HONG KONG SAR – Media OutReach – 8 August 2022 – Hong Kong is famous for its simple taxation system and low tax rate, and its territorial taxation concept has attracted many Mainland China enterprises and multinational corporations (MNCs) to set up trading companies in Hong Kong. For MNCs, Hong Kong is the platform for the Mainland China market, while for Mainland China enterprises, Hong Kong is the platform for export sales. Under the territorial source concept, the Hong Kong trading company may pursue an offshore claim for exemption of profits tax. Cheng & Cheng Taxation Services Limited (Cheng & Cheng Taxation) reveals in this article the nine “additional” challenges may be raised by the Inland Revenue Department (IRD) when approving such a claim.
Pursuant to Section 14(1) of the Hong Kong Inland Revenue Ordinance (IRO), a profit is subject to Hong Kong Profits Tax under the following circumstances:
For trading profits, the basic principle used is the “contract effected test”. When both sales and purchase contracts are effected outside Hong Kong, the trading profits would be considered as offshore sourced and therefore not subject to Hong Kong Profits Tax. The recent judgement handed down in the Newfair Holdings Limited v Commissioner of Inland Revenue case has reconfirmed the above principle. (You may refer to our April 2022 Newsletter for more details: Court continues Hang Seng Bank case principle in determining source of profits [https://henrykwongtax.com/newsletter/court-continues-hang-seng-bank-case-principle-in-determining-source-of-profits/]).
Many taxpayers believe that they have no Hong Kong Profits Tax liabilities when they do not physically travel to Hong Kong to carry out business activities
Based on the contract effected test principle, if none of the sales and purchase contracts are effected in Hong Kong, the taxpayer should have no Hong Kong Profits Tax liabilities. However, in practice, the Hong Kong IRD has been taking a stringent approach to reviewing offshore claims and will consider not only the trading arrangements but also other business activities carried out by the taxpayer.
Pursuant to Paragraph 21 of Departmental Interpretation and Practice Notes 21 (Revised) (DIPN 21), the following business activities will be considered in determining the source of trading profits:
If any of the above activities are carried out in Hong Kong, the IRD will likely consider that the trading profits are taxable in Hong Kong.
To facilitate the offshore claim tax planning of trading companies, we have identified nine potential challenges raised by the IRD when reviewing offshore trading profits claims. Taxpayers should take all nine factors into account should they wish to pursue an offshore claim in Hong Kong.
Nine potential challenges faced by taxpayers pursuing an offshore claim in Hong Kong
Under the IRO, the burden of proof lies with the taxpayer in Hong Kong. Submitting all the required documents and information in response to the IRD’s enquiry letter is the prerequisite for a successful offshore claim. Some examples of documentary evidence for a trading profit offshore claim are illustrated in Appendix 3 of DIPN No 31 (https://www.ird.gov.hk/eng/pdf/dipn31.pdf).
Taxpayers who intend to pursue an offshore claim in Hong Kong are encouraged to collate a set of supporting documents on a representative trading transaction for the review of their tax advisors. Their finance departments should then communicate with the sales, procurement and operations departments to maintain the necessary business records to avoid or defend against any challenge by the IRD.
The elevated importance of tax planning
Enhance the chance of success of an offshore claim
Although Court decisions are seemingly in favour of taxpayers, the IRD has recently taken a more stringent approach to handling offshore claims. Taking a case to Court is never desirable, given the significant economic and time costs that are incurred, and should be considered as a last resort when it comes to a tax dispute with the IRD.
Taxpayers are therefore encouraged to take into account the nine challenges raised in this article in their tax planning, and to seek advice from their tax advisors to ensure that the most appropriate measures are taken at the inception of the trading operations.
Overseas tax exposure
The OECD’s Automatic Exchange of Financial Account Information (AEOI) and Common Reporting Standard (CRS), of which Hong Kong is a participant, are designed to elevate the transparency of foreign tax exposure, one expected outcome of which is to make double non-taxation increasingly difficult. Taxpayers who have not paid tax in their operating jurisdictions should consult their local tax advisors on their permanent establishment risk arising from any offshore claim.
Hashtag: #Cheng&ChengTaxationServices
The issuer is solely responsible for the content of this announcement.
This article is by Henry Kwong, Tax Partner of Cheng & Cheng Taxation Services Limited. Cheng & Cheng is one of the top 20 accounting firms in Hong Kong, with over 250 staff in Hong Kong and Mainland China. We are the principal auditor for around 20 listed corporations in Hong Kong and the tax advisor for over 100. We specialise in providing Hong Kong, Mainland China and international tax advisory services, as well as transfer pricing services to international clients. If you would like to know more about transfer pricing in Hong Kong, or seek tax advice from our tax experts, please do not hesitate to contact us by email (henry.kwong@chengtax.com.hk) or phone (+852 5600 1980).
SL25 recognises and celebrates the 25 best projects of steward leadership excellence by for-profit organisations.…
HONG KONG SAR - Media OutReach Newswire - 2 May 2024 - On 30 April…
KUALA LUMPUR, Malaysia--(BUSINESS WIRE)--#airtransport--Milrem Robotics, Europe’s leading robotics and autonomous systems developer, is to introduce…
DUBLIN--(BUSINESS WIRE)--The "Singapore Loyalty Programs Market Intelligence and Future Growth Dynamics Databook - 50+ KPIs…
DUBLIN--(BUSINESS WIRE)--The "Thailand Loyalty Programs Market Intelligence and Future Growth Dynamics Databook - 50+ KPIs…
Identified for innovative, AI-driven solutions that drive business transformation SAN MATEO, Calif.--(BUSINESS WIRE)--SnapLogic, the leader…