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partial offshore tax claim HKWJ Tax Law

Offshore Non-taxable Claim Acceptance in Hong Kong

Pursuant to the general charging provision of Section 14(1) of the Inland Revenue Ordinance (‘HK-IRO’), an income is NOT liable to profits tax (corporate income tax) if it is (i) not derived from a trade, profession or business carrying on in Hong Kong and/or (ii) not arising in or derived from Hong Kong (i.e. sourced outside of Hong Kong). However, it is important to realise that any such offshore non-taxable claim made is usually still being examined by the Hong Kong Inland Revenue Department (‘HK-IRD’). This is the case even for partial offshore income claims.

If such examination leads to the conclusion that there is indeed a valid offshore non-taxable claim present, then this will be confirmed by the HK-IRD by means of a letter. The question has now arisen whether such confirmation provides for any certainty at all/what is the status of such letter? For example, can a legitimate expectation be derived from the confirmation letter in respect of any offshore non-taxable claims made during subsequent years and which were not subject to review?

Legitimate Expectations?

As a general rule, the HK-IRD is empowered to examine the tax position/tax claims of taxpayers, whether this was on the basis of an onshore taxable claim or on the basis of an offshore non-taxable claim, as long as the statutory period of 6 year has not lapsed.

If during those years the HK-IRD starts to look into an offshore non-taxable claim made, such review and potential acceptance, would usually be confined to that year (or confined to those years during which offshore non-taxable claims have been made). Hence, strictly speaking, the offshore non-taxable claims for subsequent years that have not been part of the investigation may still be examined and reviewed by the HK-IRD.

In view of the above, there is a potential risk that taxpayers will rely ‘too much’ on the HK-IRD’s acceptance of the offshore non-taxable claim for a particular tax year and thereby assume that the offshore non-table claim made for subsequent years will be automatically granted.

This reliance is probably mostly the result of the doctrine of legitimate expectation, i.e. when future business operations and future transactions are the same or similar to those of the past, for tax purposes taxpayers would expect to receive the same (offshore) tax treatment as they did for the previous years.

The HK-IRD however seems to disagree with such approach as they say that circumstances may have changed (which view has been supported by certain case law). One could however argue the correctness of such HK-IRD approach.

Obviously, it is a fact of life that that business operations of companies are always subject to changes. As a result, it would be very difficult to expect that every business transaction is and will be executed in exactly the same way as the previous ones and the future ones.

Therefore, if during a previous year, the HK-IRD examined, reviewed and accepted a business offshore non-taxable claim and in subsequent years, those business transactions have been executed in similar ways, would it then not be fair to say that a reliance on a legitimate expectation is justified?

One could even argue that a confirmation letter stating the acceptance of the offshore non-table claim for a particular tax year under review should be of a higher ‘hierarchy’ than a so-called advance tax ruling (which usually provides for tax certainty during multiple years), simply because advance tax rulings only look into the tax treatment of anticipated transactions, whereas a confirmation letter of an offshore non-taxable claim has been the result of looking into transactions that have properly been executed.

A more realistic reason why the HK-IRD might not want taxpayers to rely too much on confirmation letters in respect of offshore non-taxable claims is, apart from lack of time in examining the offshore claims in detail, purely related to policy.

This as tax authorities all over the world (including the HK-IRD) have been under pressure from international organisations such as Organisation for Economic Co-operation and Development as well as from foreign tax jurisdictions to fight against tax evasion and profit shifting and to avoid being blacklisted as a tax haven jurisdiction.

Consequences of Rejecting Offshore Non-taxable Claims

Usually, an offshore non-taxable claim is reviewed and examined by Unit 1 of the HK-IRD (i.e. Profits Tax – Corporations and Partnerships Unit). Where there is a suspicion that tax evasion is involved, the case potentially might be transferred to Unit 4 of the HK-IRD (i.e. the Field Audit and Investigation Unit) for a more in-depth review. In the latter situation, taxpayers will have to spend a lot of time and manpower on dealing with the tax audit investigation, such as retrieving and supplying volumes of information and documents to the HK-IRD as well as attending interviews with the HK-IRD.

The worst case scenario is that in case the offshore non-taxable claim ultimately fails, taxpayers have to pay to the HK-IRD within a relative short period of time a large huge amount of profits tax (due to a number of tax assessment years involved) plus penalties and/or interests due to the underpayment of tax.

Taxpayers are however allowed to apply for payment of those taxes by instalments, provided that they are in financial and/or cash flow difficulties, which have to be supported by sufficient documentary evidences. It should be noted though that payment by instalments usually results into 5% and/or 10% surcharges.

However, taxpayers do always have the rights to lodge an appeal to the Commissioner of Inland Revenue, the Board of Review and the Courts if they disagree with the HK-IRD’s denial of the offshore claim. In that case it is important to weigh off the potential benefits versus the costs.

Potential Solutions & Assistance

One may consider the following:

  1. Engage a tax advisor to conduct periodically a thorough review of the offshore non-taxable claim made, even in case the offshore non-taxable claim for prior years has been accepted by the HK-IRD;
  2. Retain sufficient information and documents to support the offshore non-taxable claim for potential future investigations by the HK-IRD;
  3. Any information and documents to be provided to the HK-IRD should be done with due care and involvement of a tax advisor is strongly recommended in order to avoid submission of documents and information that will potentially endanger the offshore claim made; and/or
  4. Apply for an advance ruling with the HK-IRD in order to obtain certainty on the offshore non-taxable claim.

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