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Tax Law & Practice

Since Hong Kong only taxes Hong Kong source income it will be relevant to consider factors for determining whether an item of income has a source in Hong Kong.

 

In general, factors to consider in determining source depend on the nature of the income. Following is a summary of matters to consider and planning opportunities for structuring tax efficient transactions with respect to each type of income.

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Trading

The Law

To determine the source of profits derived from the sale of goods, generally it will be relevant to consider the location where negotiation and conclusion of both the sale and purchase contracts were carried out.  If it can be demonstrated for a fact that negotiation and conclusion of both sale and purchase contracts took place outside Hong Kong, there is a basis to claim that such trading profits are sourced outside Hong Kong and are not taxable in Hong Kong.

 

The Hong Kong Inland Revenue Department (IRD) will as a matter of course request support evidence before agreeing offshore trading profits.  Consequently, structuring offshore trading profits required appropriate planning and proper implementation.

Planning Opportunities

 

Considering the realities of activities involved in consummating trading contracts by international traders, Hong Kong tax rules as set out above present Hong Kong as an ideal location for setting up international or regional trading operations.  The fact that Hong Kong is an international financial center with an excellent infrastructure and workforce further enhances the proposition.

 

Where a Hong Kong company derives both Hong Kong and non Hong Kong source trading profits, only Hong Kong source trading profits are taxable in Hong Kong.  General overhead expenses are allowable to Hong Kong and non Hong Kong profits to determine the quantum of income subject to tax.

 

Generally, so long as it can be demonstrated for a fact that activities with respect to negotiation and conclusion of both sale and purchase contracts took place outside Hong Kong, administrative support, such as banking, shipping and accounting even though undertaken in Hong Kong, will not prejudice the company’s claim that it derived non Hong Kong profits.

 

Hong Kong tax law also favours the use of Hong Kong companies for international trading operations which have no presence in Hong Kong whatsoever. Again, so long as the company is able to support the facts that all of its profits are derived from trading activities carried on outside Hong Kong, profits therefrom will not be liable to tax in Hong Kong.

 

An alternative, where trading activities are in fact carried on outside Hong Kong, will be to use an offshore company to carry on the international trading operations. This will eliminate the need to provide the IRD with information and evidence in support of an offshore trading position.

 

Regardless of whether an offshore or Hong Kong company structure is used.  Due care would need to be exercised to ensure that the offshore trading position is valid.

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Services

The Law

Where income is derived from the provision of services, whether the income has a source in Hong Kong will depend on the location where services were rendered.

 

Where services were rendered outside Hong Kong, income therefrom will not be considered as having a source in Hong Kong.  Such income is not subject to tax in Hong Kong.  It will be prudent to ensure that sufficient evidential matters are available to support the tax filing position.

Planning Opportunities

 

Based on the rules set out above, there will be many opportunities where a Hong Kong company may be used to derive income from services rendered outside Hong Kong.  Income derived from services which are clearly rendered outside Hong Kong is not liable to tax in Hong Kong.

 

Where services are rendered partly in Hong Kong and partly outside Hong Kong, it will be advisable to structure two service contracts, one for services in Hong Kong and the other for services outside Hong Kong.  This structure will insulate income from services rendered outside Hong Kong from tax in Hong Kong.

 

Where a corporation which derives income in Hong Kong is required to carry out any part of its activities outside Hong Kong, consideration may be given to setting up a separate offshore entity to carry out activities outside Hong Kong. The corporation will enter into an agreement with the offshore entity whereby the offshore entity will provide the required services outside Hong Kong for a fee.  It is important that the services are in fact rendered outside Hong Kong and the fee is commercially justifiable and determined on an arms length basis.  This arrangement if properly structured, will result in the corporation being able to claim the fee as a deductible expense against its Hong Kong profits.  The offshore entity will not suffer any Hong Kong tax on the fee income since services are provided entirely outside Hong Kong and consequently the fee income does not have a source in Hong Kong.

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Intellectual Properties

The Law

Where a person or company that does not carry on a business in Hong Kong (hereinafter rendered to as “non-resident recipient”) receives royalty for the use of intellectual property in Hong Kong, only 30% of the gross royalty is income deemed sourced and taxable in Hong Kong.  Applying the standard rate of tax of 16.50% to the deemed income of 30% of gross royalty, this effectively means that the non-resident recipient only suffers Hong Kong tax at 4.95% of the gross receipt. Where intellectual property is used outside Hong Kong, the royalty income does not have a source in Hong Kong.  Consequently, the non-resident recipient will not be liable to tax in Hong Kong on such income.  This is the situation notwithstanding the fact that the payer is able to claim a deduction for royalty expenses against Hong Kong source income.

 

Where a Hong Kong company does not carry on business in Hong Kong and services royalty for the use of intellectual property from use outside Hong Kong, such income will not have exposure to tax in Hong Kong.  In a case where development work was carried out in Hong Kong, it may be alleged that the royalty income has a Hong Kong source and any net profit therefrom may therefore have exposure to tax in Hong Kong at 16.50%.

Planning Opportunities

 

Since non-resident recipients of royalty will only effectively suffer Hong Kong tax at 4.95% of gross royalty, there is a possibility for tax savings if due care is exercised in structuring royalty agreements.  An example would be where a non-resident licenses a tradename to a Hong Kong manufacturers and exporter of garments.  It is generally advisable to licenses the tradename for use in the marketing of garments in overseas export markets as opposed to licensing the tradename for use in the manufacture of garments in Hong Kong.  This arrangement will result in removing the source of the royalty income from Hong Kong and eliminating Hong Kong tax at 4.95% of gross receipt to the non-resident recipient.  The recipient will receive tax-free royalty.  The payer of the royalty will obtain a full deduction of the royalty expenses against garment sales if such sales are treated as Hong Kong sourced trading income in its Hong Kong tax filing.

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Interest

The Law

Interest Tax has been repealed.  Interest derived by an individual or by a corporation which does not carry on business in Hong Kong will not be taxable in Hong Kong.

 

Where interest is sourced in Hong Kong by a corporation which carries on business in Hong Kong, the interest income will be taxable as business income at 16.5%.  The location of source of interest income is determined by the place where credit is provided.

 

Deductions for interest paid are allowable when they have been incurred in deriving Hong Kong source income which is subject to tax in Hong Kong; consequently interest expense incurred in acquiring shares which generated dividend income would not be deductible.  Interest must be paid a financial institution or an entity which is carrying on business in Hong Kong and will be subject to Hong Kong tax on the interest receipt.

 

Anti-avoidance legislation exists to prevent a company from claiming interest deductions on money borrowed in Hong Kong against the security of offshore deposits, the interest income of which are not subject to Hong Kong.

Planning Opportunities

 

A corporation with no business presence in Hong Kong can generally take advantage of Hong Kong as a financial center by placing funds on deposits in Hong Kong and deriving tax free interest income in Hong Kong.

 

Where a corporation carries on business in Hong Kong and wishes to derive tax free interest income from its excess funds, it is generally a simple matter of arranging for deposits to be placed outside Hong Kong in another interest tax free jurisdiction such as Singapore.

Any attempt to structure tax deductible borrowings and tax free deposits or lending must be properly planned.  In view of the extent of matters contained in Hong Kong tax legislation which require consideration in any such planning, it is not feasible to outside the scope of considerations and the planning arrangements involved.  Taxpayers with such planning needs are advised to seek our assistance.

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