Hong Kong adopts the territorial source system whereby only income arising in or derived from Hong Kong (referred as ‘onshore income’) is subject to profits tax pursuant to the general charging rule of Section 14(1) of the Inland Revenue Ordinance. In other words, income which is sourced outside Hong Kong (referred as ‘offshore income’) is generally not liable to Hong Kong profits tax. It is, therefore, not rare that a Hong Kong company can have both onshore taxable income and a partial offshore tax status that renders part of the income non-taxable.
For example, apart from maintaining an office and staff in Hong Kong to run the onshore trading business, a Hong Kong company can also have a branch/an agent overseas to handle the whole trading transactions outside Hong Kong independently. The Hong Kong company may therefore have both onshore trading income derived by its Hong Kong office and potential offshore trading income derived by its overseas branch/agent.
Another example is that a Hong Kong company is engaged in sales of products to overseas customers in Hong Kong and provision of the related installation and after-sales maintenance services at the place of the customers overseas. It is possible that the income from the sales of the products is onshore taxable while the income from the provision of the services is qualified as offshore non-taxable.
One may then ask whether it will be easier for a taxpayer to obtain a partial offshore tax status compared to a 100% offshore tax status? The answer is uncertain, depending on the relevant facts and the circumstances of each case.
Difficulties in Obtaining a Partial Offshore Tax Status
Taxpayers have to get prepared to receive lengthy enquiries on its partial offshore claim from the Inland Revenue Department (‘IRD’). As compared to a 100% offshore claim, sometimes it might be more difficult for taxpayers to prove to the satisfaction of the IRD a partial offshore claim.
One of the potential risks of the partial offshore claim is that there might be onshore elements involved in the offshore operation. Hence, apart from proving the business is offshore in nature, it is also necessary for taxpayers to clearly distinguish the onshore/offshore operation and properly identify the onshore/offshore income.
In addition, taxpayers are expected to attribute the expenses (both specific and common in nature) to the onshore and offshore operation on a fair and reasonable basis.
Possible Solutions
In order to avoid the troubles in distinguishing the onshore/offshore operation and their respective income and expenses, one of the possible ways is to set up two companies, one for onshore business and another for offshore business.
Having said that, using a separate company to run the offshore business does not necessarily mean that the offshore claim will be free of challenges from the IRD. One also needs to structure the offshore business carefully in order to have it qualified for the offshore claim. It is therefore still recommended to conduct an in-depth tax review on the offshore business and the transaction documents involved to enhance the chance of success of the offshore claim.
Please contact HKWJ Tax Law & Partners Limited, a proud member of the HKWJ Group, for further advice on the above tax issues or any other issues is required.
