Who can elect two-tiered profits tax if you have connected entities?

What counts as a connected entity

An entity is a natural person, a body of persons, or a legal arrangement such as a corporation, a partnership or a trust[1]. One entity is connected to another if[1]:

• one of them has control over the other;
• both of them are under the control of the same entity; or
• the first is a person carrying on a sole proprietorship and the other is the same person carrying on another sole proprietorship.

Control generally means owning or controlling more than 50% of the issued share capital, being entitled to exercise or control more than 50% of the voting rights, or being entitled to more than 50% of the capital or profits of the other entity, whether directly or through one or more other entities[1]. So two companies owned by the same individual are connected, because both are under that person's control.

How the election is made

The nominated entity declares in its own return that it is chargeable at the two-tiered rates for the year and that no other connected entity elects to be so chargeable[1]. A corporation or partnership does this in its Profits Tax Return; a sole proprietor does it in the Tax Return, Individuals[1].

On the BIR51 the answer goes in Item 2.3. The electing entity must also complete Item 9.1 and give a complete list of its connected entities carrying on a trade, profession or business in Hong Kong in supplementary form S1, unless it is a member of a group with a company listed on the Stock Exchange of Hong Kong[3]. A sole proprietor whose business has connected entities, none of which elects, completes Section 6 of the Appendix to the BIR60[4].

The rules that catch people out

• One per year: an election works only if no other connected entity has elected for the same year of assessment[1].
• Irrevocable for the year: once made it cannot be undone, but a different connected entity may elect in a different year if all conditions are met[1].
• The test date is the end of the basis period, so what matters is who controls whom on that date[1].
• No election, or an ineffective one, means the whole of that entity's assessable profits is taxed at 16.5% or 15%[1].
• Personal Assessment can cost more: a sole proprietor who elects it is taxed at progressive rates on income from all sources, which may exceed tax on the schedular basis where one business uses the two tiers[1].

Choosing which entity to nominate

The IRD pages do not tell a group which entity to nominate. The arithmetic is simple: the saving for any entity is the gap between its normal rate and its lower rate on assessable profits up to HK$2,000,000[2]. For a corporation that is 8.25 percentage points on that slice, and for an unincorporated business 7.5. An entity with a loss, or with small profits, gains less from the nomination than one with profits at or above the threshold. Agree the choice across the group before the first return of the year is filed, since every connected entity's return has to be consistent with it.

If the declaration turns out wrong

If an entity incorrectly declares that it has no connected entity, or that no other connected entity has elected, the IRD raises additional assessments on the basis that the two-tiered rates do not apply, and heavy penalties may be imposed for an incorrect return made without reasonable excuse[1]. The offence of making an incorrect return without reasonable excuse carries a fine of HK$10,000 and a further fine of treble the tax undercharged[5].

Group structures differ, and the IRD's own FAQ and return notes listed below decide any point where this summary and they disagree.