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Hong Kong Company: Offshore Tax Exemption on Foreign Income
Hong Kong has one of the world’s lowest taxes and foreign-sourced income (or offshore funds) is exempt from tax due to its territorial source principle for taxation. Incorporating a company in Hong Kong is, therefore, a significant advantage for many international companies looking to reduce taxation costs.
Offshore Tax Exemption in Hong Kong
Hong Kong is a good offshore tax shelter as companies looking to reduce tax costs can move their money into Hong Kong to avoid paying taxes. This strategy makes use of legal ways to defer taxation on investments.
Companies in Hong Kong are under the jurisdiction of the Inland Revenue Ordinance (IRO) and will be subject to profits tax only if:
- The profits are derived in or from Hong Kong,
- The company carries on a trade, profession or business in Hong Kong,
- The trade, profession or business derives profits.
Due to Hong Kong’s territorial source principle of taxation, the profits tax is not applicable to profits that are sourced from outside of Hong Kong. Therefore, a company’s foreign-sourced income and offshore profits will be exempt from tax. However, a company will only qualify for offshore tax exemption if it carries out all its activities outside of Hong Kong.
According to Hong Kong’s regulations, a company is an offshore company if:
- It has no customers or suppliers in Hong Kong,
- The owner or employees of the business entity operate their Hong Kong company solely outside of Hong Kong,
- It provides no services in Hong Kong,
- Its services and products are not available in Hong Kong,
- Its day-to-day business decisions and service agreements are signed outside of Hong Kong,
- It has no employees based in Hong Kong, and the owner or any overseas employees rarely visit Hong Kong,
- Its products do not enter Hong Kong.
New offshore tax system for MNE entities
On 1 January 2023, the Inland Revenue (Amendment) (Taxation on Specified Foreign-sourced Income) Ordinance 2022 (the Amendment Ordinance), which amended the provisions in relation to the Foreign Source Income Exemption regime under the Inland Revenue Ordinance (Cap. 112) (IRO) came into effect.
The new tax regime seeks to tackle tax avoidance arising from double non-taxation and targets entities that are part of a multinational group (MNE entities) which receive certain foreign-sourced income in Hong Kong but have little economic substance in Hong Kong.
Specified foreign-sourced income such as dividend, interest, intellectual property income and disposal gain in relation to shares or equity interests received in Hong Kong will be deemed to be sourced from Hong Kong and taxable if the income is received in Hong Kong by an MNE entity which fails to meet applicable exceptions.
Individuals and standalone local companies are not affected by the revised tax rules.
Procedure for Claiming Offshore Tax Exemption
Companies should lodge their claim for offshore tax exemption together with their submission for Profits Tax Return (PTR) and their audit report. Hong Kong’s Inland Revenue Department (IRD) typically issues the PTR in April and soon after the end of the fiscal year of assessment. Newly incorporated companies will only receive their first PTR notice from the IRD 18 months after the incorporation date. Subsequent PTRs should be received after every 12 months.
Processing the claim for offshore tax exemption will take several months and the IRD will need to examine several documents and details for their investigation. Their final decision will depend on the data they have gathered and the length of their investigation varies according to the company structure – larger companies and public companies are likely to take longer.
The process undergone by the IRD will be as follows:
- The IRD inspects the submitted documents from the company claiming offshore tax exemption with their Corporations and Partnerships Unit,
- Their Unit of Field Audit and Investigation might then be involved in the procedure if there are any signs of tax elimination,
- The IRD starts to make a decision on whether a company should be tax-exempted based on the company’s documents and data gathered from the investigation,
- If the investigation goes smoothly, a letter of offshore tax exemption will then be granted to the company.
Once grated offshore tax exemption, a company will be able to maintain its offshore status for a maximum of 3 to 5 years. However, the company will still need to perform annual auditing to provide to the IRD that the company’s business activities Hong Kong remain offshore.
Documents Required
The IRD will request the following documents:
- A completed copy of the Profits Tax Return
- An auditor’s report
- Tax computations from claiming offshore tax exemption (only if applicable)
In order to complete an auditor’s report and other procedures, auditors will require the following documents:
- Company’s invoices and contracts
- Bank statements
- Expense receipts
To ensure that the IRD’s investigation for offshore tax exemptions goes smoothly, it is recommended that a company maintains all its records to show that its business transactions and activities all take place outside of Hong Kong.
Should the IRD ask a company to provide additional documents and information to support their claim for offshore tax exemption, a company should be able to provide documents and records such as:
- Memos of meetings with customers and suppliers.
- Receipts or copies of purchase orders, sales orders and shipping documents.
- Itemized phone bills, emails, faxes that can provide which numbers calls are made to clients/suppliers (and also helps to prove the location of clients and suppliers).
- Location chart that shows the operation of offshore businesses.
- Travel receipts and/or passport copies that contain information on the locations and dates of a visit from company members.
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