Offshore & Onshore companies in Hong Kong: What’s the Difference?
Hong Kong is a very densely populated urban center with a skyscraper-studded skyline and is a major regional free trade port and a global financial hub.
Hong Kong uses a legal system derived from the Common Law, which means very careful and meticulous in respect of private property, and an independent judicial system in which the rule of law applies to legal and contractual procedures.
However, his jurisdiction has one of the most liberal, competitive, and flexible economies around the world. The taxation system is very simple and one of the best levels of corporation tax (8.25% / 16.5%), with capital gains and dividends free from taxes, no sales tax, and no customs duties.
Nevertheless, two different fiscal statuses for Hong Kong companies exist and often wrongly perceived.
1. Offshore status
Due to its territorial tax system, a well-structured and managed company may qualify for a 0% tax for its business carried out outside the jurisdiction.
Here are the main conditions, not limited to, the Hong Kong company will have to meet in order to obtain offshore status:
- No customers/client from Hong Kong
- No suppliers from Hong Kong
- Actual operations take place outside Hong Kong
- Goods not entering Hong Kong
- No operations office in Hong Kong
- No staff hired and working in Hong Kong
- Services agreements or sales/purchases invoices should avoid involving any Hong Kong parties
- Income contract not negotiated or concluded in Hong Kong
Once the requirements are met, the tax authority will check the supporting documents and decide whether the company can obtain an offshore status or not. Once the exemption is granted the company should still prepare annual management accounts and audit reports, as well as declare tax returns in the jurisdictions where it operates outside of Hong Kong.
It is not uncommon for the tax authority to wait 2-3 years before questioning companies offshore claim. The company will then have to prepare for a review of their books starting from incorporation. It is important to note that controls about offshore status are becoming stricter so a well-structured accounting is of the essence in case a company wants to apply for it.
Even when obtained, offshore status can be challenged by Hong Kong fiscal authorities, the Inland Revenue Department (IRD), during the next years if the company starts doing business locally.
2. Onshore status
If a company is carrying business in Hong Kong and does not meet the conditions mentioned previously, its fiscal status will be considered onshore. This implies the company will be subject to profits tax.
The Two-Tier Profits Tax Regime applies to corporations by lowering the tax rate for the first $2 million of assessable profits.
The two-tier profits tax rates have been effective from the year of assessment 2018/19 (i.e., on a taxpayer’s financial year ending between 1 April 2018 and 31 March 2019) and it aims to significantly reduce the tax burden of most taxpaying small and medium-sized enterprises (SMEs).
For corporations, the first HK$2 million of profits will be taxed at one-half of the current tax rate (i.e., 8.25%) and the remaining profits will continue to be taxed at the existing 16.5% tax rate. An HKD 20,000 tax reduction is also automatically applied to profits tax.
Assessments are issued by the IRD when the tax returns are filed. Upon receiving the assessments, companies are required to pay a provisional profits tax for the subsequent year, generally based on the preceding year’s profits. This payment is used to offset against the final profits tax for that subsequent year.
Any excess payment is applied against the provisional profits tax payable for the following year.
Company A has an assessable profit of HKD 5,000,000 for the year of assessment 2020/2021.
Let’s take an example to be clear:
Company A has an assessable profit of HKD 5,000,000 for the year of assessment 2020/2021.
Tax payable will then be:
- First step: 2,000,000 * 8.25% + 3,000,000 * 16.5% = HKD 660,000 for the year of assessment 2020/2021.
- Second step, we need to double this amount for the year of assessment 2021/2022: 660,000 + 660,000 = HKD 1,320,000
- Third and final step, we apply the tax reduction of HKD 20,000: 1,320,000 – 20,000 = HKD 1,300,000
The total tax payable for the company of the year 2019/2020, including provisional tax of the year 2020/2021, will therefore be HKD 1,300,000. IRD will then issue a payable notice and the company will settle the tax accordingly.
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