by Roddy Sage on February 26th, 2013

Over the period 2002/2003 to 2011/2012, and particularly during the period of John Tsang’s stewardship of the Government’s finances, there has become an increasing reliance on revenue from land premium, stamp duty, profits tax and salaries tax.  Revenue from these sources currently accounts for approximately two thirds of the Government’s total revenue.  Indeed, it can be seen from table (1) below that the Government’s budget surplus is very sensitive to the collections from stamp duty and land premium.


Table (1) also illustrates the substantial increase in revenue collected from stamp duty and land premium, and how these collections have outpaced the collection of profits tax in the period from 2005/2006 to 2011/2012.  The Government’s dependence on such a narrow basis of revenue is further evident when it is appreciated that the increase in revenue from profits tax over the period 2002/2003 to 2011/2012 is more than 2½ times that from salaries tax or any other form of direct taxation – see table (2) below.


The Government’s dependence on revenue from profits tax, land premium and stamp duty underlines just how important the property development sector is to the Government’s ability to manage its finances.  Hong Kong’s property companies are a major contributor to the profits tax collected.  They are the principal payers of land premium and provide the residential and commercial units of which the transfers attract significant rates of stamp duty.

Since John Tsang became Financial Secretary, there has been little relief for people paying profits tax.  Other than reducing the standard rate from 17.5% to 16.5% in his first year of office, and despite calls for a reduction in the standard rate of profits tax to 15%, a reduced rate of tax applicable to lower earnings, the ability to carry back losses and group relief, the Financial Secretary has done little for a corporate sector that has consistently funded the Government’s coffers.  By comparison, the managers of a successful division of a corporation would have expected a reasonable bonus for exceeding their budget targets.

We have heard a great deal from the Government about the rapid growth in property prices, the limited supply of land for development purposes, etc.  Indeed, it is near to becoming an obsession.  The Government has sought to control the increase in property prices, and I suspect certain individuals within Government see this as a confrontation with property developers, by increasing the rate of stamp duty.  No doubt this will have the desired effect in that the vendor of a property will receive less from the sale of his/her asset, but of course the Government will see an increase in stamp duty revenue from each sale/transfer of property.  However, let it not be forgotten that it is the Government that collects the land premium from developers.  The land premium forms a substantial part of the developers’ construction costs, and hence influences the ultimate sale price of new flats and housing.  The payment of the land premium is also indirectly responsible for the high rents payable in respect of residential and commercial property, as the owners of such properties seek a meaningful yield on their invested capital.  I would also like to add that many Hong Kong residents, in the absence of any constructive and meaningful pension arrangement provided by the Government, purchase property as part of their retirement planning for either rental income or long-term capital growth.  This behaviour is very far from the property speculation that the Government believes is rampant.

While on the subject of the need to increase the supply of property to manage the demand for flats, what is happening to the proposed development of Kai Tak (which ceased to be used as an airport 15 years ago) and the West Kowloon peninsula?

I look forward to John Tsang’s sixth budget this Wednesday, not so much in anticipation of any relief for corporate taxpayers, but rather in anticipation of assessing his ability to satisfy Hong Kong’s expectations as to whether the Government is wisely using the money it remorselessly collects from its residents.



by Roddy Sage on February 25th, 2013

John Tsang, the Financial Secretary (“FS”), will deliver his budget on 27th February 2013.  In his 2012/2013 budget, the FS forecast a deficit of HK$(3.4bn) for 2013/2014, however it will come as no surprise that, yet again, that figure is likely to be inaccurate.  Indeed, the Government has announced that its consolidated surplus for the nine months to 31stDecember 2012 was HK$40bn.  Bearing in mind that the majority of the Government’s revenue collections from salaries tax occurs in the months of January and February, the FS is likely to announce an embarrassingly large surplus.  No doubt every attempt will be made to manage this by making provision for every conceivable expense possible.

As a teaser for future “rants”, I attach a table showing the Government’s inability to forecast its own financial position.


Financial Secretary

Original Forecast

Revised Forecast

Published Consolidated Result
HK$bn HK$bn HK$bn
2002-03 Anthony Leung (45.20) (70.00) (61.75)
2003-04 Anthony Leung (67.90) (49.00) (40.13)
2004-05 Henry Tang (42.60) (13.40) (4.04)
2005-06 Henry Tang (10.50) 4.1 13.96
2006-07 Henry Tang 5.60 55.10 58.60
2007-08 Henry Tang 25.40 115.60 123.65
2008-09 John Tsang (7.50) (4.90) 1.45
2009-10 John Tsang (39.90) 13.80 25.92
2010-11 John Tsang (25.20) 71.30 75.12
2011-12 John Tsang 3.90 66.70 73.69
2012-13 John Tsang (3.40) ? ?



by Roddy Sage on August 22nd, 2012

In 2010, the Inland Revenue Ordinance was amended to enable Hong Kong to enter into comprehensive double taxation agreements (“CDTAs”) with other countries. Although the Government issued a consultation paper to assess public opinion at that time, I was never in any doubt that it would push ahead with the enactment of amending legislation. The Government simply did not want to defend Hong Kong’s right to maintain the privacy of people’s financial data against international pressure, particularly from those countries seeking excuses for their governments’ poor budgetary management. Of the 24 CDTAs that have been concluded, and the three awaiting signature, all contain a clause enabling the respective governments to exchange information relating to the income and assets of nationals of the treaty partner.

As Hong Kong does not tax non-Hong Kong-source income or withhold tax from payments of interest and dividends, the only negotiating tool available to Hong Kong was the agreement to exchange financial information relevant to a potential treaty partner’s taxpayers. Of course the Government always seeks to emphasise the benefits obtained for Hong Kong’s taxpayers, i.e., the reduction in withholding tax rates on dividends, interest, royalties etc.

The Government has now concluded another consultation exercise, this time to allow it to enter into a Tax Information Exchange Agreement (“TIEA”) with those countries that have been unwilling to enter into a CDTA with Hong Kong, in particular the USA, Australia and Germany. I have no doubt that whatever the outcome of the consultation process, the Government will proceed as it sees appropriate. I am of this opinion simply because Hong Kong is the only country out of the 109 members of the Global Forum on Transparency and Exchange of Information for Tax Purposes that does not have legislation permitting its government to enter into a TIEA.

Assuming that the Government will go ahead as anticipated, I question whether it will have the strength of character to enter into TIEAs only with those countries where there is an acceptable purpose, as opposed to a vague hope of increasing government revenues. There is also the question of ensuring that a TIEA partner does not provide the information to third parties, whether within that country or to others with whom the TIEA partner also shares information. Finally, I wonder whether the Hong Kong Government will resist any suggestion that foreign agencies should be allowed direct access to documents retained in Hong Kong.

Whatever the outcome, it is quite clear that smaller jurisdictions cannot fight the threat of sanctions from the dominant, powerful countries that are desperate for revenues to cover up their inadequacies.



by Roddy Sage on August 10th, 2012

I was heartened to read the judgment of the Hon Tang VP in the Court of Appeal case of the Li & Fung (Trading) Ltd v Commissioner of Inland Revenue.  I had become used to reading Tang’s judgments, which always seems to favour the Commissioner of Inland Revenue (“the Commissioner”).  Hence my surprise at learning of the Court of Appeal’s acknowledgement of the validity of the taxpayer’s offshore claim.

In brief, Li & Fung (Trading) Ltd (“Li & Fung”) was contracted by its clients to source manufacturers/vendors located in Asian countries.  In consideration, Li & Fung was paid a commission equivalent to 6% of the FOB value of the goods supplied to the customer.  Most of the work was done by Li & Fung’s offshore affiliates, to whom Li & Fung paid a commission of 4% of the FOB value of the goods shipped.

The Commissioner assessed Li & Fung on the basis that the senior management was based in Hong Kong and that the company had a large infrastructure in Hong Kong – both of these factors were considered to be relevant in the earning of the said profits.  This was in line with the long-held belief of the Inland Revenue Department (“the Department”) that:

(a)  “it can only be in rare cases that a taxpayer with a principal place of business in Hong Kong can earn profits which are not chargeable to tax”, Lord Jauncey in HK-TVB1, and that

(b)  it was essential to “contemplate all the relevant operations carried out to earn the profits, including the solicitation or orders, negotiation, conclusion, trade financing, shipment and performance of the contracts.”

At the Board of Review, the Commissioner lost, and appealed the decision to the Court of First Instance, where the appeal was dismissed, as it also was in the Court of Appeal.  In the Court of First Instance, the Commissioner resorted to arguing a case for apportionment, maintaining that the 2% net commission earned by Li & Fung was paid in respect of services performed by its senior management in Hong Kong.

This contention was refuted by Li & Fung, and both the Court of First Instance and the Court of Appeal found in favour of Li & Fung, stating that the Commissioner’s approach of looking at all the activities of Li & Fung, as opposed to those responsible for earning the said profit, was incorrect.  Furthermore, it was the activities of the offshore affiliates, whether those offshore affiliates were acting as a principal or an agent, that gave rise to the profit, and as such the profit was correctly claimed as having arisen offshore and therefore as not being subject to profits tax.

Following this judgment, on 18 May 2012, the Inland Revenue Department published its “Frequently Asked Questions” in relation to “The Li & Fung Case”.  Whilst all the questions and answers are interesting, particularly in view of the way in which the Department has tried to play down the significance of the decision, two issues stand out and deserve further comment.  The first is the issue of “agency”, and the second is the question “Why didn’t the Commissioner appeal to the Court of Final Appeal?”

With regard to the issue of “agency”, it is stated that:

“In CIR v Datatronics Ltd (2009) 4 HKLRD 675 and CIR v CG Lighting [2011] 2 HKLRD 763, the Court of Appeal held that the subsidiary was not manufacturing on the Mainland as agent for the taxpayer in Hong Kong.”

I have no idea how that statement could be made with reference to CG Lighting, as the taxpayer was unable to put forward that contention in the higher courts, because the question of agency was not raised at the Board of Review.  Had CG Lighting been able to raise that contention, the decision might have been different.

With regard to the second issue, the Department states that it did not consider that the “case involved questions of great general or public importance”.  This is a repetition of the statement made by the Court of Final Appeal in CG Lighting.  Personally, I find it very sad that the question of source, which is so fundamental to Hong Kong’s tax system, is considered to be of such little interest to the general public!

I suppose we should at least be grateful that in this case it was not the taxpayer who was refused leave to appeal to the Court of Final Appeal.



by Roddy Sage on July 30th, 2012

If you currently hold UK residential property through a corporation or you are thinking of using a corporation to buy UK residential property, you will need to reflect on the UK Government’s proposals “to create more equal treatment between UK residents and non-residents”.

The consultation period in regard to the UK Government’s proposals for “Ensuring the fair taxation of residential property transactions” ends on 23 August 2012.  Draft legislation is expected in the autumn, with legislation due to be enacted in 2013.

The proposed additional charges on “non-natural persons” holding UK residential property valued in excess of £2m include a 15% stamp duty charge on acquisition, an annual charge starting at £15,000 p.a. and a potential capital gains tax liability on the disposal of the property.  For more details, see the article on the same subject posted on our website.

Whilst the UK Government may promote these proposals as a means to “ensure that everyone pays their fair share of tax on residential property”, it is a clear departure from the concept that a person who is not resident in the UK for tax purposes is not liable to UK tax on capital gains derived from the disposal of UK property.  The UK Government regards this change in tax policy as being equitable, stating: “The measure creates a more equal treatment in the CGT regime between UK residents and non-residents, and brings the UK tax policy in line with that of other countries, many of whom already tax non-residents’ gains.”

I suspect many UK expatriates living in Hong Kong hold UK properties through offshore companies, whether for Inheritance Tax, asset protection or other purposes.  If such properties are currently valued in excess of £2m, owners will need to consider whether it is appropriate to retain the corporate structure or to restructure the ownership of the property such that it is held directly by the individual.  Both scenarios will undoubtedly have a cost.

Certainly, I do not expect to see any concessions in the draft legislation that will change the increased UK tax burden for expatriates.



by Roddy Sage on May 22nd, 2012

In 2010 and 2011, I commented on the progress of the case Commissioner of Inland Revenue v CG Lighting Limited HCIA 8/2009, which came to an abrupt conclusion when the taxpayer was refused leave of appeal to the Court of Final Appeal.  The case concerned an offshore profits claim filed by the taxpayer made on the basis that its profits were derived from manufacturing in Mainland China, through a processing agreement concluded with its wholly owned Mainland Chinese subsidiary.

Despite the fact that the taxpayer had structured its affairs strictly in accordance with paragraphs 15 and 16 of the Inland Revenue Department’s Departmental Interpretation and Practice Notes (“DIPN”) No.21 (Revised) issued in March 1998 (a revised version of DIPN was subsequently issued in December 2009), it was held that the parent and subsidiary were two independent entities, that the Mainland Chinese subsidiary was the manufacturer and that the taxpayer was merely trading in products purchased from the Mainland China subsidiary and sold to third parties.  As there was no evidence that the trading activities took place outside Hong Kong, it was determined that the full amount of the said profits were subject to Hong Kong profits tax.

In the Inland Revenue Department’s revised DIPN 21, a distinction is drawn between “Import Processing” and “Contract Processing”.  Neither of these terms is incorporated in the Inland Revenue Ordinance.

A contract processing arrangement is explained in DIPN 21 as follows:

“In contact processing, the document that governs the contractual relationship among the parties is the processing agreement.  It sets out the rights and responsibilities of the Hong Kong company and the Mainland processing enterprise.  The Hong Kong company is responsible for the supply of raw materials and machinery without consideration and to provide technical and managerial know-how while the Mainland processing enterprise is responsible for the provision of factory premises, utilities and labour force.

In return for the processing service, the Hong Kong company pays a subcontracting charge to the Mainland enterprise.  The legal title to the raw materials and finished goods remains with the Hong Kong company.  In the Department’s view, the Hong Kong company’s operations in Mainland China complement its operations in Hong Kong.  Recognising the operations of the Hong Kong company in the Mainland, an apportionment of profits on a 50:50 basis is usually accepted.”

An import processing arrangement is explained in paragraphs 39 and 40 as follows:

“In import processing, the manufacturing operations are carried out by a foreign investment enterprise (FIE) related to the Hong Kong company.  An FIE is often a separate legal entity incorporated in the Mainland.  The Hong Kong company sells raw materials to the FIE and buys back the finished goods from the FIE.  The Hong Kong company engages in the trading of raw materials and finished goods whilst the FIE manufacturers the finished goods.  The legal title to the raw materials and the finished goods passes to/from the FIE.

In import processing, the gross profits arise from trading transactions whereby the Hong Kong company purchases finished goods from an FIE and sells them for a profit.  The manufacturing operations of the FIE in the Mainland are not performed on behalf of, or for the account of, the Hong Kong company even though the Hong Kong company and the Mainland enterprise might be within the same group of companies.”

Until such time as a taxpayer is prepared to challenge the Department’s practice and the Court of Appeal is more disposed to consider a taxpayer’s appeal from the Court of First Instance, the decision in CG Lighting will be determinative in all offshore claims made by Hong Kong manufacturers.  Put simply, any Hong Kong taxpayer, manufacturing through a group company in Mainland China or elsewhere, will not be deemed to be a manufacturer, but will rather be deemed to be a trader, and any profits will be taxed according to the location where the contracts of purchase and sale of the manufactured products were negotiated and concluded.

The only possible opportunity for a Hong Kong manufacturer to make an offshore claim is where the taxpayer directly owns the manufacturing operation in Mainland China and manufactures products in Mainland China under a contract processing agreement, acknowledged by Mainland authorities.

In addition the taxpayer will need to demonstrate that:

  • The taxpayer is responsible for the supply of raw materials and machinery without consideration.
  • The taxpayer provides technical and managerial know how.
  • The legal title to all raw materials and finished goods at the Mainland China factory remains with the taxpayer.
  • The subcontracting charge paid to the Mainland factory for processing the goods is not a settlement of an invoice for the purchase of products.

A point of interest that was not discussed at the Court of First Instance was whether the Mainland Chinese subsidiary was in fact an agent of the taxpayer.  This would have given rise to an interesting debate that could have changed the ultimate conclusion reached by the Court of First Instance.

The decisions in CIR v CG Lighting Limited and in CIR v Datatronics Limited [2009] 4 HKLRC 675 have forced many Hong Kong manufacturers to restructure their operations, as it has become clear that the Inland Revenue Department has no wish to entertain any claim by a Hong Kong taxpayer, manufacturing in Mainland China, that its manufacturing profits are sourced offshore.

As a result, careful planning is essential, both in terms of getting the structure correct and in terms of ensuring that the documentation supports the taxpayer’s contention.



by Roddy Sage on May 16th, 2012

Section 14 Inland Revenue Ordinance (“IRO”) clearly states that a person must be carrying on business in Hong Kong before the Inland Revenue Department (“the Department”) can assess the profits derived from that business to Hong Kong profits tax.  However, Section 14 IRO also requires that before a charge to profits tax can arise, the profits must “arise in or be derived from” Hong Kong.  This determination, commonly referred to as the “source concept”, has been the subject of considerable debate between taxpayers and the Department.  The Department’s views are expressed in “Departmental International and Practice Notes No.21 (Revised) – Locality of Profits” (“DIPN21”).  In December 2009 a revised DIPN 21 was issued.  It takes into account various changes in the Department’s practice necessitated by court decisions that were handed down in the preceding 10 years. 

In DIPN 21, the Department reiterates the “broad guiding principle” on source explained by Lord Bridge in CIR v Hang Seng Bank Ltd [1991] AC306:

“the question whether the gross profit resulting from a particular transaction arose in or derived from one place or another is always in the last analysis a question of fact depending on the nature of the transaction.  It is impossible to lay down precise rules of law by which the answer to that question is to be determined.  The broad guiding principle, attested by many authorities, is that one looks to see what the taxpayer has done to earn the profit in question.”

This was further expanded by Lord Jauncey in CIR v HKTVB  International Limited [1992] 2 AC 397:

“Thus Lord Bridge’s guiding principle could be properly expanded to read “one looks to see what the taxpayer has done to earn the profit in question and where he has done it.””

More recently in Kwong Mile Services Ltd v CIR [2004] 3 HKLRD 168 Bokhary PJ remarked:

“Apart from the words of the statute themselves, the only constant is the need to grasp the reality of each case, focusing on effective causes without being distracted by antecedent or incidental matters.”

The subject of the majority of “offshore claims”, i.e., profits that are claimed by the taxpayer as not having arisen in or not having been derived from Hong Kong, concern profits earned from trading and manufacturing activities.  In the remainder of this article, I will focus on trading profits, whilst the thorny issue of what constitutes an offshore manufacturing profit will be dealt with in a subsequent article.

Lord Bridge in Hang Seng Bank stated that the relevant activities that gave rise to the profits from commodity trading were the contracts of purchase and sale and that the location of the source of such profits was determined by the location where these contracts were effected.  In DIPN 21, however, the Department states that it “agrees with the approach in Magna and will contemplate all the relevant operations carried out to earn the profits, including the solicitation of orders, negotiations, conclusion, trading financing, shipment and performance of the contracts.”  The following reflects the Department’s current assessing practice:


“(a)   Where both the contract of purchase and contract of sale are effected in Hong Kong, the profits are fully taxable.

(b)    Where both the contract of purchase and contract of sale are effected outside Hong Kong, no part of the profits are taxable.

(c)    Where either the contract of purchase or contract of sale is effected in Hong Kong, the initial presumption will be that the profits are fully taxable.  Matters, such as those mentioned in paragraph 18 above, will be examined to determine the issue.

(d)    Where 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.

(e)    Where the commodities or goods are purchased from either a Hong Kong supplier or manufacturer, the purchase contract will usually be taken as having been effected in Hong Kong.

(f)     Where the effecting of the purchase and sale contracts does not require travel outside Hong Kong but is carried out in Hong Kong by telephone, fax, etc., the contracts will be considered as having been effected in Hong Kong.

(g)    The purchase and sale contracts are important factors but all the relevant operations that produce the trading profits must be looked at to determine the locality of the profits.”

However, it must be remembered that it is the taxpayer who is making the claim that the profits are not subject to Hong Kong tax, and hence it is incumbent on the taxpayer to provide sufficient evidence to the Department to justify the claim.  I have seen many examples where the taxpayer or the taxpayer’s representative simply states that the said profits have been excluded because “they arose offshore”, or that “the sales and purchase contracts were concluded offshore” etc., without further explanation or documentary support.  In my opinion, the taxpayer should not be surprised to receive a five-page letter from the Department requesting such information as is necessary to enable the Department to assess the correctness of the taxpayer’s claim.  Typical information required would include:

  • A copy of the organisational chart of the taxpayer.


  • Details of the taxpayer’s offices, both in Hong Kong and abroad.


  • The functions of each office.


  • Details of the persons employed by each office, their title, job description and whether they have any authority to execute contracts on behalf of the taxpayer.


  • The nature of the taxpayer’s products, together with catalogues, price lists etc.


  • A full description of the taxpayer’s mode of trading, including but not limited to:


-     How and by whom was the original contact made with the customer?

-     Who negotiated the contracts of sale?

-     Where were the sales contracts negotiated?

-     Where was the customer’s purchase order sent, and who approved it?

-     Where were the sale invoices prepared and who provided the information necessary to prepare the invoice?

-     Who approved the invoice and where was that person located?

-     Who identified the suppliers and where did such meetings take place if appropriate?

-     Who was responsible for negotiating the purchase price?

-     Who prepared and approved the purchase order?

-     Who arranged for the shipment of the goods?

-     Who approved the suppliers’ invoices for payment?

-     Who authorised the payment of suppliers’ invoices, and where were the payments effected?

  • The Department will also ask for a comprehensive set of documents relating to one or two specific purchase and sale transactions.


  • A schedule may be required illustrating the taxpayer’’ 10 largest suppliers in a given year of assessment.


  • A schedule may be required illustrating the taxpayer’’ 10 largest customers in a given year of assessment.


  • A full description of the basis of the offshore claim.


  • Identification of the general overhead administrative expenses attributable to the offshore income.


Sadly, even if it can be demonstrated that both the contracts of purchase and sale were negotiated and concluded offshore, the IRD may still attempt to refute the taxpayer’s contention if any activity is undertaken in Hong Kong, however ancillary or incidental it may be to the earning of the trading profit.

In order to avoid such unnecessary and protracted correspondence, I would strongly recommend that all taxpayers who are considering making an offshore profits claim provide the Department with a full description of the activities giving rise those profits said to have an offshore source.  The taxpayer may even consider attaching a set of documents relating to a representative transaction for which the claim has been made.

Whilst this process may seem very tedious, once the claim has been agreed with the Department it is very unlikely that the enquiry will be repeated for several years, unless the taxpayer’s mode of trading changes.  This should enable the taxpayer to plan its affairs in a tax-effective manner and to confidently estimate any profits tax due.

In the next article I will deal with how to make an offshore claim in respect of manufacturing profits.



by Roddy Sage on May 10th, 2012

In a previous article, I stated that Section 14 Inland Revenue Ordinance (“IRO”) requires that a person must be carrying on a business in Hong Kong from which profits are derived before those profits fall within the charge to profits tax.

When discussing the definition of the word “business”, I concluded that it takes only a relatively low level of activity for the courts to deem that a person is carrying on a business.  However, whether a person is carrying on a business in Hong Kong is a question of fact.

Many persons who are not Hong Kong residents may have incorporated a company in Hong Kong into which they may have “booked” profits, with the belief that the said profits would not be taxed.  Typically, the Hong Kong company (“HKCo”) may have no employees and no office in Hong Kong.  All the contracts of purchase and sale may have been negotiated outside Hong Kong by persons not resident in Hong Kong.  The principal activities carried on in Hong Kong may have been those required under Hong Kong law, i.e., HKCo will require a registered office in Hong Kong and a Hong Kong-resident Company Secretary, and must have the company’s accounts audited.

Companies such as HKCo may appoint a third party, such as a corporate services provider, to undertake those and other administrative services.  Prior to the revision of the “Departmental Interpretation and Practice notes No.21 (Revised) – Locality of Profits” in December 2009, the Inland Revenue Department (“the Department”) would have accepted that HKCo’s profits were not subject to tax.  The Department’s practice prior to December 2009 was as follows:

“There may be cases where the activities of a Hong Kong trading business are limited to the following –

a)issuing and accepting an invoice (not order) to or from an ex-Hong Kong customer or supplier (whether related or not) on the basis of contracts of sale or purchase already effected by an ex-Hong Kong associate;

b)      arranging letters of credit;

c)operating a bank account, making and receiving payments, and

d)     maintaining accounting records.

This situation commonly arises when a Hong Kong business, as a member of a group pursuant to a group directive, carries out the above activities and “books” the profits in Hong Kong.  Provided the activities of the Hong Kong business do not include the acceptance or issue of sale or purchase orders in or from Hong Kong, the profits would not be taxable.”

This paragraph has been withdrawn, and has been replaced by a comprehensive discussion on the “source” of profit that, among other things, explains the operations that the Department considers to be of importance in its determination of whether a profit is derived from Hong Kong.  Inevitably, this has given rise to uncertainty and has created opportunities for the Department to challenge many of the claims previously made by taxpayers and accepted by the Department.

A favourite case cited by the Department is D107/96.  The case concerned a company incorporated in Hong Kong, established to book the profits derived from a single overseas customer.  All the contracts of purchase and sale were negotiated and concluded by an individual permanently resident outside Hong Kong.  As the company in question had no employees or business premises in Hong Kong, it employed a Hong Kong-based corporate services company to undertake certain administrative services.  Such services included the preparation and issuance of purchase orders and pro-forma sales invoices from information provided by the offshore individual, settlement of letters of credit, arranging for the preparation of the audit, etc.

The Board of Review held that:

“In the present case, there were activities outside Hong Kong.  Negotiations prior to the issuing of purchase orders or proforma invoices were carried on outside Hong Kong.  But the vast majority of the activities that followed were in Hong Kong.  Purchase orders and proforma invoices were issued in Hong Kong.  Letters of credit were received and transferred in Hong Kong.  Documents were prepared and presented here in order to obtain payment.  Payments were obtained and made in Hong Kong.  Without these activities, no profit could have gone into the Company’s bank account.”

Having concluded that the corporate services company acted as the agent for the company in question, the Board of Review stated:

“The Company had its directors in Hong Kong.  The books were kept in Hong Kong.  The bank account was in Hong Kong and the authorised signatories were in Hong Kong.”

The Board of Review found that:

“We have no hesitation in finding that the Company did carry on business in Hong Kong.”

The Board of Review then went on to discuss whether the profits arose in or were derived from Hong Kong.  The Board of Review then assumed that the said profits were derived from the business carried on in Hong Kong, which by the Board of Review’s own finding was limited to administrative activities undertaken after the negotiation and conclusion of the contracts for purchase and sale.  Clearly the profit arose from the activities undertaken by the persons resident outside Hong Kong, but could that be said to be a separate business from the administrative services provided by the corporate services company?

With this uncertainty and the change in the Department’s practice, it is not surprising that most claims made by taxpayers under Section 14 IRO relate not to whether a business is being carried on in Hong Kong, but rather to whether the said profit arose in or was derived from Hong Kong.

In my next article, I will briefly discuss the concept of source, and will review the questions that the Department commonly asks when evaluating the substance of a taxpayer’s claim.



by Roddy Sage on May 3rd, 2012

As I stated in a previous article, profits derived by a person who does not carry on “a trade, profession or business in Hong Kong” will not be subject to Hong Kong profits tax, according to Section 14 Inland Revenue Ordinance (“IRO”), and rarely will that person be required to file a Hong Kong tax return.  However, if the person is a Hong Kong-incorporated company, the company will still have to have its accounts audited.

The word “profession” is not defined in the IRO, and hence will be given its ordinary meaning, as commonly used.  The Board of Review and courts of law are seldom asked to consider the meaning of the word “profession”, as activities conducted by a profession are likely to fall within the definition of a “trade” or “business”.

Whilst it is important to be able to determine whether a person is carrying on a trade, the concept of carrying on a business is more difficult to define, and requires a significantly lower level of activity than a trade, hence the comment that “every trade is a business, but every business is not a trade.”

The word “trade” has been the subject of many tax disputes.  Cases concerning whether a person is carrying on a trade or an adventure in the nature of a trade will normally be determined by reference to the six “badges of trade”.  These six determining factors are derived from the Final Report of the Royal Commission on the Taxation of Profits and Income 1955, and are as follows:

(1)  the subject matter of the realisation

(2)  the length of the period of ownership

(3)  the frequency or number of similar transactions by the same person

(4)  supplementary work on or in connection with the property sold

(5)  the circumstances that were responsible for the realisation

(6)  motive

The word “business” is defined in Section 2(1) IRO as follows:

“business” includes agricultural undertaking, poultry and pig rearing and the letting or sub-letting by any corporation to any person of any premises or portion thereof, and the sub-letting by any other person of any premises or portion of any premises held by him under a lease or tenancy other than from the Government.

Clearly this is not an exhaustive definition, as indicated by the use of the word “includes” at the beginning of the definition.  Whilst there is no single comprehensive definition of the word “business”, courts of law have sought to outline the characteristics of a “business” but have emphasised that each case can be determined only on its own facts.  Some of the comments that are frequently referred to include:

(1)   “Every trade is a business, but every business is not a trade.”  [Wethwell v BIRD (1834)]

(2)   “It is true that in many areas of taxation law the threshold for carrying on a business is very low and easily satisfied.”  [D86/99]

(3)   “While engaging in activities with a view of profit making is an important indicator, and in some cases an essential characteristic, of a business, a profit making purpose does not conclude the question whether the activities constitute a business.  Whether or not they do depends on a careful analysis of all the circumstances surrounding the activities.”  [Lee Yee Shing v CIR [2008] 3 HKLRD 51

In practice, I have seen many cases where a person has incorporated a Hong Kong company, yet because management and control are exercised offshore, all contracts for the purchase and sale of merchandise are concluded offshore and only administrative services are undertaken in Hong Kong, it is assumed that no business is undertaken in Hong Kong.  In support of this claim, it is stated that the only infrastructure and activities conducted in Hong Kong are those required by the statute, i.e.:

  • the company has a Hong Kong-resident company secretary, often an outsourced third-party service provider
  • the company has a Hong Kong-registered office, usually the address of the taxpayer’s corporate service provider
  • accounts are prepared for the Hong Kong operation
  • accounts are audited in Hong Kong
  • annual returns and tax returns are filed by the company’s agents
  • the company has purchased a Business Registration Certificate
  • the company maintains a bank account in Hong Kong

Of equal importance, the company does not:

  • maintain an office in Hong Kong,
  • have any employees in Hong Kong, or
  • retain people in Hong Kong with the authority to negotiate and conclude contracts on behalf of the company, including contracts of purchase and sale.

Despite the fact that the company may be able to support this contention with clear factual evidence, the Inland Revenue Department (“the Department”) is extremely reluctant to state that the company is not carrying on business in Hong Kong.  In support of its rejection of the company’s claim, the Department frequently refers to the case of CIR v Bartica Investment Limited 1HKRC90, the Board of Review decision in D107/96 and the fact that the taxpayer has applied for a Business Registration Certificate.

In Bartica, Cheung J maintained that the systematic placing of the company’s funds on deposit and the use them as security for loans advanced by banks to the taxpayer’s hotel company was a “gainful use of the assets of the taxpayer which, in the words of Lord Diplock, constitute prima facie a carrying on of a business”.

The Department has stated that the decision in Bartica must be viewed in relation to its own facts, and has also stated that its current position is that:

  • the mere receipt of interest by a company does not constitute the carrying on of a business
  • actions that go beyond “mere passive acquiescence” may constitute the carrying on of a business
  • a period of inactivity does not rebut the fact that a company is still carrying on business

Nonetheless, Bartica does emphasise just how little needs to be done to fall within the concept of carrying on a business.  The reality of this was supported by the decision in D107/96.  In that case, a Hong Kong company purchased goods in Hong Kong and sold them to the company’s client in a foreign jurisdiction.  All the negotiations relating to the contracts of purchase and sales were conducted outside Hong Kong by persons not resident in Hong Kong.  Although a Hong Kong company (“Company C”) provided corporate services, including the provision of two nominee directors, the control and management of the company emanated from outside Hong Kong.  Company C was given instructions by various offshore parties and provided the necessary administrative services on behalf of the taxpayer, including the preparation of purchase documents, negotiations of letters of credit, pro-forma invoices etc.

It was found that, notwithstanding that all instructions were given from outside Hong Kong, Company C was the taxpayer’s agent and its activities constituted the carrying on of a trade on behalf of the taxpayer.  This case will be discussed later in relation to whether the business was carried on in Hong Kong, another requirement of Section 14 IRO.

All persons carrying on a business in Hong Kong are required to register that business under the Business Registration Ordinance.  This Ordinance, which is administered by the Department, defines a “business” as “any form of trade, commerce, craftsmanship, profession, calling or other activity carried on for the purpose of gain and also means a club”.

Sadly, the Department will use the fact that a taxpayer has applied for a business registration certificate as a strong indication that a business is being conducted in Hong Kong.  Coupled with the fact that case law has demonstrated that very little needs to be done in Hong Kong for a decision to be reached that a taxpayer is carrying on a business, this makes it a difficult and frustrating task to obtain the Department’s acknowledgement of such a claim.

By contrast, the Department will accept that a person is not carrying on a business if the activities are related to:

  • the maintenance of a showroom in Hong Kong where no person has the authority to negotiate and conclude contract of sale,
  • a buying office where activities are restricted to the purchase of goods, and
  • the collection of information.

In conclusion, whilst specific activities undertaken in Hong Kong will not constitute the carrying on of a business, it is only in very rare circumstances that the Department will accept such a contention.  Accordingly, if a person is seeking to claim that a company’s profits are outside the scope of Section 14 IRO, it would be worthwhile to concentrate on ensuring that factual evidence can be provided to demonstrate that the profits in question did not arise in Hong Kong and were not derived from Hong Kong.  In subsequent articles, I will briefly review this issue and the nature of the information needed to support such a claim.



by Roddy Sage on April 30th, 2012

During the past two months, the Inland Revenue Department (“the Department”) has sent out profits tax returns to companies that are known to be carrying on business in Hong Kong.  The Department is able to seek such information from a variety of sources, but the fact that a person carrying on business in Hong Kong needs to purchase a business registration certificate every year provides the Department with a useful source of information.  A taxpayer is given one month to file the return, unless he/she has applied for an extension.

Authorised tax representatives may participate in the Department’s Block Extension Scheme, under which the tax representative’s clients included in the scheme are able to benefit from the following extended filing deadlines:

Accounting Date Extended Due Date
1st April 2011 – 30th November 2011 No extension
1st December 2011 – 31st December 2011 15th August 2012
1st January 2012 – 31st March 2012 15th November 2012

Persons not participating in the block extension scheme may apply in writing to the Department to request an extension of time to file their profits tax return.

The profits tax return must be completed in its entirety, and must be signed and dated by an authorised representative of the taxpayer.  The taxpayer must also attach an audited set of accounts (Hong Kong companies only) and, preferably, a tax computation.  Failure to submit the tax return or the audited set of accounts will constitute an incomplete return, which may lead to the levying of a penalty if the omission is not rectified.  Foreign companies, registered under Part XI of the Companies Ordinance (“CO”), that are carrying on business in Hong Kong, do not need to provide audited accounts.

Section 121 requires every company to keep proper books and records to accurately reflect their transactions.  This responsibility falls on the directors, and failure to keep such records is an offence punishable by a fine and/or imprisonment.

The accounting records should be kept at the registered office or such other place as the directors determine, and must be open to inspection by all the directors of the company.  If the records are kept outside Hong Kong, records (or presumably copies of the records) no more than six months old must be maintained at the registered office so that they can be inspected by the directors.

Audited accounts need to be produced annually and presented for adoption at the company’s AGM.  The AGM should be held within nine months of the company’s year end.

As stated above, the audited accounts must be attached to the profits tax return.  However, Section 14 Inland Revenue Ordinance (“IRO”) states that profits accruing to a person will be subject to profits tax only if all the following criteria apply:

(1)     the person is carrying on a trade, profession or business in Hong Kong,

(2)     the said profits were derived from a business carried on in Hong Kong,

(3)     the profits arose in or were derived from Hong Kong,

(4)     the profits were revenue in nature, and

(5)     the profits arose in the year of assessment in question.

The fact that a person is of the opinion that the profits are not subject to tax for one of the above reasons does not absolve the person of responsibility to file a profits tax return.  What should happen is that the person should attach a profits tax computation to the profits tax return and provide a comprehensive explanation as to why it is considered that the said profits fall outside the parameters of Section 14 IRO.

It is inevitable that the Department will fully investigate the taxpayer’s claim, often sending the taxpayer and his/her representative a four- or five-page letter.  Whilst this may frustrate the taxpayer, it should be remembered that the onus of proof to establish the non-taxation claim rests with the taxpayer; the onus to disprove the taxpayer’s contention does not rest with the Department.

Since Hong Kong has started negotiations with other countries to establish a comprehensive double taxation treaty network, the Department’s enquiries have become more detailed, clearly to ensure that tax is administered properly and to prevent Hong Kong from being considered as a tax haven.

In a subsequent article, I will discuss the nature of the enquiries asked by the Department in respect of such claims.