We often get asked, “Can I save on my taxes if I setup a limited company and become a contractor instead of an employee?”. Well, that depends. There are a few important considerations you need to factor, like:
- Is it worth becoming an independent contractor if it means I lose certain staff benefits?
- What does it take for the IRD to consider someone an independent contractor?
- Do contractors actually pay less taxes?
First, let’s see how much taxes a person can actually save as an independent contractor. If you’re being taxed as a company or a contractor, the first HK$2,000,000 of net profit is only taxed at 8.25%.
Example of how much taxes an independent contractor might save:
Let’s say your annual salary is HK$1,000,000. Your final salaries tax will be HK$129,500.
As an independent contractor making the same amount of gross revenue at HK$1,000,000, many of your expenses can be deducted as business expenses. Let’s say you have HK$15,000 per month (HK$180,000 annual) of business expenses you can deduct, leaving you with HK$820,000 of net profit. If you were to pay yourself a HK$500,000 salary from your company and leave the rest in the company as net profits and dividends (which can be paid out without any taxes), then your final combined salaries tax and profits tax bill would be approximately HK$64,000. Your tax bill has been cut in half!
In order to qualify as an independent contract, it is not enough to simply be paid using a limited company. This is one of the most common mistakes we see. The Hong Kong IRD has published guidelines on how they consider whether a taxpayer qualifies as an independent contractor or not.
How IRD determines whether a taxpayer qualifies as an independent contractor
The specified criteria that the Hong Kong IRD uses to determine whether a person is an employee or an independent contractor are:
Provision of employment-type benefits
The IRD will look at whether the independent contractor in question receives any type of benefits that are usually only included in employee arrangements, such as, severance, housing benefits.
Personal performance
In an employee arrangement, usually, the work must be carried out by that person. For independent contractors, this may not be the case. Often, an independent contractor may also have other employees working for him or her. However, the Hong Kong IRD does recognizes instances where the independent contractor is expected to carry out the work, for example, if the contractor is a medical doctor, or an artist.
Subject to control or supervision
The IRD will look at the level of control and supervision involved between the two parties. In an employer relationship, it is much more common to have a high level of control and supervision over how the work is carried out. Although there is still supervision and control over independent contractors, it is usually less control than an employer would have over an employee. For example, an employee may be asked to clock in, or log their break times, whereas that would not be the case of an independent contractor.
Basis of remuneration
Independent contractors and employees are generally paid in different ways. For example, employees are often paid the same amount once each month. Contractors are usually paid depending on the terms of the contract between the two parties. The IRD will also use this as a determining factor of whether a person is an independent contractor.
Termination of arrangement
The IRD will also look at the termination arrangement between the two parties to see if the arrangement is structured more like employment. For example, an employee might have a non-compete clause, whereas an independent contractor would not.
Representation to the public
In instances where the company publishes marketing material, website information, business cards, where the person is listed as an employee, the IRD will view that as an employer-employee arrangement.
Bonus: Contracted with more than 1 company
While assisting clients handle IRD inquiries, it was apparent that one major factor that would usually be enough to convince the IRD that the person was an independent contractor is if he or she has the contractor relationship with more than 1 company. If they serve more than one client, then it would be extremely unlikely that they are an employee.
Step by step to get setup as an independent contractor
- Discuss the possibility of becoming an independent contractor with your current employer. There are benefits on both sides. For your current employer, they no longer need to provide you with insurance, health benefits, and pay your MPF.
- Incorporate your own limited company
- Draw up a contractor agreement with your employer that incorporates all the above factors so that the IRD will consider you to be an independent contractor.
- Stay compliant for your limited company, keep proper records, file taxes, get an audit each year.
Disadvantages of being an independent contractor:
Of course, tax liability is not the only consideration in this situation. Going from a salaried employee to an independent contractor may mean losing severance packages, and health insurance benefits.
IRD statement on how they determine whether a person is an independent contractor
