Offshore Profits Exemption Claim — Is It Difficult to Get?

Since 2018, the Hong Kong tax authority ("IRD") has taken a more stringent and cautious approach to dealing with offshore profits exemption claims (profits in HK-IRD mean "corporate income").

"How can I claim offshore income tax exemption status for my Hong Kong-based company?"

", or simply, "Can I file an offshore claim in Hong Kong?"

" is a popular topic among overseas entrepreneurs with a presence in Hong Kong, which we previously discussed in a blog post.

For the past ten years, we have provided Hong Kong taxation services, and we have assisted overseas clients in obtaining offshore claims status for their Hong Kong company in some tax years. As a result, we believe in our abilities.

Unfortunately, we see that the majority of the claims are eventually rejected, while the remainder are still stuck in the HK-IRD investigation, putting a tremendous burden on the clients, our tax representatives, accountants, and auditors to handle the authority’s queries.

We will investigate the reason for Hong Kong’s tax policy change.

Quick Recap: How Does Offshore Claim Work?

The claim of offshore tax exemption is regulated under the Inland Revenue Ordinance, the Hong Kong tax law, which is based on the territorial income tax principle. As states, an income is not taxable to corporate income tax, a.k.a Profits Tax, if it is:

• not derived from a trade profession or business carrying on in Hong Kong and/or
• not arising in or derived from Hong Kong

The IRD is authorized to regulate every tax exemption claim of every taxpayer. In general, when the taxpayer has an income which is claimed being sourced outside of Hong Kong, the IRD verifies if it is a valid offshore income under the legal frameworks and the previous decision made on previous tax claims.

If the IRD grants the taxpayer the offshore status after the investigation, the taxpayer is confirmed that this specific income in this tax year is exempted from tax.

Increased Efforts Are Made in Fighting Against Global Tax Avoidance

As Hong Kong is the world’s famous low-tax jurisdiction adapting territorial basis tax system, it is reasonably deemed to be a perfect place for conducting profit shifting, which is a type of tax avoidance technique, in view of the tax authorities of other jurisdictions, especially the governments of the EU members.

The tax authorities see that Hong Kong’s offshore claims are abused by some taxpayers who are using Hong Kong companies as trade companies to specifically handle the re-invoicing function among their multinational trading businesses.

Bureaucratic Response from the HK Tax Authority

If I put myself in the shoes of the Hong Kong IRD, when the IRD needs to get rid of the label of so-called tax haven sooner, it must dig deeper to every offshore income exemption claim, in hope that every claim is granted without obvious questions. Consequently, the IRD has included an extra logic in their investigation: If an income is claimed to be sourced outside of Hong Kong, then this income must be sourced from a jurisdiction, it is impossible to be sourced in the air. Thus, this income must be reported to a tax authority eventually.

Nowadays, the IRD is able to check if an income is truly sourced offshore with the help of other tax authorities. As an enhancement to the tax information transparency among overseas tax authorities, Hong Kong is acting in compliance with the framework of the OECD’s Common Reporting Standard (“CRS”) of Automatic Exchange of financial accounts information.

Costly Consequence of the Rejected Claims

If the taxpayers fail to satisfy the IRD, especially which jurisdiction the offshore income is reported to, their claim will be rejected. The first rejection of the claim usually causes worry and anger, requesting in-depth review follows, and the process could span more than one tax year.

However, the taxpayers must understand the worst-case scenario when the claim is rejected at last, such that they will be ordered to pay the IRD all outstanding Profits Tax, the penalties, and the interest incurred by the underpayment of tax due, which are due to be settled within a brief of time after. If the taxpayers apply for tax payment by instalments if approved, they will suffer from additional 10% surcharges.

Replacing HK’s Label: from “Tax Haven” to “Low Tax Jurisdiction”

To wrap things up, we must agree that saving tax expenses is a big part of doing business, which is rooted to the balance of benefits, costs and risk. If tax is inevitable, you want to settle it in where you can strike the balance of asset safety and tax saving.

With greater demand for tax transparency from the international, the cost of obtaining offshore income exemption and the risk of rejection are unprecedentedly high. Taxpayers are expected to report the income to other tax authorities at the same time if it is not taxed in Hong Kong.

It is a perfect time to rebrand Hong Kong as a reputable low tax business hub to attract international business. Our city is offering generous tax regime for international business, simple company registration, and freedom of business, here are the highlight:

• People of any nationality (or place of incorporation for corporate bodies) can be the directors and shareholders of Hong Kong companies.
• Tax reports are filed annually, and we have no capital control and no capital gain tax.
• Under the two-tiered profits tax rates regime, the profits tax rate for the first HK$2 million of assessable profits is taxed at 8.25%, while all the remaining is taxed at 16.5%.
• Every individual director or shareholder can enjoy HK$132,000 exemption to their assessable personal income.

Extra Credit — Why an Experienced Tax Specialist Is So Important for SMBs?

Even in Hong Kong, as it is getting longer and more demanding in obtaining offshore profits exemption claim, we can reasonably say that this tax tool is exclusively available to those well-prepared businesses in the city. Surely, the members of multi-billion-dollar-company can find their tailor-made tax solutions from the “Big Four” accounting firms, who have the international presence to cater the tax authorities in different countries. But for SMBs like you, what can you do?

Definitely there is some advanced preparation work for you. We have a piece of advice to enhance your Hong Kong’s offshore claim status:

• Do not set up business presence in Hong Kong, and establish solid business presence outside of Hong Kong, e.g. long-run office and other business facilities with local staff.
• Do not conduct business contracts in Hong Kong.
• Do not hold directors meetings and management meetings in Hong Kong.

At last, consult your Hong Kong tax representative (yes, AsiaBC is one of them in case you do need it) asap when your Hong Kong company is going to provide offshore business functions.

What’s next? Learn more about AsiaBC’s 4-in-one business accounting, audit, tax representative and tax consultation service, or contact us for a free initial consultation. Grab the chance now!