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Tax Treatment for Reinstatement Costs
The contents of this page are based on the Inland Revenue (Amendment) (Tax Deductions for Leased Premises Reinstatement and Allowances for Buildings and Structures) Bill 2024 which is subject to scrutiny by the Legislative Council. Readers are reminded to be alerted to the latest development upon enactment of the Bill.
1.
Q:
Are reinstatement costs allowable for deduction under section 16 of the Inland Revenue Ordinance (IRO)?
A:
Yes. For the year of assessment 2024/25 and onwards, reinstatement costs incurred for any premises under a lease are deductible under section 16(1)(gc) of the IRO if all of the conditions specified in section 16(2K) are met.
Since section 16(1)(gc) of the IRO only applies to the year of assessment 2024/25 and onwards, reinstatement costs incurred for any year of assessment before 2024/25 are not deductible due to the operation of section 17(1)(c) of the IRO. Section 17(1)(c) of the IRO provides that any expenditure of a capital nature shall not be deducted for the purpose of ascertaining profits in respect of which a person is chargeable to profits tax.
2.
Q:
What are the conditions that must be satisfied if a person wishes to claim deduction for reinstatement costs?
A:
In order for a person to claim deduction for reinstatement costs, the reinstatement costs should have been incurred. In addition, the following conditions under section 16(2K) of the IRO must be satisfied:
| (a) | the person claiming the deduction is a lessee of the lease; | |||
| (b) | the person has a reinstatement obligation for the premises; | |||
| (c) | the reinstatement costs do not relate to any provisions made under— | |||
| (i) | Hong Kong Financial Reporting Standard 16 (Leases) as issued by the Hong Kong Institute of Certified Public Accountants and in force from time to time; or | |||
| (ii) | any other similar accounting standards; | |||
| (d) | the amount of the reinstatement costs is reasonable in the circumstances. | |||
3.
Q:
What kinds of costs are covered by the deduction for "reinstatement costs"?
A:
The term "reinstatement costs", in relation to any premises under a lease, means the costs of reinstating the premises to their original condition at the end of the term of the lease or on an early termination of the lease. It also includes any amount paid or payable by a lessee of the lease to the lessor of the lease in order to discharge the lessee’s reinstatement obligation for the premises.
4.
Q:
What is the meaning of “reinstatement obligation”?
A:
A lessee’s reinstatement obligation, in relation to any premises under a lease, means an obligation to reinstate or pay, whether in full or in part, for the reinstatement of, the premises to their original condition at the end of the term of the lease or on an early termination of the lease. A lessee’s reinstatement obligation can be express or implied, whether arising from the lease or from another agreement between the lessor and lessee of the lease.
5.
Q:
If a lessee makes a payment to the lessor in lieu of reinstating the premises to their original condition, does that payment qualify for the deduction for reinstatement costs?
A:
Yes. The payment made by the lessee to the lessor will qualify for the tax deduction provided that the amount of the reinstatement costs claimed is reasonable in the circumstances and the relevant conditions under sections 16(1)(gc) and 16(2K) of the IRO are met.
6.
Q:
How to determine whether the amount of payment in lieu of reinstating the premises paid or payable by the lessee to the lessor is “reasonable” in the circumstances?
A:
In determining whether the amount of payment in lieu of reinstating the premises is "reasonable" for the purpose of section 16(2K)(d) of the IRO, the Department will consider the facts and circumstances of each case. It is considered that a "reasonable" amount is one which is made in accordance with the arm’s length principle, and would not significantly deviate from the market costs of reinstating similar leased premises (e.g. leased premises of similar nature and size) back to their original condition.
7.
Q:
Are there any restrictions on the types of premises covered by the deduction for reinstatement costs? Are residential and industrial premises covered?
A:
There are no restrictions on the types of premises covered by the deduction for reinstatement costs. A person may claim deduction for reinstatement costs even if the relevant premises are residential or industrial buildings provided that the premises are used in the production of the chargeable profits and the conditions in sections 16(1)(gc) and 16(2K) of the IRO are met.
8.
Q:
A company rents a property for use as employer’s quarters and is required to reinstate the property to its original condition at the end of the term of the lease or upon an early termination of the lease. Is the company entitled to claim deduction for reinstatement costs?
A:
Yes, provided that the conditions in sections 16(1)(gc) and 16(2K) of the IRO are met.
9.
Q:
What kind of information needs to be provided to the IRD if a lessee wishes to claim deduction for reinstatement costs?
A:
The lessee is required to complete the Profits Tax return and fill in the information in respect of the deduction for reinstatement costs. Additional information (e.g. copy of tenancy agreement, copy of bank statements and invoices showing the payment for reinstatement work, photos of the premises before and after reinstatement work, etc.) may be requested by the Department upon review of the deduction claim.