Does Hong Kong profit tax apply to your business?
Only profit arising in or derived from the carrying on of a “trade, profession or business” in Hong Kong are subject to profit tax. If profits are derived from Hong Kong in circumstances whether the taxpayer does not carry on a business in the territory, they are no taxable.
Nowadays, many investors may set up Wholly Foreign Owned Enterprise (WFOE or WOFE) in China. The Wholly Foreign Owned Enterprise is a Limited liability company wholly owned by the foreign investor(s). In China, WFOEs were originally conceived for encouraged manufacturing activities that were either export orientated or introduced advanced technology. However, after China’s entered into the WTO, these conditions were gradually abolished and the WFOE is increasingly being used for service providers such as a variety of consulting and management services, software development and trading as well. With that, any enterprise in China which is 100% owned by a foreign company or companies can be called as WFOE.
The question is do I have to pay profit tax in Hong Kong if I own a Wholly Foreign Owned Enterprise (WFOE) in China?
Branch and Subsidiary
To answer this question, we have to clearly define a branch and a subsidiary of a non-resident.
A branch is a separate taxation entity, but it is not a separate legal entity.
A branch is charged under profit tax in the same way according to the rules provided in the Inland Revenue Ordinance (IRO). As long as a branch carries on a business in HK, and its profits are derived from HK.
If the branch is located outside Hong Kong, but it helps promote Hong Kong Company business to overseas, provide liaison and marketing services, it is deemed a branch carries on a business on behalf of HK Company. Therefore, the non-resident branch’s profit is taxable in Hong Kong.
- Non-resident Subsidiary
Non-Hong Kong resident branch’s expenses and outgoings, to the extent that they are incurred in producing assessable income, and are not of a capital nature, are deductible for the purpose of arriving at the net profit which is subject to profit tax.
A subsidiary of a non-resident such as Wholly Foreign Owned Enterprise (WOFE) is a separate legal entity, and it is required to keep sufficient records for the purpose of audit and the requirements under Section 51C of the IRO to arrive at the assessable profits from the records of the subsidiary.
WOFE have to pay PRC tax, but not profit tax in Hong Kong. Typically, the Hong Kong company has the ownership of the WOFE.
Revenue versus capital receipts
Profits tax is levied only on “revenue profits” and not income of capital nature. There is no capital gain tax. As a general rule, the commonly accepted accounting principles would be a reference in drawing a distinction between revenue and capital receipts but in many cases, it is an extremely thin line, and there are no one size fits all rules.
Receipts from the sale, disposal, loss or destruction of a fixed asset are capital in nature and not subject to profits tax. The nature of capital receipts is a question of fact to be determined from the circumstances of each particular case. There is no hard and fast rule. Very often it is a matter of degree. The IRO does not lay down any definition of capital receipts or fixed assets. Reference must be made to the large body of case law.
Profits tax is assessed on profits expressed in HK dollars. Accounts prepared in foreign currencies must be converted to HK dollars for the purpose of ascertaining the assessable profit.
Exchange receipts which are capital in nature are not taxable, while receipts which are revenue in nature are taxable.
An exchange profit has the same character as the asset or liability from which it arises. Therefore, exchange profits arising from trading transaction are revenue (e.g. settlement of trade debts, acquisition of trading stock, etc). Thus, the exchange profit was held to be assessable.
For example, exchange profits arising from acquisition or disposal of fixed asset are capital in nature. Exchange profits arising from raising capital or repayment of long-term loans are capital in nature.
Dividends received from corporations which are chargeable to profits tax are exempted from profits tax.
Dividends received from a corporation which is not subject to HK profits are not specifically exempt. For example, dividends from a foreign company which is not subject to HK profits tax are not specifically exempt. However, such dividends are in practice not taxed. It is possible that such dividends are offshore in nature.
IRO Section 26(b) provides that no income or profit from the same source shall be taxed twice.
IRO Section 26A(1) exempts interest on Tax Reserve Certificates, interest on HK Government Bonds, interest on Exchange Fund debt instruments, interest on HK dollar denominated multilateral agency debt instruments from profits tax.
IRO Section 26A(1) also exempts the profit on the sale or other disposal or on the redemption on HK Government Bonds, Exchange Fund debt instruments and HK dollar denominated multilateral agency debt instruments from profits tax.
IRO Section 26A(1) also exempts the income (including interest, gain on disposal, redemption on maturity or presentment of the debt instrument) received in respect of long term debt instrument (maturity period not less than 7 years).
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