Hong Kong adopts a territorial basis for taxing profits derived from a trade, profession, or business carried on in Hong Kong. In other word, a company who carries on a business in Hong Kong but derives profits from another place is not required to pay tax in Hong Kong on those profits.  Profits tax is not applicable to profits whose source is outside Hong Kong.

Offshore Income Tax Exemption: Key Considerations

1. Basis of Taxation:

  • Territorial System: Only profits sourced in Hong Kong are taxable. Offshore profits are exempt, even if managed via a Hong Kong bank account.

2. Determining Profit Source:

  • Operations Test: Focus on where profit-generating activities occur. Key factors include contract negotiations, execution, and logistics.
  • Trading Firms:
    • Contract Location: Profits are taxable if purchase/sale contracts are “effected” in Hong Kong (negotiated, concluded, executed).
    • Presumption: If either purchase or sale is in Hong Kong, profits are presumed taxable unless proven otherwise.
    • Electronic Transactions: Contracts conducted remotely from Hong Kong (e.g., via email/phone) are deemed Hong Kong-sourced.
  • Service Businesses: Source is where services are physically performed. Offshore services are exempt.

3. Offshore Exemption Application:

  • Documentation: Submit with first Profits Tax Return, including financial statements, auditor’s report, tax computation, and exemption claim.
  • IRD Scrutiny: Expect requests for detailed evidence (e.g., transaction records, communication logs, travel documents).

4. Critical Evidence for Offshore Claims:

  • Contract Execution: Proof of negotiations/signings outside Hong Kong (e.g., emails, meeting memos).
  • Logistics: Shipping documents showing goods bypassed Hong Kong.
  • Staff Activity: Travel receipts, passport stamps, and offshore office records.
  • Communication: Itemized bills/emails showing interactions with overseas entities.

5. Common Pitfalls:

  • HK Bank Transactions: Funds received in Hong Kong accounts do not determine taxability; source of profit is key.
  • Administrative Presence: General admin in Hong Kong (non-profit-generating) doesn’t negate offshore claims but requires clear separation from operational activities.

6. Structuring for Exemption:

  • Offshore Operations: Use overseas agents/staff for negotiations, signings, and logistics.
  • Third-Party Logistics: Avoid Hong Kong in supply chains.
  • Substance Over Form: Ensure actual operations align with offshore claims, not just contractual terms.

7. IRD Considerations:

  • Decision-Making: While the location of business decisions is a factor, operational activities are prioritized.
  • Random Audits: Be prepared for detailed reviews of selected transactions to verify offshore activities.

Conclusion:
To secure offshore tax exemption, companies must demonstrate through meticulous documentation that profit-generating activities (contracts, services, logistics) occur outside Hong Kong. Proper structuring and record-keeping are essential to satisfy IRD requirements.

Link: How to Qualify for Offshore Tax Exemption in Hong Kong