Hong Kong adopts a territorial basis for taxing profits derived from a trade, profession, or business carried on in Hong Kong. This means that Onshore and Offshore Profits are taxed differently. Companies established in Hong Kong are only taxed on profits made locally, while profits from foreign sources are exempt and qualified as offshore.
A Territorial based tax system
Profits made in Hong Kong will be subject to the local corporate income tax of 16,5% (8.25% for the first 2 million Hong Kong dollars of profits), while the foreign derived profits are exempt from tax in Hong Kong.
As a rule of thumbs, if the company has no economic substance in Hong Kong nor any of its investors and directors are based in Hong Kong, the company could see its profits qualified as offshore.
Indeed, unlike Singapore, Hong Kong does have a real offshore status for companies that have no economic substance in Hong Kong. Additionally, if none of the investors and directors are based in Hong Kong, the company could see its profits qualified as offshore.
It is important for businesses and investors to understand the different tax implications and regulatory environment when operating in different sectors. The onshore status offers more stability and transparency but also comes with higher tax liabilities, while the offshore status offers more tax benefits. However, it can be seen as insecure for potential investors or bring attention from tax authorities.
In order to mitigate risks and concerns, the Hong Kong government in response to the European Union, has refined its Foreign Source Income Exemption (FSIE) regime effective from 1st January 2023.
Onshore status of Profits in Hong Kong
As explained, if the incomes of the company are generated in Hong Kong, they must be taxed in Hong Kong.
Moreover, if the company qualifies for the resident status in Hong Kong, the company will have access to the tax benefits of DTAs (Double Taxation Agreements). Please note that to be tax resident of Hong Kong, the business of the company must be controlled and managed from Hong Kong.
As of today, Hong Kong has signed 43 DTAs with different countries. The purpose of a DTA is to define the tax residence and the place of taxation of an income in order to avoid double taxation of individuals and companies who are resident in the jurisdictions of the signatory countries.
The Profits that Qualify as Offshore
According to the existed territorial source principle of taxation, only profit sourced from Hong Kong is subject to profits tax in Hong Kong. Moreover, passive incomes arisen in or derived from outside Hong Kong and received by a Hong Kong registered company are not subject to tax under the FSIE regime.
Under the new FSIE Regime and for income received in Hong Kong, non–intellectual property passive income may be deemed to be sourced from Hong Kong and subject to Hong Kong profits tax if they are received by a multinational enterprise group entity in Hong Kong which fails to meet the economic substance requirements.
For intellectual property income, they will also be subject to Hong Kong profits tax if they are received by a multinational enterprise group entity in Hong Kong which fails to meet the specific approach.
The conditions are tightened but the offshore status remains in Hong Kong. Indeed, the offshore status is more defined but brings more security and could show more credibility to some groups of companies.
However, if companies are looking for tax optimization in Hong Kong, it is critical to understand the differences between the onshore and offshore status. The offshore status offers great tax benefits, but it is important to not forget that the corporate income tax rate in Hong Kong remains one of lowest in Asia.
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