Introduction

As an international business hub, Hong Kong boasts an attractive tax system. However, tax audit, also known as field audit, can create concerns for taxpayers. Not only companies but also their shareholders may be subject to tax audit. In this article, we will delve into the intricacies of tax field audit on companies in Hong Kong and provide insights on how to navigate through them.

What is a tax field audit?

A tax field audit is a process conducted by the Field Audit and Investigation Unit of the Inland Revenue Department (“IRD”) of Hong Kong to ascertain the correctness of tax returns filed by taxpayers. Field auditors examine the books of accounts and records of the taxpayer’s business and visit the taxpayer’s business premises to gain a thorough understanding of the taxpayer’s business operations and personal affairs.

The purposes of field audit are to ensure that taxpayers comply with the requirements of the Inland Revenue Ordinance (“IRO”), file accurate returns to the IRD and detect cases of potential tax evasion or avoidance.

Difference between a field audit and a desk audit

A desk audit is the examination of an automated assessment case, while a field audit involves visiting taxpayers’ business premises to examine books of account and records, gaining an understanding of the accounting system used by the taxpayer, and assessing the adequacy of the accounting system as a basis for the preparation of financial statements. In other words, a desk audit is conducted remotely, while a field audit is conducted on-site.

During a desk audit, the assessing officer examines all aspects of the case to see whether the reported profits or income are correct, while during a field audit, the field auditor ascertains the correctness of returns not only by examining books of account and records but also by gaining a more thorough understanding of business operations.

Reasons being selected for field audit

The IRD selects taxpayers for field audit based on risk assessment and other factors such as the size and nature of the taxpayer’s business, the method of operation of the business, the accounting and book-keeping procedures used within the business, the personal financial affairs of the taxpayer and associated persons, and the taxpayer’s personal and family living expenses. The reasons why a taxpayer may be selected for a field audit or investigation include:

1.       deliberate non-filing of tax return;

2.       deliberate understatement of income or over-claiming of deductions;

3.       understatement of income or over-claiming of deductions owing to ignorance of taxation obligations (even if without any conscious intention to undermine compliance or to understate assessable income); and

4.       overly aggressive tax planning.

 

If you have not received any notification from the IRD, it is unlikely that you have been selected for a tax field audit or investigation. However, it is important to note that the IRD may select taxpayers for audit or investigation based on the above factors. Therefore, it is important to ensure that you comply with the requirements of the IRO and file accurate returns to the IRD to minimize the risk of being selected for audit or investigation.

Field audit process

The process of a tax field audit in Hong Kong involves the following steps:

1.       Notification: If you have been selected for a field audit or investigation, you will normally be notified by a letter in the first instance. The letter will inform you of the year of assessment to be considered initially and request you to contact the field auditor or investigator to make an appointment for the initial interview, and also advise you that your representative may attend the initial interview and any subsequent interview.

 

2.       Initial interview: The field auditor or investigator will conduct an initial interview with you or your representative to discuss the scope and purpose of the audit or investigation. During the interview, the field auditor or investigator may ask you or your representative to provide information or documents related to your business or personal affairs.

 

3.       Examination of records: The field auditor or investigator will examine the books of account and records of your business and visit your business premises to gain a thorough understanding of your business operations and personal affairs. The purpose of this examination is to detect cases potential tax evasion or avoidance and to encourage the filing of correct returns.

 

4.       Further interviews: If the field auditor or investigator detects any irregularities or indications of non-compliance during the audit or investigation, they may expand the scope of the audit or investigation to cover other years of assessment or other areas of your affairs. They may also conduct further interviews with you or your representative to clarify any issues or discrepancies found during the audit.

 

5.       Quantification of discrepancies: If the field auditor or investigator finds any discrepancies in your tax returns, they will quantify the discrepancies and backward project them based on the field audit findings. Other quantification methods may also be used.

 

6.       Penalty consideration: If the field auditor or investigator uncovers any substantial discrepancy during the audit or investigation, it will be taken into consideration when penalties are considered.

 

It is important to note that the progress of a field audit case depends on the complexity of your business affairs and the support and cooperation provided by you and your representative. Therefore, it is advisable to make all information and records required by the field auditor or investigator readily available to ensure a smooth and efficient audit process.

How far back will IRD investigate?

The IRD requires a taxpayer to keep proper business records and retain such records for a period of not less than 7 years after the completion of the transactions. In regular situations, a tax field audit or investigation typically encompasses the 6 preceding assessment years prior to the year in which the field audit and investigation begins.

However, in instances involving fraud or wilful evasion, the IRD may seek information and documents dating back up to 10 years for investigation purposes. Therefore, the actual period of investigation may be longer than 7 years in some cases.

Potential penalty for underpaid tax

Underpayment of tax may attract penalty. Penalty action may be taken in respect of a failure to comply with a requirement specified under the IRO where the person concerned has failed to provide a reasonable excuse or has acted wilfully with intent to evade tax. The penalties for non-compliance may include a monetary penalty, prosecution, or both. The amount of the penalty will depend on the nature and severity of the non-compliance. It may be a fixed amount or a percentage of the tax undercharged or not paid. It may also be increased if the non-compliance is found to be deliberate or fraudulent.

It is important to note that the IRD may take into account any voluntary disclosure made by the taxpayer before any field audit, investigation or other enquiry action is initiated by the IRD. Full voluntary disclosure made by a taxpayer will be regarded as a favourable factor when penalty is subsequently considered in relation to the case.

Category of Disclosure and Work Involved
Nature of Omission / Understatement	Full Voluntary Disclosure		Disclosure with FULL Information Promptly on Challenge		Incomplete or Belated Disclosure		Disclosure Denied
	Normal Loading	Max. incl. C.R.	Normal Loading	Max. incl. C.R.	Normal Loading	Max. incl. C.R.	Normal Loading	Max. incl. C.R.
Group (a)	15	60	75	100	140	180	210	260
Group (b)	10	45	50	75	110	150	150	200
Group (c)	5	30	35	60	60	100	100	150

 

What can we help?

Our company is dedicated to helping taxpayers navigate their interactions with the Inland Revenue Department (“IRD”). We understand the importance of minimizing the risk of scrutiny, and we offer thorough health checks to review your tax filing status and ensure compliance.

If you find yourself facing an investigation by the IRD, our team is here to support you every step of the way. We conduct rehearsals for your interview with IRD assessors and take care of the rest of liaison and negotiation with the IRD, ensuring effective communication and addressing any concerns you may have. Additionally, we take great care in reviewing all documents that need to be submitted to the IRD on your behalf. Our goal is to negotiate with the IRD and reach fair settlement proposals that help reduce your tax liabilities and penalties. By availing our services, you can rest assured that you will receive comprehensive assistance, ensuring compliance and minimizing tax-related risks you may face.

Conclusion

The possibility of a tax audit is not a matter to be taken lightly. It can potentially lead to substantial additional tax obligations and penalties, even including criminal repercussions. It is essential for taxpayers to approach this process with the utmost seriousness.

Should you notice any discrepancies in your tax records or have concerns about an impending investigation, it is advisable for you to seek expert advice to ensure compliance with tax laws and regulations. Contact us to schedule a confidential preliminary consultation with our team of tax experts.

 

For enquiries, please feel free to contact us at:

E: tax@onc.hk                                                                      T: (852) 2810 1212 W: www.onc.hk                                                                    F: (852) 2804 6311 19th Floor, Three Exchange Square, 8 Connaught Place, Central, Hong Kong

Important: The law and procedure on this subject are very specialised and complicated. This article is just a very general outline for reference and cannot be relied upon as legal advice in any individual case. If any advice or assistance is needed, please contact our solicitors.

Published by ONC Lawyers © 2023