Navigating the tax landscape can be intricate, especially for businesses in Hong Kong. However, there’s a noteworthy aspect called offshore tax exemption that can potentially exempt a Hong Kong-incorporated offshore company from profits tax.
In today’s article, we will explain offshore tax exemption in detail, discuss all the essentials, and illustrate how it can benefit Hong Kong businesses to help you navigate better. Let’s begin.
Understand tax exemption in Hong Kong
Is Hong Kong considered a tax haven?
Some offshore countries are considered tax havens for applying no corporate profit tax. Special company types such as international business companies (IBC) or business companies (BC) also exist for tax exemption.
Hong Kong is normally seen as a tax-free jurisdiction like Belize, Seychelles, or BVI. However, the current tax laws of the country prove that it should be considered a low-tax jurisdiction rather than a tax-free one.
If you’re a foreigner establishing a local company in Hong Kong, you have permission to do business within its territory.
Subsequently, you must pay a tax rate from 8.25 to 16.5 percent for your profit. This attractive tax rate is considerably low and is one of the best features of Hong Kong.
Even better, you can enjoy various tax incentives for special business operations such as tax exemption through offshore tax claims (OTC).
An OTC is a process of proving the sources of your profits, which will be discussed further in section 2.
What is tax exemption?
Hong Kong tax exemption refers to earnings or transactions that are not subject to taxes. The Hong Kong tax system follows a territorial principle, meaning only profits arising in or derived from Hong Kong sources are subject to profits taxation.
If you can demonstrate that your earnings are from foreign sources (i.e., offshore sources outside of Hong Kong), your earnings will be tax-exempt.
The following are some examples of how your profits may be considered offshore and thus non-taxable in Hong Kong:
- You enter a contract with suppliers or customers outside of Hong Kong and conduct activities outside of the country, the profit you get from these operations is non-taxable.
- If you own a Hong Kong company that supplies manufacturing materials to another entity located outside of Hong Kong, your profits may be exempt from taxation.
- If your Hong Kong company appoints an overseas agent to perform services on its behalf outside of Hong Kong, the profit from those services is not taxable.
Changes to the offshore regime for passive income in Hong Kong
In response to concerns raised by the European Union on the exemption of passive income without particular conditions and requirements, the Hong Kong (SAR) Government recently proposed a revised foreign source income exemption (FSIE) regime.
The revised regime is only applicable to a constituent entity (CE) of a multinational enterprise (MNE) group, regardless of the group’s earnings and asset size, and has taken effect from January 1, 2023.
The CE will need to determine whether its profit is from offshore sources and whether it is received in Hong Kong.
The offshore-sourced profit that is received in Hong Kong by a CE of an MNE group will be deemed as taxable income unless it meets the criteria for exemption from economic substance requirement (for non-IP income), the nexus approach requirement (for IP income), or the participation exemption conditions (for dividends and equity disposal gains)
Lastest update:
Following EU’s Updated FSIE Guidance as in December 2022 including disposal gains as passive income, Hong Kong, along with other jurisdictions, was urged to align its tax treatment by the end of 2023.
To comply, Hong Kong enacted the Inland Revenue (Amendment) (Taxation on Foreign-sourced Disposal Gains) Ordinance 2023, expanding asset scope related to foreign-sourced disposal gains and introducing intra-group transfer relief. These changes take effect from January 1, 2024.
How can you qualify for tax exemption in Hong Kong?
To be eligible for Hong Kong offshore tax exemption, your company must file an offshore tax claim (OTC) with the Inland Revenue Department (IRD) to obtain an “offshore status”.
In common offshore jurisdictions, a company formed under specific types (i.e., IBC or BC) is automatically subject to the offshore status from its incorporation date.
Yet, a local Hong Kong company may need more time, effort, and paperwork to verify offshore status through OTC.
What is an offshore status?
Offshore status for a local company is a Hong Kong tax exemption letter released by IRD after their prudent inspection period. It indicates that it’s tax-free for the profits derived outside the territory.
Without an OTC, your company must pay full profit tax despite your sources of income.
The process to get approval from IRD is quite long, not sooner than 6 months. However, it’s worthwhile since your offshore status maintains its effect for 3-5 years.
Your business may be qualified for a particle offshore claim in some circumstances if it makes both onshore and offshore profits.
For instance, if you establish a trading company in Hong Kong with agents and branches abroad to manage logistics outside of Hong Kong, you only pay taxes on the profit that is attributable to your trading company and not the profits from your overseas branches.
You can apply for a partial Hong Kong offshore claim. Yet, it can be more complicated, time-consumed, and costly to prove the satisfaction of the IRD, and you will have to do OTC on an annual basis.
To determine the tax status of your income types and confirm your eligibility for making an offshore claim, give our Hong Kong Offshore Claim Tool a try for a better picture.
Who is qualified for an offshore claim?
As mentioned above, Hong Kong IRD has the power to determine and approve the offshore status of a company under a letter form.
Your company is requested to answer the “Question to determine the source of profit” by IRD as exactly detailed as possible to avoid confusion and doubts.
There are also chances that IRD will reject your OTC requests. This unexpected situation occurs mainly because you cannot meet the requirements of IRD.
Therefore, to raise the success percentage, you should ensure that your company satisfies these criteria:
- Having no clients in Hong Kong
- Running no physical office and having staff in Hong Kong
- Hosting no website in Hong Kong
- Performing no services, sales, or business in Hong Kong
- Having no warehousing and fulfillment in Hong Kong
In addition, it’s recommended that you take every piece of advice from the Certified Public Accountant before making any submission to IRD.
When should you register for an offshore claim?
Some people might advise you to start the OTC progress right after your company is incorporated. Likewise, it is recommended to make an offshore application as soon as filing a profit tax return for the first period (18 months after the incorporation date).
The examination goes more smoothly and effectively when you can submit the required documents for IRD.
There are different aspects of Hong Kong company registration that you might want to consider, feel free to take a look at our guide to setting up a company in Hong Kong.
How to file a Hong Kong offshore claim
You should file an OTC at the same time as filing your profit tax return (PTR), as this document is a mandatory part of the offshore status examination.
You must submit the first PTR once your business has been operating for 18 months. Following that, PTR periods take place once every year and the following information is needed:
- Invoices and contracts
- Bank statements
- Expense receipts
The Hong Kong tax authority will confirm your company’s claim by randomly choosing a sales transaction and examining the activities involved in this transaction to see where those activities took place.
Therefore, it is advised that you maintain thorough documents to demonstrate that all activities take place outside of Hong Kong, such as:
- Trading proofs such as sales and purchase orders
- Shipping documents
- Meeting minutes with customers and suppliers
- Travel documents for any visits to clients and suppliers
- Phone numbers, email, and fax as communication means to support the negotiation process with customers and suppliers
The process can take several months as IRD will raise questions during the investigation before making a final decision.
The timeframe also relies on how your organization is set up. The more layers your company has, the more thorough the procedure, and the more it costs certainly.
Firstly, IRD inspects submitted documents from your company with the Corporations and Partnerships Unit. After that, the Unit of Field Audit and Investigation might get involved in the progress if there is any signal of tax elimination.
You can receive a letter of offshore tax exemption after the company’s documents and clarification to persuade IRD.
Important
The offshore status maintains effect for a maximum of 3 to 5 years, but you should remember to do annual reporting to state with IRD that your business still stays offshore. In case there are any changes, you should mention those in the auditing reports.
Conclusion
Hong Kong’s offshore exemptions, in short, not only enhance its renowned global reputation but also provide unparalleled business opportunities for international companies. It is crucial to understand the key attributes of this incentive if you intend to set up an offshore company in Hong Kong.
Through today’s article, BBCIncorp has guided you through the definition, the eligibility requirements, and the process of registering for tax exemptions in this jurisdiction.
For any questions about Hong Kong offshore claims and related matters, our dedicated team is always ready to support you and share with you practical advice. Feel free to get in touch with us via service@bbcincorp.com.
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Disclaimer: While BBCIncorp strives to make the information on this website as timely and accurate as possible, the information itself is for reference purposes only. You should not substitute the information provided in this article for competent legal advice. Feel free to contact BBCIncorp’s customer services for advice on your specific cases.
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