Hong Kong’s tax landscape continues to evolve through judicial interpretation and legislative amendments. Recent court rulings and Board of Review decisions have refined the application of deductible expenses under the Inland Revenue Ordinance (IRO), impacting how businesses structure their operations and claim tax relief. This article examines the latest developments in Hong Kong tax law regarding deductible expenses, drawing on recent Court of First Instance (CFI), Court of Appeal (CA), and Court of Final Appeal (CFA) decisions, as well as significant Board of Review determinations.

The Legislative Framework: Sections 16 and 17 of the IRO

The foundation of Hong Kong’s deductible expenses regime rests on two key provisions of the Inland Revenue Ordinance:

Section 16(1): Allowable Deductions

Section 16(1) IRO permits deductions for all outgoings and expenses, to the extent they are incurred by the taxpayer in the production of assessable profits. The general principle is straightforward: expenses that are incurred for producing profits chargeable to tax and that are not capital in nature are generally tax deductible.

The Inland Revenue Department (IRD) applies a core rule: an expense is deductible only if it is wholly and exclusively incurred for producing assessable profits and is not capital in nature. This test has been refined through decades of case law and remains the cornerstone of expense deductibility analysis.

Section 17: Non-Deductible Expenses

Section 17 IRO establishes specific categories of non-deductible expenses, including:

• Domestic or private expenses – Personal expenditures not related to generating business profits
• Capital expenditure – Section 17(1)(c) disallows any expenditure of a capital nature or any loss or withdrawal of capital
• Improvements – Section 17(1)(d) disallows the cost of any improvements to premises or assets
• Recoverable amounts – Amounts recoverable through insurance or indemnity contracts

The critical distinction between capital and revenue expenditure remains one of the most frequently litigated issues in Hong Kong tax law. Capital expenditure is generally not tax-deductible, though several exceptions exist for specific types of capital expenditure, such as plant and machinery for research and development, environmental protection facilities, and certain prescribed fixed assets.

Landmark Court Decisions Shaping Deductibility Principles

CIR v Secan Ltd & Another (2000) 3 HKCFAR 411

This Court of Final Appeal decision remains the foundational case for determining assessable profits and the distinction between capital and revenue items in Hong Kong tax law. Lord Millett NPJ established the principle that “both profits and losses must be ascertained in accordance with the ordinary principles of commercial accounting as modified to conform to the Ordinance.”

The Secan case requires tax treatment to follow accounting treatment as a starting point, subject to specific modifications required by the IRO. This principle means that the proper accounting classification of an expense generally determines its tax treatment, unless the IRO specifically provides otherwise.

Key Takeaway: Taxpayers must ensure their accounting treatment aligns with commercial accounting principles, as this forms the foundation for tax deductibility analysis under the Secan principle.

Tests for Distinguishing Capital vs Revenue Expenditure

Hong Kong courts have developed several tests to distinguish capital from revenue expenditure:

1. The Fixed Capital vs Circulating Capital Test

Receipts are capital in nature if connected with fixed capital (fixed assets) of the business but revenue in nature if connected with circulating capital (current assets). Fixed capital is what a person turns to profit by keeping it in their possession; circulating capital is what a person makes a profit by parting with it and allowing it to change ownership (such as inventory for resale).

2. The “Once and For All” Test

Derived from the English case Vallambrosa Rubber Co Ltd v Farmer (1910), this test asks: “Is this expenditure incurred once and for all, or is it a recurring expense?” Capital expenditure is typically incurred once and for all, while revenue expenditure tends to recur regularly in the course of business operations.

3. The Operations Test

The operations test examines what the taxpayer has done to earn the profits in question and where those profit-producing activities took place. This test is particularly relevant for determining the source of profits and whether expenses incurred in producing those profits are deductible.

The operations test is the default test for determining the source of profits in Hong Kong. Under this test, the question of locality of profits is “a hard, practical matter of fact” – one looks to see what the taxpayer has done to earn the profits and where those activities occurred.

Recent Court of Appeal and CFI Decisions (2023-2025)

Court of Appeal Refines Source Rules (October 2024)

In a significant October 2024 decision, the Hong Kong Court of Appeal refined the source rules for royalty income, with important implications for deductibility of related expenses. The Court held that if royalties are received based on the exploitation of intellectual property assets (such as sub-licensees’ sales), the location of the marketing of the IP for sub-licensing and the negotiation and procurement of sub-license agreements should also be considered in determining the source of profits.

This ruling expands the factors to be considered in the operations test and may affect how businesses structure their IP licensing arrangements and claim related expense deductions.

Chapman Development Limited v CIR (2024)

This case, decided by the Court of First Instance on 30 September 2024, concerned whether management fees paid to the taxpayer’s related British Virgin Islands (BVI) company were tax deductible.

Background: The taxpayer was engaged in manufacturing and trading of fabric and yarn and the provision of trade-related services. Under a management agreement, the taxpayer appointed the BVI company as its management agent for various production management tasks and agreed on a service fee at a fixed rate.

Issues: The central question was whether the management fees satisfied the requirements under Section 16(1) IRO – were they wholly and exclusively incurred in the production of assessable profits, and were they of a revenue (not capital) nature?

This case demonstrates the IRD’s increased scrutiny of related-party transactions and management fee arrangements, particularly those involving offshore entities. The CFI’s judgment provides guidance on what evidence taxpayers must provide to substantiate the business purpose and arm’s-length nature of such fees.

Foxconn (Far East) Limited v CIR

This case involves two key issues:

1. The taxpayer’s offshore claim on trading profits
2. Deduction claims on staff costs and certain operating expenses of a factory located in mainland China

The second issue only arose if the first issue was decided against the taxpayer. This case illustrates the interaction between source of profits determinations and expense deductibility – if profits are determined to be offshore (and thus not taxable in Hong Kong), related expenses would not be deductible against Hong Kong assessable profits.

Aviation Fuel Supply Company v CIR (2014 CFA)

Although decided in 2014, this Court of Final Appeal case remains highly relevant for its procedural implications on tax disputes. The CFA held that it would be unfair to deprive the taxpayer of the protection of the normal six-year limitation period, as the issue of balancing charge would require further investigation of facts.

Principle: Taxpayers’ rights should be protected under the six-year limitation period, and the IRD cannot circumvent this protection by raising new issues that require factual investigation outside the normal timeframe.

Board of Review Decisions on Deductible Expenses

The Board of Review (Inland Revenue Ordinance) is an independent statutory body constituted since 1947 under Section 65 of the IRO to hear and determine tax appeals. Board decisions provide important guidance on the application of deductibility principles in practice.

Recent Board of Review Trends (2023-2024)

The Second and Third Supplements of Volume 37 of Inland Revenue Board of Review Decisions were published in December 2023 and March 2024, respectively. These publications reported seven cases:

• Five salaries tax cases addressing:
  • Taxability of share options
  • Timing of taxability of awards under incentive plans
  • Deduction of dependent brother or sister allowance
  • Two cases concerning late appeal
• Two profits tax cases, including:
  • Deduction of management fees paid to a related party

Volume 37 and Volume 37 First Supplement, published in June 2023 and September 2023 respectively, reported seven additional cases including five profits tax cases. One notable case considered the deduction of management fees paid to a related party, demonstrating ongoing challenges in this area.

Common Themes in Board of Review Decisions

Analysis of recent Board decisions reveals several recurring themes:

• Related-party transactions – The Board applies heightened scrutiny to management fees, service charges, and other payments between related entities
• Commercial substance – Expenses must have genuine commercial purpose; form over substance arguments are generally rejected
• Documentation requirements – Taxpayers must maintain comprehensive documentation supporting the business purpose and commercial rates for claimed expenses
• Timing of deductions – When expenses are deductible can be as important as whether they are deductible, particularly for multi-year arrangements

Recent Legislative Amendments Expanding Deductible Expenses

The Hong Kong government has introduced several legislative amendments in 2024-2025 to expand the scope of deductible expenses, providing tax relief to businesses and individuals.

Tax Deductions for Leased Premises Reinstatement (2024)

The Inland Revenue (Amendment) (Tax Deductions for Leased Premises Reinstatement and Allowances for Buildings and Structures) Ordinance 2024 was gazetted on 27 December 2024. This significant amendment provides:

• New profits tax deduction for reinstatement costs for leased premises
• Removal of time limits for claiming annual allowances for commercial/industrial buildings or structures

Effective Date: Year of assessment 2024/25 onwards

Significance: Previously, under Section 17(1)(c) IRO, reinstatement costs were considered capital in nature and thus non-deductible. This amendment overrides that principle for leased premises, providing significant tax relief for businesses that relocate or renovate, enhancing cash flow and operational flexibility.

Tax Deductions for Spectrum Utilization Fees (2024)

The Inland Revenue (Amendment) (Tax Deductions for Spectrum Utilization Fees) Ordinance 2024, passed on 19 January 2024, provides new profits tax deductions for spectrum utilization fees paid by telecommunications operators and other businesses requiring spectrum licenses.

This amendment recognizes spectrum fees as revenue expenses incurred in producing assessable profits, rather than capital expenditure for acquiring spectrum rights.

Enhanced Deductions for Personal Expenses (2024/25)

Starting from the year of assessment 2024/25, several personal expense deductions were enhanced:

• Home loan interest deduction – Raised from HKD 100,000 to HKD 120,000 for taxpayers who reside with their child (subject to specified conditions)
• Domestic rent deduction – Raised from HKD 100,000 to HKD 120,000 for taxpayers who reside with their child (subject to specified conditions)

Assisted Reproductive Services Expenses (2025)

The Inland Revenue (Amendment) (Tax Deductions for Assisted Reproductive Service Expenses) Ordinance 2025 was gazetted on 28 February 2025, introducing a new tax deduction for assisted reproductive service expenses.

• Maximum deductible amount: HKD 100,000
• Effective date: Year of assessment 2024/25 onwards
• Applicable to: Salaries tax and personal assessment

Special Deduction Rules and Restrictions

Interest Expense Deductions – Complex Rules

Interest expenses are subject to particularly complex rules in Hong Kong tax law:

General Principle (Section 16(2))

Section 16(2) IRO provides that interest on money borrowed for the purpose of producing taxable profits may be deductible, together with any legal fees, stamp duty, and other expenses in connection with that loan. However, the interest must also satisfy one of several other specified conditions before it is deductible.

Restrictions on Interest to Overseas Recipients

Interest expenses paid to an overseas recipient other than a financial institution (whether a related or unrelated party) are generally not deductible if the overseas recipient is not subject to Hong Kong profits tax on the interest income.

Asymmetric Treatment Alert: This creates potentially asymmetric tax treatments where companies may not receive expense deductions even if their interest income is taxable. Companies with intercompany loan arrangements should reassess their tax exposure and consider revisiting their financing arrangements.

Intra-Group Financing Exception

Section 16(2)(g) IRO provides that interest payable to non-Hong Kong associated corporations (as defined) is deductible if, among other things, it is in relation to an intra-group financing business carried on in Hong Kong by a corporate taxpayer.

Trademark and IP Acquisition Costs

By virtue of Section 16EA IRO, capital expenditure incurred on the acquisition of a trademark is tax deductible subject to conditions. The tax deduction is granted over five successive years on a straight-line basis, starting from the year of acquisition.

The 2025-2026 Budget proposes a review of tax deduction arrangements for the purchase of intellectual property usage rights and related transactions, suggesting potential further amendments in this area.

Environmental Protection and R&D Expenditure

Certain capital expenditures qualify for deduction despite their capital nature:

• Capital expenditure on plant and machinery for research and development
• Capital expenditure on environmental protection facilities
• Capital expenditure on prescribed fixed assets
• Capital expenditure on renovation or refurbishment of buildings (other than domestic buildings)

Practical Implications for Taxpayers

Table: Summary of Recent Key Cases and Their Implications

Best Practices for Claiming Deductions

Based on recent court rulings and Board of Review decisions, taxpayers should observe the following best practices:

1. Comprehensive Documentation – Maintain detailed records supporting the business purpose, commercial necessity, and arm’s-length nature of all claimed expenses, particularly for related-party transactions
2. Align Accounting and Tax Treatment – Following the Secan principle, ensure accounting treatment aligns with ordinary commercial accounting principles as this forms the foundation for tax treatment
3. Apply the Operations Test – When claiming deductions for expenses related to profit-producing activities, clearly identify what activities produced the profits and where those activities occurred
4. Distinguish Capital from Revenue – Apply the fixed capital/circulating capital test and the “once and for all” test to properly classify expenditures before claiming deductions
5. Review Related-Party Arrangements – Management fees, service charges, and interest payments to related parties face heightened scrutiny; ensure these arrangements have genuine commercial substance and are priced at arm’s-length
6. Monitor Legislative Changes – Stay current with amendments to the IRO, such as the 2024 reinstatement costs deduction and spectrum fees deduction, to maximize available tax relief
7. Consider the Six-Year Limitation – Following Aviation Fuel Supply v CIR, understand your rights under the six-year limitation period and raise all relevant arguments within this timeframe
8. Review Financing Arrangements – Given the complex and potentially asymmetric treatment of interest expenses, particularly those paid to overseas associated corporations, reassess intercompany loan arrangements for tax efficiency

Emerging Trends in Tax Disputes

Legal commentators have noted that the Commissioner of Inland Revenue’s assessing practices have become notably more aggressive and inflexible in recent years. If recent decisions are any indication, there is an expected increase in tax disputes between taxpayers and the Revenue, together with an increased willingness of the Commissioner to progress appeals to the higher Courts should a decision not favor the IRD.

This trend suggests taxpayers should:

• Prepare for more rigorous IRD challenges to expense deductions
• Consider early engagement with tax advisors when structuring material transactions
• Maintain even more comprehensive documentation than previously required
• Be prepared for potential litigation if significant deductions are at stake

Salaries Tax Deductions – The “Wholly, Exclusively, and Necessarily” Test

For completeness, it is important to note the more restrictive deductibility standard that applies to salaries tax (personal employment income).

Under salaries tax, outgoings and expenses other than those of a domestic, private, or capital nature are allowable only insofar as they are incurred wholly, exclusively, and necessarily in the production of income subject to salaries tax.

This is a more stringent test than the “wholly and exclusively” test applied to profits tax deductions under Section 16(1). The additional requirement that expenses be necessarily incurred means that, in practice, very few expenses can meet these restrictive requirements for salaries tax purposes.

Most employees cannot claim significant expense deductions against employment income. The specified deductions (such as home loan interest, domestic rent, elderly residential care expenses, and charitable donations) are statutory exceptions to the general restrictive rule.

2025-2026 Budget Proposals

The 2025-2026 Budget includes several proposals relevant to deductible expenses:

• 100% reduction in profits tax payable for 2024-2025, subject to a ceiling of HKD 1,500 (a one-time tax relief measure)
• Review of tax deduction arrangements for the purchase of intellectual property usage rights and related transactions (suggesting potential amendments in this area)
• Continued focus on enhancing deductions to support business operations and economic development

Last updated: December 2025. This article is based on Hong Kong tax law and court decisions as of the date of publication. Taxpayers should consult with qualified tax professionals regarding their specific circumstances, as tax laws and interpretations continue to evolve.