Setting Up in Hong Kong: An Overview of the Tax Regime
Multinational businesses often chose to establish companies in Hong Kong to serve as their base for operations in the Asia-Pacific Region. Amongst the many reasons for so doing is that Hong Kong is a tax friendly jurisdiction. It has a low rate of tax and its taxes apply only to income sourced in Hong Kong. At the same time, it has established a comprehensive international tax treaty network and complies with international standards to enhance tax transparency.
Liability for Profits Tax
Hong Kong operates what is known as a schedular tax system. Under this system, the tax treatment of income depends on the type of income. For businesses, there are 2 types of income giving rise to 2 different types of tax, namely profits tax and property tax. There is no sales tax, value added tax (VAT) or other taxes on goods and services (GST).
Under the Inland Revenue Ordinance ("IRO"), a company may be liable to profits tax only on profits sourced in Hong Kong. This territorial sourcing principle means that a company may be liable to profits tax only if 2 conditions are satisfied. First, the company must carry on a trade or business in Hong Kong. Secondly, the company must have profits that arise in or derive from Hong Kong from that trade or business.
These 2 conditions are distinct and separate. For example, a company may establish an office in Hong Kong which employs staff. On this basis, it would meet the 1st condition, namely that it is carrying on a business in Hong Kong. However, if the company earned its income by trading shares which are listed on the New York Stock Exchange, that income would likely not be regarded as arising in or derived from Hong Kong. As a result, even if the traders were based in that Hong Kong office, the company would likely not be liable to Hong Kong profits tax on that income. Equally, if the company established branch operations outside of Hong Kong, income earned by those branches would likely not be subject to Hong Kong profits tax.
Rate of Profits Tax
Profits tax is charged at a rate of 16.5%. It is a flat tax rather than a marginal tax. In other words, unlike many other jurisdictions which charge a different rate of tax for different income brackets, the rate of tax remains the same regardless of the level of income. Nevertheless, Hong Kong offers a concessionary rate of 8.25% for the 1st HK$2 million (approx. US$250,000) of income.
By global standards, the rate of profits tax in Hong Kong is considered low. As a result, historically, multinational businesses have often sought to locate income in Hong Kong to minimise overall global tax burdens.
Treatment of Capital Gains
Hong Kong’s profits tax specifically excludes profits arising from the sale of capital assets. Whether a profit arises from the sale of an asset is normally a question of the original intention when the asset was acquired. For example, where a company acquires inventory, the sale of that inventory would normally not be regarded as the sale of a capital asset as the inventory would have normally been acquired with the intention of resale.
Treatment of Dividends
Where a company earns income in the form of a dividend, that income will not normally be subject to profits tax. The IRO specifically excludes from profits tax any dividend from any company which is chargeable to profits tax. This means that if a Hong Kong company, A Co., pays a dividend to another Hong Kong company, B Co., on the basis that A Co. pays profits tax, B Co. would not include that dividend in the calculation of its profits tax. Where a dividend is received from a company that is not chargeable to profits tax, the dividend typically falls outside the the profits tax regime because it is sourced outside of Hong Kong (i.e. it does not arise in or derive from Hong Kong). This is because typically, a company that is not chargeable to profits tax either does not carry on a business in Hong Kong or does not have profits that arise in or derive from Hong Kong.
International Tax Compliance
In recent years, governments around the world have introduced a number of initiatives to increase tax transparency. Hong Kong has opted to co-operate with these initiatives and has introduced legislation to bring into effect the Automatic Exchange of Financial Account Information ("AEOI") and measures to combat Base Erosion and Profit Shifting ("BEPS"). At the same time, Hong Kong has entered into a number of tax treaties. These tax treaties are mostly based on the model established by the Organisation for Economic Co-operation and Development ("OECD") and, amongst other things, provide greater certainty as to the allocation of income for tax purposes and facilitate the sharing of information for tax administration purposes.
Hong Kong has tax treaties with trading partners around the world. Treaty partners include:
Austria, Belgium, Czech, Finland, France, Ireland, Italy, Jersey, Liechtenstein, Luxembourg, Netherlands, Portugal, Spain, United Kingdom
China, Japan, Korea, Malaysia, Thailand, Vietnam
Hong Kong has no tax treaty with Germany or the United States.