Introduction

Hong Kong is famous for its simple taxation system and low tax rate, and has therefore been one of the preferred locations for investors entering the Asian market, particularly the Mainland China market. In this article, we will give an overview of 10 features of Hong Kong’s taxation system that foreign investors need to know in order to fully appreciate the benefits of setting up their business in Hong Kong under Hong Kong’s taxation system.

Benefits of setting up an intermediate holding company in Hong Kong

1.    No withholding tax in general

Most countries impose withholding tax when money is transferred out of the country at a rate which might be even higher than the local corporate income tax rates. In Hong Kong, however, no withholding tax is imposed on dividends, interests and services in general. Withholding tax is imposed only on royalties at a low rate. When a Hong Kong company is required to pay royalties to an overseas entity, it has to withhold tax for that overseas entity at a rate between 2.475% and 4.95% generally, thought under certain circumstances the tax rate could be as high as 16.5%.

The fact that Hong Kong does not generally impose withholding tax on dividends and interests makes it an ideal place for setting up an intermediate holding company.

2.     No capital gains tax

Capital gains tax planning is common in Hong Kong, because there are huge differences between tax rates on long-term capital gains and short-term trading gains. While short-term trading gains are subject to normal tax rates of 16.5%, that of long-term capital gains are 0%.

In Hong Kong, there is no clear definition that distinguishes between long-term and short-term investments. The “six badges of trade test” is generally used by the Hong Kong Inland Revenue Department (“IRD”) to determine the difference, which leaves room for tax planning opportunities before investment decisions are made. Long-term investments in securities and immovable properties are also eligible for claims for capital gains tax exemption.

For a group company, the non-taxable capital gain claim provides greater flexibility in the exit of an underlying investment or subsidiary. This adds to the benefits of setting up an intermediate holding company in Hong Kong.

3.    No tax on dividend income

Dividend income, whether derived from Hong Kong or foreign investments, is exempted from Hong Kong profits tax. Hong Kong-sourced dividend income is exempted under Section 26 of the Inland Revenue Ordinance to avoid double taxation on the same profits, while foreign-sourced income is generally non-taxable in Hong Kong. Similarly, fund distribution income is generally exempt from Hong Kong profits tax.

4.    DTAs with 49 tax jurisdictions

As an international city located at the centre of Asia and so close to Mainland China, Hong Kong is in a good position to attract multinational corporations to set up economic substance (including personnel and office) here. To facilitate the use of Hong Kong entities to carry on cross-border business and investments, Hong Kong has been rapidly expanding its Comprehensive Double Taxation Agreement (“DTA”) network in recent years. The number of DTAs has already reached 49. The expanded DTA network will effectively reduce the overseas withholding tax when a Hong Kong company sets up an overseas subsidiary or carries on business with overseas business partners. For a detailed list of DTAs concluded by Hong Kong, please click here.

It has become a global practice to require taxpayers to obtain a Certificate of Resident Status in order to enjoy the tax benefits under a DTA.

Benefits for trading companies

5.    No GST or VAT

To facilitate the development of the trading industry, Hong Kong does not impose goods and services tax (GST) or value-added tax (VAT). Only certain specific items, such as like liquor and tobacco, are subject to tax.

More pertinently, while digital services tax (DST) has become a global trend, Hong Kong does not currently plan to introduce DST, a fact that will attract corporations working in the digital economy arena.

As such, multinational corporations tend to set up a Hong Kong office as their Asian trading hub and sales office. They first sell the products to the Hong Kong group company, which will subsequently sell the products to customers in other Asian countries.

 

6.    Not adopting the worldwide taxation system

Unlike many developed countries, Hong Kong adopts a territorial taxation system. Regardless of whether a company is a Hong Kong resident or non-resident, only Hong Kong-sourced profits are subject to Hong Kong profits tax in most circumstances. In other words, if a Hong Kong company carries on operations outside Hong Kong, it may pursue an offshore claim even when the relevant profits are deposited with the bank accounts in Hong Kong.

For taxpayers pursuing an offshore non-taxable claim in Hong Kong, the Inland Revenue Department (“IRD”) issues an enquiry letter to ensure that their operations are carried out outside Hong Kong. As such, it is important for taxpayers to plan their inter-company arrangements and operational flow in advance, so as to avoid and defend against any challenge by the IRD. Sufficient trade transaction documents should be in place as the burden of proof is on the taxpayer.

On the other hand, under the Common Reporting Standard (“CRS”) and Automatic Exchange of Information (“AEOI”) regime, taxpayers pursuing an offshore claim in Hong Kong should be aware of their foreign tax risk. Double non-taxation is not encouraged under the OECD’s Base Erosion and Profit Shifting (“BEPS”) framework. Nevertheless, an offshore claim is one of the effective ways of avoiding double taxation issues, particularly with countries without a DTA with Hong Kong.

7.    Low corporate profits tax rate

The corporate profits tax rate in Hong Kong is 16.5%, which is among the lowest across the globe. For the first HK$2 million of profits, the tax rate can even be halved, i.e., 8.25%. The low tax rate has attracted a lot of Mainland China enterprises and multinational corporations to set up companies and operations in Hong Kong.

Furthermore, taxpayers in certain specified industries (such as insurance, shipping and corporate treasury centres) can enjoy a special tax rate of 8.25%, while taxpayers carrying out R&D activities in Hong Kong can enjoy an enhanced tax deduction of 200% or 300%. 

By setting up operations in Hong Kong, the group / company can enjoy a low tax rate and certainly benefit from a lower group effective tax rate to reduce the tax burden.

Employers’ obligations

8.    No obligation to withhold tax for employees

Unlike in many other tax jurisdictions, employers in Hong Kong generally do not have an obligation to withhold tax on behalf of their employees when the remuneration is paid. The employees are under their own obligation to settle their Hong Kong salaries tax.

A withholding tax obligation only arises when an employee will permanently leave Hong Kong. In such cases, the employer has to notify the IRD at least one month before the expected date of departure. The employer is also required to temporarily withhold payment of salaries until receipt of the “letter of release” from the IRD.

9.    Obligation to report salaries paid to employees

Every April, employers are required to file an Employer’s Return (BIR56A and IR56B) with the IRD to report the remuneration paid to its directors and staff, regardless of whether the work was carried out in or outside Hong Kong. It is a common misconception that filing the Employer’s Return is not required if the employees work outside Hong Kong.

Mismatch between salary expenses incurred by a corporation and the Employer’s Return is one of the reasons that will trigger a field audit and investigation by the IRD. As such, employers should also report remuneration paid to both Hong Kong and non-Hong Kong employees. Employees are under their own obligation to lodge a non-taxable offshore claim to the IRD if they work outside Hong Kong.

Having said that, it is worthwhile for the employers to make a note in the IR56B that the employee did not perform his or her job duties in Hong Kong. All employment contracts should also be well drafted to avoid any challenge by the IRD.

Transfer pricing rule

10.  Hong Kong has its own transfer pricing rule

Large corporations in Hong Kong are now required to file transfer pricing documentation, which comprises Master File, Local File and Country-by-Country (“CbC”) reporting. Since the implementation of the transfer pricing rule on 13 July 2018, we have seen an increased trend by the IRD to carry out transfer pricing audits on taxpayers.

Hong Kong follows the international threshold for CbC reporting. Multinational groups with consolidated revenue of EUR750 million (or HK$6.8 billion) are required to file a CbC notification and report in Hong Kong. An important point to highlight is that, even though a multinational group has already submitted a CbC report in another tax jurisdiction, they must submit their CbC notification in Hong Kong, even when there is an information exchange mechanism.

 

Below is the specific threshold for transfer pricing Master File and Local File in Hong Kong:

Criteria (A): Based on size of business (any two out of three of the below)	Threshold
1.       Total annual revenue	≥ HK$400 million
2.       Total assets	≥ HK$300 million
3.       Employees	≥ 100

 

Criteria (B): Based on related party transactions (any one out of four of the below)	Threshold (HK$)
1.       Transfers of properties (excludes financial assets / intangibles)	≥ $220 million
2.       Transactions in financial assets	≥ $110 million
3.       Transfers of intangibles	≥ $110 million
4.       Any other transactions (e.g. service income / royalty income)	≥ $44 million

 

Taxpayers above the threshold are required to prepare a Master File and Local File on an annual basis.

Should you have any enquiries on tax planning for your business, please 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 © 2024