Tax implications - By Alex Frew McMillan (SF issue 26)
You've bought a property, seen it shoot up in value, and now you want to sell it for a quick buck. Since there's no capital gains tax in Hong Kong, you figure you can pocket the profits.
Not so fast … if the Inland Revenue Department determines you have turned into a property trader instead of an investor, you're required to pay tax on your gain.
1. Sale vs trade
Most people know pretty clearly if they're acting as a trader or as an investor. Although there can be a middle ground, where a property owner intended to hold a property for a while but ended up selling it quickly.
「A property is capable of being acquired by a person for trading or investment purposes and it is not uncommon that the person might change the intention of holding the property during the period of ownership,」 a tax guide from the Hong Kong Institute of Certified Public Accountants notes.
Case law in Hong Kong has established what are known as six 「badges of trade」 that the tax department will consider when deciding if a sale was a trade.
The first question – what was sold – isn't normally much of an issue with real estate. It's an apartment or a house. So that badge is more important to consider with other kinds of traded goods – it's hard to argue that you bought one million rolls of toilet paper intending them either for personal use or as a long-term investment.
The property will come into question if the apartment isn't completed yet. A 「flipped」 sale of an uncompleted apartment bought off plan will almost always count as a trade. It's tough to argue you were planning on occupying or renting the apartment if you sold it before it was built.
The second issue to consider is motive. Was the purchase intended as a quick trade or as a long-term investment? If it is for long-term investment, don't talk about selling in the short term or short-term market expectations.
So the four other 「badges of trade」 are important to consider. What was the length of ownership? How frequently has the seller performed similar transactions? Was there supplementary work done to add value to the asset? And were there extenuating circumstances such as an emergency that forced the sale?
2. Burden of proof
Every case is different, and it can be a subjective call. But the decision has to be backed up by objective proof, accountants say.
The burden of proof is on the taxpayer, who is typically trying to claim the property was an investment, not on the tax department, who may feel it was a trade.
It's important to justify and document your reasoning. Perhaps your circumstances have changed – you were fired from a job, or forced to relocate, or a spouse or family member has died. Perhaps you have a new addition to the family in the form of a child. These circumstances would count as emergencies that obligated the sale of an investment property.
Alternatively your spouse didn't like the property, or you decided to trade up to a bigger place. Selling one property and quickly using the proceeds to buy another will often satisfy the tax department that the sale was of your home and not just a trade. But the tax department may want a look at your utility bills to show you were really there – electricity and gas bills are the best proof.
There is no explicit length of time that you need to hold a property for it to qualify as an investment. But the longer, the better. Anything less than a year will certainly trigger questions with the tax department.
The number of transactions doesn't really matter – an investor can hold five properties for decades and then sell them all at once. It's the frequency that matters – three flipped sales in a year is almost certain to land you in the trader camp.
3. Tax issues
The moment of truth arrives when a questionnaire from the Inland Revenue Department asking you to explain details of the sale hits the doormat. You'll need to outline all the details of the sale and explain what expenses were involved. This is also the time to explain the reason behind the sale.
Just because you receive a questionnaire, it doesn't mean you'll be taxed on the gain. The tax department may just want an explanation for the reasons behind the sale. Maybe one per cent of property sales in Hong Kong generate a questionnaire from the tax department. And probably only 10 per cent of those people end up paying profits tax.
If the property sale is classified as a trade, the seller has to pay profits tax – 16 per cent being the highest bracket of personal income tax in Hong Kong, or corporate profits tax at 17.5 per cent if the property was held by a company.
A big property gain made in a reasonably short time is likely to generate a questionnaire, because the tax department will consider it in the public's interest to investigate. Yet it doesn't matter how small your profit is.
Filling out the questionnaire is on an honour basis – you're not initially required to file documentary evidence. However, you may be required to produce those documents if the tax department has any doubts.
Most of the records of the sale are on file at the land registry, in any case, so there's little way of fudging details such as the price. Any misrepresentation could land you in big trouble. You can certainly declare any reasonable expenses, such as mortgage interest, bank charges, brokerage and legal fees, and renovation costs, even if you spent HK$1 million on renovating a HK$2 million flat.
Most property traders buy and sell so frequently that there's no doubt about it. And it's not worth risking falling afoul of the tax department on the issue.
Professional traders also typically hold their properties in a corporate structure, normally a limited company. Like an individual, they can deduct any expenses against their profits, but they can also offset any losses on one property against another one that made a gain. |
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