By Stephen O’Regan
International Business Advisory, Dezan Shira&Associates
Hong Kong is often seen as a favorable business location, due to its low tax rates, easier access to the Asian market, as well as a relatively stress-free establishment procedure. The region’s stable political environment and excellent finance and banking services also provide investors with a better business environment. Moreover, there are no exchange controls in Hong Kong. A Hong Kong company may do business anywhere in the world and there is no requirement for the Directors and Shareholders to be residents in Hong Kong. The last benefit leads us to the consideration of the region’s stance on the offshore status of Hong Kong companies. There is no offshore status regulation in Hong Kong per se.
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A company in Hong Kong can be established without substance. This means that the business operation can be run in name only with no office or staff and can be operated remotely. Under the current practices if no income is sourced from the Hong Kong company, meaning that all the income is sourced from abroad, then the company will not be liable for tax in Hong Kong. Generally, there are two common types of tests to determine a company’s offshore status:
Contract Effected Test
The contract effected test is used for determining the taxability of the income accruing to the taxpayer from trading transactions. The important factor here is whether or not the contract of purchase or sale is made in Hong Kong. This includes negotiation, conclusion and execution of the terms of the contract. The following factors should also be taken into consideration:
- How were the goods shipped?
- How were the sales solicited and orders processed?
- How were the goods procured and stored?
- How was financing arranged?
- How was the payment made?
The operations test is for cases other than trading and money lending (manufacturing income and passive income). For commission income, when applying for tax exemptions, one should take the following questions into consideration:
- What is the originating cause of the income?
- Did the originating cause take place in Hong Kong?
- What has been done to earn profits and where was it done?
Essentially enterprises should be aware of the following needs when applying for offshore status:
- No operations office in Hong Kong
- No staff hired and working in Hong Kong
- No customers/client from Hong Kong
- No suppliers from Hong Kong
- Income contract not negotiated or concluded in Hong Kong
- Goods not entering Hong Kong
- Services agreements or sales/purchases invoices should avoid involving any Hong Kong parties
- The actual operations take place outside Hong Kong
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Once these basic requirements are met, the tax authority will check the supporting documents and decide whether the company should pay tax or not. However, once the exemption is granted the company should prepare annual accounting and audit reports, as well as tax returns in the jurisdictions where it operates outside of Hong Kong.
It is common for the tax authority to wait 2-3 years before questioning companies regarding their offshore status. At that point the company should prepare for a review of their books starting from incorporation. Obtaining an offshore status was quite popular up to five years ago, but now the tax authority is becoming quite strict.
Documentary evidences including but not limited to the following documents are critical to the success of the claim:
- Organization chart with full details of the company’s establishments in Hong Kong and overseas which should include the location and size of the office, the number of employees and their respective names, post titles, duties and remuneration packages.
- Travelling schedule and passport of the directors and the persons who are involved in the business of the Hong Kong company.
- A detailed description of the businesses carried out by the company in order to earn income. For each of the activities identified, the company should specify the name of the responsible person and the place where such activity was performed.
- With regard to the income, especially high-income, the investor needs to provide the following documents:
- Correspondence of negotiation with the customer and suppliers (email, fax etc.,)
- Distribution agreement or master sales agreement should be provided if any
- The purchase/sales order, sales confirmation, shipping documents and invoice of sales and purchase
- Relevant banking documents