I. Introduction of Offshore Income Tax
II. Application for the Offshore Claims process
With the features of simple, predictable and tax system advantageous, Hong Kong has become one of the most tax-friendly economies in the world. “Low taxation rate and encouragement of business operation” is a policy persistently followed by the Hong Kong Government.
In Hong Kong, the city does not have VAT, withholding tax, capital gains tax and tax on dividends, ect. Their tax bureau, Inland Revenue Department (“IRD”) only imposes the follow three direct taxes:
1. Profits Tax, there are Two-tiered Profits Tax Rates, which is 8.25% and 16.5 %; Sole Proprietorship or Partnership is 15%
2. Salaries Tax is capped at 15%
3. Property Tax is 15%
Other than that, IRD has generous allowances, deductions and exemptions which reduce the taxable burden and provides enterprises with the most satisfactory business environment to help investors expand their businesses. The most famous and important characteristic is the availability of Offshore Income Tax Exemption.
Hong Kong adopts a territorial basis for taxing profits derived from a trade, profession, or business carried on in Hong Kong. Profits Tax is only charged on profits which arise in or are derived from Hong Kong. In simple terms this means that a person who carries on a business in Hong Kong but derives profits from another place is not required to pay tax in Hong Kong on those profits.
Many places levy tax on a different basis. Unlike Hong Kong, they tax the world-wide profits of a business, including profits derived from an offshore source. Under the Inland Revenue Ordinance, a company is chargeable to Profits Tax only under the following conditions of the pre-conditions for liability to Profits Tax:
♦ a company carries on a trade, profession or business in Hong Kong;
♦ the trade, profession or business derives profits; and
♦ the profits arise in or are derived from Hong Kong.
The first two conditions are straightforward. Some elaboration is necessary for the third. Let us have a brief look at the basic principles for determining the source of profits.
The Courts have over the years considered the subject of the source of profits. The following principles have emerged from authoritative court decisions –
The question of locality of profits is a hard, practical matter of fact. No universal rule can apply to every scenario. Whether profits arise in or are derived from Hong Kong depends on the nature of the profits and of the transactions which give rise to such profits.
The broad guiding principle is that one looks to see what the taxpayer has done to earn the profits in question and where he has done it. In other words, the proper approach is to identify the operations which produced the relevant profits and ascertain where those operations took place. The source of profits must be attributed to the operations of the taxpayer which produce them and not to the operations of other members of the taxpayer’s group.
The relevant operations do not comprise the whole of the taxpayer’s activities. The focus is on establishing the geographical location of the taxpayer’s profit-producing transactions as distinct from activities antecedent or incidental to those transactions.
The place where the day-to-day investment/business decisions take place is only one factor which has to be taken into account in determining the source of profits. It is not usually the deciding factor.
The distinction between Hong Kong profits and offshore profits is made by reference to the gross profits arising from individual transactions.
A business may maintain a presence overseas which earns profits outside Hong Kong but the absence of a business presence overseas does not, of itself, mean that all the profits of a Hong Kong business invariably arise in or are derived from Hong Kong. However, in the vast majority of cases where the principal place of business is located in Hong Kong and there is no business presence overseas, profits earned by that business are likely to be chargeable to Profits Tax in Hong Kong.
The factor that determines the locality of profits from trading in goods and commodities is generally the place where the contracts for purchase and sale are effected. “Effected” does not only mean that the contracts are legally executed. It also covers the negotiation, conclusion and execution of the terms of the contracts.
Following the Court of Appeal judgement (Magna Industrial Co. Ltd v CIR) it is now clear that a wider approach is necessary. The proper way is to look at all the relevant operations carried out to earn the profits, not simply the purchase and sale of the goods.
In Magna Industrial Co. Ltd. v CIR, the Court of Appeal noted that:
“Obviously the question where the goods were purchased and sold is important. But there are other questions: For example: How were the goods procured and stored? How were the sales solicited? How were the orders processed? How were the goods shipped? How was the financing arranged? How was payment effected?”
In considering the relevant facts the nature and quality of the activities matter more than their quantity. It is the cause and effect of such activities on the profits that is the deciding factor.
Facts not directly related to the trading activities are considered irrelevant in determining the locality of profits. For example, renting office premises, recruiting general staff, setting up office, etc.
♦ Where the contracts of purchase and sale are effected in Hong Kong, the profits are taxable here.
♦ Where the contracts of purchase and sale are effected outside Hong Kong, the profits are not taxable here.
♦ Where either the contract of purchase or the contract of sale is effected in Hong Kong, the initial presumption is that the profits are taxable here. However, other relevant facts will have to be examined to determine the source of profits.
♦ Where the sale is made to a Hong Kong customer (including the Hong Kong buying office of an overseas customer), the sale contract will usually be taken as having been effected in Hong Kong.
♦ Where the effecting of the purchase and sale contracts does not require travelling outside Hong Kong but is carried out in Hong Kong by use of telephone, or other electronic means including the Internet, the contracts will be considered as having been effected in Hong Kong.
Trading profits are regarded as being either wholly taxable or wholly non-taxable here. Apportionment is not appropriate.
The place where service is performed
When a business earns commission by securing buyers for products or by securing suppliers of products required by customers, the activity which gives rise to the commission income is the arrangement of the business to be transacted between the principals. The source of the income is the place where the activities of the commission agent are performed. If such activities are performed in Hong Kong, the income has a source in Hong Kong.
Factors such as the place where the principals are located, how they are identified by the commission agent, and the place where incidental activities are performed prior or subsequent to the earning of the commission are not generally relevant in determining the source of the commission income.
In the event that the commission income is earned by a person carrying on a business in Hong Kong but the activities which give rise to the commission are performed entirely outside Hong Kong, the commission is not taxable in Hong Kong.
Some examples of the tests used to determine the source of the main types of other business profits are as follows –
| Profits | Tax liability in Hong Kong |
|---|---|
| Rental income from real property | Taxable if the property is located in Hong Kong |
| Profits derived by an owner from the sale of real property | Taxable if the property is located in Hong Kong |
| Profits from the purchase and sale of listed shares and other listed securities | Taxable if the stock exchange where the shares or securities in question are traded is located in Hong Kong. Where the purchase and sale took place over-the-counter, taxable where the contracts of purchase and sale are effected in Hong Kong |
| Profits accruing to a business (other than a financial institution) from the purchase and sale of unlisted shares and other unlisted securities | Taxable where the contracts of purchase and sale are effected in Hong Kong |
| Service fee income | Taxable if the services which give rise to the payment of the fees are performed in Hong Kong |
| Royalties received by a business | Taxable if the licence or right of use is acquired and granted in Hong Kong |
| Royalties on intellectual property received from Hong Kong by a non-resident | Taxable if the intellectual property is used in Hong Kong For royalties received or accrued on or after 25 June 2004, if the intellectual property is used outside Hong Kong, taxable if the royalty payment is deductible in ascertaining the assessable profits of the payer under profits tax |
| Interest accruing to a business (other than a financial institution) | Taxable if the lender provides the funds in Hong Kong to the borrower |
If the company intent to apply for the tax exemption, it should be lodged at the time of filing of the first Profits Tax Returns together with the following documents:
♦ Audited Financial Statement by HKICPA
♦ Tax computation with schedules showing the details of Assesable Profits
♦ The reasons of the application
In addition, we strongly advise our client to keep the complete company’s transaction records to illustrate the fact of all activities are not happened in Hong Kong, such as:
♦ Organization chart and Operation map
♦ Emails, faxes & itemized telephone bills showing the correspondence record with stakeholder
♦ Records of meeting with customers and suppliers
♦ Purchase orders, Sales orders and Shipping documents
♦ Traveling Expense and Custom record of the key persons of the company
