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The Hong Kong Inland Revenue Department (HKIRD) issued, in July 2008, a revised edition of the Departmental Interpretation and Practice Notes (DIPN) No. 3 (Revised) on Profits Tax – Apportionment of Expenses. The first edition of the DIPN was issued in July 1974 and revised in December 1989. In the 1989 revision of DIPN 3, the HKIRD had adopted the principles based on Rules 2A, 2B and 2C of the Inland Revenue Rules (IRR), i.e. the method for apportionment of expenses in general, and of interest and management expenses in relation to the holding of share investments. Under Rules 2A, 2B and 2C of IRR, apportionment should be made on a basis that is most appropriate in the circumstances of the case. Apportionment can be based on turnover, gross profit, income or assets.

In the latest revision, although there is no change in practice, relevant court decisions have been incorporated to illustrate the principles relating to the apportionment of expenses. The court decisions incorporated into the DIPN are as follows:

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Ronpibon Tin (NL) v. FCT 4 AITR236

Two kinds of expenditure are recognized for apportionment, i.e. (i) several parts of expenditures that are distinctly devoted to making profits and other parts are devoted to other ends, and (ii) a single outlay that serves both the profit-making purpose and some other purpose indifferently.

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Anthony Patrick Fahy trading as A.P. Fahy & Co. v. CIR 3 HKTC 695

Outgoings or expenses that have dual purposes, i.e. partly for domestic or private purpose, and partly for business purpose. The part for domestic or private purpose is a non-deductible expense.

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CIR v. Hang Seng Bank Ltd. 3 HKTC 351

With regard to profits partly derived within Hong Kong and partly outside Hong Kong, the gross offshore profits should be reduced to reflect their fair share of the general expenses of the business.

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SO Kai-tong, Stanley trading as Stanley So & Co. v. CIR HKTC 38

Ledgers are secondary and not primary documents to support the basis that an expenditure was truly incurred in the production of chargeable profits when raising an objection or appeal.

Additionally, attention is drawn to the apportionment rules contained in the Inland Revenue Ordinance for specific types of expenditures, namely:

-		Sec. 16B(2): Research and development payments or expenditure are apportioned where the relevant payments or expenditures are made or incurred outside Hong Kong and trade is carried on partly in and partly out of Hong Kong;
-		Sec. 16E(2): Expenditure on patent rights are apportioned where the rights purchased are partly for use in and outside Hong Kong. The deduction allowable will be determined after having regard to the extent of the use in Hong Kong; and
-		Sec. 16E(2): Apportionment of expenditure on prescribed fixed assets is required where the asset is partly used in the production of chargeable profits.