Are profits from overseas transactions booked by a Hong Kong company subject to Hong Kong profits tax?
Only profits derived from a trade, profession or business carried on in Hong Kong are considered to be of a Hong Kong source nature and are subject to profits tax.
The Court of First Instance ruled in 2022 that profits from bookable transactions only are not subject to Hong Kong profits tax. Profits tax is levied only on the act of the taxpayer in earning the profits in question and not on their role or purpose in Hong Kong.
Background
Newfair Holdings Limited v CIR
In this case, a local company was a wholly-owned subsidiary of a foreign company. The local company was incorporated in Hong Kong, but did not have an office or employ any staff in Hong Kong. The address of the local company in Hong Kong is only the registered address for regulatory compliance purposes.
The local company has a bank account in Hong Kong.
The principal place of business of the parent company is in the Netherlands.
For the relevant year of assessment, the local company was engaged in the trading of electronic products. The electronic products are sourced from two independent Hong Kong suppliers, both of which have their production sites in the PRC, pursuant to sourcing agreements with the local company. The local company then resold the products to its group affiliates in the Netherlands pursuant to sales agreements. Both the Purchase Agreement and the Sales Agreement were negotiated, entered into and signed outside of Hong Kong by the Parent Company on behalf of the Local Company. The purchase prices set out in the Purchase Agreements are negotiated between the Parent Company and suppliers outside Hong Kong. The directors of the Parent Company who signed each agreement reside in the Netherlands and do not work in Hong Kong. All local company support and administrative work is performed by employees of affiliated companies within the Group.
The electronic products are then shipped from the supplier’s factory in China directly to the Group’s affiliates in the Netherlands.
Controversy
In this tax case, the focus of the dispute was:
(1) whether the local company was carrying on trade or business in Hong Kong; and
(2) whether the profits were generated in or derived from Hong Kong.
The local company argued that it did not carry on a trade or business in Hong Kong and that the profit-generating business was carried on outside Hong Kong. Under section 14 of the Inland Revenue Ordinance, the profits credited to it are not subject to profits tax.
The Inland Revenue Department objected to the local company’s return. The company appealed, but the Board of Review upheld the Commissioner’s decision and dismissed the company’s appeal.
Court of First Instance’s Decision
The Court found that the appeal did involve a disputed point of law and had a reasonable chance of success, and finally granted the company’s appeal in 2021. The Court of First Instance ruled in 2022 that the appeal was successful and granted the local company’s appeal.
First, on the issue of whether the local company was carrying on a trade or business in Hong Kong, the Court held that the focus should be on the actions of the company rather than the nature of the company. The Court of First Instance held that if a company makes a profit from a purchase and resale, it is generally considered to be carrying on that business in the jurisdiction in which the relevant agreement was entered into. As both the purchase agreement and the sale agreement were entered into outside Hong Kong and no commercial operations were carried out in Hong Kong, the company did not carry on trade or business in Hong Kong. The court also noted that the mere receipt of proceeds from the sale of goods in a Hong Kong bank account, which was an administrative act following the conclusion of the agreement, did not constitute a profit-generating activity.
Moreover, the investigation of the source of the sales profits should be based on the actual act and place where the company earned the profits. Therefore, the IRS cannot charge profits tax based solely on the nature of the company and ignore the actual actions taken by the company to generate profits. The operation of a local company’s Hong Kong bank account to receive income from transactions is not related to the place of origin, it is merely incidental to the formation of the agreement.
The court also clarified that although the local company could help its corporate group in foreign jurisdictions to obtain a better tax planning structure, this did not mean that it was therefore subject to tax in Hong Kong. Just because profits are not taxed elsewhere does not mean that they are taxed in Hong Kong. Successful tax planning in overseas jurisdictions is not a basis for the IRD to seek to collect tax in Hong Kong.
Conclusion
The Court of First Instance’s decision confirms that profits tax liability in Hong Kong is generally imposed on taxpayers only on the basis of the conduct or business that generates the profits. The role of the taxpayer is not determinative. Even if the role of the local company in this case is to avoid overseas taxation in Hong Kong, it is not thereby liable to pay profits tax. The role of the taxpayer in Hong Kong is not usually related to determining the source of profits.
However, it is important to note that there is the possibility of further appeals by the IRS. Also, the offshore operation of taxation may include different jurisdictions, so if you have any questions, please consult a tax or legal professional.
