Tax of Charitable Institutions and Trusts of a Public Character
Section 88 of the Inland Revenue Ordinance (Cap. 112) (the Inland Revenue Ordinance) provides that charitable organizations are exempt from profits tax, subject to the fulfillment of certain conditions in relation to the trade or business carried on by the charity.
Tax Exemption
Charities are exempt from tax under section 88 of the IRO. The general exemption contained in section 88 is subject to the conditions and the charity will continue to be a charity.
Trading or business profits are taxable unless certain conditions are met
Section 14 of the Inland Revenue Ordinance provides that every person carrying on a trade, profession or business in Hong Kong shall be charged for each year of assessment on his assessable profits arising in or derived from Hong Kong from such trade, profession or business for that year (excluding profits from the sale of capital assets). Prima facie, all profits derived from trade or business activities in Hong Kong are subject to profits tax. Accordingly, charities carrying on a trade or business are subject to profits tax unless the charity meets certain conditions under section 88 of the Inland Revenue Ordinance.
The proviso to section 88 of the Inland Revenue Ordinance states that if a charity carries on a trade or business, the profits from that trade or business are exempt from profits tax only if:
(a) the profits are used solely for charitable purposes; and
(b) the profits are not substantially spent outside Hong Kong; and
(c) either —
(i) the trade or business is carried on in the actual execution of the charity's stated objectives; or
(ii) the work in connection with a trade or business is primarily carried out by persons for whose the benefit such charities are established.
If a charity derives profits from a trade or business, it must ascertain that all the requirements of the proviso to section 88 of the IRO have been met for the profits to be exempt from profits tax.
Trading or carrying on business
Trade is defined to include every trade and manufacture, and every venture and concern of a trade nature and business is defined to include agricultural undertakings, poultry and pig raising the letting or sub-letting of any premises or part thereof by any corporation to any person, and the subletting of any premises or part of any premises held by any other person under a lease or lease other than the Government.
Badges of Trade
Whether sale goods and services by a charity is a "trade" depends on a number of factors, including:
(a) the volume and frequency of transactions;
(b) the nature of the goods or services being sold;
(c) the charity's intention to purchase the goods for sale;
(d) whether the goods can be used and enjoyed by the charity that sold them;
(e) the nature and mechanism of the sale; and
(f) whether there is a profit motive.
However, the fact that the sale of goods, services and property furthers the aims of the charity, or that the profits from the trade will be used to further those aims, does not prevent an activity from being considered a "trade".
Indicators of operating business
While it may not be possible to state clearly what a business is, it has been observed that business is a process of conduct for profit involving the concepts of continuity and repetitive behaviour.
While all the facts will be considered, the key indicators for determining whether the activities carried out by an organization amount to conducting business are:
(a) whether the organization intends to conduct business;
(b) the nature of the activities, in particular whether they are for-profit;
(c) Whether the activity is:
(i) repetitive and regular;
(ii) organized in a business-like manner, including keeping books, records and using systems;
(d) the size and scale of the organization's activities, including the amount of capital employed therein; and
(e) whether these activities are better described as hobbies or recreation.
Trading or non-trading transaction
The following transactions are generally not considered "trading" and profits derived from such transactions are not considered trading profits:
(a) sale of merchandise donated to charity for sale purposes;
(b) sale of capital investments; and
(c) sale of capital assets that the charity uses or has used for its charitable purposes.
If the charity conducts trading, the profits from the trades are in principle subject to profits tax, unless specifically exempted under the proviso to section 88.
A charity simply selling goods donated to it is generally not considered a "trade" for tax purposes. For charities, the sale proceeds are only a realization of the value of the gift. Where goods donated to a charity are substantially altered or improved such that they are placed in a different state for sale, such as turning donated raw materials into finished and marketable goods, profits from such sales may be considered trading profits. However, tidying up, cleaning, or making small repairs to donated items does not turn the profits from their sale into a trading profit.
Primary purpose trade/business or auxiliary trade/business
Subject to the other conditions of the proviso to section 88 of the Inland Revenue Regulations, charities are entitled to profits tax exemption on profit from trade/business that directly contribute to the stated objectives of the charity (i.e. the primary purpose trade/business) and/or ancillary trade/business to the primary purpose trade/business which indirectly contributes to the successful promotion of the expressed object (i.e. ancillary trade/business). In other words, a charitable institution can carry on not only a trade/business for the main purpose trade/business, but also an ancillary business of the primary purpose trade/business without paying profits tax.
Examples of primary purpose trades/businesses include:
(a) sales of religious tracts by religious charities;
(b) provision of educational services by a charity school or college in exchange for course fees;
(c) exhibitions put on by art charities in return for entry fees;
(d) the sale of tickets for dramatic productions staged by theater charities;
(e) provision of health care services or accommodation by health care charities in return for payment;
(f) sale of certain educational supplies by museum charities;
(g) sale of products made from recycled materials by environmental charities;
(h) provision of medical advice by aged care and welfare charities in return for a consultation fee;
(i) provision of training courses for children with special educational needs by children's charities in return for course fees;
(j) provision of extra-curricular activities/after-school care programs/after-school tutoring classes to school-age children and young people by children's and young people's charities in return for a fee;
(k) provision of family counseling services by family charities to help dysfunctional families in return for fees;
(l) provision of low-priced meals to the poor by poverty charities;
(m) provision of aged care homes by aged care charities for a fee;
(n) provision of recreational facilities for elderly persons by aged care charities for a fee; and
(o) provision of medical or rehabilitation equipment by a elderly charity or medical charity for a fee.
Examples of ancillary trades/businesses include:
(a) provision of serviced accommodation to students by a charitable university or college;
(b) sale of goods or services for the benefit of students by a charitable school or college;
(c) sale of food, drink and snacks to patrons of arts charities or museum charities;
(d) sale of confectionery, toiletries and flowers to patients and their visitors by a charity hospital;
(e) provision of childcare services in churches for parents attending church services;
(f) sale of vegetarian food by religious charities in temples built to promote religion, such as Buddhist temples;
(g) provision of study tours for children by educational charities; and
(h) provision of pilgrimage for believers by religious charities.
A trade/business should not be considered ancillary to the achievement of the charity's stated objectives simply because its purpose is to raise funds for the charity.
Trade/Business where the work is primarily carried out by the beneficiary
Subject to the other conditions of the proviso to section 88 of the IRO, a charity may claim tax exemption on the profits of a trade/business if the work in connection with the trade/business is primarily carried out by the beneficiaries of the charity. Examples of trades/businesses run by charities where work is primarily carried out by beneficiaries include:
(a) cafes run by students as part of a catering course in the Faculty of Further Education;
(b) a bakery run by a charity which primarily employs physically handicapped persons to provide them with on-the-job training;
(c) stores selling low-cost goods or products, such as arts and crafts, made by disabled persons who are beneficiaries of disability charities;
(d) sale of art created by elderly persons as part of their rehabilitation by aged care and welfare charities;
(e) a restaurant operated primarily by deaf people as part of a training program run by hearing loss charities to promote the inclusion of deaf people in the community; and
(f) auto detailing services by ex-mentally ill persons as part of an on-the-job training scheme run by rehabilitation charities.
Charging for services - public benefit
Charities may charge for services or facilities they provide. This is usually because the charity's services or facilities are expensive to provide, or the charity simply cannot operate unless the charity charges a fee. Examples of charities that often charge for their services include:
(a) educational charities (e.g. schools, colleges, universities);
(b) charities advancing education or promoting the arts (e.g. theatres, concert halls, museums, art galleries);
(c) charities promoting health or sickness relief (such as charitable hospitals);
(d) charities providing residential care; and
(e) charities promoting heritage or environmental protection or improvement.
If a charity charges for services or facilities it provides, the charity must consider whether it meets the charity's public benefit requirements. The poor cannot be excluded. When determining the charges for services or facilities provided by charities, charities must consider whether the poor can afford them. This may depend, for example, on the nature of the services and the frequency or regularity with which such services may be used or required, and the resulting financial commitments that may be required by the beneficiary. But, in general, this usually means a fee that modest income earners won't easily afford. If charges are of levels that the poor cannot afford, it is important to ensure that the poor can benefit.
When charities provide benefits to the poor, the level of provision must be higher than minimal or nominal. There are no objective benchmarks for charities to follow when it comes to providing minimal or token provisions to the poor. This is something the charity decides after considering all the circumstances of the charity. Examples are:
(a) reduction in charges for those who cannot afford to pay the full cost;
(b) provision of benefits in other ways, such as supporting another charity to provide a similar service; and
(c) sources of funding other than charities that help poor people access charitable benefits (such as scholarships offered by others).
Investee trading company is not tax-exempt
Tax-exempt charities may invest in trading companies, subject to clearly stated objectives and powers in the governing instrument. Profits earned by such trading companies (i.e. investee trading companies) are not eligible for tax exemption under section 88 of the IRO. Under section 14 of the IRO, a trading company is liable to pay profits tax in the usual way (for example, if the investee trading company operates a hotel or restaurant).
Financial investment
A charity may make investments for financial returns that further the goals of the charity. Generally, such investments should be made in an appropriate and prudent manner so as to generate the optimum return within an acceptable level of risk. Financial returns may be subject to profits tax, depending on their nature and circumstances, including the manner in which the return is applied (i.e. whether it is used solely for its charitable purpose) and the place where the return is applied (i.e. whether it is principally in Hong Kong or elsewhere) ). If a charity buys an asset with the intention of selling it for a profit in the course of the transaction, it is likely to be considered a trading. Profits from the sale of trading assets by charities are subject to profits tax unless the conditions of the proviso to section 88 of the IRO are met. The following is an example of financial investments that does not have profits tax consequences:
A charity invests surplus funds that are not needed in the short or medium term in diversified investment funds (i.e., capital assets) designed for long-term investment. The charity does not deal in trading of investment funds or financial securities. The resulting financial returns from investment funds will not be subject to profits tax.
If the charity invests through a discretionary account (that is, an account that allows a licensed or registered investment manager to trade investment products on behalf of a client without specific authorization from the client), the investment manager will act as an agent for the charity. Whether an investment by an investment manager on behalf of a charity is of a capital or revenue nature is a matter of fact and degree, taking into account all surrounding circumstances, including investment mandates or pre-defined model portfolios. "Badges of trade" is still relevant to answer this question.
Under the IRO, the following income, gains or profits are specifically exempt from profits tax:
(a) dividends received from corporations which is subject to Hong Kong profits tax;
(b) interest on, and any profit made in respect of bonds issued under the Loans Ordinance (Cap. 61) or the Loans (Government Bonds) Ordinance (Cap. 64), or in respect of Exchange Fund debt instruments or in respect of Hong Kong dollar-denominated multilateral agency debt instruments;
(c) interest, profit or gain on qualifying debt instruments (issued on or after April 1, 2018);
(d) interest accruing on any deposit placed with an authorized institution in Hong Kong, excluding interest received by or accrued to a financial institution;
(e) interest and any profits on RMB sovereign bonds and non-RMB sovereign bonds; and
(f) interest and any profits on debt instruments issued by the People's Bank of China in Hong Kong.
Where a charity makes a financial investment in a company or entity in which members of its governing body have a personal interest, due consideration must be given to whether:
(a) the investment is appropriate for the charity and consistent with its investment policy;
(b) any conflict of interest issues have been identified and managed; and
(c) any personal benefit is acceptable provided it is necessary in the circumstances, is of a reasonable amount and is in the interest of the charity.
If personal interest is at an unacceptable level such that the public benefit requirement cannot be met, it may affect the charitable status of the charity and therefore its exemption under section 88 of the IRO.
Program related investment
Charities can use assets to directly advance the charity's goals, while also potentially generating financial returns. This program-related investment by a charity differs from the financial investment described above in that the rationale for the investment is to further the goals of the charity. As with financial investments, financial returns from program-related investments may be subject to profits tax depending on their nature and circumstances. The following is an example of program-related investment that does not incur any profits tax liability:
A charity working in poverty relief may lend to another charity to help unemployed people return to work according to the latter's stated goals (i.e. the loan is made for the actual achievement of the latter's stated goals). This will alleviate poverty (i.e. fully promote the goals of philanthropy); is for the public good and will hopefully result in loan repayment and a financial return from interest on the loan. In this case, the interest payment on the loan is not subject to profits tax.
When a charity makes a program-related investment, it must ensure that any personal benefit arising from the investment, including to other investors, is necessary, reasonable and in the charity's interest. If an investment no longer furthers a charitable purpose, there should be a reasonably practicable means of exiting. If personal benefit is at an unacceptable level such that the public benefit requirement cannot be met, it may affect the charitable status of the charity and therefore its exemption under section 88 of the IRO.
Property letting
Charities can rent out their property for rental income, which can then be used for charitable purposes. The letting of property may amount to a business. The term "business" is clearly defined to include the letting of property by any company and the sub-letting by anyone other than the company. Regardless, the following are strong signs of a business:
(a) the number of properties let out is substantial and the charity has employed a number of staff to handle the tenancies and deal with tenants;
(b) the charity provides additional services or facilities as a landlord of the rental property; or
(c) letting by a charity in the course of the selling properties which constitutes a trade.
In such circumstances, the rental income derived by the charitable organization from the letting of the property is exempt from profits tax only if the proviso to section 88 of the IRO is satisfied.
Generally speaking, if the property is not leased out during the course of actually carrying out the stated object, the rental income is subject to profits tax. The following example illustrates this situation:
A charity holds a property and lets it out at market rents, without any specific target group of tenants. The charity establishes to promote religion conduct direct charitable activities and/or make grants to their charitable objects. Although the rental income is used only for its charitable objectives and is not expended substantially outside Hong Kong, such letting is clearly not exercised in the actual execution of the charity's expressed objectives. Therefore, the rental income derived from the letting of properties is subject to profits tax.
If the letting of property is carried out in the course of actually carrying out the stated objectives of the charitable organisation, the rental income will not be subject to profits tax if the rental income is used solely for charitable purposes and is not substantially expended outside Hong Kong. The following example illustrates this situation:
A charity set up to help the poor is renting out apartments it owns to the poor at below-market rents. The resulting rental income is only used for charitable activities in Hong Kong to relieve the poor. Leases are clearly exercised in the actual execution of the charity's stated aims, namely, relief of the poor. Therefore, the rental income derived from the letting of properties will not be subject to profits tax.
Charities can also rent out their property to other charities for use. If the resulting rental income is used for charitable purposes only and is not substantially expended outside Hong Kong, the rental income will not be subject to profits tax. The following is an example of such a situation:
An environmental charity organization has a multi-functional hall to hold environmental protection promotional activities. When the function room is not reserved for such events, the charity rents it out to other charities for use. The rental income so derived will not be chargeable to profits tax if it is only used for charitable purposes and not expended substantially outside Hong Kong.
Charities Qualify for a Tax Exemption
Only charities established in Hong Kong or overseas charities established in Hong Kong, such as charities established in Hong Kong under section 4 of the Societies Ordinance (Cap. 151), or charities established in Hong Kong under Part 16 of the Companies Ordinance (Cap. 622).
Other Tax Advantages
Inland Revenue Ordinance (Cap. 112)
For the purposes of profits tax, salaries tax and personal assessment, sections 16D and 26C of the IRO allow deduction under certain conditions for donations made by taxpayers to the charity under section 88 or Government for charitable purposes (i.e. approved charities donation).
Stamp Duty Ordinance (Cap. 117)
Section 44 of the Stamp Duty Ordinance provides that no conveyance of immovable property shall be chargeable with stamp duty pursuant to heads 1(1) (ad valorem stamp duty on property transactions), 1(1AA) (special stamp duty) and 1(1AAB)( buyer’s stamp duty); or any transfer of Hong Kong shares under head 2(3) of First Schedule (ad valorem stamp duty and fixed duty on share transactions), where a beneficial interest is transferred by way of a gift from a person entitled to the interest, registered owner or transferor, or trust of a charitable institution or public trust. The instrument must be submitted to the Collector of Stamp Revenue for determination under section 13 of the Ordinance. It is not considered to be stamped unless it has been specifically stamped or by way of a stamp certificate denoting that it is exempt from stamp duty or has been properly stamped.
Business Registration Ordinance (Cap. 310)
Where a charitable, ecclesiastical or educational institution of a public character carries on a trade or business, it is exempt from the obligation to register a business only if it satisfies the conditions set out in section 16(1)(a) of the Business Registration Ordinance. These conditions are similar to those set out in the proviso to section 88 of the IRO.
Approved Charitable Donations
Definition of approved charitable donation
Sections 16D and 26C of the IRO allow for the deduction of approved charitable donations made by an individual during the year of assessment. Section 2 of the IRO defines the term "approved charitable donation" as a donation to:
(a) any charity or trust of a public character exempt under section 88 of the IRO; or
(b) the Government,
for charitable purposes.
The basic criteria for granting the deduction are:
(a) the payment must be a donation;
(b) the donation must be a monetary donation;
(c) donations must be made to a tax-exempt charity or government;
(d) donations must be made for charitable purposes;
(e) the person's total donations (including donations from the person's spouse (other than the person's estranged spouse)) must not be less than $100;
(f) the allowable deduction for any year shall not exceed 35% of the person's assessable income or profits;
(g) the deduction for the same donation shall not be granted to more than one person; and
(h) a deduction for donations can only be claimed once under profits tax, salaries tax or personal assessment.
The word "donation", in the ordinary sense, means gift. To constitute a gift, the transferred property must have been transferred voluntarily, not as a result of a contractual obligation, and the transferor had not received any substantial benefit by way of return.
If the person making the payment to the tax-exempt charity receives a material benefit, the entire payment does not qualify as a gift because the requirement that the donor must not receive a material benefit is violated. Payments other than strictly gifts are not donations for the purposes of sections 16D and 26C of the IRO. There is no provision in the IRO to allow the apportionment of payments into the "charity" and "material benefit" components.
Donation receipt
Charities should note that donors may be asked to produce donation receipts in support of any claim they may make for an allowance under the IRO. For donations received, tax-exempt charities can prepare and issue appropriate receipts. To assist donors in claiming a tax deduction, donation receipts should show the full name of the tax-exempt charity according to its constitutional or formation document.
If the donation is not a monetary donation, it will not constitute an approved charitable donation and will not be allowed to be tax deducted. Therefore, it is important for charities to distinguish donations from other payments when issuing these types of receipts. Non strictly gifts (e.g. payments for cemeteries, services such as prayers, reservations for ancestral worship sites, tickets to movie screenings, etc.) should not be considered donations. In borderline cases, the exact nature of the payment should be clearly stated on the receipt so that the Department can consider such transactions individually.
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