Can the renovation expenses apply commercial building allowance or building refurbishment? The endless dispute!

Whether it is between the superiors and subordinates of a company, between colleagues, between accountants and auditors, or even between employees in the audit firm, it is often found that everyone is always arguing over this issue. Does the renovation apply commercial building allowance or building renovation? What are the differences? Yes, in fact, no one cares about these two terms. What everyone concern should be the percentage of tax deductions behind those terms.

Commercial building allowance can only be deducted 4% per year, that is, if HKD one million is used for renovation, only HKD40,000 can be deducted per year. But building refurbishment is different that is 20% deduction per year, you can deduct HKD200,000 per year. Everyone will immediately think that 20% of building refurbishment is a must to apply! Right?

However, the fact is that if you want to apply `building refurbishment’ to deduct tax, the Inland Revenue Department has relevant tax regulations to enable eligible renovations to enjoy this tax rate, and it will also exclude unqualified renovations to only enjoy other tax rates such as Commercial building allowance.

Let’s take a look at Section 16F of the Inland Revenue Ordinance first. Section 16F (4) explains three situations where building refurbishment cannot be applied:

(a) capital expenditure incurred for a building or structure which is used or intended to be used as a domestic building or structure;

(b) capital expenditure incurred by a person to enable a building or structure to be first used substantially by the person for the production of profits in respect of which the person is chargeable to tax under this Part;

(c) capital expenditure incurred by a person to enable a building or structure to be used for a purpose different from that for which it was used immediately before the capital expenditure was incurred. (Replaced 32 of 1998 s. 9)

Then let’s take a look at Section 33A(1) of the Inland Revenue Ordinance to find out who can enjoy the Commercial building allowance:

• Where any person is, at the end of the basis period for any year of assessment, entitled to an interest in a building or structure which is a commercial building or structure and where that interest is the relevant interest in relation to the capital expenditure incurred on the construction of that building or structure, an allowance for depreciation by wear and tear of that building or structure, to be known as an “annual allowance”, of an amount equal to, subject to subsection (2), one-twenty-fifth of the expenditure, shall be made to the person for that year of assessment. (Amended 12 of 2004 s. 9)

Finally, let’s take a look at paragraph 16 of the Departmental Interpretation and Practice Notes no. 5 (revised) of the Inland Revenue Ordinance. When eligible renovations cannot enjoy building refurbishment, they will enjoy commercial building allowances:

16. Capital expenditure incurred on the initial construction, decoration or fitting out of a commercial building or structure, and expenditure on alteration of a building to enable a different usage do not qualify for the deduction under section 16F(1) but they may qualify for commercial building allowance under section 33A.

Let us briefly explain the actual situation. After you have renovated your company or shop, you will immediately want to enjoy the 20% tax deduction rate for building refurbishment, so what is eligible renovation? The answer is at least the reason for renovation must be making a profit. For example, it is not for self-occupation or other personal use.

Now, we have passed the eligible test. For example, I newly operate a restaurant. Of course, the renovation occurred due to making profit, so this is an eligible renovation. So can I enjoy the building refurbishment? Now, there are the first and second thresholds, as long as we can cross one of them, we will achieve our goal!

1. Threshold 1: If this is the company’s first renovation, you cannot enjoy building refurbishment

2. Threshold 2: If this is the company’s second/Nth renovation, and its renovation purpose is inconsistent with the last renovation purpose, you cannot enjoy building refurbishment. For example, the purpose for my first renovation is running a restaurant, I realized that I could not make any money after a while, so I decided to try other businesses such as fashion industry. The original restaurant was renovated into a fashion shop. The fashion shop and the restaurant are completely different businesses. So you can’t enjoy “building renovation” (building refurbishment).

To sum up, if you want to enjoy building refurbishment, it must be a eligible renovation, and the renovation must be the company’s second/Nth renovation. And the purpose of the renovation must be the same as the last one. Let’s take the last example, if the first purpose is running a restaurant, the second purpose is running a fashion store, and the third purpose changed back to running a restaurant.

The first and second time must not be able to enjoy building refurbishment, but what about the third time? The answer is no, because the purpose of the third time is inconsistent with the purpose of the last one (second time).

But if the purpose of the third time is for upgrading the fashion store, then the purpose is the same as the last (second time) purpose, so that the company can enjoy building refurbishment.

The above information is for reference only. If in doubt, we welcome your tax inquiries