The Two-Tiered Profits Tax Rates: Who Qualifies, and Why Connected Entities Get Only One

At a glance

Rates, thresholds, the definition of connected entities and the nomination requirements are governed by the Inland Revenue Ordinance and the IRD’s latest published guidance.

How are “connected entities” defined?

Two entities are connected if any of the following applies:

• One directly or indirectly controls the other (generally holding more than 50% of the issued share capital or voting rights)
• Both are directly or indirectly controlled by the same person or entity
• Two sole proprietorships or partnerships are owned by the same person

Example: Mr Chan holds 100% of both Company A and Company B — A and B are connected, only one may claim the two-tiered rates, and the other is charged entirely at the standard rate.

Note the test is control, not whether the businesses are related. Two companies in completely different trades are still connected if the same person controls both.

With several companies, which one should you nominate?

Nominate the one with the highest assessable profits.

The saving equals the profit that lands in the lower band multiplied by the rate difference. A company earning less than HK$2 million cannot use the full allowance.

So the answer is direct: nominate whichever earns most. And this decision has to be revisited every year — A may be ahead this year and B next.

How do you nominate?

No separate application, but three things have to be handled on the return:

1. Declare whether you have connected entities
2. Nominate which one claims the two-tiered rates
3. List the names of all connected entities

If you do not nominate, the IRD may decide which entity gets it — and that will not necessarily be the one that suits you.

This step is easy to miss, especially where several companies are handled by different accountants.

A detail few people know: short periods are not pro-rated

If the accounting period is less than 12 months — a first financial year, or a mid-stream change of year end — the HK$2 million threshold is not reduced proportionately.

In other words, a seven-month accounting period still gets the full HK$2 million lower-rate band.

That is worth calculating when changing your year end or filing for the first time — but note a change of year end also moves your filing extension code, so do not look at the tax side alone.

How do you legitimately reduce assessable profits?

Under the two-tiered regime, bringing assessable profits under HK$2 million has an outsized effect. Common deductions include:

• Depreciation allowances — plant and machinery
• R&D expenditure — qualifying local R&D at 300% on the first HK$2,000,000 and 200% on the balance
• Employer MPF contributions — deductible, subject to a cap
• Approved charitable donations — capped at 35% of adjusted assessable profits
• Prescribed fixed assets (computer hardware and software and similar) — generally written off in full immediately

Do not split companies to claim it twice

This needs saying plainly.

In theory, companies that are not connected each claim their own two-tiered rates. In practice:

1. Common ownership means connected. Several companies you own yourself sit under the same control, so the relief is still available once. Making them genuinely unconnected means genuinely giving up control — that is not an arrangement, it is handing the company over.

2. The Inland Revenue Ordinance has anti-avoidance provisions. If the main purpose — or one of the main purposes — of the split is to obtain a tax benefit, the IRD can disregard the arrangement.

3. Splitting has real costs. Every additional company means another audit, another annual return, another secretary fee. And Hong Kong has no group loss relief, so a loss in one cannot shelter a profit in another (see how losses carry forward).

Separating businesses for genuine commercial reasons is one thing; separating them for tax is another. In the first case the tax outcome is an incidental and defensible result; in the second it is an arrangement the IRD will look at.

A worked example

A company with assessable profits of HK$5,000,000 for 2026/27:

At a flat 16.5%: HK$825,000. A saving of HK$165,000.

One more thing: this is the same calculation as salary versus dividend

The two-tiered rates set your company-level rate — 8.25% under HK$2 million, 16.5% above it.

And that figure is precisely what decides whether an owner should draw a salary or take a dividend: when the company rate is low, dividends look better; when it is high, there is more value in the deduction a salary creates. See salary or dividend for the owner.

The full rules are in the profits tax guide.

Want someone to run this year’s numbers and check which company should hold the nomination? Talk to us.

This article is general information and does not constitute tax advice. Rates, thresholds, the definition of connected entities, nomination requirements and the anti-avoidance provisions are governed by the Inland Revenue Ordinance and the IRD’s latest published guidance; group structures warrant advice from a professional tax adviser.