Endowment Insurance Bonuses: Tax on Withdrawals from Insurance Savings Plans

A growing number of Hong Kong middle-class professionals and small business owners have turned to endowment-linked insurance savings plans as a core component of their long-term savings strategy, drawn by the promise of guaranteed returns and capital protection. However, a 2025 revision to the Inland Revenue Ordinance’s interpretation guidelines, coupled with an uptick in Inland Revenue Department (IRD) field audits targeting insurance policy surrenders, has created a new layer of tax exposure that many policyholders have not anticipated. The IRD’s recent focus on the distinction between “pure insurance proceeds” and “investment-linked returns” within these bundled products means that a withdrawal that was once assumed to be tax-free may now trigger a charge to Hong Kong Profits Tax or Salaries Tax, depending on the policyholder’s circumstances and the nature of the gains. For a jurisdiction that does not impose capital gains tax, the tax treatment of a savings plan withdrawal is anything but straightforward, and the 2025-2026 assessment cycle is likely to see the first wave of contested assessments on this very point.

The Tax Status of Insurance Savings Plan Withdrawals Under Hong Kong Law

Hong Kong’s Inland Revenue Ordinance (Cap. 112) does not contain a general capital gains tax. This absence is often cited by insurance agents as the primary reason why withdrawals from savings plans are “tax-free.” The operative legal position, however, is more nuanced. Under section 8 of the IRO, Salaries Tax is chargeable on “income arising in or derived from Hong Kong” from any employment, office, or pension. Under section 14, Profits Tax is chargeable on profits arising in or derived from Hong Kong from any trade, profession, or business. The critical question is whether the surplus received upon surrender or partial withdrawal of an endowment policy constitutes “income” or “profit” in the hands of the recipient, and if so, whether it arises from a source in Hong Kong.

The Distinction Between Capital and Income

The foundational principle in Hong Kong tax law is that receipts of a capital nature are not subject to tax. In the context of a pure life insurance policy—where the payout is triggered solely by death or total disability—the proceeds are universally accepted as capital. The IRD’s Departmental Interpretation and Practice Notes (DIPN) No. 48, paragraph 12, states that “proceeds of a life insurance policy received by a policyholder upon the death of the life assured are generally regarded as capital receipts and are not subject to tax.” This guidance, issued in 2020, does not extend to savings plans where the policyholder is also the life assured and where the policy has a significant investment or savings element.

Where a policyholder surrenders a policy before maturity, or makes a partial withdrawal of the accumulated cash value, the IRD’s current view—articulated in a 2024 internal operational circular—is that the portion of the withdrawal representing investment return (i.e., the excess of the surrender value over the total premiums paid) may be treated as income if the policyholder is engaged in a trade of buying and selling insurance policies, or if the policy is held as a revenue asset in the course of a business. For the typical individual policyholder, the IRD has historically not pursued this line, but the 2025 revision explicitly flags “frequent or systematic withdrawals from multiple savings plans” as a potential indicator of a profit-making undertaking.

Section 26A and the “Pure Insurance” Safe Harbor

Section 26A of the IRO provides a specific exemption for sums received under a “policy of insurance” that are “in the nature of capital.” This section has been interpreted narrowly by the courts. In the leading case of Commissioner of Inland Revenue v. Lo & Lo (1984) 2 HKTC 34, the Court of Appeal held that a lump-sum payment received upon the cancellation of a life insurance policy was a capital receipt and not taxable. However, the policy in Lo & Lo was a traditional whole-life policy with no surrender value in the early years, and the payment was triggered by the insurer’s breach of contract. The court did not address the modern endowment savings plan where the policyholder can withdraw accumulated bonuses or surrender the policy for a guaranteed cash value at any time.

The IRD’s interpretation post-2025 is that section 26A does not apply to the “bonus” or “dividend” components of a savings plan. These sums, the IRD argues, are akin to interest or investment returns and are not proceeds of insurance risk. The department has cited the definition of “insurance policy” in section 2(1) of the IRO, which requires an element of “risk” to be present. In an endowment plan where the guaranteed return is fixed and the mortality risk is minimal (especially for a young, healthy policyholder), the IRD contends that the “insurance” element is incidental, and the savings element is the dominant purpose.

When a Withdrawal Triggers a Tax Liability

The tax exposure for a Hong Kong resident policyholder depends on three factors: the frequency of withdrawals, the policyholder’s occupation, and whether the policy is held personally or through a business entity.

The “Trade” Test for Frequent Policyholders

A policyholder who purchases and surrenders multiple endowment policies within a short period—for example, buying a 5-year plan and cashing it in after 12 months, then repeating the pattern—may be found to be carrying on a trade of dealing in insurance policies. The IRD applies the “badges of trade” test derived from English case law, including Marson v. Morton (1986) 1 WLR 1343. The key badges relevant here are:

• Frequency of transactions: More than three surrenders in a five-year period is a strong indicator.
• Length of ownership: Policies held for less than 50% of their original term are scrutinised.
• Subject matter: Policies that are not held for personal protection are more likely to be treated as trading stock.
• Motive: Evidence that the policy was acquired with a view to profit on resale or surrender.

If the IRD successfully characterises the activity as a trade, the full surrender profit (surrender value minus total premiums paid) is chargeable to Profits Tax under section 14. The standard rate for the 2025-2026 year of assessment is 16.5% for corporations and the progressive rates for individuals (up to a standard rate of 15% on profits exceeding HKD 5,000,000).

The Employment Nexus and Salaries Tax

For employees who receive bonuses or commissions from their employer in the form of an insurance savings plan, or who are required to hold a policy as a condition of employment, the withdrawal may be treated as a perquisite of employment. Section 9(1)(a) of the IRO includes in the definition of “income from employment” any “perquisite” or “allowance” granted by the employer. In Commissioner of Inland Revenue v. Humphrey (1993) 3 HKTC 1, the Court of Final Appeal held that a benefit provided by an employer to an employee is taxable unless it is a “reimbursement of expenses incurred in the performance of the employee’s duties.”

Where an employer pays the premiums on an endowment policy for an employee, the premiums themselves are a taxable perquisite in the year they are paid. If the employee subsequently surrenders the policy, the surrender value received is not taxed again because it represents the employee’s own capital (the premiums having already been taxed). However, if the employee contributes to the premiums and the employer matches the contribution, the IRD’s view—as set out in DIPN No. 10 (Revised 2023), paragraph 38—is that the portion of the surrender value attributable to the employer’s contributions is a taxable perquisite in the year of surrender, not the year of contribution. This creates a timing mismatch that can catch employees off-guard.

The Business Asset Trap for Sole Proprietors and Small Companies

A sole proprietor or a small company that takes out an endowment policy on the life of a key employee, a shareholder, or the proprietor themselves, and then surrenders the policy, faces a different analysis. Under section 16(1) of the IRO, premiums paid on a policy of insurance are deductible only if the policy is taken out “for the purpose of producing the profits” of the business. The IRD’s long-standing practice, confirmed in DIPN No. 48, paragraph 24, is that premiums on a “key person” policy are deductible. The surrender proceeds, in turn, are a taxable receipt of the business under section 15(1)(b), which charges to tax “any sum received by way of recoupment or recovery of any expenditure which has been allowed as a deduction.”

The practical trap arises when a business takes out a savings plan but does not deduct the premiums, perhaps because the proprietor is unaware of the deduction or because the policy is held for personal reasons. The IRD will still treat the surrender proceeds as a taxable receipt if it can be shown that the policy was “an asset of the trade.” In CIR v. Hang Seng Bank Ltd (1990) 2 HKTC 299, the court held that a bank’s investment in a life insurance policy was part of its trading assets, and the proceeds were taxable. For a small business, any policy that is listed on the balance sheet as an asset is vulnerable to this treatment.

Planning Considerations and the 2025-2026 Audit Cycle

The IRD’s enhanced scrutiny of insurance savings plans is not occurring in a vacuum. The 2025-2026 Budget announced an increase in the IRD’s field audit headcount by 15%, with a specific allocation for reviewing “financial products with mixed investment and insurance characteristics.” Policyholders who have surrendered or partially withdrawn from an endowment savings plan in the past three years should be aware of the potential for a tax audit.

The Statute of Limitations and Voluntary Disclosure

Under section 82A of the IRO, the IRD can raise an assessment within six years after the end of the year of assessment in which the income arose. For a surrender that occurred in the 2020-2021 year of assessment, the deadline for an assessment is 31 March 2027. For surrenders in 2024-2025, the deadline is 31 March 2031. The IRD has a voluntary disclosure programme under section 82A(4) that allows a taxpayer to avoid penalties if they make a full and accurate disclosure before the IRD commences an investigation. The penalty for failure to report a taxable surrender can be up to 100% of the tax undercharged, plus a further penalty of up to treble the tax under section 82A(2).

Structuring the Policy to Minimise Tax Exposure

For a policyholder who wishes to avoid the tax consequences of a surrender, the most straightforward approach is to hold the policy to maturity. Upon maturity, the lump-sum payment is generally treated as a capital receipt, as the policy has run its full term and the “insurance” purpose is fulfilled. A partial withdrawal of accumulated bonuses, rather than a full surrender, may also be structured as a loan against the policy’s cash value, which is not a taxable event because it is a debt, not income. The IRD’s DIPN No. 48, paragraph 30, acknowledges that “a loan advanced by an insurer to a policyholder against the security of the policy’s cash value is not a receipt of income.”

For a business owner, the optimal structure is to ensure that the policy is held by a separate trust or a special-purpose vehicle that is not engaged in a trade. If the policy is held by a family trust, the surrender proceeds may be treated as capital in the hands of the trust, provided the trust is not carrying on a business. This structure requires careful planning with a qualified tax advisor, as the anti-avoidance provisions in sections 61 and 61A of the IRO can recharacterise transactions that have no commercial purpose.

The Interaction with Mainland China and US Tax Residency

For a Hong Kong resident who is also a tax resident of Mainland China under the “183-day rule” or the “habitual abode” test of Article 4 of the US-China Tax Treaty, or who is a US citizen or Green Card holder living in Hong Kong, the tax treatment of an insurance savings plan withdrawal becomes exponentially more complex. Under the US-Hong Kong Tax Information Exchange Agreement (TIEA), the IRS can request information on Hong Kong insurance policies held by US persons. The IRS treats the inside build-up of cash value in a life insurance policy as a “controlled foreign corporation” if certain thresholds are met under IRC § 1297, and a withdrawal may trigger a deemed dividend under IRC § 1291. For a US person, the annual reporting of foreign financial assets on FinCEN Form 114 (FBAR) and FATCA Form 8938 includes the cash surrender value of any foreign insurance policy if the aggregate value exceeds USD 10,000 (FBAR) or USD 50,000 (FATCA for a single filer living abroad). The 2024 FBAR deadline for calendar year 2023 was 15 October 2024; the 2025 deadline for calendar year 2024 is 15 April 2025, with an automatic extension to 15 October 2025.

For a Mainland China tax resident, the withdrawal may be subject to Individual Income Tax (IIT) under the “income from personal services” or “income from property transfer” categories, depending on whether the policy is classified as “financial product” or “insurance.” The China-Hong Kong Double Tax Arrangement does not specifically address insurance policy withdrawals, leaving the matter to domestic law. A Hong Kong resident who spends more than 183 days in Mainland China in a calendar year should consult a China tax advisor before surrendering any Hong Kong insurance policy.

Actionable Takeaways

1. Review all endowment savings plans surrendered or partially withdrawn since 1 April 2020 (the start of the 2020-2021 year of assessment) to determine whether the IRD’s six-year assessment window applies, and whether a voluntary disclosure is prudent.
2. For any policy surrendered within 50% of its original term, or where more than three surrenders have occurred in five years, prepare a contemporaneous record of the policyholder’s intention at the time of purchase—specifically, whether the policy was acquired for personal protection or for investment.
3. Do not assume that a partial withdrawal of bonuses is tax-free; the IRD’s 2025 guidance treats the bonus component as income, not capital, unless the policy is held to maturity.
4. If you are a US person, ensure that the cash surrender value of all Hong Kong insurance policies is reported on FBAR (FinCEN Form 114) and FATCA Form 8938 for each calendar year in which the aggregate value exceeds the applicable threshold, and consult a US tax advisor before making any withdrawal.
5. Before surrendering a policy held by a sole proprietorship or a limited company, confirm whether the premiums were deducted as a business expense; if so, the surrender proceeds are a taxable receipt under section 15(1)(b) of the IRO.

本文不構成稅務建議。涉及個人稅務情況請諮詢持牌會計師或稅務師。 This does not constitute tax advice. Consult a licensed CPA or tax advisor for your specific situation.