There is tax exemption if we set up offshore companies?
Absolutely not! Conversely, Hong Kong companies that meet the requirements of the Offshore claim can be exempt from Hong Kong Profits Tax.
Hong Kong adopts a territorial source principle of taxation. Only profits which have a source in Hong Kong are taxable here. Profits sourced elsewhere are not subject to Hong Kong Profits Tax.
Under the Inland Revenue Ordinance, a person is chargeable to Profits Tax under the following conditions
he carries on a trade, profession or business in Hong Kong;
the trade, profession or business derives profits; and
the profits arising in or are derived from Hong Kong.
Offshore profits claim
Based on the prevailing practice of the Hong Kong Inland Revenue Department (IRD), the first lodgement of offshore profits claim will be assessed by the IRD in details. No annual assessment will normally be conducted by the IRD once the offshore profits claim is agreed.
As the Companies are not subject to Hong Kong Profits Tax under the offshore profits claim, the potential tax savings for applying the offshore profits claim is enormous. The Inland Revenue Department will check whether there are any changes in the mode of operation in relation to the offshore claim of the applicants on a regular basis only few years after a successful application.
Eligibility for Exemption: Companies need to demonstrate to the Hong Kong Inland Revenue Department that their profits originate from outside Hong Kong. Generally, companies must show that their core business activities and transactions take place outside Hong Kong to ensure that the profits qualify for the exemption.
Exemption Application Process: Companies must complete the relevant offshore profits exemption section when submitting their profits tax return. If the tax authorities have any questions about the application information, the company will need to provide sufficient evidence to support the exemption application, such as contracts, invoices, and descriptions of business processes.
Post-Exemption Tax Compliance: After obtaining the offshore profits exemption, companies must still maintain compliance with Hong Kong tax regulations and submit profits tax returns regularly. If there are any changes in the company's business circumstances that might affect the exemption eligibility, the tax authorities should be notified promptly.
Our team of tax specialists will help you determine whether you qualify for the offshore profits exemption and assist you in completing the relevant application process. Additionally, we will provide ongoing tax advisory services to ensure your company remains compliant and takes full advantage of tax benefits.
Foreign Source Income Exemption (FSIE)
Starting from 1 January 2023, the difficulty in applying offshore profits claim would be increased significantly due to the enactment of the FSIE regime in Hong Kong under the pressure of EU and the compliance with the action points of BEPS proposed by OECD.
OECD and EU consider some companies receiving passive income do not have sufficient economic substance and there may be potential risks of double non-taxation.
In short, company receiving passive income (for instance, interest, dividend, disposal gain on interests in equity or royalty income) may require substantial economic substance or activities before applying offshore profits claim.
How to determine whether the source of profit originates from the basic principles of Hong Kong
As there are lot of controversies in the operation of the law, the court has ruled on the issue of the source of profits, thus becoming an authoritative reference case for other taxpayers in the future:
1. Matter of fact
The question of locality of profits is a hard, practical matter of fact. No universal rule can apply to every scenario. Whether profits arise in or are derived from Hong Kong depends on the nature of the profits and of the transactions which give rise to such profits.
2. The operations test
The broad guiding principle is that one looks to see what the taxpayer has done to earn the profits in question and where he has done it. In other words, the proper approach is to identify the operations which produced the relevant profits and ascertain where those operations took place. The source of profits must be attributed to the operations of the taxpayer which produce them and not to the operations of other members of the taxpayer's group.
3. Antecedent or incidental activities
The relevant operations do not comprise the whole of the taxpayer's activities. The focus is on establishing the geographical location of the taxpayer's profit-producing transactions as distinct from activities antecedent or incidental to those transactions.
4. Place where decision is made
The place where the day-to-day investment/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.
5. Gross profits from transactions
The distinction between Hong Kong profits and offshore profits is made by reference to the gross profits arising from individual transactions.
6. Business presence overseas
A business may maintain a presence overseas which earns profits outside Hong Kong but the absence of a business presence overseas does not, of itself, mean that all the profits of a Hong Kong business invariably arise in or are derived from Hong Kong. However, in the vast majority of cases where the principal place of business is located in Hong Kong and there is no business presence overseas, profits earned by that business are likely to be chargeable to Profits Tax in Hong Kong.
Further, there are different deterimination factors for different industries:
A. Profits of trading firms
B. Profits of manufacturing businesses
C. Service fee income
A. Profits of trading firms
The factor that determines the locality of profits from trading in goods and commodities is generally the place where the contracts for purchase and sale are effected？
Where are the goods purchased？
Where the goods are stored？
How to liasise the contracts？
How to handle the purchase / sales order？
How to deliver the goods？
How to arrange the financing？
How to arrange the pament term？
Trading profits are regarded as being either wholly taxable or wholly non-taxable here. Apportionment is not appropriate.
B. Profits of manufacturing businesses
The source of profits for a manufacturing business is the place where the goods are manufactured. The profits arising from the sale of goods manufactured in Hong Kong are fully taxable here. Where goods are manufactured partly in Hong Kong and partly outside Hong Kong, that part of the profits which relates to the manufacture of goods outside Hong Kong will not be regarded as arising in Hong Kong. The place where the manufactured goods are sold is not relevant.
In contract processing, the document that governs the contractual relationship among the parties is the processing agreement. It sets out the rights and responsibilities of the Hong Kong company and the Mainland processing enterprise. The Hong Kong company is responsible for the supply of raw materials and machinery without consideration and to provide technical know-how while the Mainland processing enterprise is responsible for the provision of factory premises, utilities and labour force. In return for the processing service, the Hong Kong company pays a subcontracting charges to the Mainland enterprise. The legal title to the raw materials and finished goods remains with the Hong Kong company.
Strictly speaking, the Mainland processing enterprise is a separate sub-contractor distinct from the Hong Kong company and the question of apportionment in respect of the latter's profits should not arise. In the Department's view, the Hong Kong company's operations in the Mainland complement its operations in Hong Kong. Recognising the operations of the Hong Kong company in the Mainland, an apportionment of profits on a 50:50 basis is usually accepted.
In import processing, the manufacturing operations are 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 from the FIE. The Hong Kong company engages in the trading of raw materials and finished goods whilst the FIE manufactures the finished goods. The legal title to the raw materials and the finished goods passes to/from the FIE.
The Departments holds the view that the profits which accrued to the Hong Kong company from "trading transactions" carried out in Hong Kong cannot be attributed to the manufacturing operations of the FIE carrying on business in the Mainland. The source of the trading profits must be attributed to the operations of the Hong Kong company which produced them. Apportionment of profits is not appropriate.
C. Service fee income
Any portion of services are rendered outside of Hong Kong?
Any overseas agents or overseas service providers involved?
Any service agreements as supporting?
As illustrated in the above, offshore profits claim is complicated tax services. Accurate description of the mode of operation of the business, sufficient supporting documents and the technical analysis of the case are required for the lodgement of an offshore profits claim. Hence, tax professionals with extensive tax experience are highly recommended to increase the chance of offshore profits claim.
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