Profits Tax Exemption Key Facts

Profits Tax Exemption Key Facts | Bestar

Profits Tax Exemption Key Facts

Hong Kong's profits tax system is based on a "territorial source principle," meaning that only profits sourced in or derived from Hong Kong are subject to tax. This is the foundation for various exemptions. Here are some key facts about profits tax exemptions in Hong Kong:

The Territorial Source Principle

• Core Principle: This is the most significant aspect of Hong Kong's tax system. If a company's profits are generated from activities outside of Hong Kong, they are generally not subject to Hong Kong profits tax, regardless of whether the company is incorporated in Hong Kong.

  
  

• Offshore Profits: Profits are considered "offshore" and exempt from tax if the key profit-generating activities (like sales, procurement, and contract negotiations) take place outside of Hong Kong.

  
  

• What Doesn't Matter: The Inland Revenue Department (IRD) generally considers factors like where a company is incorporated, where its bank accounts are located, or the residence of its directors to be irrelevant when determining the source of profits.

Foreign-Sourced Income Exemption (FSIE) Regime

• Expanded Scope: Effective from January 1, 2024, the FSIE regime in Hong Kong was expanded to include a wider range of foreign-sourced income that can qualify for exemption from profits tax. This includes interest, dividends, intellectual property (IP) income, and gains from the disposal of equity interests and other assets.

  
  

• Economic Substance Requirement: To qualify for these exemptions, entities must meet "economic substance" requirements. This means they must have adequate human resources and premises to carry out the specified economic activities in Hong Kong.

Other Specific Exemptions

• Capital Gains: Gains and receipts that are capital in nature are generally not subject to profits tax.

  
  

• Dividends: Dividends from both local and overseas companies are typically exempt from profits tax.

  
  

• Qualifying Debt Instruments (QDIs): Income from QDIs issued on or after April 1, 2018, is tax-exempt, subject to certain conditions.

  
  

• Fund-Specific Exemptions: Privately offered funds (both onshore and offshore) and certain publicly offered funds can be exempt from profits tax on profits derived from specific transactions.

  
  

• Concessionary Rates: Some industries, like qualifying corporate treasury centers, aircraft leasing, and ship leasing activities, may be eligible for a concessionary profits tax rate (e.g., 8.25% or even 0%) under specific conditions.

The Application Process

• Making a Claim: To claim a profits tax exemption for offshore income, a company must complete its Profits Tax Return, stating that its assessable profits are nil or zero. A note or computation explaining the offshore claim must be attached.

  
  

• Supporting Documentation: Companies must be prepared to provide supporting documentation to prove that their profit-generating activities took place outside of Hong Kong. This can include invoices, contracts, correspondence with clients, and travel records.

  
  

• IRD Assessment: The IRD will conduct an "operations test" to review the specific facts of the business. The process can take 12 to 24 months for an average case and longer for more complex situations. Rejection is common if the business's activities are not truly offshore or if the evidence is poor or inconsistent.

  
  

• Professional Advice: Due to the complexity and potential for rigorous IRD review, it's highly recommended to seek professional advice to determine eligibility and assist with the application and documentation process.

How Bestar can Help

Navigating Hong Kong's profits tax system, especially with claims for offshore exemption, can be complex. The Inland Revenue Department (IRD) conducts a "totality of facts" test, which is a detailed examination of a company's operations to determine the source of its profits. This is where professional assistance becomes invaluable.

Here's how Bestar can help:

1. Initial Assessment and Strategic Planning

• Eligibility Assessment: Bestar can analyze a company's business model, operations, and transaction flows to determine the likelihood of a successful offshore claim. We can identify potential red flags and advise on whether the company's activities truly qualify for an exemption.

  
  

• Restructuring and Optimization: For companies with mixed operations, Bestar can advise on how to restructure business activities to enhance tax efficiency and strengthen the case for an offshore profits claim. This might involve setting up a clearer division of labor between Hong Kong-based and overseas employees or defining where key business decisions are made.

2. Comprehensive Documentation and Preparation

• Gathering Evidence: A successful offshore claim hinges on robust documentation. Bestar assists in identifying, gathering, and organizing all necessary evidence. This includes contracts, invoices, purchase orders, shipping documents, email correspondence, travel records, and meeting minutes to prove that key profit-generating activities occurred outside of Hong Kong.

  
  

• Preparing the Tax Return: We handle the preparation and filing of the Profits Tax Return, ensuring the offshore claim is properly stated and supported by a clear, detailed tax computation and a cover letter that preemptively addresses potential IRD questions.

  
  

• Ensuring Compliance: Bestar is up-to-date on the latest tax laws and regulations, including recent changes like the Foreign-Sourced Income Exemption (FSIE) regime. This ensures that the claim is not only strong but also compliant, mitigating the risk of penalties for incorrect filings.

3. Liaison with the Inland Revenue Department (IRD)

• Handling Inquiries: The IRD will almost certainly issue an inquiry letter seeking further information. Bestar acts as the company's representative, handling all correspondence and providing clear, timely, and well-supported responses. Our experience with IRD procedures and legal frameworks is crucial in this process.

  
  

• Managing Audits and Investigations: If the IRD decides to conduct a field audit or investigation, Bestar will guide the company through the process, helping to present the documentation and information in a systematic and convincing manner.

4. Risk Mitigation and Peace of Mind

• Avoiding Penalties: An unsuccessful or poorly substantiated offshore claim can lead to the IRD imposing back taxes, penalties, and interest. By ensuring the claim is properly prepared and supported, Bestar significantly reduces this risk.

  
  

• Saving Time and Resources: The process of preparing an offshore claim is time-consuming and complex. Outsourcing this to Bestar allows a company's management to focus on its core business activities, knowing that its tax affairs are being handled by experts.

  
  

In essence, Bestar acts as a crucial partner, providing not just technical expertise but also a strategic approach to navigating Hong Kong's tax landscape, maximizing a company's chances of a successful profits tax exemption.

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