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
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  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.