Following abolition of the offsetting mechanism between the mandatory provident fund (MPF) and long service payment (LSP), the Inland Revenue Department (IRD) provided guidance regarding the profits tax treatment of items recognized in financial accounts in relation to provision for LSP:
- Profits tax deduction of LSP is governed by sections 16(1) and 17 of the Inland Revenue Ordinance (IRO). In general, any LSP or provision for LSP made in accordance with the Employment Ordinance (EO) will be allowed for deduction under section 16(1) of the IRO so long as the provision is fairly accurate and incurred in the production of assessable profits.
- Under Approach 1:
- Any specific provision (i.e., current service cost and the relevant interest expense) made by an entity for meeting its liability to pay LSP will be allowable for deduction provided that it is made in accordance with the provisions of the EO (and in particular, has taken into account the offsetable accrued benefits) and is fairly accurate (i.e., based on valid actuarial assumptions and reasonable estimates by reference to the wages and service years of each employee).
- The one-off catch-up adjustment for the expected net cost of the LSP obligation to an entity as determined in accordance with the Amendment Ordinance and recognized as the “past service cost,” is in the nature of a provision made for meeting the entity’s liability to pay LSP under the EO. It will be deductible (or taxable) in the year in which it is recognized in the accounts, provided that it is made in accordance with the provisions of the EO and is fairly accurate.
- Under Approach 2:
- Given that it is only a matter of timing difference when the total amount of allowable deduction in respect of an entity’s LSP liability throughout an employee’s period of service is equal to the total actual amount of employers’ mandatory MPF contributions and LSP incurred by the entity, the amounts recognized in the entity’s profit or loss (i.e., the gross amount of current service cost and the one-off adjustment to the pre-transition portion of LSP) will be deductible (or taxable) by concession on the condition that no separate claim for deduction of employer’s mandatory MPF contributions has been/will be made.
- The remeasurement gains or losses (due to changes in actuarial assumptions) recognized in the other comprehensive income (OCI) can be regarded as part of LSP made or provisions made for meeting the employer’s LSP liability. Such remeasurement gains or losses will be taxable or deductible in year they are recognized in the OCI provided that they are recognized in accordance with the provisions of the EO, fairly accurate, and incurred in the production of employer’s assessable profits.
- Alternatively, tax deduction could be claimed based on the actual amount of LSP paid in accordance with the provisions of the EO so long as the basis is consistently adopted.
For more information contact a KPMG tax professional:
David Ling | davidxling@kpmg.com