Losses

Welcome to the World of Tax Losses!

Making a profit is every business owner's dream, but in the real world, losses happen. The good news? In the world of Hong Kong Profits Tax, a loss isn't just a "bad year"—it’s actually a valuable "tax asset" that can help you pay less tax in the future! In this chapter, we will learn how to calculate these losses and how the Inland Revenue Department (IRD) allows businesses to use them to lower their tax bills. Don't worry if this seems a bit technical at first; we’ll break it down step-by-step.

1. What is a "Tax Loss"?

Just like we calculate Adjusted Profits by taking the accounting profit and making tax adjustments (adding back non-deductible items and subtracting non-taxable income), we calculate a Tax Loss (or Adjusted Loss) the same way. If the final result is a negative number, you have a loss for tax purposes.

Important Note: Not all accounting losses are tax losses. If your business lost money because of a capital expense (like selling a building at a loss), the IRD generally ignores it, just as they ignore capital gains!

Key Takeaway:

A tax loss is simply an "Adjusted Profit" that ends up being a negative number. It follows the same rules of Source and Deductibility as profits do.

2. How to Use Losses (Section 19C)

In Hong Kong, the rules for using losses are quite generous compared to other countries. The primary rule is found in Section 19C of the Inland Revenue Ordinance (IRO). There are two main ways a corporation can use a loss:

A. Set-off against other income in the same year

If a company carries on more than one trade (for example, a bakery and a shoe store), and the bakery makes a profit of \( \$100,000 \) while the shoe store has a loss of \( \$40,000 \), the company can use the shoe store loss to offset the bakery profit. The net taxable profit would be \( \$60,000 \).

B. Carry forward to future years

If the company has no other profits to offset this year, the loss is carried forward indefinitely. This means you can keep that loss on the books until the company makes a profit in the future, no matter how many years it takes!

Analogy: Think of a tax loss like a "discount voucher" for your future tax bills. If you can't use the voucher today, you can save it in your drawer until you have a bill to pay later on.

Quick Review: The Set-off Rules

• Losses are set off against the assessable profits of the company.
• Losses can be carried forward indefinitely.
• Hong Kong does not allow "Loss Carry-back" (you can't use today's loss to get a refund for last year's tax).
• Hong Kong does not have "Group Relief" (you cannot usually give your loss to a sister company or a parent company).

3. Losses in Partnerships

Partnerships are a bit special because they aren't separate legal "people" in the same way corporations are. When a partnership has a loss, it is shared among the partners based on their profit-sharing ratio.

Step-by-Step Loss Allocation:
1. Calculate the partnership's total adjusted loss.
2. Divide that loss among the partners (e.g., 50/50).
3. Individual Partners: Can use their share of the loss against their other income if they elect for Personal Assessment, or carry it forward against their share of future partnership profits.
4. Corporate Partners: Can use their share of the loss to offset their own company's profits.

Common Mistake to Avoid: Students often think the partnership "keeps" the loss. Actually, the loss belongs to the partners. If a partner leaves the partnership, their share of the carried-forward loss is lost forever—it cannot be used by the remaining partners.

4. Anti-Avoidance: Section 22B

Because losses are so valuable (they save money!), some people try to "buy" companies that have big losses just to avoid paying tax on their own profitable businesses. This is called "Loss Buying."

The IRD doesn't like this. Under Section 22B, the IRD can disallow the use of carried-forward losses if they are satisfied that:

• There was a change in shareholding of the company; AND
• The sole or dominant purpose of that change was to use those losses to avoid tax.

Did you know? The IRD looks at "purpose." If you bought a loss-making company because you genuinely wanted to turn the business around and keep it running, Section 22B might not apply!

5. Key Restrictions and Special Situations

Cessation of Business

If a company stops doing business (ceases trade) and still has unused losses, those losses disappear. You cannot sell those losses to someone else, and you cannot use them after the business has officially closed.

Capital vs. Revenue

Remember: Only revenue losses (losses from your normal business operations) are deductible. If you lose money selling a fixed asset like a delivery van, that is a capital loss and cannot be used to offset your trading profits.

Summary Checklist for Students

Before you sit for your exam, make sure you can answer these questions:

• Can I calculate a tax loss? (Use the same adjustments as profits tax).
• How long can a company carry forward a loss? (Indefinitely).
• Can one company in a group use another company's loss? (Generally, NO—no group relief in HK).
• What happens to a partner's share of loss if they retire? (It is lost).
• What is the IRD's main weapon against "loss buying"? (Section 22B).

Encouraging Note: Taxation of losses is one of the more straightforward parts of the syllabus once you realize it follows the same logic as calculating profits. Just keep track of where the loss is going (carried forward) and who it belongs to (the specific company or partner), and you'll do great!