The issue of DIPN21 has provided greater certainty regarding the IRD’s approach to the source of profits. However DIPN21 does not deal in detail with test (1), that is, whether a company is carrying on a trade, profession or business in Hong Kong.

DIPN21 is particularly useful in respect of test (3), namely whether a company’s profits have a Hong Kong or a non Hong Kong source. The guidelines set out in DIPN21 facilitate the tax efficient use of Hong Kong companies for transactions which take place outside Hong Kong.  

Where a Hong Kong company follows the guidelines and practice in DIPN21 in structuring its activities and documentation, the company can book offshore trading profits, commission and interest income without incurring a liability to Hong Kong Profits Tax.

A Hong Kong company that intends to lodge an offshore claim in respect of its profits must demonstrate to the satisfaction of the IRD that its profits have a non Hong Kong source. Accordingly, planning should be undertaken at the start of an operation, or before undertaking a particular transaction, to ensure that the company:

• has properly reviewed and structured the way in which it intends to undertake its operations;

• will generate the necessary documentation to identify and support the offshore claim;

• will produce clear documentation and transaction trail; and 

• has the relevant information for submission to the IRD with the first Profits Tax Return.

The offshore claim will have a greater chance of success with a minimum of correspondence with the IRD, if this information is submitted with the first Profits Tax Return where an offshore claim is made, preferrably supported by a full set of documentation for a typical transaction.

This approach may also result in the IRD granting the company an exemption from filing Profits Tax Returns on an annual basis in subsequent years. Once this exemption is granted, the IRD will normally issue a Profits Tax Return on a random basis every three to six years to ensure that the exemption continues to apply. However, the company will still be required to prepare audited accounts in order to comply with the requirements of the Companies Ordinance and the exemption.

DIPN 21 offers a degree of certainty regarding the source of profits based on various Court decisions and provides an opportunity for effective tax planning regarding offshore profit claims.

Details of the factors to be considered in reviewing the source of profits of trading companies are contained in our Tax Notes Issue 6, and our Tax Notes Issue 7 which deals with the position for commission, manufacturing profits and other sources of income.