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
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
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
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
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
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.
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.
Lewis Lu (email@example.com) and Curtis Ng (firstname.lastname@example.org)
Tel: +86 (21) 2212 3421