Corporate Income Tax Planning in Hong Kong
Paying taxes may be one of the unavoidable realities of doing business. It is essential to understand the tax regulations and reliefs available in order to remain compliant with the relevant laws.
As you may be aware, offshore profits are tax exempt in Hong Kong. Taxation in Hong Kong is based on the territorial source principle instead of the residency status. Profits Tax is only charged on profits which arise in or are derived from Hong Kong. A person who carries on business in Hong Kong but derives profits from another place is not required to pay tax in Hong Kong. Although this principle appears to be clear, it can be contentious in the actual application for certain cases.
The Hong Kong Inland Revenue Department has issued some basic principles as guidelines:
- The question of locality of profits is a hard, practical matter of fact. There is no universal rule to cover every case. Whether profits arise in or are derived from Hong Kong depends on the nature of the profits and the transactions giving rise to them.
- The broad guiding principle is to see what the taxpayer had done to earn the profits in question and where he has done it. In other words, the proper approach is to determine what were the operations that produced the profits and where these operations took place.
- The distinction between Hong Kong profits and offshore profits is made by reference to gross profits arising from individual transactions.
- In certain situations, where gross profits from an individual transaction arise in different places, they can be apportioned as arising partly in and partly outside Hong Kong.
- The place where day-to-day business decisions take place is only one factor which has to be taken into account in determining the source of profits. It is not usually the deciding factor.
For different nature of profits, the relevant factors used in ascertaining the source of profits can vary.
Locality of Trading Profits
The location of where the contracts are effected is crucial in determining the source of trading profits ‘Effected’ does not only mean the place of signing the contract. It also includes the place where a particular contract is negotiated, concluded and enforceable. Factors like renting office premises, recruiting general staff, setting up office etc are not considered to be relevant in ascertaining the locality of trading profits as they are not directly related to the trading activities.
Locality of Manufacturing Profits
The place where the goods are manufactured is an indication of the source of profits for a manufacturing business. Profits are fully taxable which are generated from the sale of goods manufactured in Hong Kong. In the case where goods are manufactured partially in Hong Kong and partially outside Hong Kong, the portion of the profits relating to the manufacture of goods outside Hong Kong will not be regarded as being generated in Hong Kong. Do note that the place where the manufactured goods are being sold is not relevant.
Locality of Service Profits
The place where services are being rendered is the key factor for deciding where service income is sourced. Service fees for services performed in Hong Kong are taxable.
Locality of E-commerce Profits
For an e-commerce business, factors including places where merchandises are stored and delivered by the person, services are provided, payments are made and received, purchases and sales are made, bank accounts are maintained, and business back-up services are provided should be considered in determining whether the e-commerce business is carrying on a trade or business in Hong Kong. It is the location of the core physical business operations, rather than the location of server alone, that determines the locality of profits. It is after all the management and control exercised by humans in the physical office that makes the server become functional. A company having its business operations in Hong Kong, apart from the server for e-commerce being located outside Hong Kong, will be liable to profits tax.
For companies seeking tax exemption on offshore profits, it is essential to maintain documentary evidence to substantiate that the profit producing activities were indeed sourced outside Hong Kong.
Below are some pointers for a company in a tax paying position to note for consideration:
In a Tax-paying Position
- The possibility of declaring director fees can be considered if such arrangement offers potential tax savings. This may be achieved through proper tax planning which involves the comparison of effective tax rates. Attribution basis of remuneration should be of commercial substance and be aligned with economic reality i.e. type of work done, the amount of work contribution, and the extent of each director’s responsibility in the running of the business. Tax savings should not be the sole objective.
- Companies may also consider debt financing over equity financing as interest expenses can be tax deductible.
- Review may be conducted on the outstanding debts to write off long overdue debts.
- Companies may re-assess the accounts to identify the omittance of any accrual expenses.
- Ensure that tax deductions have been maximized, for example, 100% immediate deductions for prescribed fixed assets, certain R&D expenditure may qualify for additional deductions above the normal 100% deduction.
It is important to manage your business decisions with the income tax implications effectively. At 3E Accounting, we work closely with you to identify the best tax strategies for your organisation while managing your tax compliance.
Contact us today at firstname.lastname@example.org for a no-obligation consultation!