Under the two-tiered profits tax system, a policy issued by the Hong Kong Government, profits tax rate is 8.25% for the first $2 million of assessable profits of a corporation and 16.5% for subsequent assessable profits of over $2 million for a corporation.
However, only one of the two or more related entities can opt for a two-tiered profits tax rate.
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Determination of connected entities
Let's use a table as an example:
▲Example figure 1
As shown in Figure 1:
▶ Corporations A and B are not under the control of Mr. or Mrs. Chan and they are not related entities. Both Corporation-A and Corporation-B are taxable at a two-tiered profits rate.
▶ Partnership C and sole proprietorship D are controlled by Mr. Chan and are related entities. Only Partnership C or Sole Proprietorship D can elect to be taxed at a two-tiered profits tax rate in the profits tax return of the partnership or in Mr. Chan's individual return.
▶ Sole proprietorship E and sole proprietorship F are also related entities as they are both sole proprietorships operated by Mrs. Chan. In her individual tax return, Mrs. Chan can only choose either sole proprietorship E or sole proprietorship F to be taxed at the two-tier profits rate.
▲Example figure 2
As shown in Figure 2:
▶ Partnership D and sole proprietorship E are related entities as they are controlled by Mr. Lee. Only one of Partnership D or Sole Proprietorship E may elect to be taxed at a two-tiered profits rate in the profits tax return of the partnership or in Mr. Lee's individual return.
▶ CorporationA and Sole Proprietorship F are related entities as they are controlled by Mrs. Lee. Only one of Corporation-A or Sole Proprietorship F may elect to be taxed at the two-tiered profits tax rate in its corporate profits tax return or in Mrs. Lee's individual return.
▶ Corporations B and C are related entities as they are controlled by Mr Lee's brother. Only one of the corporations B or C can elect to be taxed at the two-tiered profits rate in their corporation's profits tax return.
▶ Although CorporationA is controlled by Mrs. Lee and Partnership D is controlled by Mr. Lee, CorporationA and Partnership D are not related entities.
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There is no case with the associated entity
If the taxing entity does not have a related entity, the taxing entity must declare that there is no related entity at the end of the base period of assessment for the year of assessment. For administrative convenience, a taxing entity may declare on its tax return that its business is taxable at a two-tiered profits rate.
It should also be emphasized that such an unjustified incorrect declaration may result in heavy penalties if a taxing entity incorrectly declares in its tax return that it has no related entity, or if no other related entity elects to be taxed at the two-tiered profits rate.
The Inland Revenue Department (IRD) will issue a supplementary assessment in accordance with the provisions of the Inland Revenue Ordinance where the two-tier profits tax rate does not apply.
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