Tax planning is relevant for individuals and companies alike who wish to mitigate tax liabilities as well as plan ahead for the payment of those. Such planning is also part of tax management and it is a relevant key facet of estate planning.

It is important to be aware that proper tax planning is beneficial to optimise tax liabilities, but it should be differentiated from aggressive tax planning, tax avoidance, and tax evasion. Let’s discuss 3 common tax planning areas in depth.

Hong Kong Tax Planning

For Hong Kong companies with full substance/operations/proper substance in Hong Kong tax planning is less straightforward than for resident Hong Kong companies with hardly any substance or for resident Hong Kong companies that are mostly used for re-invoicing purposes.

The latter group of resident companies can easily request for the offshore regime to be applied, but the taxable profits of the first group of resident companies are however likely to be fully taxable in Hong Kong.

Although Hong Kong currently applies a corporate income tax rate of 8.25% or 16.5% depending on the assessable profits, which is considered low by many European countries; local Hong Kong resident companies or Hong Kong companies with proper substance but with overseas parents still wonder if and how they can reduce their tax liability even further. Although local tax planning is possible, one should be careful with its execution and one has to ensure that proper documentation is in place.

Some tax advisers might toy with the concept of ‘bonus payments versus dividend payments’ in order to reduce local corporate income taxes, while others might suggest setting up regional offices in other jurisdictions, and still others might suggest putting certain royalty structures in place.

One must be prudent, however, and take into account various HK case laws and Hong Kong’s anti-abuse/avoidance provisions.

Tax Management Issues

When doing tax planning, special attention should also be given to import processing versus contract processing arrangements. Benefits for a Hong Kong company might arise when part of its manufacturing process takes place with an entity in Mainland China as an agent or as a sub-contractor.

Under these latter arrangements, a factory in China would be responsible for the processing and manufacturing of a portion of the products. The factory would charge the Hong Kong company a processing fee.

The Hong Kong company would complete the product and also often provide the raw materials needed to make the product. By means of DIPN 21, the Hong Kong Inland Revenue is however willing to apportion the profit made by the Hong Kong company as a result of the products sold to third parties on a 50:50 basis.

As a result of some recent court cases such as “CG Lighting Limited versus CIR” and “Datatronics versus CIR,” it has become more evident that the structure of the arrangements is quite important.

Within these court cases, the Court of First Instance came to the conclusion that the Hong Kong companies’ involvement in the manufacturing business of the Mainland China company (whether or not the agreement in place was one of import processing or contract processing) included antecedent or incidental activities where the profit-making transactions are the sale of goods and therefore the above-mentioned DIPN 21 cannot be applied.

From the above it follows that (if one wants to pay less tax in Hong Kong) proper rulings with the authorities have become more important and also it will be necessary to proper identify the transaction & activities of the Hong Kong company.

For example, one could consider affecting the sale outside of Hong Kong, making the activities of the Hong Kong company more than only antecedent or incidental, or by using proper agency structures.

Tax Management & Securities Trading

Hong Kong is known for its trade in securities and commodities. For profits from dealing in securities or commodities it is often said that these do have their source where the contracts of sale and purchase are affected.

If this source is in Hong Kong, then the securities trading profits realized would be fully taxable in Hong Kong at the corporate income tax rate of 16.5%.

However, in addition to the above rules, several case laws, especially where commissions are involved, need to be taken into consideration in order to judge whether or not the local activities in reality resulted in Hong Kong corporate income tax.

As follows from those case laws (for example “Baring Securities Limited versus CIR”), the drafting of the underlying agreements is important, but one also has to resolve questions such as, ”From which jurisdiction is the bill presented to the client?”, “Which company is responsible for executing it?” and “Where are the clients based?”

When properly structured, security traders could save some money in Hong Kong as part of their tax planning.