Taxes in Hong Kong: When is it beneficial to be a tax resident and pay taxes in Hong Kong in 2020?

Dear readers – as many of you are already aware, majority of countries worldwide, including Hong Kong, have become signatories of the agreement on the automatic exchange of banking information. This agreement, in particular, stipulates the terms and conditions for the transfer of bank account information from one jurisdiction in which the account is opened, to another jurisdiction where the account holder is a tax resident.

If the account belongs to an individual, the information is first transferred to the tax authorities of the country in which the bank is located, and then to the tax authorities of the country, to which the account holder is domiciled, according to the information available to the bank. In some cases, the bank may designate the owner of a personal account to several jurisdictions simultaneously, based on the fact, for example, that the account holder has a citizenship in one country, resides in another, and receives income in a third country. In such situations, the account holder may declare himself as a tax resident of only one country, on the basis of applicable laws, by submitting relevant official documents to the bank. In that case, the account information will be sent to the country indicated in the declaration.

In the instances when the account owner is a legal entity, the information is sent to the country where the company is incorporated, or where it has a tax number, or where it is actually paying its taxes. The Bank, at its discretion, may request documents separately from the company as well as from its owner. For example, if the company does not have a tax number, as is the case with classical offshore companies, then confirmation of the actual office address is requested, i.e. the venue from which the business is in fact run.  Additionally, confirmation may be requested related to the place of permanent residence of the company’s beneficiary and the latter’s tax residence. If the information received by the bank suggests that the company can be considered a taxpayer in several countries, then the details of the account are likely to be transferred to several countries at once.

Hong Kong, being a region where the territorial taxation principle is applied, exempts companies from profit tax, if they are registered in Hong Kong while doing business elsewhere, i.e. outside the country.

Doing business outside Hong Kong means that the company does not have a physical presence or employees, nor does it conclude contracts in Hong Kong, nor does it pay for goods or services to residents of Hong Kong, nor does it sell goods or services to residents of Hong Kong. Additionally, the place of origin of goods and services should also be taken into consideration. It must be borne in mind that the services provided to the company by registration agents, secretarial companies, lawyers, accountants and auditors located in Hong Kong are not taken into account in determining the tax status of the company, since these are treated as supporting  services for the company, i.e. the company does not generate profit from these services.

Upon registration, all companies in Hong Kong are provided with the same package of constituent documents, including a tax number. The only difference between companies doing business outside Hong Kong is that after the audit is completed, the audit report and tax reports indicate that the company does not conduct business in Hong Kong, nor does it have taxable profits in Hong Kong, but in all other respects, most of the companies apparently look identical.

In addition to the audit, the company should subsequently confirm its tax status by providing the documents and information requested by the tax authorities. Such requests from the tax authorities usually are made once every 3-5 years.

Previously, the only concern expressed Hong Kong tax authorities was exclusively related to the fact whether the business is present in Hong Kong. Typically, the company would be required to provide clarifications and documentary support to substantiate that it had no business ties with Hong Kong during the reporting period. This used to be a sufficient evidence base for the tax authorities, which would then issue a letter in which they confirmed that the entity was not subject to tax payment obligations for the given reporting period.

However, the situation is gradually changing; over the past few years, a deeper insight was exercised by tax authorities, aimed at spotting possible violations of legislation by the company; inquiring whether the company is trying to avoid payment of taxes on its profits in the place of its operation. More specific questions are asked, for example, to identify the location of the office from which the actual business is managed, clarifications are required in relation to the methods of interaction with customers and suppliers. Companies are now required to provide detailed explanations with documentary evidence to prove that it is in no violation of the law.

In practice, assistance in interactions with the Hong Kong Tax authorities in confirming tax-free status is provided by local auditors, who are the company’s tax representatives. The auditing process can take excessively long, from 3 to 6 months, or even longer. Auditors charge an additional fee for such services, based on the hours spent preparing responses to requests and clarifications to questions raised by the Tax authorities.

As you can see, the process of confirming tax-free status is becoming increasingly more complicated, and many banks now prefer to open accounts for companies that actually have a physical presence in the country of registration.

Also, there had been instances, when a letter confirming tax residency was required at the contracting stage; however, while the company may actually have a tax number in Hong Kong, the Hong Kong tax authority normally does not issue those letters to companies without a local presence Hong Kong, who  also do not pay taxes in the country. In fact, a letter can be received if the company demonstrates evidence of its actual office-based presence in Hong Kong, and also substantiate the fact of paying profits tax.

Many companies registered in Hong Kong, which actually were not engaged in business in Hong Kong and had not previously paid income taxes here, with specifically declared offshore status of their activities, started looking at the issue from a different angle, as the emerging trend internationally suggests that each company should eventually be assigned to a particular jurisdiction where it would be required to pay taxes.

In light of these circumstances and taking into account all of the above, the key question which businesses now ask themselves, is not about where to incorporate the company in order avoid paying taxes anywhere, but rather it is about where to incorporate the company so that business and assets can be protected to the highest extent possible by international law, and inherently, where they would be offered minimal level of taxes.

When considering Hong Kong as your preferred tax residence for conducting business, the following facts should be considered:

1. In Hong Kong, only one tax is applied – this is the company’s net profit tax, which has a two-scale accrual system. All net profit, which is equal to the positive difference between all income received and all expenses incurred, is divided into two parts:

• Net profit up 2,000,000 HKD (approximately 260,000 USD) is taxed at a rate of 8.25%;
• Any remaining profit exceeding 2,000,000 HKD (approximately 260,000 USD), is taxed at 16.5%.

Example: During the reporting period a company sold goods in the amount of 700,000 USD , while expenses (purchase and transportation of goods, and other overhead costs) amounted to 300,000 USD , net profit amounted to 400,000 USD = 700,000 USD – 300,000 USD . The tax is calculated according to the following scheme:

The first 260,000 USD is taxed at a rate of 8.25%, i.e. the amount of tax would be 260,000 USD x 25% = 21,450 USD.

The remaining 140,000 USD is taxed at a rate of 16.5%, i.e. the amount of tax would be 140,000 USD x 5% = 23,100 USD.

Total tax charged: 44 550 USD.

As you can see, the total tax amount is only about 11% of the overall net profit of the company. Most obviously, this is not the highest tax rate, if we compare with other countries of the world.

2. In Hong Kong, the Government provides concessions for tax accrued from year to year, for example, over the past reporting period, such concession amounted to 75% of the accrued tax, but not more than 20,000 HKD (approximately 2,600 USD). If you look at the example above, the tax amount in the end amounts to 41 950 USD = 44 550 USD – 2 600 USD . Which is 10.5% of the company’s net profit.
3. In Hong Kong, there is no tax on distributed dividends and on accumulated capital.
4. There is no payroll tax in Hong Kong, there is only a 5% pension fund charge on salaries paid to employees who are local residents.  This charge does not apply if the employees are not local residents.
5. In calculating the company’s net profit, the following expenses of the company are considered deductible expenses:

• Travel costs of the director and employees (taxi, metro, air and train tickets);
• Accommodation costs of the director and employees (renting an apartment in Hong Kong).
• Accommodation and meals for the director and employees on business trips (hotel, restaurant, supermarket).
• Business development costs (advertising materials, exhibitions, market research, meetings with clients (restaurant), etc.).

As you can see, with competently developed business processes optimization and robust accounting, taxation in Hong Kong can be optimized, to become highly beneficial for conducting business.

Our company’s professionals would be happy to offer you our services in terms of preparation of financial statements. Additionally, we can also help you through the process of audit and tax reporting. Our consultants speak English and they will be happy to offer you their advisory support in relation to accounting and taxation in Hong Kong. Do not hesitate to contact us at [email protected].