Hong Kong adopts a territorial source principle of taxation. Profits sourced from OUTSIDE Hong Kong are not subject to Hong Kong Profits Tax. Or in other words, your company will pay 0% tax on all of its offshore profits. Sounds great right? Let’s continue the reading.
What are the tax rates for Hong Kong companies?
8.25%! It has already made Hong Kong one of the lowest tax cities in the world. And what is better than 8.25% tax? The 0% tax on all offshore profits!
What is an offshore claim?
Under the territorial basis, the profits tax is only charged on profits arising in or derived from Hong Kong. In simple terms, this means that a person who carries on a business in Hong Kong but derives profits from another place is not required to pay tax (i.e. 0% profits tax) in Hong Kong on those profits.
Remember that the offshore claim is a kind of “EXEMPTION”, which is not applied in default to your company even though all your company’s profit is sourced outside Hong Kong. The company has to apply for it in its yearly profit tax return.
Who is eligible to apply for an offshore claim?
Here are the circumstances that the companies have to meet to be eligible to apply for the offshore claim:-
- No Customers in Hong Kong
- No Vendors in Hong Kong
- No Physical Offices and Employees in Hong Kong
- No Contracts Negotiated or Concluded in Hong Kong
- No Properties in Hong Kong
- No Management Personnel Working in Hong Kong
- No Web Hosting in Hong Kong
- No Business Performed in Hong Kong
- No Warehousing/ Fulfillment/ Shipping in Hong Kong
IMPORTANT: The Hong Kong Inland Revenue Department (“HKIRD”) takes a “totality of facts” approach to determine whether the profit is taxable or not.
What kind of businesses can apply for offshore claim?
There is no rule limiting what kind of business or industry can apply for the offshore claim or not. Indeed, any company from any sector can apply for the offshore tax exemption if its profits do not derive from Hong Kong. The industry type can be Trading, Services, Retailing, Manufacturing, etc.
Here are some typical businesses that might meet the offshore claim:-
- E-Commerce, selling on Amazon, Shopify
- Digital Marketing Services
- Online Software Sales
- Mobile App Sales
- Consulting Services
- Rental from overseas Real Property
- Security Trading/Investment
- International Trading
What will happen after the application of the offshore claim?
Tax investigation
The HKIRD will raise the tax Investigation to the Company when they note the offshore claim application from the Company’s Profit Tax Return. The investigation will work by physical letter(s) to the Company directly, asking for additional detailed information and supporting documents. The Company has to reply to the HKIRD by physical letter(s) with the print supporting documents in 1-2 months.
Depending on the potential tax amount under the offshore claim, the HKIRD would typically issue the enquiries to the company three years at once, covering three financial years. In some cases, the HKIRD would do the yearly assessment of the company’s offshore status.
What enquiries will HKIRD raise for the offshore claim?
Company’s background
The HKIRD will require the company to provide very detailed information with supporting documents to prove its source of profits. That covers almost even part of the business. Here are some common areas the HKIRD would ask for:-
- Operation cycle
- Nature of business
- Customer base
- Suppliers base
- Place of the central management
Transactions details
The HKIRD would also select some transactions for detailed review. See the typical documentation they would require includes, but is not limited to:
- The correspondence with customers and suppliers that was related to the specific transactions (e.g. email, fax, telephone calls)
- The passport traveling records of the management or the key personnel in the company
- Purchase invoices, contracts
- Sales invoices, contracts
- Shipping documents for products sales
The HKIRD has the power to determine and approve the offshore status of a company. There is also a chance that the IRD will reject the offshore claim requests.
What to do when the company receives the HKIRD’s enquiry letter?
Reply by yourself
The Company can reply by itself if the director is knowledgeable of the tax rules and regulations. The HKIRD will ask for the company background information details like the operation cycle and flows in their inquiry letter. It is highly recommended to have the company’s director(s) answer these questions directly.
Seek professional advice
More commonly, the Company should appoint a tax expert as their tax representative to help outline the answer and directly reply to the HKIRD. That is an essential step while there are a lot of technical points involved in the tax enquiry that should require high-level knowledge of the Hong Kong tax rules.
What is the timeline of offshore claim?
Timeline for application
The company should claim offshore profits tax exemption when submitting the yearly profits tax return* and Audit Report.
*The IRD generally issues profits tax returns on the first working day of April of the following assessment year. The first profit tax return for a newly incorporated business is usually issued around the 18th month after its incorporation.
Timeline for investigation
Depending on the potential tax amount, the HKIRD would generally issue the enquiries by physical letters to the company for three years at once, covering three financial years. Once the company receives the enquiries letter, the company must reply to the HKIRD by physical letter(s) with the print supporting documents within 1-2 months.
The time frame of the tax investigation depends on the complexity of the company’s businesses. The HKIRD would raise multiple rounds of enquiries towards the claim until they feel satisfied with the proof of the company’s offshore nature. Including the response time between the HKIRD and the applicants, the whole processing time of the offshore enquiries might last for over 6 months.
Timeline for approval
The offshore status maintains its effect generally for 3 years, and the audit report should be filed to the HKIRD as a sign of staying offshore. If there are any changes, you should mention those in the auditing reports.
Is it easy to get an offshore claim?
The offshore claim is the game of facts proving. The applicants are responsible for providing valid information and supporting documents to support their offshore status. The HKIRD has the right to reject the offshore claim application due to the lack of evidence.
Also mentioned above, the HKIRD would require the company to provide the documentation and information comprehensively when determining whether the company’s profits are offshore by nature.
So, the company needs to keep complete records to prove the company’s income is not Hong Kong sourced.
What are the costs of offshore claim?
Time cost
As mentioned above, good documentation is the key to getting the application successful. Therefore, the company might take extra time to keep and manage all the correspondence of their transactions.
Professional cost
There are a lot of technical questions around the Hong Kong tax law in HKIRD’s enquires letter(s). The company might need to seek advice from a tax expert and will incur a particular professional cost.
What are the risks of offshore claim?
Tax implications outside Hong Kong
In this tax-transparent century, when the company’s profits tax is exempt from Hong Kong, a tax in another country may arise instead. Especially under the Tax Information Exchange Agreements, Hong Kong has signed deals with different governments, giving the country that the company is operating in the right to request the HKIRD to exchange the company’s tax information that it has filed in Hong Kong.
In other words, there is a possibility that the tax authorities of another country request the HKIRD about the background of an offshore tax claim to administer their local tax regulation.
Failure of the offshore claim
The HKIRD has the power to determine and approve the offshore status of a company. As a result, the company will be subject to 100% profits tax. A typical example is the lack of documentary evidence.
Conclusion
The offshore claim is an attractive tax system due to the 0% profits tax. However, many companies underestimate the complexity of the offshore claim. Indeed, many preparations work and processes to make a claim successful, like documentation management and tax investigation.
Reachtop KSHK CPA
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