Only profits which have a source in Hong Kong are taxable here. Profits sourced elsewhere are not subject to Hong Kong Profits Tax. Here is a breakdown of how the principle operates, if you wish to explore this subject more, please consult directly.
1) Hong Kong's basis of taxation on profits from businesses
Many countries levy tax on different basis, they tax the world-wide profits, including those received offshore. Hong Kong only charges profits that are derived from within the country.
2) Basic principles for determining the source of profits
Matter of fact: Determining locality of profits is hard, no universal rule can be applicable to all so it depends on the nature of the profits and the transactions that lead to the profits.
Operations test: Where did the taxpayer carry out the action to earn the profit.
Antecedent or incidental activities: The focus is to define the geographic location of the taxpayer’s profit-producing actions, and not the activities that were antecedent or incidental to those actions.
Place where decision is made: Although the daily business decisions matters, it is not necessarily the deciding factor.
Gross profits from transactions: The distinction between Hong Kong and offshore profits is made by reference to the gross profits from individual transactions.
Business presence overseas: Is there business presence overseas? In the majority of cases, the principle place is business may be located in Hong Kong, and profits earned are likely to be chargeable.
3) Profits of trading firms
For trading firms, the location of where the contract was “effected” is key. “Effected” does not only mean where the contract was legally executed, it also covers negotiation and conclusion.
In considering relevant facts, the nature and quality of the activities matter more than quantity. Irrelevant facts are facts not directly related to the trading activities, for example renting office premises and setting up office.
In practice, other things to note:
Where the sale is made to a Hong Kong customer (overseas customer with Hong Kong office), the contract is considered to be effected in Hong Kong
If the contract does not require traveling outside of Hong Kong but is carried out in Hong Kong by electronic channels i.e. internet/telephone, it is considered effect in Hong Kong
Trading profits are either wholly taxable or non taxable here. Apportionment is not allowed.
The profits arising from the sale of goods manufactured in Hong Kong are fully taxable here. If goods are partially manufactured in Hong Kong, the profits which relate to manufacture of goods outside will not be regarded as arising from Hong Kong. Where the good is sold is not relevant.
In Mainland, two types of processing trade involves Hong Kong companies. Contract and import processing.
Contract processing: The Hong Kong company is responsible for the raw materials, machinery, and know-how, the Mainland party is responsible for providing the factory, labour, and utilities.The Hong Kong company pays the Mainland party for subcontracting charges. The legal title to the raw material and finished goods belongs to the Hong Kong company. An apportionment of profits on a 50:50 basis is usually accepted.
Import processing: The manufacturing operations is 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. Apportionment of profits is not accepted.
Manufacturing by an independent sub-contractor in the Mainland of China
Where the assembly work is contracted to various contractors in the Mainland, the Hong Kong company has minimal involvement in the assembly work. Given that the Hong Kong company does not carry out any manufacturing operations outside Hong Kong, its profits should be fully chargeable. Apportionment is not accepted.
5) Sale or purchase commissions
When a business earns commission by securing buyers for products or by securing suppliers of products required by customers, the location in which the activities of the commission agent take place matters. If they are performed in Hong Kong, the income is from Hong Kong.
Where the principles are located or where incidental activities take place prior or subsequent to the earning of the commission will not be relevant.
Source: Inland Revenue Department https://www.ird.gov.hk/eng/paf/bus_pft_tsp.htm
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