All expenses incurred by a taxpayer in the course of business in a year of assessment are deductible under profits tax, but only if they are incurred in the ordinary course of business, i.e. are of an operational nature. Expenses of a capital nature are not deductible.
One example is office removal expenses. How can you tell if relocation expenses are operational or capital in nature? It depends on whether the relocation is spontaneous or forced. If the taxpayer is forced to move by the landlord or the government, the costs are operational in nature and all costs including demolition, removal and installation of machinery are fully deductible. In the case of spontaneous relocation, the costs are incurred to improve the business environment or to expand the business. Therefore, such costs are capital in nature and are not deductible. However, depreciation allowances can be claimed for the cost of dismantling, moving and installing machinery.
On the other hand, capital expenditure has long-term benefits, such as the purchase of an operating right.
Franchisees pay a large franchise fee and an annual royalty, which gives the franchisee exclusive access to technology, marketing strategies, operations, management experience, etc…
Under the Inland Revenue Ordinance, deductions claimed under profits tax also include payments for the use of trademark rights or patent rights, provided that the following conditions are met:
the registration of the right is in force
the taxpayer must own the right outright
the right is used to generate assessable profits in Hong Kong
As the franchisee is not paying a large franchise fee to buy out the patent rights, i.e. he does not fully own the rights, but is required to pay a further franchise fee upon renewal of the franchise after a few years, such fees are in fact capital in nature with long-term benefits and are therefore not fully deductible. The annual royalty fee is a business expense and is deductible.
The above information is for reference only. If you have any questions, we welcome your tax enquiries.
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