Content Outline
Hong Kong provides a territorial source regime of profits which is levied on income arising in or derived from Hong Kong. A company may be entitled to a tax exemption through a offshore non-taxable claim.
A person or an entity is subject to Hong Kong profits tax under the general charging provision of the Inland Revenue Ordinance if all the three requirements are met:
- The person is currently engaged in trade, profession, or business in Hong Kong.
- The income-generating source is trading, occupation, or carrying on business.
- The earnings are engaged in or put to use in Hong Kong or are sourced in Hong Kong.
As long as one of the three conditions is met, the income flow to an entity will not be taxed in Hong Kong.
The place of incorporation and residency of an entity is not relevant as the source and taxability of its income in Hong Kong are concerned.
There would be a controversy if conditions (i) or (iii) are met and as a result, tax disputes between taxpayers and the Inland Revenue Department might arise. Some of the claims are filed with the Board of Review (such as an appeal tribunal) and Court, to reach a decision.
Moving on, conditions (i) and (iii) are examined below.
Condition (i): A person engaging in trade, profession, or business in Hong Kong
An entity will likely be considered to be legally carrying on a trade, profession, or business in Hong Kong if its central management and control takes place in Hong Kong.
There are scenarios where, even if the entity carries on only a few or very limited business functions relating to Hong Kong, IRD still considers them as carrying on business in Hong Kong.
However, the entity would be regarded as a tax resident of that specific jurisdiction and would be obligated to the effective income tax of the foreign country as soon as it declared that it was being managed and controlled through the tax authority of that foreign country.
It is no longer beneficial from a tax standpoint when claiming that the central management and control of her Hong Kong firm is located in a foreign tax authority, particularly one with high taxation, because of the information exchange of tax systems across the different nations.
Condition (iii): Income Generated In Or Originating From Hong Kong
An entity can justify its profits as offshored and non-taxable by stating that condition (iii) is not applicable.
In Hong Kong, there is no specific provision that lays out the criteria for determining the source of income. The fact of the matter is, where one’s source of income stands on the ground level. There will not be any standard judge-made rule that takes care of every single case.
Whether revenue is earned in or derived from Hong Kong depends on the nature of the revenue and how it is made and used, such as project or business operation.
It comes from the Hong Kong law that has set, as a general principle, for an income-source determination that “one sees how and where the taxpayer has been doing in terms of earning profits.”
However, the IRD typically considers the totality of facts test, i.e. looking at all the business functions and factors relevant for the generation of the ‘offshore’ income when establishing the income source.
Sometimes it is difficult to establish the source of income as the business mode of some entities is quite sophisticated, i.e. using agents and online transactions.
Procedure for filing a non-taxable offshore claim
An entity should apply its offshore income in its annual tax return, to exclude non-taxable components.
Next, the IRD will most certainly issue a letter of inquiry to provide detailed information on the matter as well as the entity’s operations and supporting documentation.
As for that, the IRD here more likely needs at least one full set of walk-through transaction documents for the review or process, respectively.
- The very first contact with the customers or clients.
- Negotiation and closure of sales or service talks.
- The shipping of the goods or the delivery of services to the clients.
- The last payment of the trade debt or service charges.
The IRD takes about 6 to 9 months to review the reply appeals provided by the entities. The IRD will also accept the reply and grant an offshore non-taxable status if the entity has satisfied its requirements. Besides that, the IRD may ask follow-up questions or call for the provision of further documents for review.
If there is a rejection of the offshore non-taxable claim, the entity has the right to appeal Commissioner of Inland Revenue and to the Board of Review and the Courts.
Additionally, it should be noted that when such a tax-free offshore claim is accepted, the IRD will review a claim after several years about 5-7 years in general.
Advice on filing a non-taxable offshore claim
A claim for an offshore non-taxable amount is usually under review and agreement by the IRD. The IRD has been strict in analyzing a non-tax offshore claim. Considering that, the tax claim should be resolved with a plan and strategy.
Here are some of our advice on filling non-taxable offshore claims:
- It is recommended to plan and organize the business activities right from the beginning of the ‘offshore’ business as well as identify who, how, from where and the partner for each business activity will be involved. Hong Kong is an international city however, the income-generating activities should be conducted outside of Hong Kong.
- The business should conduct a review of its mode of operation and transaction periodically if the business already exists and is in operation. The goal is to identify the negative aspects and risks that might affect the non-taxable offshore application create modifications to those situations as well as find ways to enhance the opportunity of the non-taxable offshore application.
- It is necessary to keep a record, of documents like transaction documents and letters sent to the concerned business parties, to support the offshore non-taxable revenue claim? Lack of evidential support in the documentation will cause the denial of the offshore non-taxable claim by the IRD.
- The supply of the data and documents to the IRD has to be performed carefully and strategically. It is observed that some of the data that the IRD (Inland Revenue Department) demands is not connected to prove the source of that income. Disclosing some undesirable or uneven data may create follow-up inquiries from the IRD and/or lower the credibility of the offshore untaxable claim.
- It will become significant to cite relevant case laws and legal grounds or arguments by the offshore non-taxable claim to the IRD to strengthen the claim.
It is best to get professional tax lawyers for structuring and reviewing the “offshore” business, as well as for handling IRD inquiries and/or disputes, to maintain and reinforce the offshore non-taxable claim. The IRD may reject the offshore non-taxable claim if there are any small inadequacies or inaccuracies.
On top of that, one must be aware of the entity’s tax positions and exposure to international tax responsibilities at the location where business operations are conducted.
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