FAQ

HONG KONG TAXATION SYSTEM

Commonly Asked Question

Under the Basic Law of Hong Kong, the taxation system in Hong Kong is independent of, and different from, the taxation system in mainland China. In addition, Hong Kong has independent public finance, and no tax revenue is handed over to the Central Government in China. 

The taxation system in Hong Kong is generally considered to be one of the most simple, transparent, and straightforward systems in the world. Taxes are collected through the Inland Revenue Department (“IRD”).

Since the Common Law System is applied in Hong Kong, judgements by the Courts and Boards of Review in tax law cases are resorted to assist the interpretation of taxation rules and concepts. Furthermore, the IRD also issues Departmental Interpretation and Practice Notes (“DIPNs”) from time to time to clarify and elaborate on the tax rules and to smoothen the tax collection process.

Unlike most countries which apply both residential jurisdiction and territorial jurisdiction in determining the tax liability of a person, Hong Kong uses only the territorial source jurisdiction and disregards the concept of residence. Thus, only profits sourced in Hong Kong would be taxable whereas a person’s overseas income will not be taxable.

Salaries Tax

The wages and incomes received from Hong Kong employment are subjected to tax. It charged at a maximum rate of 15% on an individual’s income from employment in Hong Kong.

Profits Tax

Hong Kong Profits Tax is a tax levied on the net profits on business. Companies carrying out business in Hong Kong will be liable to Profits Tax provided that the profits are sourced in Hong Kong. The source of profits is one of the most controversial topics in the context of Hong Kong taxation. Principally, it is guided by an established set of tests and judgments in court cases. The DIPNs provides viewpoints from IRD’s perspective but these are subject to revision if major inconsistencies with court judgments are subsequently found. Capital gain is out of the scope of Hong Kong Profits Tax.

Turnover Tax

No turnover tax (e.g. Value-Added Tax and Goods and Services Tax) has been imposed in Hong Kong. As a result, Hong Kong is considered to be favourable for profit shifting and conducting re-invoicing activities. 

The following taxes do not exist in Hong Kong

  • Sales tax, GST or VAT;
  • Tax on dividends;
  • Tax on bank interest received;
  • Witholding tax on management fees paid to overseas companies;
  • Capital gains tax;
  • Inheritance tax or estate duty.

Profits Tax charged at the rate of 8.25% on the first HK$2 million of profits from business activities taking place in Hong Kong and at 16.5% on profits above HK$2 million. Companies whose business activities take place entirely outside of Hong Kong are not subject to Profits Tax (see the Offshore Profits Tax Exemption section for further details).

Generally, all outgoings and expenses, to the extent to which they have been incurred by the taxpayer in the production of chargeable profits, are allowed as deductions. The following expenses are tax deductible:

  • Rental – for occupying buildings or land to generate taxable profits;
  • Fees and other remunerations paid to directors / employees are generally deductible that such payments are incurred in the production of assessable profits;
  • Travelling and business costs include: plane and train tickets, accommodation, company’s car maintenance, public transport and taxi, etc.;
  • Charitable donations made to approved charitable institutions;
  • Expenses connected with lending money;
  • Royalties, service fees, management fees, etc. paid to foreign affiliated companies are deductible provided these expenses are revenue in nature and were incurred in the production of assessable profits;
  • Bad debt which has been written off;
  • Expenses incurred for repair, refurbishment, and replacement of machinery, equipment, and premises;
  • Cost incurred for trademark and patent registration;
  • Retirement scheme contributions;
  • Expenses related to research and development;
  • Fees related to technical education;
  • Expenses incurred in the purchase of patents, registration of trademarks, copyrights, and registration of designs;
  • Capital expense on prescribed fixed assets and environmental protection machinery;
  • Tax losses can be carried forward indefinitely to offset assessable profits in future but cannot be carried backward;
  • Except the Foreign corporate income tax, other types of foreign taxes (e.g. value-added tax) that are not calculated by reference to the profits may be deductible under the general deduction rules in the IRO. Foreign tax credit is available for foreign taxes paid under double tax treaties entered by Hong Kong with other jurisdiction.
  • domestic or private expenses and any sums not expended for the purpose of producing the profits;
  • any loss or withdrawal of capital, the cost of improvements and any expenditure of a capital nature;
  • rent of or expenses relating to premises not occupied or used for the purpose of producing the profits;
  • taxes payable except Salaries Tax paid in respect of employees’ remuneration;
  • any sum recoverable under insurance or contract of indemnity

Offshore profit claim

Hong Kong adopts a territorial source principle of taxation. If a Hong Kong company’s business activities take place entirely outside of Hong Kong it qualifies for an Offshore Profits Tax Exemption granted by IRD which results in the company’s profits being tax-free in Hong Kong. There is therefore no distinction made between residents and non-residents. No tax is levied on profits arising abroad, even if they are remitted to Hong Kong.

When a company fulfills the following conditions –

  • he 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 –

  • Matter of fact
  • The operations test
  • Antecedent or incidental activities
  • Place where decision is made
  • Gross profits from transactions
  • Business presence overseas

Trading income

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.

Re-invoicing centre

Commission income or profit that accrues to a “re-invoicing centre” for services rendered is chargeable to profits tax. The IRD would examine the nature of the operations and the type of risks in question to determine whether they constitute the provision of services or trading. The label “re-invoicing centre” clearly does not in itself provide the answer as it can mean different business structures.

Example 1

Company A, incorporated in Hong Kong, is a re-invoicing centre of a group of companies with a holding company incorporated in the United States, as more particularly described below. It manages in Hong Kong all foreign currency exposures from intra-company trade, guarantees the exchange rates for future orders and manages intra-affiliate cash flows, including lead and lags of payments. Manufacturing affiliates in Mainland China sell goods to Company A, which in turns resells to the distribution affiliates in North America and Europe. Company A resells at cost plus a mark-up for its services. The mark-up covers the cost of the re-invoicing centre and a reasonable return on the services provided.

The profits accrue to Company A are service income derived from Hong Kong. The mark-up earned by Company A, which acts as a re-invoicing centre, is chargeable to profits tax.

Buying office

A trading company, carrying on business outside Hong Kong, may set up a branch in Hong Kong to act as a buying office for the purpose of purchasing goods or merchandise or of collecting information. The activities of the branch are confined to the purchase of goods or merchandise or of collecting information in Hong Kong and it is not involved in their sale, either in Hong Kong or elsewhere. In such a situation, a liability to Hong Kong profits tax would not arise.

Profits of manufacturing businesses

The source of profits for a manufacturing business is the place where the goods are manufactured. Where goods are manufactured partly in Hong Kong and partly outside Hong Kong, profit can be apportionment. In the Mainland, two types of processing trade normally involve Hong Kong companies: contract processing and import processing.

  • Contract processing
    In contract processing, the document that governs the contractual relationship among the parties is the processing agreement. It sets out the rights and responsibilities of the Hong Kong company and the Mainland processing enterprise. The Hong Kong company is responsible for the supply of raw materials and machinery without consideration and to provide technical know-how while the Mainland processing enterprise is responsible for the provision of factory premises, utilities and labour force. In return for the processing service, the Hong Kong company pays a subcontracting charge to the Mainland enterprise. The legal title to the raw materials and finished goods remains with the Hong Kong company.

    In the IRD’s view, the Hong Kong company’s operations in the Mainland complement its operations in Hong Kong. Recognising the operations of the Hong Kong company in the Mainland, an apportionment of profits on a 50:50 basis is usually accepted.
  • Import processing
    In import processing, the manufacturing operations are carried out by a foreign investment enterprise (FIE) incorporated in the Mainland and related to the Hong Kong company. The Hong Kong company sells raw materials to the FIE and buys back the finished goods from the FIE. The Hong Kong company engages in the trading of raw materials and finished goods whilst the FIE manufactures the finished goods. The legal title to the raw materials and the finished goods passes to/from the FIE.

    The IRD holds the view that the profits which accrued to the Hong Kong company from “trading transactions” carried out in Hong Kong cannot be attributed to the manufacturing operations of the FIE carrying on business in the Mainland. The source of the trading profits must be attributed to the operations of the Hong Kong company which produced them. Apportionment of profits is not appropriate.

Service fee income

The source of profits for a service business is the place where the services are performed which give rise to the fees.

When a HK company provide services partly in Hong Kong and partly outside Hong Kong. It may be possible to claim that part of the service income is offshore.

If HK company hires overseas agent or service provider to perform services on its behalf outside Hong Kong, it may claim that the entire service income are no Hong Kong source.

Loan interest income

The source of loan interest income is determined by two tests:

  • Provision of credit test
    The “provision of credit” means where the loan is provided by the lender. (ie. Where the bank account of borrower receives the fund? In HK or outside HK?) If the loan is provided by the lender outside Hong Kong, then the interest income will not be assessable.  
  • Operation test
    The “operation test” means “one looks to see what the taxpayer has done to earn the profit in question and where he has done it”. It means where the taxpayer earned its profits by borrowing and lending of money. (ie. Where the bank account of borrower receives the fund? Where the bank account of lender gets the fund? In HK or outside HK?) In such case, regard should also be made to the chief place of business. Put it simply, the so called “operation test” will usually apply to determine the company’s chief location of business activities that gives rise to the interest income. If the chief relevant place of business is in Hong Kong, then IRD will assess the interest incomes even though such incomes are arranged to be derived from funds lent outside Hong Kong.

Profits from the purchase and sale of listed shares and other securities

IRD will see the location of the stock exchange where the shares or listed securities. securities in question are traded. When the purchase and sale took place over-the-counter, the place where the contracts of purchase and sale are effected.

Royalty income

The source of royalty income is the place of acquisition and granting of the licence right of use.

The process of applying for offshore profit claim is not automatic. The company have to apply for it when submitting the first Profits Tax Return (issued on 18 months after the incorporation date) together with the audited financial statements and Profits Tax computation to IRD.

In order to illustrate the fact that all activities take place outside of Hong Kong, you should keep complete records including:

  • Sales agreements/contracts;
  • Purchase agreements/contracts;
  • Service agreements;
  • Catalogue, price list or quotation of company products;
  • Sale register analysis to show customers name, address, amount of yearly sales and any relationship with the customers;
  • Purchase register analysis to show suppliers name, address, amount of yearly purchases and any relationship with the suppliers;
  • Indent basis table to illustrate no inventories are kept at year end date;
  • Invoices issued to customers;
  • Invoices from suppliers;
  • Sales orders;
  • Purchase orders;
  • Shipping/Delivery documents to show the origin and destination of the product supplied to the customer;
  • Inspection document of goods before shipment is made;
  • Receive payment bank record;
  • Remit payment bank record;
  • Correspondence by way of letters, facsimile, emails with customers and supplier to support the negotiation process;
  • Notes of meetings with customers and suppliers;
  • Travel documents to demonstrate any visits to customers and suppliers;
  • Documents of arrangement of finance (e.g. letter of credit, bill of exchange)

It is the letter issued by the IRD for the company who apply the offshore profit claim. Within this letter, the IRD decides whether the company able to claim for offshore activities and profits exemption for the company. 

After the IRD issues the tax query letter, the company has normally one to two months to prepare all the required documents and complete all the questions. If IRD find that the provided details or evidence in the response letter which is unclear, the IRD may issue a follow up letter to clarify your position. 

The letter usually asks the following topic:

  • Company’s business establishments;
  • Company’s product;
  • Company’s mode of trading;
  • Company’s purchases;
  • Company’s sales;
  • Representative transactions;
  • Basis of the offshore claim

When the IRD accepts the letter, the company has successfully been granted the profits exemption, and IRD issue a letter to states that “no tax adjustments are required in relation to the issues raised in the enquiry.” It will normally have this offshore status for several years. Typically, the IRD will not send another tax query letter questioning the business activities for the company.

If the IRD conclude that the company’s activities did effect in Hong Kong, the IRD would assess the offshore profits be taxable and a tax demand note for the total amount of taxes to be issued.

Claiming of offshore profit in Hong Kong may be a double-edged sword. The company can lessen tax burden in Hong Kong but other jurisdictions may regard this claim as a proof of collecting tax, especially some jurisdictions adopt worldwide taxation system. In other words, even though the company pays taxes in Hong Kong at 16.5% (8.25% for profits under HK$ 2 million), the company may hedge the risk of these activities being taxed under another jurisdiction. If the company choose to claim offshore profits, then these offshore activities would be under the jurisdiction of another country, which may have a higher tax rate than that of Hong Kong.

As every case is different, weigh the cost and benefits of your business activities before making important decisions for your company.

Tax Resident Certificate

Double taxation arises when two or more tax jurisdictions overlap, such that the same item of income or profit is subject to tax in each. Hong Kong has entered into Comprehensive Double Taxation Agreements / Arrangements (DTAs) with a number of jurisdictions such as Austria, Belarus, China, Croatia, Czech, Denmark, Estonia, Faroes, France, Germany, Hungry, India, Indonesia, Japan, Korea, Kuwait, Latvia, Liechtenstein, Malaysia, Mexico, Netherlands, Portugal, Romania, Russia, Spain, Thailand, United Arab Emirates, United Kingdom, USA and Vietnam etc.

It is a document issued by the competent authority in Hong Kong to a Hong Kong resident who requires proof of resident status for the purposes of claiming tax benefits under the Comprehensive Double Taxation Agreements / Arrangement (DTAs).

While the IRD is committed to providing Hong Kong residents with assistance in claiming all the tax benefits they are entitled to under a DTA, the IRD may refuse to issue a Tax Residency Certificate where it is clear that the person would not be entitled to those benefits. As such, there may be cases where a person will not be able to obtain a Tax Residency Certificate because that person does not fulfill the criteria of the particular article under which that person intends to claim benefits.

Persons should also be aware that issuance of a Tax Residency Certificate will not guarantee that they will be successful in their claim to benefits under the relevant DTA. The decision as to whether relief from foreign taxes can be granted is, ultimately, to be made by the treaty partner. It will be up to the treaty partner to determine whether all the relevant conditions are fulfilled and whether benefits can be granted.

In general, the following persons can apply for a Tax Residency Certificate:

• Individual who ordinarily resides in Hong Kong;

• Individual who stays in Hong Kong for more than 180 days during a year of assessment or for more than 300 days in two consecutive years of assessment one of which is the relevant year of assessment;

• Company / partnership / trust / body of persons incorporated or constituted in Hong Kong; or

• Company / partnership / trust / body of persons incorporated or constituted outside Hong Kong but managed or controlled in Hong Kong.

It normally takes 21 working days to process an application. Where the information available is not sufficient to determine the resident status, further information will be required by the IRD.

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If you need more information on our services (taxation, offshore profit claim and/or tax resident certificate), please email Manson at info@mansoncpa.com or whatsapp at 852 – 64628548.

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