Double Taxation - Introduction

What is double taxation

• Double taxation arises when two or more tax jurisdictions overlap, such that the same item of income or profit is subject to tax in each.

HK¡¯s special case - because of territorial concept - no need of double tax treaty

• Hong Kong adopts the territorial basis of taxation, whereby only income / profit sourced in Hong Kong is subject to tax and that derived from a source outside Hong Kong by a local resident is in most cases not taxed in Hong Kong;
• Therefore, Hong Kong residents generally do not suffer from double taxation;
• Many countries which tax their residents on a worldwide basis also provide their residents operating businesses in Hong Kong with unilateral tax credit relief for any Hong Kong tax paid on income / profit derived from Hong Kong;
• We allow a deduction for foreign tax paid on turnover basis in respect of an income which is also subject to tax in Hong Kong. Businesses operating in Hong Kong therefore do not generally have problems with double taxation of income.

Double Tax Agreement (DTA) - provides more certainty

• Notwithstanding this, the Hong Kong Government recognizes that there are merits in concluding double taxation agreements (DTAs) with our trading partners;
• A DTA provides certainty to investors on the taxing rights of the contracting parties; helps investors to better assess their potential tax liabilities on economic activities; and provides an added incentive for overseas companies to do business in Hong Kong, and likewise, for Hong Kong companies to do business overseas;
• Therefore, it has been the policy of the HK Government to establish a DTA network that would minimize exposure of Hong Kong residents and residents of the DTA partner to double taxation.

DTA coverage

• Can be divided into 3 categories :
  • Airline related income;
  • Shipping related income;
  • General income (other than airline and shipping business);
• Due to the international nature of transportation operations, airline and shipping operators are more susceptible to double taxation than other taxpayers. Therefore, most DTA is relating to airline and shipping business.

Hong Kong - Double Tax Agreement (DTA) - as at 30/7/2008

• ( Extracted from IRD website = Country / Territory Analysis )

 Profits Tax Annual Filing

• Generally, tax filing in Hong Kong (HK) is once a year;
• 1st tax filing request will be issued by tax department around 18 months after company is incorporated;
• future tax filing will be around April or May each year;

 1st tax filing request

• if our company is the register address and company secretary, the request will be sent to us;
• we'll advise client about the request :
• advise about the deadline;
• advise possible annual financial year end to use - usually using 31/3 each year;
• seek client approval whether appoint us to handle the work;
• collect info about business operation - to determine how to handle the filing;
• collect info about business operation
• one of the key info to clarify is whether client has any business activity started yet in HK
• considering HK adopts territorial concept of tax, no tax is payable if there is totally no business activty in HK;
• of course, the tax rule adopts tax jargon and it is written in legal terms.
  Therefore,
• if need to have thorough reading of the exact info,
  please read this [ tax concept ];
• if need to have general idea, the testing criteria will be :
• any operational office in HK ?
• any staff hired in HK ?
• any customers located in HK ?
• any suppliers located in HK ?
• any goods shipped into HK ?
• audit report and offshore tax exemption application
• audit report is about the numbers - to calculate how much profit or loss is generated;
• tax exemption is focus on how the business is operated - to see whether the income is earned in HK;
• duty to keep proper accounting record
• no matter how the tax filing is handled, it is always a company's duty to keep proper record of all income and expenses;

 Offshore income of a company is not taxable in Hong Kong?

Hong Kong adopts a territorial source principle of taxation. Only profits which have a source in Hong Kong are taxable here. Profits sourced elsewhere are not subject to Hong Kong Profits Tax. The principle itself is very clear but its application in particular cases can be, sometimes, contentious.

To clarify the operation of the principle, Inland Revenue Department prepared a
[ simple guide on the territorial source principle of taxation ].

It gives a brief explanation of how the principle operates and provides simple examples for illustrative purposes of the tests applied to different types of businesses. If you wish to explore the subject in greater depth, consultation with professional advisers is recommended.

 Process of applying for Offshore Operation Tax Exemption

Offshore income claim is not automatic. It needs to be applied.

It can be done by 2 ways:

• Advance Ruling
• Before you start the operation, write to HK tax department (IRD), describe your intended operation and request for "Advance Ruling";
• Example of advance ruling = [ Example ]
• The fee for this starts from around HK$50,000 ;
• Tax Filing
• 1st filing request will normally issued by tax department around 18 months after company incorporation date;
• Usually the company has around 3 months to handle the filing;
• The period to cover is usually from incorporation date to 31/3 of next year;
• Therefore, the company can also start arranging the filing work - even the filing request is not issued yet.
• What documents are require for Tax Filing ?

If apply for tax exemption without giving sufficient information. Tax department will issue a letter asking for proof. [ Document Sample ]

 Example - Organization chart

Brief Description of business :

• International trading of shoes;
• Buying mainly in China and selling to USA customers

Director Board :

• Mr. A = director = located in New York (USA)
• Mr. B = director = located in Shanghai (China)
• Mr. C = located in Shanghai (China)
• Mr. D = located in Shanghai (China)
• Marketing Department : Mr. A = Marketing Manager
• Responsible for customer sourcing, contract negotiation, conclusion of contract;
• Sourcing Department : Mr. B = Procurement Manager
• Responsible for sourcing of supplier, conclusion of buying order and definition of quality requirement;
• Quality Control Department : Mr. C = QC Manager
• Responsible for on-going quality check of products;
• Shipping Department : Mr. D = Shipping Manager
• Responsible for product transportation, warehousing and shipping arrangement;
• Accounting & Finance Department : Mr. A = Finance Manager
• Responsible for issuing invoice, LC terms control and banking transaction;
• Controlling HK HSBC bank by internet banking;

Please Click to enlarge

 Example - Walk-Through document

This is a collection of all documents (for a typical business transaction) to show how the business is carried out.

All document shows none of the activity is carried out in Hong Kong.

1. [ With Customer ] Negotiation with new customer - by USA Marketing Manager with USA customer
• email message printout;
• customer visit record;
2. [ With Customer ] Conclusion of customer order
• email message printout;
• courier receipt of signed order from customer;
• a copy of the sales contract;
3. [ With Customer ] Receiving downpayment from customer - received by Finance Manager
• email message printout - showing money transfer receipt;
4. [ With Supplier ] Negotiation with supplier - by Shanghai Procurement Manager with China supplier
• email message printout
• supplier factory visit record;
5. [ With Supplier ] Conclusion of order to supplier
• email message printout;
• courier receipt of signed order to supplier;
• a copy of the supplier contract;
6. [ With Supplier ] Paying downpayment to supplier - by Finance Manager to supplier
• email message to send money transfer info to supplier;
• online banking instruction printout to arrange money transfer;
7. [ With Supplier ] Quality check of products - by QC Manager
• factory visit quality check record;
8. [ With Shipping Company ] Concluding shipping order = by Shipping Manager
• email message to place the order;
• job order confirmation from shipping company;
9. [ With Supplier ] Sending Packing List, Proforma Invoice, Quality Check Certificate and Bill of Lading to customer - by Shanghai Procurement Manager
• courier order to FedEx;
10. [ With Customer ] Receiving final payment
• money receipt advice from HK HSBC.

 Tax Department feedback

• it takes around 3 months for the tax department to give feedback;
• example of [ IRD feedback ];
• in short, it means:
• there is no tax payable;
• the tax department will not issue tax filing request every year (from experience, next request will be 2 years later);
• the company must not wait for such request - if the company's operation changed, and starts subject to HK tax;

 Examples for offshore income claim

• Offshore Income - Case No 4 [ Fail ]
• Offshore Income - Case No 8 [ Success ]
• Offshore Income - Case No 11 [ Fail ]
• Offshore Income - Case No 12 [ Success ]

There is no single determining factor, but, below will be advantageous:

Having a bank account in HK to receive money is not relevant in most cases.

As the Inland Revenue Department will select some transactions and request all the documents relating to these transactions to be submitted to ensure that all the company's operations are carried out outside HK. Therefore you are recommended to keep all the correspondence for all the transactions e.g. faxes, emails, telephone bills, memos of meetings, purchase orders, sales orders, shipping documents.

 Employee / Director - important to know

• Generally, salaries tax also follow territorial concept - to see whether salary income is subject to HK tax;
• Director

  • Territorial concept does not apply to director's income (fee, salary or whatever);
  • As directorship is regarded as an office. In this context, the term "director", in relation to a Hong Kong company, means a person having duties and responsibilities under the Companies Ordinance, or of similar nature under a corresponding foreign legislation for a director of an overseas company. In general, if you are director of a company resident in Hong Kong, your full income derived from such office in Hong Kong is chargeable to Salaries Tax irrespective of the number of days you stayed in Hong Kong and neither exemption nor relief is available.
• [ Tax Information - Salaries Tax ] ;