Taxation of charities A look at the IRD’s revised tax guide for charitable institutions On 21 April 2020, the Hong Kong Inland Revenue Department (IRD) published a revised version of its Tax Guide for Charitable Institutions and Trusts of a Public Character, addressing various key issues concerning taxation of charitable institutions. This is an evolving area of tax law in Hong Kong as the importance of the work done by charitable institutions is increasing. It is, therefore, crucial for taxpayers in the sector to understand the basis on which they will be taxed. The revised tax guide provides practical guidance on the IRD’s views in respect of assessing taxable profits derived by charitable institutions as well as on specified requirements to qualify for the tax exemption provided under Section 88 of the Inland Revenue Ordinance (IRO).
Background Section 88 of the IRO provides that approved charitable institutions are exempt from profits tax (as well as stamp duty and business registration fee) where certain conditions are met. While a charity can seek to obtain such a tax exempt status from the department, the IRD is not empowered to register or govern charities. The charity status is important in practice not only because of the tax exemption position, but for the ability to accept donations, which may be deductible for tax purposes by the donors if certain conditions are met. Section 88 does not contain a clear definition of what charitable purposes are, with the IRD using the well-known “four heads of charity” to characterize charitable purposes. These were derived from an 1891 United Kingdom House of Lords decision, while there are more recent court cases and actions in the U.K., where the Charity Commission (a governance body regulating charities) has evolved the definition of “charitable purposes.” In addition to those traditional June 2020
charities such as hospitals, youth organizations, schools, religious bodies, etc. there is an increasing number of charities being established in Hong Kong, as the community is willing to give support to the underprivileged groups. There are also charities or foundations established by corporate groups as part of their corporate social responsibility initiatives. As the IRD is not empowered to regulate charities, the revisions have not focused on providing guidance on what are “charitable purposes.” The IRD has, instead, attempted to provide more clarity on the tax exemption status in the revised guide.
Overview The IRD has recently updated the guidelines twice, firstly in connection with the tax exemption available to charities in September 2019, and secondly by providing more examples to clarify their position in April 2020. The key highlights from the revised guide are summarized below. Carrying on a business The guide confirms that a charity “carrying on a trade or business” in Hong Kong should generally be chargeable to profits tax, unless it can fulfil specified conditions under Section 88 of the IRO. Regarding the question of whether a charity is “carrying on business” in Hong Kong, the IRD provides that while the totality of facts would be considered, the key to determining whether the activities carried on by a charitable institution amount to the “carrying on of a business” are: (i) the intention of carrying on a business; (ii) the nature of the activities performed, particularly whether they have a profit-making purpose; (iii) whether such activities are repeated and regular or organized in a businesslike manner (i.e. including the keeping of books, records and the use of a system); (iv) the size and scale of the institution’s
activities including the amount of capital employed in them; and (v) whether the activities are better described as a hobby, or recreational activities. Exemptions from profits tax The guide reiterates that a charity can be exempt from profits tax in respect of the profits from a trade that contributes directly to an expressed object of the charity (i.e. a primary purpose of the trade/business) and/or a trade ancillary to the primary purpose trade that contributes indirectly to successful furtherance of the expressed object (i.e. an ancillary trade/business). The revised guide also considerably expands the list of example activities that may be exempted from profits tax. The guide also includes some relevant comments regarding charges by charitable institutions for services provided or usage of facilities. Specifically, the IRD confirms that if a charge is imposed on the provision of services or usage of facilities by a charitable institution, the said charge must fulfill the purpose of public benefit, such as non-exclusion from the poor or sufficient provision must be made for the poor to benefit in order for income earned to qualify for exemption under Section 88. Financial investments The guide further elaborates on financial investments made by charitable institutions. Specifically, it clarifies that if a charity invests by way of a discretionary account and the investment manager will act as the agent of the charity, the determination of whether the investments made by the investment manager on behalf of the charity are of capital or revenue nature is a question of fact and degree, which should take into account all the surrounding circumstances, including the investment mandate or pre-defined model portfolio and that the "badges of trade" should remain relevant for answering the question. 28
