Hong Kong has long been a popular tax haven jurisdiction, along with the British Virgin Islands or the Cayman Islands. Compared to other tax friendly jurisdictions however, Hong Kong also has a highly developed legal, regulatory, and financial framework. For these reasons, many companies often choose Hong Kong as their primary offshore jurisdiction to set up a base of operations, where the profits of the company may be considered tax-free.
Hong Kong uses a territorial basis tax system, meaning that only tax income made within Hong Kong is taxed, and Income that was made outside Hong Kong can be tax exempt if an offshore profits claim is made.
What is an Offshore Profits Claim?
To attract large corporations to set up a branch in the city, Hong Kong implemented the profits tax exemption to allow companies filing their profits tax to claim their offshore income as being tax free.
However, there are numerous factors that need to be considered when Hong Kong’s tax authority, the Inland Revenue Department (IRD), determines whether the company and their claimed income can qualify, as different industries have varying standards for what qualifies. In general, there are three conditions that all companies must meet to qualify.
The Three-Condition Test
The IRD uses a basic Three-Condition test to determine whether a company should be paying taxes in Hong Kong, also known as the basic test for liability to profits tax. They are:
- The person or company must carry on a trade, profession, or business in Hong Kong.
- The profits to be charged must be directly from that trade, profession or business carried on by the person or company in Hong Kong.
- Those same profits must be derived from Hong Kong.
The third condition of the basic test is the main deciding principle that determines whether a company can make an offshore claim on their income, according to the IRD’s official tax note “Departmental Interpretation And Practice Note 21”. The note also lists rules for different the natures of business, activities, and industry of the company, as illustrated below..
| Business Activity | Department’s View on Source of Profits |
| Trading Profits | The source of trading profits are determined by where the profit-producing activities are carried out, such as where contracts are negotiated, where the employees servicing the contract are located, and where the management of the company works. |
| Service income | The source of income made from providing services is the location where the services are provided. |
| Manufacturing Profits | Where the manufacturing process takes place is the key factor in determining the source of profits, rather than the location of sale, shipment or other ancillary activities. |
| Re-invoicing Centre | Profits from a re-invoicing operation are sourced where the essential profit-producing activities take place, such as the negotiation, conclusion and execution of the contracts. |
| Buying Office | Profits are sourced where the buying activities (negotiation, conclusion and execution of contracts) take place, rather than where the goods are shipped to or resold. |
| Contract Processing | Profits are sourced where the contract processing activities are carried out, rather than where the raw materials are supplied from or where the processed goods are delivered to. |
| Import Processing | Similarly, the source of profits is where processing activities take place, not where the raw materials are obtained or the processed goods are sold. |
| Group Service Companies | The source of profits will depend on where the service activities that generate the profits are performed. |
| Agency fee | The source of agency profits depends on where the agent’s activities that generate the commission take place. |
The Note emphasizes that the source of profits must be determined on a case-by-case basis. This is why the IRD will often consider the totality of the profit-making activities and where they are carried out, before making a final judgement.
Read More: How to File a Profits Tax Return
The Process of filing for an offshore claim
How long the offshore claim process takes differs from claim to claim, but it all generally follows the same steps:
- Split your company’s income from onshore and offshore. The company needs to report its onshore and offshore income separately.
- Aggregate all documentation for income considered offshore.This information may need to be submitted as supporting documentation to the IRD on request.
- Submit the offshore claim when you make a profits tax filing. While filling out the profits tax return, in Part 10, lines 59 to 61, enter the amount of income which the company will be claiming as offshore. If all of the company’s operations take place outside of Hong Kong, then the entire income of the company would be entered here.The amount of income to be claimed as offshore profit should be entered in Part 10 of the profits tax return and in the accompanying tax computation, with a supporting rationale on the claim.
Part 10 of the Profits Tax Return - Be prepared to answer the IRD’s enquiries. The IRD may issue an enquiry letter 6-8 weeks after submission to follow-up, requesting supporting documentation and further clarification dependent on the complexity of the claim and the company’s response.
- IRD will issue a final judgement on the case. Successful claims have a validity period of 3 years, during which time the same claimed income will be accepted as offshore. Note that the company must still file the offshore claim for said income each year.
Advance Ruling – Process & Fees
An Advance Ruling allows companies to receive advance confirmation from the Hong Kong tax authorities on whether a specific income transaction would be taxed in Hong Kong. This is a useful process for multinational companies that need clarity while tax planning. To apply, companies that submit detailed information on specific transactions to the IRD will issue a written response on whether they will tax this income or not. However, advance rulings can be a costly process.
The Advance Ruling Process for offshore profits claims
To apply for an advance ruling, a company must submit a written application along with the following supporting documentation:
- Detailed information and supporting documents about the specific proposed arrangement or transaction.
- Information about the parties involved, the relationship between the parties, the commercial and financial details of the parties
The Advance Ruling Fees for offshore profits claims
The application fee for offshore profits claims advanced ruling is HK$45,000, covering up to 23 hours of work by IRD staff. Complex transactions or insufficient information provided causing IRD staff to use more than the allotted 23 hours will incur further hourly fees ranging from HK$1,730 to HK$2,650 per hour.
Other Rules for Claiming Offshore Profits Tax
Multinational corporations may also need to apply for exemptions from the Foreign-Sourced Income Exemption (FSIE), a regime designed to prevent global tax evasion by multinational entities across multiple tax-free jurisdictions. Coupled with the new rules on disclosing the business owner’s tax residency, companies must be more diligent than ever in planning their tax strategy.
Conclusion
The Hong Kong profits tax offshore claim provides a valuable tax exemption for companies that can demonstrate their profits were earned outside of Hong Kong. However, the process of making an offshore profits claim can be complex and often requires quite a bit of expertise in tax regulation, which is why companies often consult practicing CPAs for the best course of action.
Yau and Wong CPA brings a wealth of experience to the table invaluable to your tax strategy, with offshore profits claim fees starting from US$250. If you’re looking for help navigating offshore profits tax claims, drop us a message and we’d be happy to help!
