Profits Tax - Section 16(1) deductions

Section 16 of Inland Revenue Ordinance states that in ascertaining the assessable profits there shall be deducted outgoings and expenses to the extent to which they are incurred in the production of the profits chargeable to tax.

Because Section 16(1) allows deduction of expenses to the extent that they are incurred in the production of assessable profits, expenses charged in the accounts are to be apportioned between "deductible" and "non-deductible" wherever applicable. The Revenue's practice for the apportionment as based on Rules 2A, 2B and 2C of the Inland Revenue Rules are as follows:-

(a) where profits are derived partly within Hong Kong and partly outside:

Expenses directly attributable to the profits derived outside Hong Kong are to be disallowed --- apportionment is based on turnover or sales.

(b) where profits are derived from trading (taxable) and also from dividends (non-taxable):

(i) interest incurred for financing the investments producing dividends --- not allowable.

(ii) management cost of the investment --- no apportionment needed in general.

The apportionment for non-deductible expenditures has been approved by court in the case re Stanley So & Company. It was held that certain entertainment expenses, equipment rental and office facilities charges are disallowed because they are regarded as excessive and not in the production of chargeable profits. In such cases, the IRD can make appropriate adjustments when computing the assessable profits. Click here for details.