Hong Kong taxes business profits on a territorial basis: profits tax is charged only on profits arising in or derived from Hong Kong. Profits sourced outside Hong Kong are not taxable here, even if the company is incorporated in Hong Kong and the money is received into a Hong Kong bank account, subject to the separate rules for certain foreign-sourced passive income (FSIE).
Where profits come from is decided by what the company did to earn them, and where. A company can make an "offshore claim" in its Profits Tax Return, but the burden of proof lies with the company. Claims need strong, contemporaneous evidence and should be planned before the business starts operating.
How the source of profits is decided
The Inland Revenue Department applies what the courts call the "operations test": what were the operations that produced the profit, and where were they carried out? The Department's practice is set out in Departmental Interpretation and Practice Notes No. 21 (DIPN 21).
| Type of profit | Broad guide to source |
|---|---|
| Trading in goods | Where the contracts of purchase and sale are effected: negotiated, concluded and executed |
| Services | Where the services are actually performed |
| Commission and agency | Where the agent carries out the activities that earn the commission |
| Interest (moneylending) | Generally where the credit is provided; different rules apply to financial institutions |
| Royalties and licensing | Depends on the facts; some royalties are deemed taxable in Hong Kong by statute |
| Manufacturing | Generally where the goods are manufactured |
Making an offshore claim
- The claim is made in the Profits Tax Return, with the tax computation and supporting explanation.
- Expect a detailed enquiry from the Department, often a questionnaire covering who did what, where, and with what evidence.
- Typical evidence includes travel records, contracts showing where they were signed, correspondence, staff locations, office arrangements outside Hong Kong and bank records.
- The claim is assessed year by year. A claim accepted in one year does not bind the Department for later years if the facts change.
- An advance ruling from the Department can provide certainty for a proposed arrangement, for a fee.
Offshore claims and FSIE
Since 1 January 2023, the foreign-sourced income exemption (FSIE) regime deems certain foreign-sourced passive income (dividends, interest, disposal gains and IP income) received in Hong Kong by a member of a multinational group to be taxable, unless an exception such as economic substance or the participation exemption is met. FSIE does not change the territorial treatment of active trading or service profits, but group companies receiving passive income from overseas must consider both sets of rules.
Risks and penalties
- If a claim is rejected, tax becomes payable with any surcharges for late payment.
- An incorrect return without reasonable excuse can attract additional tax of up to three times the tax undercharged.
- Banks and auditors increasingly ask about offshore claims; inconsistent explanations can affect both.
- A profit that is "offshore" for Hong Kong may be taxable in the jurisdiction where the activities take place.
This guide is general information, not tax advice. Offshore claims depend entirely on the facts and should be reviewed by a Hong Kong tax adviser or CPA before they are made.
- Reviewing your business model before you start trading, so that the tax position matches how you actually operate.
- Organising documentation and records to support the position you take.
- Preparing the Profits Tax Return and coordinating with a specialist tax adviser on offshore claims and enquiries.
- Considering FSIE and the tax rules of other jurisdictions involved, with specialist advisers where needed.
Official references
- Inland Revenue Ordinance (Cap. 112), section 14
- Inland Revenue Department: DIPN 21 (Locality of Profits) and FSIE regime guidance, www.ird.gov.hk