So how do we structure a “Hong Kong Sourced Profits”?
The Courts have over the years considered the subject of the source of profits. The Inland Revenue Department has provided certain board principles based on various court decisions on their website:
1) Matter of fact
The question of locality of profits is a hard, practical matter of fact. Whether profits are derived from Hong Kong depends on the nature of the profits and of the transactions, which give rise to such profits.
2) The operations test
One broad principle in determining the source of profits is to see what the company has done to earn the profits in question and where the company has done it. In other words, the proper approach is to identify the operations, which produced the relevant profits and ascertain where those operations took place.
3) Principal place of business
A company may maintain a business presence overseas, which earns profits outside Hong Kong, but the absence of a business presence overseas does not, in itself, mean that all the profits of a Hong Kong business are derived from Hong Kong. However, if a company’s principal place of business is located in Hong Kong and there is no business presence overseas, profits earned by that company is likely to be considered as Hong Kong sourced.
4) Place where decision is made
The place where the day-to-day investment / business decisions take place is only one of the factors to consider in determining the source of profits. However, it is not generally the deciding factor.
5) Non-profit generating activities
In determining the nature of business activities that give rise to the profit, only profit-generating activities of the company are taken into consideration. As such, general administration activities do not qualify as profit generating activities.
6) Principles on Profits of Trading Firms
Contracts for purchase and sale of goods
An important factor that determines the source of profits from trading in goods and commodities is the place where the contracts for purchase and sale are affected.
“Effected” does not only mean that the contracts are legally executed. It also covers the negotiation, conclusion and execution of the contract terms.
Factors to consider include: How were the goods procured and stored? How were the sales conducted? How were the orders processed? How were the goods shipped? How was the financing arranged? How was payment effected?
Circumstances to consider
| ♦ | If the contracts of purchase and sale are effected in Hong Kong, the profits are subject to tax in Hong Kong. |
| ♦ | If the contracts of purchase and sale are effected outside Hong Kong, the profits are NOT taxable in Hong Kong. |
| ♦ | If either the contract of purchase or the contract of sale is effected in Hong Kong, the initial presumption is that the profits are taxable in Hong Kong. However, other relevant facts will have to be examined to determine the source of profits. |
| ♦ | If the sale is made to a Hong Kong customer (including the Hong Kong buying office of an overseas customer), the sale contract will usually be taken as having been effected in Hong Kong. |
| ♦ | If the effecting of the purchase and sale contracts does not require travelling outside Hong Kong but is carried out in Hong Kong by use of telephone, or other electronic means including the Internet, the contracts will be considered as having been effected in Hong Kong. |
7) Principles on Profits of Servicing Business
The place where service is performed
For servicing business, the source of the income is the place where the services are performed. If services are performed in Hong Kong, the income has a source in Hong Kong.
In the event that a company carrying on a business in Hong Kong earns the service income but the services are performed entirely outside Hong Kong, the service fee is not taxable in Hong Kong.