The Hong Kong Tax Exemption Claim allows companies to be considered offshore, as they are only taxed on profits earned within the city and not on their worldwide income. This creates a more straightforward system for determining which profits are subject to taxation and should be reported to the Hong Kong Inland Revenue Department.
As a result, the Hong Kong offshore tax regime is better equipped to identify taxable profit-making activities and ensure that they are appropriately taxed.
The “offshore status” of Hong Kong firms, refers to those that carry out all of their operations and administration outside of the territory..
WHAT IS THE OFFSHORE STATUS?
Offshore status more accurately represents a company’s situation when claiming its income on an offshore basis and when it is free from Hong Kong’s profits tax.
Refer to our Hong Kong offshore company page for information.
The IRD typically won’t bring up a review of a company that successfully claims its offshore income for a number of years (typically 3-5 years), or unless the company’s business significantly changes.
This is because the IRD will have thoroughly reviewed the company’s claim and found no chargeable profits occurring in Hong Kong.
As a result, the company’s business operations effectively have an “offshore status.”
In spite of this, the business should continue to keep regular annual accounts and archive all of its paperwork and other corporate records in case they are needed in the future.
RULES FOR TAX EXEMPTION OF HONG KONG OFFSHORE PROFITS
For this profits tax exemption for offshore claims, the IRD has implemented the guidelines as laid out in the IRO (Inland Revenue Ordinance)
According to the IRO, a person or company is liable for profits tax if any of the following apply:
- He operates a business, trade, or profession in Hong Kong,
- Derives profits from that business, trade, or profession, and
- Those gains originate in or are generated from Hong Kong.
When a firm submits an offshore claim for gains tax exemption in Hong Kong, the IRD will base its decision on these regulations and the fundamental guidelines for identifying the source of profits that have been developed over time. The company’s business model has a significant role in the source of these profits.
OFFSHORE SOURCED AND NON-TAXABLE PROFITS IN HONG KONG
A Hong Kong corporation conducts the necessary operations outside of Hong Kong while also negotiating and finalizing the terms of the buy and sale contracts with suppliers and consumers outside of Hong Kong. It might be feasible to argue that the trading gains obtained in this way aren’t subject to Hong Kong taxes.
With entities in the Mainland and other countries where the arrangement is comparable to the one with the Mainland firm, a Hong Kong manufacturing company engages into a contract processing or assembly agreement. The Hong Kong manufacturing company will supply the labor that is hired locally with the necessary raw materials, technological know-how, management, training, and supervision, among other things.
A Hong Kong business offers services both within and outside of Hong Kong. It might be feasible to argue that a portion of the service income is nontaxable since it can be linked to services provided outside of Hong Kong.
An overseas agent or service provider is hired by a Hong Kong corporation to carry out tasks outside of Hong Kong. It might be feasible to argue that none of the service income from work done outside of Hong Kong is taxable.
HOW TO MAKE A CLAIM FOR HONG KONG OFFSHORE STATUS?
The corporation may proceed with the offshore claim for profits tax exemption if all of its operations and revenue-generating activities are carried out outside of Hong Kong.
The first Audit Report and PTR (Profits Tax Return) for the company must be filed before the offshore claim for exemption from profits tax may be made. This is the point at which the corporation discloses the total amount of its overseas income as well as the amount of tax exemption it is requesting.
If the IRD decides to review the offshore claim, the type and number of questions they ask will depend on the finalized Audit Report.
The IRD (and most other government agencies) only deals with factual information, so a business cannot base an offshore claim on speculative future events before they actually happen or are completed.
As a result, the timing of an offshore claim is different from other applications, such as a request for tax exemption under Section 88 of the IRO, mainly for charities and non-profit organizations. Such an application can be made before the first accounts are closed or even before the firm is incorporated.
COMPANY DOCUMENTS NEEDED FOR HK OFFSHORE CLAIM
Possessing the necessary paperwork and key information is essential for claiming profits tax exemptions that will provide you with offshore status.
Even if the business does carry out all of its operations outside of Hong Kong, they risk losing its offshore claim if they lack the proper paperwork.
- Sales invoices, Purchase invoices, and order confirmations
- Bank statements showing receipt/payment of invoices.
- Shipping documents (postage receipts, bill of lading) showing the location and flow of goods.
- Travel expense documents (flight tickets and hotel receipts) and passport book copies showing the location of travel.
Uncertainty surrounding your offshore claim
Even though the tax exemption and, eventually, offshore status won’t be known with certainty until after the tax year is closed and the audit report is submitted, this might create confusion for businesses when they plan their taxes.
HOW TO FILE AN OFFSHORE CLAIM IN HONG KONG?
OTCs should be filed simultaneously with profit tax returns (PTRs) because they are required for the offshore status examination.
Once the firm has been open for 18 months, the owner is required to file the first PTR. After that, PTR periods occur once a year and the following details are required:
- Contracts and invoices
- Banking records
- expense remittances
By selecting a sales transaction at random and investigating the activities involved in this transaction to determine where those activities took place, the Hong Kong tax authority will verify the company’s claim.
While IRD will raise concerns throughout the investigation before rendering a final conclusion, the process could take several months.
The timeline also depends on how the company is organized. Obviously, the process is more involved and expensive the more layers the firm has.
Initially, IRD examines the paperwork that the business has submitted to the Companies and Partnerships Unit. After that, if there is any indication of a tax elimination, the Unit of Field Audit and Investigation may become involved in the development.
If the corporation provides the necessary documentation and explanation to the IRD, it can obtain a letter of offshore tax exemption.
HOW TO KNOW IF THE OFFSHORE CLAIM IS SUCCESSFUL?
The IRD may issue you a Tax Enquiry letter explaining additional information and documentation they need to substantiate your claim after reviewing your offshore claim after receiving your audit report.
They will provide you with a written confirmation letter declaring no taxation is necessary for the specified year if you can provide all the information requested in their queries and they are happy with the responses. Nevertheless, depending on how precise or ambiguous the responses are, the IRD may send multiple follow-up letters before this to further explain the information supplied.
WHAT HAPPENS IF THE OFFSHORE CLAIM IS REJECTED?
Although the tax exemption and offshore status will not be known with certainty until after the tax year is closed and the audit report is submitted, the rejection of an offshore claim can create confusion for businesses in planning their taxes.
What amount of tax will the business eventually be required to pay to the HK government, and what if the business is ultimately subjected to double taxation for the same activity in multiple jurisdictions?
These concerns highlight the importance of having a tax expert with experience in managing claims for offshore earnings tax exemptions assess your company’s activities or business operations at the halfway point of the year.
Reach out to us at Relin Consultants for more information.
Can I make an appeal to the IRD’s decision? Is there a time limit?
The corporation has the right to protest the tax that the IRD is imposing on its profits.
After the tax demand note’s issuing date, you have one month to file this objection.
But, for offshore allegations, the corporation should present fresh evidence or documentation to back up its assertion rather than just restating the details of earlier statements.
You should be aware that after a judgement has been taken by the IRD, it might be challenging to reverse it.
If I need to pay tax, is there interest and penalties on the tax from a few years ago?
On chargeable tax due from a prior year for an offshore claim, the IRD typically won’t impose further interest or penalties. However, if the business knowingly seeks to defraud or provides false or misleading information or papers to the government, separate sanctions may apply.
You can see additional details on the penalty provisions under the IRO.
What happens if my offshore claim is unsuccessful?
The IRD will issue a tax demand letter (tax bill) to the corporation requesting payment of the specified tax on the profits if the offshore claim is unsuccessful. Typically, the corporation will have 4-6 weeks to pay the taxes.
What types of income can be excluded under an offshore claim?
The following types of income can be excluded under an offshore claim:
- income from sources outside Hong Kong
- capital gains arising from the disposal of assets situated outside Hong Kong
- dividends paid by non-Hong Kong resident companies