Disagreements between the Inland Revenue Department (“the Department”) and taxpayers as to whether a particular source of profit accruing to a business carried on in Hong Kong is derived from Hong Kong, and therefore taxable, arise all to frequently. It would be foolish to believe that this uncertainty is ignored by persons contemplating establishing a business in Asia and, in my opinion, this lack of clarity is not conducive to Hong Kong being considered the jurisdiction of choice.
Readers of my Blog will be aware of my frustration regarding the Department’s stance on the taxation of “offshore” manufacturing profits and the inconsistencies of it’s approach with it’s own Departmental Interpretation and Practice Note 21 – Locality of Profits” (“DIPN 21″). Sadly, this is not the only example of where DIPN 21 fails to reflect decisions of the Hong Kong courts. Reference in DIPN 21 to the adoption of a “totality of facts” approach to the determination of whether a source of profit is taxable needs to be amended to reflect the Hong Kong Courts’ recent rulings. Numerous decisions have made it clear that first one must identify each individual source of profit then ascertain what the taxpayer did to earn the profit in question and where this was done, without being distracted by antecedent or incidental matters.
The tendency for the Department to focus on irrelevancies has never been more evident than in the case of ING Baring Securities (Hong Kong) Ltd v CIR (2007) 90-195. In this case the Board of Review commented, in support of the Commissioner of Inland Revenue’s adoption of the totality of facts approach, that;
“A body cannot be said to be fully functional without the brain. From a Hong Kong tax source of profit point of view, the place where a business was administered is certainly one factor which should be taken into consideration”.
Ribeiro PJ emphatically rejected this approach as being “inconsistent with prior court decisions” and “fails to focus on the transactions which proximately produce the profits and emphasises antecedent and incidental matters that, while commercially essential are legally irrelevant”.
Ribeiro PJ continued,
“In other words, the Board believed that in order to ascertain the source of the disputed profits, it had to investigate every facet of the taxpayer’s business so that it could engage a qualitative assessment of the relative importance of its operations, choosing “the more important things done” toward the generation of those profits as the criteria for determining geographical source. That is not the approach mandated by the authorities and places an erroneous emphasis on matters properly regarded as antecedent or incidental to the profit generating operations. ”
This is yet another reason to redraft the DIPN No. 21 to ensure that the Department exercises the correct approach to the determination of a taxpayer’s assessable profit. There will always be differences of opinion between the Department and a taxpayer but at least by updating DIPN 21 to reflect more recent court rulings taxpayers will be in a far better position to determine whether a given source of profit will be subject to Hong Kong Profits Tax.
