the judge said: "In cases of this sort there is no single path to a correct decision. An approach which suits the facts and arguments of one case may be unhelpful in another. I agree with the views expressed by Mummery J. in the present case [1992] 1 W.L.R. 939, 944: 'In order to decide whether a person carries on business on his own account it is necessary to consider many different aspects of that person's work activity. This is not a mechanical exercise of running through items on a check list to see whether they are present in, or absent from, a given situation. The object of the exercise is to paint a picture from the accumulation of detail. The overall effect can only be appreciated by standing back from the detailed picture which has been painted, by viewing it from a distance and by making an informed, considered, qualitative appreciation of the whole. It is a matter of evaluation of the overall effect of the detail, which is not necessarily the same as the sum total of the individual details. Not all details are of equal weight or importance in any given situation. The detail may also vary in importance from one situation to another. The process involves painting a picture in each individual case. As Vinelott J. said in Walls v. Sinnett (1986) 60 T.C. 150, 164: 'It is, in my judgment, quite impossible in a field where a very large number of factors have to be weighed to gain any real assistance by looking at the facts of another case and comparing them one by one to see what facts are common, what are different and what particular weight is given by another tribunal to the common facts. The facts as a whole must be looked at, and what may be compelling in one case in the light of all the facts may not be compelling in context of another case...  Again the question whether the individual is in business on his own account, though often helpful, may be of little assistance in the case of one carrying on a profession or vocation.  A self-employed author working from home or an actor or a singer may earn his living without any of the normal trappings of a business.  For my part I would suggest there is much to be said in these cases for bearing in mind the traditional contrast between a servant and an independent contractor.  The extent to which the individual is dependent on or independent of a particular pay master for the financial exploitation of his talents may well be significant." 

If a “relevant person” pays remuneration for services rendered by a “relevant individual” to a company controlled by that individual, the remuneration is deemed to be employment income and assessed as such on that individual. 

The use of service companies is to take advantage of the less stringent expenses deduction under Profits Tax vis-à-vis that under Salaries Tax. Under profits tax, expenses are deductible to the extent they are incurred in the production of profits. But under salaries tax, expenses are generally not deductible unless they satisfy the stringent conditions of Section 12(1)(a): they are not of a domestic, private or capital nature, and they are wholly, exclusively and necessarily incurred in the production of assessable income.

2.27 Disguised employments

Section 9A is invoked when tax avoidance scheme is suspected. In other cases, the IRD will look to such factors as master and servant relationship, control, organization, economic risk... etc. to determine the question of contract of service versus contract for service. 

It provides that if a “relevant person” pays remuneration for services rendered by a “relevant individual” to a company controlled by that individual, the remuneration is deemed to be employment income and assessed as such on that individual. 

The use of service companies is to take advantage of the less stringent expenses deduction under Profits Tax vis-à-vis that under Salaries Tax. Under profits tax, in general expenses are deductible to the extent they are incurred in the production of profits. But under salaries tax, expenses are generally not deductible unless they satisfy the stringent conditions of Section 12(1)(a): they are not of a domestic, private or capital nature, and they are wholly, exclusively and necessarily incurred in the production of assessable income. 

Section 9A applies if the following conditions exist:

(a) The relevant person carries on a trade, a profession or a business, or a prescribed activity;

(b) The relevant person enters into an agreement with the relevant individual for the services carried out by the relevant individual. The agreement may be in writing or implied; and

(c) Under the agreement, remuneration for such services is paid to a “service company”.

A prescribed activity under (a) is one prescribed in the Gazette by the Revenue under Section 9A(6). So far, there has been no such prescribed activity.  

It is anticipated that Section 9A affects many business arrangements that are done without a tax-avoidance purpose. To restrict its effect, the law provides that a business arrangement satisfying all the following conditions falls outside its scope: 

(a) the agreement does not provides for remuneration to include annual leave, passage allowance, sick leave, pension entitlements, medical payments or accommodation, etc;

(b) in the case of the agreement requiring any services to be carried out personally by the relevant individual, that individual also carries out similar services for other persons;

(c) the performance of the relevant individual is not subject to “employer-type” control or supervision by the relevant person;

(d) the remuneration is not paid on a basis commonly used under a contract of employment;

(e) the relevant person does not have the right to terminate the services in a manner commonly provided for under a contract of employment; and

(f)  the relevant individual is not held out to the public to be an officer or employee of the relevant person. 

Besides, the Commissioner of Inland Revenue may in his discretion exclude a business arrangement from Section 9A if he is satisfied that at all relevant times the carrying out of the services under the agreement is not substantially in the nature of an office or employment. This provides an escape route for those arrangements failing to meet all the above conditions.  

Section 9A is invoked when tax avoidance scheme is suspected. In other cases, the IRD will look at such factors as master and servant relationship, control, organization, economic risk... etc. to determine the question of contract of service versus contract for service.

Queries by IRD on claims for an assessment under Profits Tax instead of Salaries Tax

(a) Copy of employment contract

(b) Position / title of taxpayer

(c) Duties and responsibilities

(d) Copy of name card

(e) How the remuneration is determined?

(f) Monthly analysis of the remuneration received

(g) Did the taxpayer attend office at regular hours?

(h) Was the taxpayer responsible for his own outgoings and expenses?

(i) Was the taxpayer required to provide his own equipment and facilities?

(j) Was the taxpayer required to hire his own assistants?

(k) Was the taxpayer required to seek approval for outside work?

(l) Was the taxpayer entitled to benefits similar to other employees of the company?

(m) Was the taxpayer needed to seek approval for taking leave?

(n) Was the taxpayer's performance appraised like an employee?

(o) How can the contract be terminated?

(p) Has the taxpayer got a business registration?

2.28 Employee versus Office holder　

An employee has a master and servant relationship with his employer. The work of an employee is within the control of his employer as to what to do, how to do and when to do.  

An office holder holds an office created by law or covenants. The office holder's duties are statutory and irrespective of whoever holding the office. A common example is the director office of a company. 　

Not all so-called "directors" are office holders in law. If a "director" is employed by a company through an employment contract, he is an employee only, not a "director" for tax purpose. 　

The income from a Hong Kong employment is taxable in full. The remuneration from a Hong Kong office is taxable in full too. So, in general, whether the income is from a Hong Kong employment or from a Hong Kong office is unimportant.  　

From case law, the location of a director office depends on the management and control of the company. In practice, the director office of a company incorporated in Hong Kong is treated as locating in Hong Kong unless the contrary is proved.   

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2.29 Tax clearance on leaving Hong Kong

Under section 51(7), a person chargeable to tax must notify the Revenue of his imminent departure from Hon Kong if the departure period is more than one month. Such notice must be given at least one month before the expected date of departure although the Revenue can accept shorter notice. Notification is not required if the person has to frequently travel in and out of Hong Kong in the course of his employment or business. 

Besides, under section 52 of IRO, an employer must notify the Revenue of his employee's imminent departure from Hong Kong. Notification should be made in the form IR56G reporting the date of departure as well as the employee's income up to the date of departure. Such notice must be given at least one month before the date of departure. After the notification, the employer should immediately withhold payment of any sum due to the employee until he receives a “letter of release” from the Revenue. 

As soon as the Revenue receives a notification that a taxpayer is about to leave Hong Kong permanently, a tax return for that year of assessment will be issued to the employee. The employee should call at the Revenue to file the tax return and get the tax assessment for tax payment as early as possible. 

If the person has outstanding share options as part of his taxable income, he can elect for a notional exercise for computing the gain on the share options. It assumes that the share options are exercised on a day as chosen by the person within 7 days before the filing of the related tax return. Given this assumption, the taxable gain is computed for the year of departure, and there will be no further tax liability when the share options are actually exercised or sold afterwards. It is advisable for the taxpayer to make the election if the taxable gain so computed is zero or quite small.

If the person withdraws accrued benefits from a recognized retirement scheme, he can get exemption under the Proportionate Benefit rule. 

If the person does not clear his tax liabilities before he leaves Hong Kong, the Revenue will issue a “recovery letter” to the employer requiring payment of tax from the sum withheld. 

A tax officer may apply to court to stop a tax defaulter from leaving Hong Kong.

2.30 Employer's obligations

An employer is required to notify the Revenue of a new employee who is likely to be chargeable to Salaries Tax. That is his annual income larger than the basic allowance. The notification should be made in the form IR56E. The time limit for the notification is three months after the appointment date. 

An employer is required to deliver a form IR56B to the Revenue in respect of every employee who is likely to be chargeable to Salaries Tax every tax year. The time limit is stated in the Revenue's letter annexed with the forms, usually one month of the letter.  

An employer must notify the Revenue of the termination of employment of an employee who is chargeable to Salaries Tax. The time limit for the notification is at least one month before the termination. The notification should be made in the form IR56F. 

An employer must notify the Revenue of an employee who is about to leave Hong Kong for more than a month. The notification should be made in the form IR56G. The time limit for the notification is at least one month before the date of departure. This notification is not required if the employee frequently travels in and out Hong Kong during his course of employment. After the notification, the employer cannot pay the employee without the permission of the Revenue. 

The above provisions also apply to a person who is deemed to be employed under Section 9A of IRO or an office holder liable to Salaries Tax under Section 8.

Employers are required to report the employee's income even if it consists of a variable commission. 

Free lance broker who does not have a fixed office and master-servant relationship with the company hiring them is treated as carrying on a business chargeable to Profits Tax.  Nevertheless, the Revenue still requires the company to file quasi Employer's Return IR56M to report the sum paid to them.  

The Revenue may impose penalty or take legal action against those employers who do not comply with the legal requirements.

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