One of the key reasons for operating an offshore company in Hong Kong is to enjoy favourable tax treatment. In addition to the sound financial system, supportive government, and ready business environment, investors want to enjoy lower taxes so that they can keep more profits, dividends, or plough them back to grow your business.
In this article, we explore why you should maintain tax substance in Hong Kong after opening a company. A company that is registered under Hong Kong Law is referred as a Tax Resident for tax reasons. Besides, the company is only subject to tax in Hong Kong and no other jurisdictions.
However, it is very important to note that if a Hong Kong company (tax resident) lacks tax substance/ economic substance, it could be considered to have taken its operations (tax residency) in an area with greater tax substance. As a result, the tax resident becomes subject to both Hong Kong and other foreign corporate income tax simultaneously. This would result to double taxation.
A closer look at tax substance
While there lacks a clear definition of what tax substance is according to Hong Kong Tax legislation, the tax authorities evaluate the operations and nature of a company to establish its economic substance. The authorities evaluate the following among others.
- Is the business operated and controlled from Hong Kong?
- If it is carried out in Hong Kong, what is its nature?
- Do managers and senior managers stay in Hong Kong? What roles and duties do they play in the company?
- Do directors of your company hold meetings in Hong Kong?
- Are there staffs employed by the company in Hong Kong? If there are, how many, what are their responsibilities, and remunerations?
- Does the company maintain a physical office, warehouse, and other establishments?
- Bank accounts held by the company.
- What are the fixed assets owned by the company in Hong Kong and other jurisdictions?
- If the company keeps cash in the office and how the money is managed.
Dangers of not having enough tax substance when operating a company in Hong Kong
If your company lacks tax substance, the impact can be categorized into two main groups.
Being exposed to corporate income tax from other foreign entities
The place where your company is managed from is a great component in determining a Hong Kong-based company. Therefore, while your company might be incorporated in Hong Kong, if it is operated and run from another country, it will be a tax resident in that country. This means that the company will be exposed to corporate income tax in the country of control.
Inability to get resident status certificate
For a company to enjoy specific tax treatment according to Hong Kong Double Tax Arrangements that have been signed with other 35 countries, the Hong Kong Company is required to be qualified as a tax resident. The evaluation is done by Hong Kong Inland Revenue Department before a certificate of Tax residency can be issued to compliant companies. To get a resident status certificate, IRD is very particular if the company makes sufficient tax substance to the economy.
Recently, IRD has become extra strict in reviewing companies’ applications for resident certificates. This is perhaps because of international pressure and effort to provide an even playing ground for businesses. This way, they encourage businesses to work harder for higher profitability and to be able to support the Hong Kong economy.
For a company to get the certificate of residency, it has to apply at the Inland Revenue Department. The company must provide all the details about tax treaty benefits that will be claimed and answer all the questions by the revenue department. If the Inland Revenue Department finds the information insufficient, it makes a follow up with a letter to the company requesting for additional details as well as supporting documentation.
Maintaining tax substance is very important for Hong Kong registered companies in order to mitigate exposure to foreign tax jurisdictions and getting a Certificate of residency from Inland Revenue Department.
It is important to no note that tax information in future will be more transparent and getting necessary protection is vital in order to avoid unnecessary taxation especially when operating in different countries.
The concept of tax substance is not always easy for many people to understand. While some might argue that simply registering their companies is enough, it is important to run the company well and where possible from Hong Kong. To understand more about Hong Kong company registration, tax substance, and other aspects of keeping your company atop of the Hong Kong jurisdiction, it is advisable to consult experts.
Professionals who have studied the tax Hong Kong law and tax substance clauses will give you appropriate advice to ensure you get the certificate and all the tax protection under local Hong Kong laws and international treaties.