A POPULAR Hong Kong tax dodge can create big headaches for territory residents intending to emigrate to the United States and American citizens living in Hong Kong, a tax accountant says. Hong Kong, with its low-tax regime, rarely warrants the elaborate tax-avoidance schemes seen elsewhere. But at least one method of reducing taxes has become common. Many people have discovered they can save substantially on local income taxes by owning their homes through a corporation. But the ultimate consequences can be costly for US citizens and those planning to move to the US. Patrick Yip, a senior tax manager at accounting firm Deloitte Touche Tohmatsu, said half of his US-tax clients in Hong Kong had problems caused by the corporate ownership of their main home. As housing costs are so high and Hong Kong tax law requires that only housing expenses equivalent to 10 per cent of a person's base salary be included in assessable income, it is not uncommon for employers to provide a portion of their workers' wages in the form of housing allowances. For example, take an employer who has budgeted to pay a particular employee $1.5 million annually. If the entire sum is paid as salary, the employee will, for Hong Kong tax purposes, have an assessable income of $1.5 million. However, if the package is structured as a $1 million base salary and a $500,000 housing allowance, the employee's assessable income will be only $1.1 million - that is, the $1 million base salary plus a housing supplement equivalent to 10 per cent of base salary. The difference works out to a $60,000 tax saving. Applying the same principle, resourceful Hong Kong home-owners have found a way to own their homes without sacrificing the tax benefits of housing allowances. They own their homes through corporations, pay rent to those corporations and collect housing allowances from their employers. The employers' bottom lines have not changed by so much as a cent, and the employees are able to enjoy the same Hong Kong tax advantages as when renting. The home-owning corporations are unlikely to owe any profits tax because their savvy owners (the home-owners) will deduct interest payments, depreciation and other expenses, ensuring there is no profit. 'This is kind of a perfect scenario,' Mr Yip said. 'On the one hand, you get a benefit for Hong Kong tax savings. On the other hand, you get the appreciation in the property.' The approach works well for people who plan to remain in Hong Kong and for expatriates from nearly every country except the US. When the time comes to sell the residence, the tax ramifications are damaging for American citizens and residents, and for those with aspirations to move to the US. As the US taxes its citizens and residents on global income, the Internal Revenue Service (IRS) requires, at a minimum, the filing of informational tax returns detailing taxpayers' overseas financial arrangements. The IRS would consider the home-owning corporation described above as a controlled foreign corporation whose earnings must be reported and tax liabilities paid in full each year. These will not be arduous requirements for the years when the company makes a net loss. But when the property is sold and a gain realised, there will be expensive problems. First, the gain will typically be considered ordinary income (subject to tax rates as high as 39.6 per cent) rather than capital gain (subject to a concessionary rate of 28 per cent). Second, because the gain is considered ordinary income instead of capital gain, tax cannot be deferred. US taxpayers are normally allowed to defer payment of capital-gains tax on the sale of a principal residence for up to two years. If another home of equal or greater value is bought within that time, the capital gain is fully offset. What does all this mean for the Hong Kong person who owns his home through a corporation but intends to emigrate to the US? 'The guy basically has a big problem on his hands,' Mr Yip said. There is only one solution: set up the home-owning corporation with your non-US spouse as sole owner. No non-US spouse? Then there is no solution and you can look forward to a very steep US tax bill.