Hong Kong Tax Audit & Disputes
The tax system in Hong Kong is simple but not straight forward. In Hong Kong where the territorial source system is adopted, one of the most controversial tax issues is whether or not an income is arising in or derived from Hong Kong (i.e. sourced in Hong Kong) and hence subject to Hong Kong income tax. A number of tax dispute cases regarding the source/taxability of income are reviewed under tax audit and investigations every year. Tax disputes and ex officio field audits have been put forward to the Board of Review (i.e. a tax tribunal) and Courts for determination.
Apart from issues related to the source of income, more and more tax disputes in Hong Kong are arising as a result of taxpayers’ late lodgements of objections to the Hong Kong Inland Revenue Department/Hong Kong Tax Office (“HK Tax Office”) against the (estimated/additional) tax assessments/tax bills issued by the HK Tax Office.
The consequence of a late objection, unless the HK Tax Office considers it in rare circumstances as a valid objection, is that taxpayers are required to pay income tax in Hong Kong as demanded in the tax assessments/tax bills concerned notwithstanding their income potentially qualified for tax exemption in Hong Kong.
Disputes on whether an income is sourced in Hong Kong
Many taxpayers are of the belief that their income will not be liable to Hong Kong income tax as long as their business activities are not carried out in Hong Kong, substantiated by the facts that no office, staff, customers and suppliers are maintained/employed/located in Hong Kong.
Please note however that these facts are in general not sufficient for obtaining an offshore non-taxable status from the HK Tax Office. It is also required, amongst others, for taxpayers to have sufficient and appropriate supporting documents, such as the transaction documents and correspondences, regarding its business operation to substantiate its offshore non-taxable claim.
Kindly also note that the HK Tax Office has been more and more stringent when reviewing an offshore non-taxable claim. An offshore non-taxable claim would potentially be rejected by the HK Tax Office if amongst others,
- The information and documentary evidences supplied to the HK Tax Office are insufficient, or unfavourable/contradictive to the offshore non-taxable claim; and/or
- The reply in response to the HK Tax Office’s enquiries is not handled with proper care.
In addition, the HK Tax Office is sometimes rather aggressive in assessing an offshore non-taxable claim probably for the purpose of protecting tax revenue. It might apply various tests (e.g. totality of fact tests, contract tests and operation tests) and put different emphasis (e.g. substance over form or form over substance) when reviewing an offshore non-taxable claim. Hence, it is important to have in-depth and comprehensive knowledge in tax laws in particular case laws in order to fight for the offshore non-taxable claim with the HK Tax Office.
Ultimately, if taxpayers do not accept the tax assessor’s denial of their offshore non-taxable claim, they are empowered to lodge an appeal to the Commissioner of Inland Revenue and then to the Board of Review/Courts.
Tax Audit & Investigations Regarding Hong Kong Sourced Income
There is a possibility that an offshore non-taxable claim case will be transferred by the HK Tax Office to its tax field audit and investigation unit for review. Penalties and/or interests would potentially be imposed/charged by the HK Tax Office upon conclusion of the tax audit if it is found that an incorrect tax claim is lodged without reasonable excuse.
Hence, apart from tax knowledge, good negotiation and presentation skills are also important for the purpose of offshore non-taxable claim as well as for the concerns of penalties/interests. Other reasons for being selected for an audit or investigation may include:
- A company’s audited financial statements are heavily qualified
- Transactions are mainly settled in cash
- A business has an unreasonably low turnover or profit when compared to prior years or to other businesses in the same industry
- Significant reduction in the profit as a result of restructuring
- A company received injection of a large amount of capital from unknown sources
- A large scale of domestic and cross-border transactions between a company and its associated companies
- Failure to submit the profits tax return on time
- Failure to maintain sufficient business records
- Other cases referred by other government departments
Disputes on Late Objections
Similarly, the HK Tax Office may issue (estimated/additional/protective) tax assessments to taxpayers after the completion of the tax returns or due to various other reasons, such as late or the absence of a tax return filing in general or because of an upcoming 6 years’ statutory time limit for issuance of a tax assessment.
In case taxpayers do not agree with the tax assessments, they are obliged to lodge an objection to the HK Tax Office against the tax assessments within 1 month after the date of the notices of assessment. Failure to do so will render the tax assessments final and conclusive.
Taxpayers are sometimes unable to lodge an objection to the HK Tax Office by the 1-month deadline for various reasons, such as delivery failure of the tax assessments, the issuance of the tax assessment is overlooked by taxpayers themselves/their tax representatives, loss of the taxpayers’ contacts by the tax representatives, miscommunication between taxpayers and their tax representatives as well as sickness of the relevant person. The consequence is therefore that the tax demanded in the tax assessments will become final payable and late payment surcharge will be imposed if tax payment is in default.
With a view to preserve the tax position, some taxpayers will still lodge a late objection to the HK Tax Office. Disputes on whether such late objection should be accepted by the HK Tax Office often occur. While taxpayers may have various reasons for a late objection, according to the tax laws and in practice, it is uncommon for a late objection to be accepted by the HK Tax Office unless there are (very) exceptional circumstances/reasons.
In order to mitigate the chance of late objection disputes with the HK Tax Office, it is important for taxpayers to ensure their correspondence address with the HK Tax Office is up-to-date. The role of the tax representative is also crucial and it is suggested to appoint a competent and well-organised party as the tax representative. Moreover, it is advised for taxpayers to maintain a good communication channel with their tax representatives.
In case a late objection is lodged, it is recommended to maintain all the relevant documentary evidences to substantiate the late objection.
It is generally not straight forward to obtain an offshore non-taxable status under the HK taxation system. In addition, a late objection against a tax assessment will potentially result into a tax payment obligation. In order to mitigate the extent/chance of disputes with the HK Tax Office, the offshore non-taxable claim and tax assessments have to be handled with care. We can offer our service to assist you with offshore non-taxable claims and any tax dispute and tax audit during any stage of the process.