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Profits Tax Guide -- Assessable profits 

What are assessable profits? This question hinges on two points: first, there are profits, and second, such profits are assessable

The Inland Revenue Ordinance does not define “profits”. In fact, there are a number tax cases, particularly in the U.K., on this question. In business practice, profit means the net profit, or the net gain, or the surplus of incomes over expenses. It follows that profits concern determining incomes and expenses.

The second point is: what profits are assessable? As established from tax cases, assessable profits are the accounting profits determined in accordance with generally accepted accounting principles (GAAP) as adjusted to conform with the provisions of Inland Revenue Ordinance. See CIR v Secan Limited & Ranon Limited.

Then, what are accounting profits or GAAPs? This is a big topic and there are a lot of accounting textbooks on the question. Besides, the Hong Kong Institute of Certified Public Accountants has from time to time issued Statements of Standard Accounting Practice to standardize the accounting treatments of various topics of importance. Among these principles and practices, the following are of fundamental importance and adopted for tax purpose.

Going concern principle

  • When preparing the business accounts, we assume that the business will go on in the foreseeable future.

Accrual or matching principle

  • Expenses incurred but not yet paid for should be taken into account when computing profits. Likewise, the expenses paid for future accounting periods should be carried forward to match the related future revenue and hence they should are not deductible when computing the current-year profits.

Revenue versus capital principle

  • Incomes or gains of a revenue nature are included in the Profit and Loss Account and hence taxable.

  • Incomes or gains of a capital nature are credited to capital reserves and hence not taxable.

  • Expenses or losses of a revenue nature are recognized in the Profit and Loss Account and hence deductible.

  • Expenses or losses of a capital nature, even though they may in some cases be deductible in computing accounting profits, are not tax deductible --- and if they have been charged to Profit and Loss Account, they will be added back in computing the assessable profits.

  • Naturally the taxpayers are inclined to claim more incomes to be capital in nature (non-taxable); and the Revenue will treat more losses of a capital nature (non-deductible). So, there are quite a number of tax cases on how to apply this principle in practice.    

Where the Inland Revenue Ordinance (IRO) makes a specific provision for a topic, such provision will over-ride the accounting principle or the general commercial practice of that topic. To read my tax guide on common topics of importance, please click here.

 

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