May 20, 2022
Hong Kong Court rules booked trading profits are not necessarily subject to profits tax
Hong Kong's Court of First Instance (CFI) recently handed down a favorable decision which clarified that profits tax liabilities are imposed on what a taxpayer has done to earn the profits in question, as opposed to what its role or purpose in Hong Kong is, notwithstanding that its role in Hong Kong is to mitigate the overseas tax liabilities of its group.
The taxpayer was a private limited company incorporated in Hong Kong engaged in the trading of electronic products. It purchased the products from two independent Hong Kong suppliers and sold to its group company in the Netherlands. All business operations of the taxpayer were conducted by affiliates outside Hong Kong, while its only connection with Hong Kong was limited to having a bank account in Hong Kong.
The CFI held that the taxpayer's booked profits are not subject to Hong Kong profits tax, on the basis that: (i) it did not carry on a trade or business in Hong Kong; and (ii) all the commercial operations relevant to the production of the trading profits were performed outside Hong Kong.
The CFI held that a Hong Kong incorporated company with limited activities carried out in Hong Kong, such as operating a bank account from outside Hong Kong and maintaining a registered office in Hong Kong, would not normally be regarded as carrying on a business in Hong Kong. The locality of the Hong Kong suppliers' business was irrelevant.
In the context of a trading business, the CFI considered that operating a bank account to settle payments due to suppliers and receive payments from customers would not by itself amount to profit-producing activities. They were incidental acts done after the formation of the profit-generating contracts of purchase and sale and would not generally be relevant for determining the source of trading profits. While the tax planning arrangement undertaken by the group prevented a portion of the profits from being charged to tax anywhere, it was not relevant in determining the source of profits.
For additional information with respect to this Alert, please contact the following:
Ernst & Young Tax Services Limited, Hong Kong
Ernst & Young LLP (United States), Hong Kong Tax Desk, New York
Ernst & Young LLP (United States), Asia Pacific Business Group, New York
Ernst & Young LLP (United States), Asia Pacific Business Group, Chicago