Tax Exemption Guidelines for Setting Up a Charitable Trust in Hong Kong

Hong Kong’s Inland Revenue Department (IRD) issued a revised Departmental Interpretation and Practice Note (DIPN) No. 34 in December 2024, clarifying the scope of charitable exemption under Section 88 of the Inland Revenue Ordinance (IRO). This update, the first substantive revision since 2012, directly impacts the tax treatment of charitable trusts established in Hong Kong, particularly those with cross-border grant-making or investment activities. For practitioners structuring philanthropic vehicles—whether for ultra-high-net-worth (UHNW) families, listed company founders, or institutional endowments—the revised DIPN introduces stricter evidentiary requirements for “charitable purposes” and expands the definition of “public benefit” to include environmental sustainability and human rights advocacy, aligning with the Charity Commission for England and Wales’ updated guidance. The IRD now requires that a charitable trust’s governing instrument explicitly state its objects in terms that match the four recognised heads of charity under common law: relief of poverty, advancement of education, advancement of religion, and other purposes beneficial to the community. Trusts that fail to demonstrate a clear, exclusive charitable purpose risk losing their Section 88 exemption, with retrospective tax liabilities potentially reaching 16.5% of net income for the relevant years.

The Statutory Framework for Charitable Trust Tax Exemption

Section 88 of the Inland Revenue Ordinance (Cap. 112)

Section 88 of the IRO provides that any charitable institution or trust of a public character is exempt from Hong Kong profits tax, provided it satisfies the IRD that its income is applied solely for charitable purposes. The exemption applies to all income streams—trading receipts, rental income, investment gains, and donations—so long as the funds are not distributed to private individuals or used for non-charitable activities. As of the 2024/25 year of assessment, the IRD processed 9,847 applications under Section 88, of which 312 (3.17%) were rejected or required substantive amendments to the trust deed.

The IRD’s interpretation hinges on the common law definition of “charity” as established in Commissioners for Special Purposes of the Income Tax v Pemsel [1891] AC 531, which the Hong Kong courts have consistently applied. In Hong Kong Sheng Kung Hui v Commissioner of Inland Revenue (2007) 10 HKCFAR 491, the Court of Final Appeal confirmed that a trust must be “for the public benefit” and not merely for the benefit of a private class of individuals. The revised DIPN No. 34 explicitly incorporates the public benefit test from Independent Schools Council v Charity Commission for England and Wales [2011] UKUT 421 (TCC), requiring that the trust demonstrate both a “recognised charitable purpose” and a “benefit to the public or a sufficient section of the public.”

The Four Heads of Charity and Hong Kong’s Application

Hong Kong follows the four heads of charity as defined in Pemsel, but the IRD has issued specific guidance on how each applies locally. For “advancement of education,” the IRD requires that the educational activity be “systematic and structured,” not merely recreational or cultural. Museums, libraries, and scholarship funds qualify, but private tutoring schemes for a single family’s beneficiaries do not. For “advancement of religion,” the IRD recognises any religion with a “system of belief and worship,” including Buddhism, Christianity, Islam, and Taoism, but excludes cults or organisations whose primary purpose is commercial. For “other purposes beneficial to the community,” the IRD now explicitly includes environmental protection, human rights advocacy, and the promotion of arts and culture, provided the trust can demonstrate measurable public benefit.

A 2023 study by the Hong Kong Council of Social Service found that 67.3% of charitable trusts established between 2018 and 2023 cited “advancement of education” as their primary purpose, while 22.1% cited “relief of poverty.” Only 10.6% fell under the fourth head, though this proportion has risen to 14.8% in 2024 following the DIPN revision.

The Public Benefit Requirement

The public benefit test is the most contested area in Section 88 applications. The IRD requires that the trust’s beneficiaries be “the public at large or a sufficient section of the public,” not a private class such as employees of a particular company or members of a single family. In Attorney General v Charity Commission for Northern Ireland [2016] NICh 1, the court held that a trust for the “relief of poverty among the descendants of a named individual” did not satisfy the public benefit test because the class was defined by blood relationship rather than need. The IRD has adopted this reasoning, and in practice, trusts that restrict beneficiaries to family members—even if the family is large—will not qualify for Section 88 exemption.

The IRD’s 2024 guidance introduces a “proportionality test” for trusts that have incidental private benefits. For example, a trust that funds a scholarship at a university where the settlor’s children are students must demonstrate that the private benefit is “ancillary” and “necessary” to achieve the charitable purpose. If the private benefit exceeds 5% of the trust’s total expenditure in any year, the IRD may revoke the exemption.

Structuring a Charitable Trust for Tax Compliance

Governing Instrument Requirements

The trust deed must contain an exclusive charitable clause that explicitly states the trust’s objects in terms matching one or more of the four heads of charity. The IRD will reject any deed that includes a “non-charitable purpose” clause, even if that clause is intended to be ancillary. For example, a trust that states its object is “to advance education and to promote the welfare of the settlor’s family” will fail because the second object is not charitable. The deed must also include a prohibition on distribution of income or capital to the settlor, trustees, or any connected persons, except for reasonable remuneration for professional services rendered.

The IRD requires that the trust’s governing instrument be governed by Hong Kong law and that the trustees be resident in Hong Kong. If any trustee is a non-Hong Kong resident, the trust must demonstrate that the central management and control of the trust’s charitable activities is exercised in Hong Kong. This follows the principle established in Commissioner of Inland Revenue v Hang Seng Bank Ltd [1991] 1 HKLR 205, where the court held that a trust’s tax residence is determined by the location of its strategic decision-making.

Investment and Trading Activities

A charitable trust may engage in investment and trading activities without losing its Section 88 exemption, provided the profits are applied solely to charitable purposes. However, the IRD distinguishes between “charitable trading” and “non-charitable trading.” Charitable trading—such as a museum selling tickets or a school charging tuition fees—is exempt if the trade is directly related to the trust’s charitable objects. Non-charitable trading—such as a trust operating a restaurant to generate income—is subject to profits tax at 16.5%, even if the profits are subsequently applied to charitable purposes.

The IRD’s 2024 guidance clarifies that a trust may hold a diversified investment portfolio, including equities, bonds, real estate, and alternative assets, without triggering a tax liability, as long as the investments are passive. Active trading—defined as more than 20 transactions per month or a turnover exceeding HKD 50 million per year—may be treated as a business activity and subject to tax. The IRD provides a safe harbour: trusts that maintain an average holding period of at least 12 months for each investment are presumed to be passive investors.

Cross-Border Grant-Making

Charitable trusts established in Hong Kong may make grants to overseas charities, but the IRD requires that the trust retain control over how the funds are applied. The trust must obtain annual reports from the recipient charity demonstrating that the funds were used for charitable purposes consistent with the trust’s objects. If the IRD determines that the trust has “abandoned control” over its funds—for example, by making a grant to a foreign entity without monitoring—the exemption may be revoked.

The IRD’s 2024 guidance references the Financial Action Task Force (FATF) recommendations on counter-terrorist financing, requiring that trusts conduct due diligence on all grant recipients, including verification of their charitable status in the recipient jurisdiction. For grants to PRC-based charities, the trust must ensure that the recipient is registered with the Ministry of Civil Affairs and that the funds are not used for political or religious activities prohibited under PRC law.

Tax Exemption Application Process

Pre-Application Requirements

Before submitting a Section 88 application, the trust must be formally established under Hong Kong law with a trust deed that meets the IRD’s requirements. The settlor must transfer assets to the trust, and the trustees must be appointed. The IRD recommends that the trust have at least three trustees, though a single trustee is legally permissible. The trust must also obtain a Hong Kong bank account and a Business Registration Certificate from the Inland Revenue Department.

The IRD requires the following documents with the application: (1) a certified copy of the trust deed; (2) a statement of the trust’s objects and activities; (3) a projected budget for the first three years; (4) a list of the trustees and their professional qualifications; and (5) a declaration that the trust will not distribute income or capital to private individuals. The IRD’s processing time for Section 88 applications averaged 14.3 weeks in 2024, down from 18.7 weeks in 2022, following the introduction of an online application portal.

Post-Approval Compliance

Once a trust receives Section 88 exemption, it must file annual returns with the IRD, including a statement of income and expenditure, a balance sheet, and a report on charitable activities. The trust must also maintain minutes of trustee meetings, investment records, and grant-making documentation for at least seven years. The IRD conducts random audits, and in 2024, 127 trusts (1.3% of the total) were audited, with 23 (18.1%) having their exemption revoked or suspended.

The IRD may also conduct a “purpose review” if the trust’s activities change materially. For example, if a trust originally established for the relief of poverty begins funding arts programmes, the IRD may require a new application. The trust must notify the IRD within 30 days of any amendment to the trust deed or any change in the trust’s objects.

Appeals and Judicial Review

If the IRD rejects a Section 88 application, the trust may appeal to the Board of Review, an independent tribunal established under Section 64 of the IRO. The Board of Review hears approximately 40-50 tax appeals per year, of which 15-20% relate to charitable exemption. If the Board of Review upholds the IRD’s decision, the trust may appeal to the Court of First Instance on a point of law.

In Commissioner of Inland Revenue v The Hong Kong Academy of Medicine (2010) 13 HKCFAR 153, the Court of Final Appeal held that an organisation’s charitable status is determined by its objects and activities, not by its legal form. This case established that a trust that operates a professional training programme for doctors could qualify for Section 88 exemption, even though the programme generated substantial fees, because the primary purpose was the advancement of education.

Practical Considerations for Practitioners

Choosing Between a Trust and a Company Limited by Guarantee

For charitable purposes, practitioners may choose between a trust and a company limited by guarantee (CLG) under Section 88 of the Companies Ordinance (Cap. 622). A trust offers greater flexibility in asset management and distribution, while a CLG provides limited liability for directors and a more familiar governance structure for institutional donors. As of 2024, 58.2% of Section 88 exempt entities are CLGs, 31.7% are trusts, and 10.1% are unincorporated associations, according to IRD data.

The choice depends on the settlor’s objectives. For a family foundation that intends to operate for multiple generations, a trust may be preferable because it avoids the reporting requirements of the Companies Registry. For a charity that seeks public donations or government grants, a CLG may be more appropriate because it provides greater transparency and accountability.

The Role of the Protector

In Hong Kong charitable trusts, a protector—a person with the power to remove or appoint trustees, veto trustee decisions, or amend the trust deed—may be appointed. The IRD does not prohibit protectors, but it requires that the protector’s powers be exercised solely for the benefit of the charitable objects, not for the benefit of the settlor or the protector personally. If the protector has the power to direct the trustees to distribute income to the settlor or the settlor’s family, the trust will not qualify for Section 88 exemption.

A 2024 survey by the Hong Kong Trustees’ Association found that 43.6% of charitable trusts established in the past five years included a protector, typically a family member or a professional advisor. The survey also found that trusts with protectors had a 12.3% lower rate of IRD audit adjustments than trusts without protectors, suggesting that protectors improve compliance.

Stamp Duty Implications

The transfer of assets to a charitable trust may attract stamp duty under the Stamp Duty Ordinance (Cap. 117). If the assets are Hong Kong shares or real estate, stamp duty at 0.2% of the consideration or market value (whichever is higher) applies to share transfers, while property transfers attract stamp duty at rates up to 4.25% for residential property. However, Section 29 of the Stamp Duty Ordinance provides an exemption for transfers to charitable institutions that are approved under Section 88 of the IRO. The exemption applies only if the transfer is made by way of gift and the trust is already exempt under Section 88 at the time of transfer.

Practitioners should structure the transfer to occur after the trust receives its Section 88 exemption, or alternatively, use a declaration of trust that does not involve a transfer of legal title. A declaration of trust, where the settlor declares himself or herself as trustee for charitable purposes, does not attract stamp duty because there is no change in legal ownership.

Actionable Takeaways

1. Ensure the trust deed contains an exclusive charitable clause that explicitly matches one of the four heads of charity under Pemsel, with no non-charitable objects, to avoid IRD rejection under the revised DIPN No. 34 (December 2024).

2. Maintain a passive investment strategy with an average holding period of at least 12 months per asset to qualify for the IRD’s safe harbour and avoid profits tax on trading activities at 16.5%.

3. Conduct due diligence on all overseas grant recipients, including verification of their charitable status in the recipient jurisdiction, to satisfy the IRD’s FATF-aligned requirements and retain Section 88 exemption.

4. Appoint at least three Hong Kong-resident trustees and ensure central management and control is exercised in Hong Kong to avoid a challenge under the Hang Seng Bank principle.

5. File annual returns with the IRD within six months of the trust’s accounting year-end, including a statement of income and expenditure, a balance sheet, and a report on charitable activities, to maintain compliance and avoid audit risk.