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NL086E Profits Tax Liability for Businesses in Hong Kong May19 Newsletter No. 86 (EN) Profits Tax Liability for Businesses in Hong Kong May 2019 All rights reserved © Lorenz & Partners 201 9 Newsletter No. 86 (EN) L&P Legal, Tax and Business Consultants Although Lorenz & Partners always pays great attention on updating information provided in newsletters and brochures we cannot take responsibility for the completeness, correctness or quality of the information provided. None of the information contained in this newsletter is meant to replace a personal consultation with a qualified lawyer. Liability claims regarding damage caused by the use or disuse of any information provided, including any kind of information which is incomplete or incorrect, will therefore be rejected, if not generated deliberately or grossly negligent. tious. This newsletter is designed to clarify I. Introduction the territorial principle of taxation. Please note that this newsletter will focus on the The law governing the imposition of in- taxation of corporations as this is the come based taxation in Hong Kong is con- most popular corporate format in Hong tained in the Inland Revenue Ordinance Kong. (“IRO”), Chapter 112 and its subsidiary legislation, the Inland Revenue Rules II. Taxation Rates in Hong Kong (“IRR”), and in various orders made by the Chief Executive in Council. Every assess- On 29 March 2018, the Inland Revenue ment issued under the IRO is related to a (Amendment) (No. 3) Ordinance 2018 came year of assessment. The year of assessment into force introducing a two-tiered profits in Hong Kong is from 01 April to 31 tax rate regime. The new regime applies to March. both corporations and unincorporated busi- nesses. It will commence from the year of The IRO regulates three (3) distinct taxes assessment 2018/19 (i.e., on a taxpayer’s fi- on income, namely the Profits Tax, the nancial year ending between 1 April 2018 Salaries Tax and the Property Tax. There and 31 March 2019). Under the two-tiered are no taxes on other incomes such as profits tax rate regime, the profits tax rate for capital gains, or rental income. the first HKD 2 million of assessable profits will be lowered to 8.25% (half of the rate Hong Kong (like some other Common- specified in Schedule 8 to the IRO for cor- wealth countries) adopts a territorial basis porations and 7.5% (half of the standard of taxation. Only profits which have a rate) for unincorporated businesses (mostly source in Hong Kong are taxable in Hong partnerships and sole proprietorships). As- Kong. Profits sourced elsewhere are not sessable profits above HKD 2 million will subject to Hong Kong tax (but may be tax- continue to be subject to the rate of 16.5% able as permanent establishment in other for corporations and standard rate of 15% jurisdictions). This means that a person for unincorporated businesses. who carries on a business in Hong Kong but derives profits from another place is Only one entity in each group of companies not required to pay tax in Hong Kong on is eligible for the tiered rates regime. As the those profits. main objective of the regime is to reduce the tax burden of small and medium-sized en- Section 14 IRO: terprises and start-up enterprises, the re- striction was introduced to avoid a group (1) Subject to the provisions of this Ordinance, splitting income amongst numerous entities profits tax shall be charged for each year of assess- in order to enjoy the lower tax rate. There is ment at the standard rate on every person carrying an extensive definition of “connected entity” on a trade, profession or business in Hong Kong in in the legislation which is designed to ensure respect of his assessable profits arising in or derived that a group of connected taxpayers can ben- from Hong Kong for that year from such trade, pro- efit from the reduction only in respect of one fession or business. of such connected taxpayers. For this pur- pose, the group will need to identity which The principle itself is quite clear, but its entity will benefit from the reduction and to application in certain cases can be conten- make an election accordingly. The election, © Lorenz & Partners May 2019 Page 2 of 13 E-Mail: [email protected] Newsletter No. 86 (EN) L&P Legal, Tax and Business Consultants once made, is irrevocable in respect of a par- III. Profits Tax Overview ticular year of assessment. 1. Profits Tax Liability An entity means – Under the IRO, a person is chargea- (a) a natural person; ble to Profits Tax under the following (b) a body of persons; or conditions: (c) a legal arrangement, including – (i) a corporation; ➢ The taxpayer must carry on a trade, (ii) a partnership; and profession or business in Hong Kong; (iii) a trust. and ➢ The profits to be taxed arise from If a natural person carries on more than one such trade, profession or business car- sole proprietorship business, the person is ried on by the person in Hong Kong; and taken to be a separate entity in relation to ➢ The profits arise in or are derived from each sole proprietorship business. Hong Kong. An entity is a connected entity of another en- The first two conditions are straightfor- tity if – ward. The third condition needs to be elaborated further. (a) one of them has control over the other; 2. Proof of Origin of Profits (b) both of them are under the control of the same entity; or The basic principles for proving the source (c) in the case of the first entity being a of profits have been considered by the natural person carrying on a sole Courts of Hong Kong many times and can proprietorship business – the other be summarised as follows: entity is the same person carrying on another sole proprietorship business. (1) The question of the origins of prof- its is a practical matter of fact. There Generally, an entity has control over another is no universal rule. Whether profits entity if the first-mentioned entity, whether arise in or are derived from Hong directly or indirectly through one or more Kong depends on the nature of the than one other entity, profits and of the transactions which give rise to such profits. (a) owns or controls more than 50% in aggregate of the issued share capital (2) The broad guiding principle states of the latter entity; that the tax authorities will evaluate (b) is entitled to exercise or control the the place of the source of profits and exercise of more than 50% in aggre- what the taxpayer has done to earn gate of the voting rights in the latter these profits. In other words, the entity; or proper approach is to ascertain the (c) is entitled to more than 50% in ag- operations which produced the rele- gregate of the capital or profits of the vant profits and where those opera- latter entity. tions took place (Operations Test). The source of profits must be at- An illustrative example of the definition of tributed to the operations of the tax- “connected entity can be found in the payer which produced them and not ANNEX. to the operations of other members of the taxpayer’s group. © Lorenz & Partners May 2019 Page 3 of 13 E-Mail: [email protected] Newsletter No. 86 (EN) L&P Legal, Tax and Business Consultants (3) The distinction between Hong Kong was payment effected?”11. profits and offshore profits is made by reference to gross profits arising “Effected” does not only mean that the from individual transactions. contracts are legally executed. It also cov- ers the negotiation, conclusion and perfor- (4) The place where day to day in- mance of the contracts. vestment/business decisions take place generally does not determine (2) Relevant and irrelevant facts the source of the profits. It is not the deciding factor. In considering the relevant facts, the nature and quality of the activities matter more (5) The relevant operations do not com- than their quantity. The cause and effect of prise the whole of the taxpayer's activ- such activities are the most relevant factors. ities. The focus is on establishing the geographical location of the taxpayer's Facts which are not directly related to the profit-producing transactions as dis- trading activities are considered irrelevant in tinct from activities antecedent or in- determining the origin of profits. For ex- cidental to those transactions. ample, renting office premises, recruiting staff, the setup of an office, accounting etc. (6) The absence of a business presence overseas does not generally mean that (3) When are profits taxable in Hong all of the profits of that particular Kong? (General Practice) business arise in or are derived from Hong Kong. However, in the vast The question of source of profits is a majority of cases where the principal practical matter of fact. place of business is located in Hong Kong and there is no business pres- ➢ If the sales/purchase contracts are ef- ence overseas, profits earned by that fected in Hong Kong, then the profits business are likely to be chargeable to are taxable there. Profits Tax in Hong Kong. ➢ If the contract is effected outside Hong 3. Profits of Trading Companies Kong, then the profits are not taxable in Hong Kong. (1) Totality of facts ➢ If either the sale or purchase contract is The question of the origin of profits de- effected in Hong Kong, then the initial rived from trading of goods has caused presumption is that the profits are tax- the most controversy in the past. General- able there. However, the totality of facts ly, the determining factor is the place need to be examined to determine the where the sales contract is effected.
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