The Inland Revenue (Amendment) (Tax Deductions for Leased Premises Reinstatement and Allowance for Buildings and Structures) Bill 2024 relaxes the tax depreciation regime for commercial building allowances and industrial building allowances for buildings sold on or after April 1, 2024. If you’d like more information about the deductibility of lease reinstatement costs or Hong Kong tax generally, please contact one of our Tax lawyers.
The Inland Revenue Ordinance (“IRO”) generally prohibits any deduction in respect of any expenditure of a capital nature for the purpose of computing assessable profits. As a result, the costs of acquiring land upon which a commercial or industrial building is erected is non-deductible.
Though this general prohibition equally restricts the deduction of the cost of construction of a building, the IRO provides for commercial building allowances and industrial building allowances to enable tax depreciation of the costs of the construction of a building to be deducted from assessable profits.
Under the regime, annual commercial building allowances provide for straight line depreciation over a fixed period of time and industrial building allowances comprise a 20% initial allowance as well as annual straight line depreciation thereafter.
Allowances claimed reduce the residue value of a building. The result is that, absent any reset event such as the sale of the building, the residue value of the building at any time is the original construction cost less the aggregate of all allowances claimed to that time.
Upon the occurrence of a reset event, the residue value is adjusted. In the case of the sale of a building, if the sale price exceeds the residue value, the building is regarded as having been over-depreciated, with the result that a balancing charge equal to the difference (and up to a maximum of the total of all allowances claimed to that time) is added to the residue value. Conversely, if the residue value exceeds the sale price, the building is regarded as having been under-depreciated, with the result that a balancing allowance equal to the difference is subtracted from the reside value.
Historical Allowance Methodology
Prior to the Inland Revenue (Amendment) (Tax Deductions for Leased Premises Reinstatement and Allowance for Buildings and Structures) Bill 2024, the IRO set a fixed period of time following the construction of a building in which allowances could be claimed. In broad terms, the period of time reflected the straight line depreciation calculation – at a depreciation rate of 4% per year, a building should fully depreciate in 25 years.
The fixing of a period of time means that once the period of time expires, a purchaser of a building can no longer claim allowances. Unfortunately, this remains the case even if a sale occurs after the end of the fixed period of time and results in a balancing charge that increases the residue value. In a worst case, the seller pays a balancing charge to fully claw back all allowances to the time of the sale, thus resetting the residue value back to the original construction cost. Conversely, because the sale takes place after the end of the fixed period of time, the buyer can claim no allowances, resulting in no depreciation expense being or having been deductible for the building.
New Allowance Methodology
Where an interest in a commercial or industrial building or structure (that has already been put into use) is sold in a tax year beginning on or after April 1, 2024, in each tax year subsequent to the sale, including the tax year in which the sale took place, the buyer is now entitled to an annual commercial building allowance or industrial building allowance, as the case may be, set at 4% of the residue value immediately after the sale. This allowance can be claimed with no limit in time. Each sale continues to have the potential to reset the residue value.
Sales of interests in commercial and industrial buildings or structures which took place prior to April 1, 2024 are unaffected by the legislative changes.