Common Pitfalls in Employer Tax Reporting

Companies that are incorporated in Hong Kong SAR have a statutory obligation to report all matters related to employee compensation and tax as per the prescribed rules by the Inland Revenue Department (IRD). In addition, companies are also obligated to report renumeration paid to persons other than an employee.

Quite often, company management and administrative staff are not fully aware of their obligations, leading to errors in their reporting. These errors can lead to substantial fines, while damaging the company’s reputation.

Hong Kong’s Simplified Tax Regime

Being one of the world’s largest financial centers, Hong Kong has built a reputation for the ease of business. One of the key contributors to this reputation is the relatively simple tax regime for individuals. Salaries Tax is charged in full on every person in respect of his income arising in or derived from Hong Kong. This includes income derived from office, employment and pensions^[1].  

The IRD considers any director of a company, or person engaged in the management of a company, to be deemed as a person employed by the company. Furthermore, for salaried employees the salaries taxation in Hong Kong is territorial. The residence status of an employee is not the key determinative for calculation of tax payable. The salaries tax is charged on a time apportionment basis on non-HK source employment income as well.

Key Employer’s Obligations for Tax Reporting 

As per Section 9 of the IRO, income from an office or employment is assessable to salaries tax (s8). While Hong Kong does not have the concept of tax deductible at source, there are statutory obligations of an employer to report remuneration paid to an employee. The reporting must consider the date of receipt of income as well as income accrued to a person when he/she becomes entitled to claim payment of a salary and bonus. The reporting is required irrespective of whether the employee performed these services in or outside Hong Kong, so long as their total income exceeds the set limits. In addition, commencing from the time of hiring, the employer must maintain payroll records for at least 7 years. They must also inform the IRD if there are any changes to this information.

The employer is also obligated to give notice to the Commissioner not later than 1 month before employees cease to be employed in Hong Kong. After the cessation of employment, additional reporting is also required. This includes obligation to report if such individuals are about to leave Hong Kong for any period exceeding 1 month. The employer is required to withhold any payment of money, or its equivalent, to the employee or payable on their behalf for a period of one month from the date on which the notification is given.

Failure to comply with the above requirements is a serious offence which carries penalty, including monetary fines and imprisonment in serious cases. Typically, the fines can range from HK$10,000 upwards with additional fine of up to three times the tax undercharged. The management and directors of the company can also be held personally liable.

In the past few years, there have been several cases where both large and small companies faced penalty due to misreporting. For example, in 2000, a Japanese company was fined HK $130,000 under section 80(2)(a) for incorrect employer’s returns and commissions. In another example a Senior Manager was fined HK $500,000 and sentenced to 240 hours of community services for tax evasion under Section 82.

The below table gives an overview of the obligations of the employer and the relevant forms that the employer has to file with the IRD:

Types of Incomes and Benefits to be Aware of

Some of the common reporting mistakes are to do with benefits and types of renumeration. This highlights the need for employers to be acutely aware of what are the incomes and benefits mandated to be reported as well as the ones that are exempt.

The type of taxable income includes wages, salary, leave pay, fee, commission, bonus, gratuity, perquisite or allowance and any other income derived from the employer or others. The only exemption is for any amount paid by the employer to or for the credit of a person other than the employee subject to subsection (2A) of the tax regime. Below is a look at the main types of benefits and the reporting requirements for each:

1. Fringe Benefits: Defined as any emolument or reward of value to an employee in addition to salary and wage. This includes benefits capable of being converted into money’s worth by the recipient, as well as the amounts paid by an employer to discharge the personal liability of the employee. Some examples of fringe benefits include education benefits, medical benefits, club benefits, relocation expenses, holiday journey benefits and expense reimbursement. It is important that both the employee and employer report the fringe benefits to the IRD to avoid any surcharge on the tax liabilities.
   
   
2. Housing Benefits: Many employers choose to provide housing benefits for their employees as regular practice. These need to be considered when the rental value of any place of residence is provided rent-free by the employer or an associated corporation. In instances where a place of residence is provided by an employer or an associated corporation at a rent less than the rental value, the excess of the rental value over such rent would be considered as the benefit. In Hong Kong companies typically provide these benefits as cash housing allowance, free place of residence and through rental reimbursement.
   
   The IRD requires the employer to exercise proper supervision and control but there is limited guidance on the requirements. Employers are expected to know the entitlements well, while putting proper controls in place to verify the benefits clearly.
   
   
3. Stock Awards and Share Options: To increase employee retention, stock awards and ESOPs rewards have gained in popularity. Share based awards entail awarding shares to employees with or without considerations. Employers can also grant share options, giving the employees a right to acquire shares at a nominated price within a time period in the future. In some instances, companies choose to grant phantom share plans or employee share purchased scheme for the employees as a benefit. While filing the tax report, care must be taken to include the date of grant, date of vest, date of exercise, and considerations for the share awards and options as applicable.

Being Well Prepared of Obligations is Key to Good Governance

Companies should constantly evaluate and identify the tax implications due to new changes in the market. They must ensure they have reviewed and identified the fringe benefits that fall under the personal expenses, which in some cases may have been disguised as business expenses. To reduce chance of incurring penalty due to miscommunication, companies must discuss with relevant finance team and business divisions about the reporting in past 3 years. In addition, regular audit of vendors is important to ensure that all expenses have been properly paid for by the employees.

Being well prepared with all the necessary checks and balances in place for tax reporting along with a regular review of company policies for employee benefits, plays a vital role in maintaining good governance. By constantly adhering to the above best practices, companies can avoid common pitfalls in tax reporting and save themselves from related fines.

[1] https://www.gov.hk/en/residents/taxes/salaries/salariestax/exemption/employee.htm