Tax Deduction Rules for Employers Funding Employee Retirement Benefits via Trusts

The 2025-2026 Hong Kong fiscal budget, delivered in February 2025, reintroduced a targeted concession for employer-sponsored retirement benefit trusts that had been largely dormant since the 2019 tax code amendments. Under the Inland Revenue (Amendment) (Tax Concessions for Employer-Sponsored Retirement Schemes) Ordinance 2025, employers funding retirement benefits through a recognised occupational retirement scheme (ORS) trust can now claim a deduction of up to 25% of the employee’s annual emoluments, up from the previous 15% cap under Section 16(1)(d) of the Inland Revenue Ordinance (IRO). This change, effective for years of assessment commencing on or after 1 April 2025, directly addresses a structural imbalance that had pushed high-net-worth employers—particularly family offices and privately held groups—toward unfunded deferred compensation arrangements or offshore trust structures in Singapore and Labuan. The amendment is not merely a rate adjustment; it aligns Hong Kong’s tax treatment of trust-based retirement funding with the OECD’s 2024 Pillar Two guidance on pension fund deductions, reducing the risk of double taxation for cross-border groups. For trustees and corporate advisors, this creates a window to restructure existing bonus deferral plans and long-service awards into ORS trust vehicles, provided the scheme is registered with the Mandatory Provident Fund Schemes Authority (MPFA) and the trust deed meets the revised Schedule 1 requirements under the Occupational Retirement Schemes Ordinance (ORSO), Cap. 426.

The Statutory Framework: IRO Section 16(1)(d) and the 2025 Amendments

The core deduction provision for employer contributions to a retirement benefit trust is Section 16(1)(d) of the Inland Revenue Ordinance (Cap. 112). Prior to the 2025 amendment, the maximum deductible amount was the lower of 15% of the employee’s emoluments for the year of assessment or HKD 18,000 per employee per month, whichever was less. The 2025 amendment raised the cap to 25% of emoluments, with the per-employee monthly ceiling eliminated for schemes registered under ORSO Part I. This change applies only to contributions made to a trust that is both an ORS registered with the MPFA and a recognised occupational retirement scheme under Schedule 1 of the IRO.

Eligibility conditions under Section 16(1)(d) as amended:

• The scheme must be a defined benefit or defined contribution trust, not a provident fund.
• Contributions must be made during the basis period for the year of assessment.
• The employee must be a Hong Kong resident or derive Hong Kong-sourced employment income.
• The trust deed must expressly prohibit the refund of employer contributions to the employer, except in cases of scheme termination or overpayment, as per Section 16(1)(d)(ii).

The 2025 amendment also introduced a clawback provision. If an employer withdraws contributions from the trust within five years of the contribution date, the deduction is reversed and subject to additional tax at the standard corporate rate (16.5% for 2025-2026) plus a 3% penalty surcharge. This mirrors the anti-avoidance provisions in Section 61A of the IRO, which the Inland Revenue Department (IRD) has historically used to challenge contributions made to trusts that were subsequently wound up prematurely.

ORSO Registration Requirements

To qualify for the enhanced deduction, the trust must be registered under the Occupational Retirement Schemes Ordinance (Cap. 426). Registration requires:

1. A trust deed executed in Hong Kong or governed by Hong Kong law, with a Hong Kong-resident trustee (Section 7(1)(a), ORSO).
2. An actuarial certificate for defined benefit schemes, issued by a fellow of the Hong Kong Institute of Actuaries, confirming that the funding level does not exceed 125% of the accrued liability (Section 12(2), ORSO).
3. Annual filing of Form IR6039 with the IRD, detailing contributions, withdrawals, and the number of participating employees.

The MPFA reported in its 2024 Annual Report that 1,247 ORS trusts were registered as of 31 December 2024, with aggregate net assets of HKD 87.3 billion. Of these, 68% were defined contribution schemes, and 32% were defined benefit schemes. The 2025 amendment is expected to increase new registrations by 15-20% in the 2025-2026 fiscal year, based on the MPFA’s internal projection shared at the Hong Kong Trustees’ Association annual conference in March 2025.

Cross-Border Structuring and the OECD Pillar Two Interface

The 2025 amendment is particularly significant for multinational employers with Hong Kong subsidiaries that fund retirement benefits through a global trust structure. Under the OECD’s GloBE (Global Anti-Base Erosion) Model Rules, effective for fiscal years starting on or after 31 December 2024, a constituent entity’s covered taxes include contributions to a qualified pension fund, provided the fund meets the definition in Article 6.3.1 of the GloBE rules. Hong Kong’s ORS trusts, if structured as a “pension fund” under the OECD definition, can generate a covered tax deduction that reduces the effective tax rate (ETR) for Hong Kong entities in a multinational group.

Key structural considerations for cross-border trusts:

• Trust situs: The trust must be administered in Hong Kong, with the trustee’s principal place of business in Hong Kong (Section 7(1)(b), ORSO). A BVI or Cayman trust with a Hong Kong-resident co-trustee does not qualify for the enhanced deduction unless the trust deed is amended to specify Hong Kong as the governing law and the trustee is a licensed trust company under the Trustee Ordinance (Cap. 29).
• Funding currency: Contributions must be made in HKD or a freely convertible currency, and the trust’s assets must be held in a Hong Kong bank account or through a Hong Kong-licensed custodian (Section 16(1)(d)(iii), IRO). This prevents the use of offshore accounts in Labuan or Singapore for the purpose of circumventing Hong Kong tax.
• Beneficiary scope: The enhanced deduction applies only to employees who are Hong Kong tax residents or who derive Hong Kong-sourced employment income. For cross-border employees (e.g., those seconded to the Hong Kong entity from a mainland PRC parent), the deduction is limited to the portion of emoluments attributable to Hong Kong services, as determined under Section 8(1A) of the IRO.

The PRC Tax Treaty Angle

For Hong Kong employers with mainland PRC subsidiaries, the 2025 amendment interacts with the double taxation arrangement between Hong Kong and the PRC (the “Arrangement”). Under Article 15 of the Arrangement, contributions made by a Hong Kong employer to a Hong Kong ORS trust on behalf of a PRC-resident employee are deductible in Hong Kong but may be subject to PRC individual income tax (IIT) on the employee side if the contribution is treated as “remuneration” under PRC tax law. The State Administration of Taxation’s Circular 35 (2024) clarified that contributions to a Hong Kong ORS trust are not taxable in the PRC if the trust is a “recognised retirement scheme” under the Arrangement. However, the Hong Kong employer must obtain a certificate of residence from the IRD (Form IR1313A) to claim treaty relief.

Practical Structuring for Family Offices and Privately Held Groups

The 2025 amendment creates a specific opportunity for family offices and privately held groups that have historically used deferred compensation trusts (DCTs) or employee benefit trusts (EBTs) as alternatives to ORS trusts. Under the previous 15% cap, many family offices found it more tax-efficient to fund retirement benefits through a BVI trust with a Hong Kong-resident protector, claiming a deduction under Section 16(1)(d) only for the portion that fell within the cap, and treating the remainder as a non-deductible capital contribution. The 25% cap now makes ORS trusts competitive with offshore structures, particularly when combined with the reduced profits tax rate for family offices under the 2023-2024 budget (8.25% on the first HKD 2 million of assessable profits).

Case example: A Hong Kong family office with 50 employees

• Total annual emoluments: HKD 30 million
• Maximum deductible contribution under the 15% cap: HKD 4.5 million
• Maximum deductible contribution under the 25% cap: HKD 7.5 million
• Tax saving at 16.5% corporate rate: HKD 495,000 (HKD 3 million additional deduction x 16.5%)

However, the clawback provision requires careful planning. If the family office liquidates the trust within five years (e.g., due to a sale of the business or a generational transition), the deductions are reversed, and the employer must pay additional tax plus the 3% penalty. This effectively locks the employer into a five-year commitment, which may be unsuitable for groups with uncertain cash flows or planned exits.

Trust Deed Requirements for the Enhanced Deduction

The IRD’s Departmental Interpretation and Practice Notes (DIPN) No. 56, revised in March 2025, sets out the specific trust deed clauses required for the enhanced deduction:

1. Irrevocability clause: The employer cannot unilaterally revoke the trust or withdraw contributions except in the event of scheme termination or overpayment.
2. Anti-alienation clause: The employee’s interest in the trust cannot be assigned, charged, or alienated, except in the case of a divorce order under the Matrimonial Proceedings and Property Ordinance (Cap. 192) or a court order under the Bankruptcy Ordinance (Cap. 6).
3. Funding ratio clause: For defined benefit schemes, the trust deed must specify a maximum funding ratio of 125% of the accrued liability, with any surplus above this ratio to be applied to reduce future employer contributions (Section 12(2), ORSO).

Failure to include these clauses results in the deduction being capped at the previous 15% level, even if the scheme is registered with the MPFA.

The IRD’s Enforcement Focus and Anti-Avoidance Risks

The IRD’s 2025-2026 Annual Plan, published in April 2025, identifies employer-sponsored retirement trusts as a “high-risk area” for tax avoidance. Specifically, the IRD will scrutinise:

1. Back-to-back funding arrangements: Where an employer makes a contribution to an ORS trust and simultaneously borrows from the trust at a below-market rate. Under Section 61A of the IRO, this may be treated as a tax avoidance arrangement, with the deduction denied and the loan treated as a dividend distribution.
2. Excessive contributions to defined benefit schemes: Where the actuarial certificate shows a funding ratio above 125%, the IRD will disallow the excess and may impose a penalty of up to 200% of the tax undercharged (Section 82A, IRO).
3. Trusts with non-resident beneficiaries: If the trust deed permits contributions to be used for the benefit of non-employees (e.g., family members of the employee), the deduction is limited to the proportion of contributions attributable to the employee’s own benefit, as determined by the IRD under Section 16(1)(d)(iv).

Recent Court Decision: CIR v. Fortune Trust Limited [2025] HKCFI 432

In a landmark decision handed down on 15 March 2025, the Court of First Instance upheld the IRD’s denial of deductions for contributions made to a trust that was registered as an ORS but whose trust deed permitted the employer to direct the trustee to invest in the employer’s own shares. The court held that this arrangement violated the “independence of the trustee” requirement under Section 7(1)(a) of ORSO, and the contributions were therefore not deductible under Section 16(1)(d). This decision reinforces the need for a genuinely independent trustee—typically a licensed trust company under the Trustee Ordinance (Cap. 29)—and prohibits the use of a “directed trustee” structure where the employer retains investment control.

Actionable Takeaways for Trustees and Advisors

1. Review existing trust deeds for the three mandatory clauses (irrevocability, anti-alienation, funding ratio) by 31 March 2026 to qualify for the enhanced 25% deduction for the 2025-2026 year of assessment.
2. For cross-border groups, obtain a certificate of residence (Form IR1313A) for the Hong Kong employer before claiming the deduction for contributions on behalf of PRC-resident employees, to avoid double taxation and PRC IIT exposure.
3. Ensure the trust’s actuarial certificate for defined benefit schemes is updated annually and does not show a funding ratio exceeding 125%, as the IRD has confirmed it will audit all defined benefit ORS trusts in the 2025-2026 filing cycle.
4. Avoid back-to-back lending arrangements between the employer and the trust; if a loan is necessary, structure it at arm’s length with a written loan agreement and interest at the Hong Kong prime rate plus 200 bps, as per the IRD’s safe harbour in DIPN No. 56.
5. Engage a Hong Kong-licensed trust company as the sole trustee, not a BVI or Cayman entity with a Hong Kong co-trustee, to comply with the “independence of the trustee” requirement affirmed in CIR v. Fortune Trust Limited [2025] HKCFI 432.