May 25, 2022
Hong Kong Tax Authority clarifies multiple issues around profits tax
In its 2021 annual meeting with tax practitioners, the Hong Kong Tax Authority clarified the following issues related to the profits tax:
- When a Hong Kong resident enterprise has a "server permanent establishment (PE)" located outside Hong Kong which forms an essential and significant part of its e-commerce business, the Tax Authority has indicated that a part or all of its profits could be regarded as non-taxable offshore Hong Kong profits. The Tax Authority reconfirmed that the location of the server PE alone would not determine the locality of the profits, instead the core operations for the e-commerce transaction and the place where those operations had been carried out should be focused on.
- Genuine businesses established in Hong Kong with a view to enjoy the tax concessions under the preferential tax regimes or the tax treaty network of Hong Kong would not fall under the anti-avoidance provisions of the "main purpose test."
- Transfer of trading stock between two related Hong Kong taxpayers at below market value would not be subject to tax adjustments under the arm's-length transfer pricing rules if the transfer was: (i) in the course of trade; or (ii) made upon cessation of business, given certain conditions are satisfied.
- Currently taxpayers can make an irrevocable election so that fair value changes from a financial instrument held for trading purposes could be taxed as reflected in the accounts rather than on realization basis. While taxation based on fair value accounting would not affect the general onshore-versus-offshore nature of the profits under the source principles, taxpayers should assess whether there is a reasonable prospect that the profits eventually realized could be regarded as being offshore sourced and non-taxable. It's critical to note that even if the subsequent sales activities warrant an offshore claim of the profits, in practice, it may be difficult for taxpayers to re-open prior year tax assessments regarding the fair value changes which have already been taxed.
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