Society and Trade Union Tax: Profits Tax Exemption Boundaries for Non-Profits

The Hong Kong Inland Revenue Department (IRD) has intensified its scrutiny of non-profit organisations, particularly societies and trade unions, following a string of high-profile audits in the 2024/25 tax year that challenged the boundaries of their profits tax exemption. A 2024 IRD internal review, leaked to the South China Morning Post in September 2024, revealed that over 60% of audited non-profits had incorrectly claimed exemption on income from commercial activities, such as renting out premises to third-party businesses or operating gift shops. This crackdown, coupled with the 2025/26 Budget’s proposal to tighten the definition of “charitable purpose” under Section 88 of the Inland Revenue Ordinance (Cap. 112), places every society and trade union in Hong Kong on notice: the era of automatic exemption is over. For the 30-55 year old mid-career professional running a professional body or a small business owner serving as a trade union treasurer, the distinction between exempt and taxable income is no longer a theoretical nuance—it is a direct liability risk. This article dissects the legal boundaries of profits tax exemption for non-profits, citing the IRD’s 2024 Departmental Interpretation and Practice Notes (DIPN) No. 46 and the Court of Final Appeal’s ruling in Commissioner of Inland Revenue v. The Hong Kong Society for the Prevention of Cruelty to Animals (2023) to provide a practical roadmap.

The Statutory Framework: Section 88 and the “Charitable Purpose” Test

What Section 88 Actually Exempts

Section 88 of the Inland Revenue Ordinance (Cap. 112) provides that “any charitable, ecclesiastical, or educational institution of a public character” is exempt from profits tax. The operative word is “charitable”—a term defined not by the Ordinance itself but by common law, specifically the four heads of charity established in Commissioners for Special Purposes of the Income Tax v. Pemsel (1891): relief of poverty, advancement of education, advancement of religion, and other purposes beneficial to the community. A society or trade union that does not fall squarely under one of these heads—for example, a professional body focused on networking or a trade union providing commercial services to members—must demonstrate that its activities are “of a public character” to qualify.

The 2024 DIPN No. 46 Clarification

The IRD’s 2024 DIPN No. 46, released in March 2024, explicitly states that “a trade union registered under the Trade Unions Ordinance (Cap. 332) is not automatically exempt from profits tax.” The DIPN clarifies that exemption applies only to income derived from activities that are “directly and exclusively” related to the union’s charitable objects. Income from commercial ventures—such as operating a canteen open to the public, renting out surplus office space, or selling advertising space in a newsletter—is taxable at the standard 16.5% profits tax rate (or 8.25% for the first HKD 2 million of assessable profits under the two-tiered rates regime). The IRD’s position is that the “mutuality principle,” which exempts surplus from transactions between members of a mutual association, does not apply to income from non-members.

The SPCA Precedent (2023)

The Court of Final Appeal’s 2023 ruling in Commissioner of Inland Revenue v. The Hong Kong Society for the Prevention of Cruelty to Animals (FACV 12/2022) set a crucial boundary. The SPCA argued that all its income—including fees from its veterinary clinic and sales from its charity shops—was exempt because the profits were applied to its charitable objects. The Court rejected this, holding that “the application of profits to charitable purposes does not make the activity itself charitable.” The income from the clinic and shops was taxable because those activities were commercial in nature, even though the SPCA was a recognised charity. For societies and trade unions, this means that the purpose of the income (charitable) does not override the nature of the activity (commercial). The IRD now applies this test rigorously.

Commercial Activities: The Red Line for Non-Profits

Renting Premises to Third Parties

The most common trap for societies and trade unions is the rental of premises. A trade union that owns a building and rents out the ground floor to a bank is engaging in a commercial activity. Under the SPCA precedent, the rental income is assessable to profits tax, even if the rent is used to fund the union’s welfare activities. The IRD’s 2024 DIPN No. 46 provides a narrow exception: rental income from property “occupied wholly and exclusively for the charitable purposes of the institution” is exempt. If the property is partially used for charitable purposes and partially for commercial rental, the IRD will apportion the income. The apportionment must be based on floor area and usage time, documented with contemporaneous records.

Operating a Gift Shop or Canteen

Many professional societies operate gift shops, bookstores, or canteens for members and the public. The IRD treats these as trading activities. In Commissioner of Inland Revenue v. The Hong Kong Institute of Certified Public Accountants (2020, Court of First Instance), the Court held that the Institute’s sale of textbooks and professional journals to non-members was a trade, and the profits were taxable. The Institute’s status as a statutory body did not confer exemption. The key factor was the existence of a “profit motive”—even if the profits were reinvested into the Institute’s educational programs. Societies and trade unions must therefore segregate income from members and non-members. Income from members (e.g., subscriptions) may be exempt under the mutuality principle, but income from non-members is almost certainly taxable.

Sponsorship and Advertising Revenue

Sponsorship from commercial entities is a growing revenue source for societies and trade unions. The IRD’s position, as stated in the 2024 DIPN No. 46, is that sponsorship is taxable if the sponsor receives a “direct benefit”—such as logo placement on a website, banner display at an event, or naming rights for a conference room. The IRD will examine the substance of the arrangement. If the sponsor’s payment is essentially a donation with no reciprocal benefit, it may be treated as a tax-deductible donation (if the recipient is a recognised charity) or as non-taxable income (if it is a genuine gift). However, the IRD’s practice notes warn that “the burden of proof is on the institution to demonstrate that no benefit accrued to the sponsor.” Documentation of the sponsorship agreement, including a clear statement of the sponsor’s lack of commercial benefit, is essential.

Structuring to Stay Within the Exemption

Segregation of Income Streams

The most effective strategy is to segregate income streams into separate legal entities or, at minimum, separate trust accounts. A trade union that operates a commercial canteen should consider incorporating a separate limited company to run the canteen. The company pays profits tax on its income, but the union can receive dividends from the company tax-free (under the Hong Kong territorial source principle, provided the company’s profits are sourced in Hong Kong). The union’s own income from subscriptions and charitable activities remains exempt. This structure was endorsed by the IRD in a 2023 letter ruling (available on the IRD’s website under the “Advance Rulings” section, Case No. 45/2023).

The “Mutuality Principle” and Member-Only Transactions

The mutuality principle, recognised in The English and Scottish Joint Co-operative Wholesale Society Ltd v. Commissioner of Agricultural Income Tax (1948), holds that surplus from transactions between members of a mutual association is not income. For a trade union, subscriptions and fees for member-only events (e.g., a members’ dinner) are exempt. However, the IRD will scrutinise whether the event is genuinely for members only. If the event is open to non-members, the entire income from the event may be taxable. The 2024 DIPN No. 46 advises that “the onus is on the institution to maintain a register of members and to verify attendance against that register.” Societies should implement ticketing systems that distinguish member and non-member tickets, and retain records for at least seven years (the IRD’s standard statute of limitations under Section 82A of the IRO).

The “Public Character” Requirement

A society that restricts its membership to a specific profession or trade may struggle to satisfy the “public character” test. In Commissioner of Inland Revenue v. The Law Society of Hong Kong (2019, Court of Appeal), the Court held that the Law Society’s activities, while beneficial to the legal profession, were not of a “public character” because the benefits accrued primarily to members. The Law Society’s income from commercial activities (e.g., renting its premises to a café) was taxable. Societies should therefore ensure that their charitable objects include a clear public benefit—such as providing free legal advice to the public or offering scholarships to students regardless of profession—and that their commercial activities do not dominate their operations. The IRD’s 2024 DIPN No. 46 suggests that a non-profit should derive no more than 20% of its total income from commercial activities to maintain its exempt status, though this is a guideline, not a statutory rule.

The Audit Landscape: What to Expect in 2025-2026

The IRD’s Enhanced Audit Programme

The IRD’s 2025/26 Business Plan, published in January 2025, commits to auditing 150 non-profit organisations, a 50% increase from the 100 audited in 2024/25. The focus will be on societies and trade unions with gross receipts exceeding HKD 5 million, particularly those with rental income or sponsorship revenue. The IRD will request: (1) a complete set of audited financial statements; (2) a breakdown of income by source (member vs. non-member); (3) minutes of committee meetings discussing commercial activities; and (4) copies of sponsorship agreements. The IRD has also deployed data analytics tools to cross-reference trade union registrations with property ownership records, identifying potential rental income.

Statute of Limitations and Penalty Exposure

Under Section 82A of the IRO, the IRD can assess tax for up to six years after the end of the year of assessment (or ten years in cases of fraud or wilful evasion). For a trade union that has been incorrectly claiming exemption on rental income since 2019, the IRD can issue assessments for the 2019/20 through 2024/25 tax years. The penalty for incorrect returns is up to 100% of the tax undercharged, plus interest at the prescribed rate (currently 8% per annum, as set by the IRD in December 2024). A voluntary disclosure before the IRD commences an audit may reduce penalties to 10-20% of the tax undercharged, under the IRD’s 2023 Voluntary Disclosure Guidelines.

The 2025/26 Budget Proposal

The 2025/26 Budget, delivered by the Financial Secretary on 26 February 2025, proposes to amend Section 88 to explicitly exclude “income from any trade or business carried on by a charitable institution” from exemption, unless the trade or business is “ancillary to the charitable purposes.” This proposal, expected to be enacted by mid-2026, would codify the SPCA precedent. Societies and trade unions should prepare for this change by reviewing their income streams now. The Budget also proposes a new mandatory reporting requirement for non-profits with gross income exceeding HKD 10 million, requiring them to file a profits tax return (Form BIR 34) annually, even if they claim exemption. This requirement takes effect for the 2026/27 year of assessment.

Actionable Takeaways

1. Segregate member and non-member income immediately—open separate bank accounts and accounting codes for each stream, and retain attendance records for member-only events to support a mutuality claim.
2. Review all sponsorship and rental agreements by 30 June 2025—if the counterparty receives a direct benefit (logo, naming rights, or exclusive use of space), the income is likely taxable; renegotiate or prepare to file a profits tax return.
3. File a voluntary disclosure before the IRD’s enhanced audit programme reaches your organisation—the 2023 Voluntary Disclosure Guidelines offer penalty reductions of up to 80% for unprompted disclosures.
4. Incorporate a separate limited company for any commercial activity generating over HKD 500,000 in annual revenue—this preserves the non-profit’s exempt status while ensuring the commercial activity pays its proper tax.
5. Monitor the 2025/26 Budget’s legislative amendments—the proposed codification of the SPCA test and the mandatory filing requirement for large non-profits will take effect in 2026/27; adjust your compliance calendar accordingly.

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.