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Hong Kong: Recent accounting changes in Hong Kong

15 October 2018

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In recent years, there have been various accounting changes which have had significant tax implications on how certain items are accounted for and potentially taxed. The two main changes in Hong Kong have been HKFRS 9 (affecting financial instruments) and HKFRS 16 (leases).

HKFRS 9 – financial instruments

HKFRS 9 applies to annual periods beginning on or after January 1 2018, with earlier adoption permitted. HKFRS 9 makes changes to the classification and measurement of financial assets and financial liabilities, as well as to the determination of impairment losses for financial instruments.

The tax treatment of financial assets and financial liabilities generally follows the accounting treatment. However, whether financial instruments are capital or revenue in nature and whether such gains or losses are sourced onshore or offshore will still depend on the particulars of each case.

HKFRS 9 could result in timing differences between the accounting and taxation treatment of financial assets/liabilities. More importantly, tax deductibility issues on expected credit losses could lead to increased tax compliance and operating costs. The adoption of HKFRS 9 is not limited to financial institutions; its most significant impact will be on financial institutions given the volume and types of financial instruments that they transact.

HKFRS 9 also prescribes new rules for calculating impairment losses where a three-staged approach is used to determine the quantum of such losses. Based on current law and practice, financial instruments should only be regarded as credit-impaired in stage 3, at which stage the impairment would likely qualify for a bad debt deduction for Hong Kong tax purposes. There are a number of considerations when determining whether a loss is impaired and thus tax deductible.

Legislative revision is required to ensure Hong Kong remains competitive with the likes of Singapore and the UK regarding the tax deductibility of such losses. This is expected later in 2018.

HKFRS 16 – leases

HKFRS 16 applies to annual periods beginning on or after January 1 2019, but earlier adoption is permitted under certain conditions. HKFRS 16 eliminates the accounting distinction that lessees have made in the past between operating leases and finance leases. HKFRS 16 introduces a single lessee accounting model under which all leases will be treated similarly to a finance lease under the existing Hong Kong Accounting Standard (HKAS) 17.

Under HKFRS 16, a lessee is required to recognise assets and liabilities for all leases with terms of more than 12 months, unless the underlying asset's value is low. The lessee's balance sheet will recognise both a right-of-use asset, representing its right to use the leased asset, and a lease liability, representing the present value of the future lease payments that the lessee is obliged to pay. Depreciation of the leased asset (i.e. the right-of-use asset) and interest on the lease liability will be charged to the lessee's profit and loss account.

The Inland Revenue Department (IRD) has stated that tax deductions for lease payments incurred by a lessee are governed by the ordinary deduction provisions. As such, if the lease payments are in the nature of rent for the use of the leased asset only, the lessee should be entitled to a tax deduction for the lease payments.

However, if the lease payments are, in substance, consideration for the sale of goods framed as a finance lease, the relevant lease payments excluding interest would be outgoings of a capital nature, which are not tax deductible, though they might qualify for tax depreciation allowances.

The IRD considers that the implementation of HKFRS 16 does not change anything and that it will have no effect on the operation of sections 16 and 17 of the Inland Revenue Ordinance. Lease payments incurred by a lessee should continue to be tax deductible as per the contractual terms. As a result, the relevant information should be retained in the company's accounting records to enable the necessary adjustments.

Ultimately, the legal form and substance of the relevant contractual arrangements for a lease would still have to be ascertained in order to determine the tax treatment of the lease payments concerned, regardless of the single lessee accounting model adopted under HKFRS 16.

Conclusion

Companies will need to consider the tax impact for financial reporting during the current year. The recent accounting changes will have a significant impact on how companies and financial institutions account for certain assets and liabilities. Given the potential mismatch between tax and accounting, these accounting changes could increase compliance and operating costs and create additional administrative burdens for tax reporting and filing.

The changes in the classification and timing of income and expenses could also result in more challenges from the IRD. Further guidance and/or legislative changes would therefore be welcome to provide clarity on the tax treatments.

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Lewis Lu (lewis.lu@kpmg.com) and Curtis Ng (curtis.ng@kpmg.com)
KPMG China
Tel: +86 (21) 2212 3421
Website: www.kpmg.com/cn






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