In June 2020, the IRD issued a revised Departmental Interpretation Practice Notes No. 42 to clarify the tax deduction on an expected credit loss (“ECL”) provided for financial instruments under HKFRS 9.
Under 3-stage approach, the application of tax deduction on ECL is not subject to the deduction rule for bad debts under Section 16(1)(d) of the Inland Revenue Ordinance (“the IRO”). The ECL should be treated as deductible only if the financial instrument is credit-impaired (i.e. stage 3). For financial instrument not credit-impaired (i.e. stage 1 and 2), the ECL will unlikely to be deductible. The tax treatment of ECL of financial instruments is summarized as follows:-
Stage of ECL | Tax treatment on ECL | Subsequent reversal of ECL | Relevant Inland Revenue Ordinance |
|---|---|---|---|
Stage 1 and 2 | Non-deducible | Non-taxable | Section 18K(2) |
Stage 3 | Deductible | Taxable | Section 18K(3) |
Points to Note
For cases using simplified approach, the deduction criteria is similar to that of Section 16(1)(d) of the IRO which requires taxpayer to prove to the IRD’s satisfaction that the debt has become bad and reasonable recovery actions have been taken to recover the debt. Please consult your auditor and tax advisor for details and implication on your company.
