The Wong Consultancy: Assessment Elections, Mortgage Interest and Incorporation
Mr Wong runs a consultancy as a sole proprietorship with assessable profits of HKD 1.35 million a year after all expenses. He and his wife own a rented-out flat in equal shares; the gross rent is HKD 240,000 a year and the outstanding mortgage interest is HKD 180,000 a year. They live in a rented flat elsewhere and pay HKD 30,000 a month in rent. Mrs Wong has no income of her own and no other assets. Mr Wong contributes the maximum HKD 18,000 a year to his MPF as a self-employed person. His accountant has suggested two things: elect personal assessment "to use up the allowances", and incorporate the consultancy to pay profits tax at 8.25% instead of 15%. A business contact has also suggested routing part of the consultancy fee through a BVI company owned by Mr Wong's brother, which would "keep the profits offshore".
1. Evaluate whether Mr Wong and Mrs Wong should elect personal assessment or joint assessment, showing the computations.
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Joint assessment is a red herring here: it combines spouses' incomes only for salaries tax, and Mr Wong has no employment income. The relevant election is personal assessment, and it should be made by one spouse only.
Status quo. Profits tax at the two-tiered rate on HKD 1.35m is 7.5%, i.e. HKD 101,250. Property tax for each owner: HKD 120,000 rent less the 20% statutory allowance gives a net assessable value of HKD 96,000, taxed at 15% = HKD 14,400 each, so HKD 28,800 in total. Family total: HKD 130,050.
Mr Wong electing personal assessment. Total income HKD 1.35m plus HKD 96,000 = HKD 1,446,000; less MPF HKD 18,000 and the married person's allowance of HKD 264,000, chargeable income is HKD 1,164,000. On the progressive scale that is HKD 1,000 + 3,000 + 5,000 + 7,000 + (HKD 964,000 at 17% = HKD 163,880) = HKD 179,880, which is below the 15% standard rate figure of HKD 216,900. That is HKD 64,230 worse than paying profits tax and property tax separately.
Mrs Wong electing personal assessment. Her share of net assessable value is HKD 96,000; the basic allowance of HKD 132,000 covers it, so her liability falls from HKD 14,400 to nil.
The answer is therefore the opposite of the accountant's advice: she elects, he does not. Saving: HKD 14,400 a year.
2. Can the HKD 180,000 of mortgage interest be deducted anywhere? Explain, and correct any misconception.
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No - and this is where most people assume a deduction that does not exist.
Under property tax, the only relief is the statutory 20% allowance for repairs and outgoings, which has already been applied in arriving at the HKD 96,000 net assessable value. Mortgage interest is not separately deductible against rental income, whether under property tax or under personal assessment.
The home loan interest deduction is a different relief with different conditions. It is available only where the borrowed money was used to acquire a dwelling that is the taxpayer's principal place of residence in Hong Kong, it is capped at HKD 100,000 per year of assessment, and it is available for a maximum of 20 years. The Wongs live in rented accommodation and let out the flat, so the flat is not their principal residence and the interest does not qualify. Their own rent is a personal expense and not deductible either.
There is a further trap in the personal assessment computation: electing personal assessment does not convert the mortgage interest into a deduction, and the 20% allowance is not replaced by actual expenses. Anyone advising them should also note that the interest could only be claimed by the person who is the borrower, and only for the property he or she occupies.
The practical planning point is that the flat is running at a modest net yield after tax, and any decision on whether to keep it should be made on an after-tax basis rather than in the belief that the interest is sheltering the rent.
3. Advise on the incorporation proposal and on the BVI arrangement, including the professional issues raised.
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Incorporation. Run the numbers before the structure. A company pays 8.25% on the first HKD 2 million of profits, i.e. HKD 111,375 on HKD 1.35 million, against HKD 101,250 for the sole proprietorship - already worse. If he draws a salary of HKD 600,000, company profits fall to HKD 750,000 and company tax to HKD 61,875, but his salaries tax on HKD 600,000 after the HKD 18,000 MPF deduction and the HKD 132,000 basic allowance is about HKD 58,500, so the total is roughly HKD 120,375, plus audit and filing costs. There is no tax saving unless profits are genuinely retained in the company for reinvestment, and only one entity in a group can elect the two-tiered rates. Incorporation can still be justified for limited liability, separating clients and contracts, or building a retirement fund inside the company - but not on a tax claim that does not survive the arithmetic.
The BVI arrangement. I would not implement it and would say so in writing. A fee paid to a related offshore company with no substance is unlikely to be deductible as an expense incurred in producing chargeable profits, and the arrangement is exactly the kind of transaction the general anti-avoidance provision is designed to strike down, with penalties and back-year assessments following. It also misdescribes the source of income that is in fact earned from Hong Kong work.
Professionally, advising or facilitating a structure whose main purpose is to mislead the Inland Revenue Department is incompatible with the duty to act with integrity and in the client's long-term interest, and the client's real exposure is not the tax saved but the cost of a dispute. Document the advice, decline to be involved, and set out the legitimate alternatives.