Learn the key differences between incorporating a local company in Hong Kong and registering as a registered non-Hong Kong company about the legal structure, liability, and requirements.
Tax in Hong Kong Rules You Should Not Overlook
Many companies exploring doing business in Hong Kong ask the same question: if their customers are overseas, the goods do not pass through Hong Kong, and payments are received from abroad, does that automatically mean the Hong Kong company can qualify for offshore tax exemption in Hong Kong?
It is a common question, but also one of the most misunderstood areas of tax in Hong Kong.
Hong Kong profits tax is not determined by whether a business appears “international” or whether it serves overseas customers. Hong Kong follows a territorial source principle of taxation, which means that only profits arising in or derived from Hong Kong are subject to Hong Kong profits tax. In other words, Hong Kong does not automatically tax the worldwide profits of a business.
In general, three conditions must be satisfied before profits tax can be charged:
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the taxpayer carries on a trade, profession, or business in Hong Kong;
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the taxpayer has earned profits from that trade, profession, or business; and
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those profits arise in or are derived from Hong Kong.
In practice, the third condition is often the most debated one: how the source of profits should be determined.
What Is ‘Offshore Tax Exemption’?
The term ‘offshore tax exemption’ is not the name of an automatic tax incentive. More accurately, it refers to a position taken by a business when filing its tax return — namely, that the relevant profits did not arise in or derive from Hong Kong, and therefore should not be subject to Hong Kong profits tax.
This point is important because it shapes how businesses should understand Tax in Hong Kong. If “offshore tax exemption” is misunderstood as some kind of automatic entitlement, companies may focus too heavily on formal arrangements — such as where the customer is located, whether an offshore bank account is used, or where a contract is signed. In reality, what the tax authority is primarily concerned with is the substance of the business operations.
Overseas Business Does Not Automatically Mean Tax Exemption
A common assumption is that if a Hong Kong company deals with overseas customers, the goods do not enter Hong Kong, or the contract is signed outside Hong Kong, then no Hong Kong profits tax should apply.
The key issue is not whether the business ‘looks offshore,’ but whether the profits are in fact sourced from Hong Kong. This means that, when assessing whether profits are Hong Kong-sourced, the main question is not where the owner is located, nor where the bank account is opened. The real question is:
Where did the business carry out the key profit-generating activities that produced those profits?
How Should the Source of Profits Be Determined?
The Inland Revenue Department does not apply one single formula to all types of business. Instead, it looks at different categories of profit separately, identifies the most relevant profit-generating activities for each category, and then examines where those activities took place.
Below, Hongda explains how different types of businesses should assess the source of their profits.
(1) Trading Companies
For the purchase and sale of goods, the Inland Revenue Department will generally look at where the contracts of purchase and sale are effected. However, ‘effected’ does not simply mean where the final signature takes place. It can include the negotiation of terms, the conclusion of the contract, and the execution of the relevant terms.
The Department also emphasizes that, when determining the source of trading profits, it is not enough to look only at where the buyers and sellers are located. A broader review of the relevant operations is required, including procurement, storage, sales solicitation, order processing, shipment, financing, and payment arrangements. If the relevant persons remain in Hong Kong and conclude the transactions by phone or via the internet while in Hong Kong, the contracts may still be regarded as having been effected in Hong Kong.
This is why, in some cases, goods may be shipped directly from Mainland China to Europe without physically passing through Hong Kong, yet the profits may still be treated as Hong Kong-sourced if the negotiations, confirmations, credit arrangements, and payment control are all handled in Hong Kong. By contrast, where both the contracts and the key profit-generating trading operations can be shown to have been carried out outside Hong Kong, there may be a stronger basis for an offshore profits claim.
(2) Service or Consulting Companies
The profit source analysis for service businesses is different from that for trading businesses.
For service fee income, the Inland Revenue Department takes a relatively direct approach: if the services that generate the fees are performed in Hong Kong, the service income is generally taxable in Hong Kong. In some cases that even though the client are located overseas, the project management, communication, research, delivery, review, and day-to-day collaboration may still be carried out in Hong Kong. In those circumstances, the fact that the client is outside Hong Kong is usually not enough to support an offshore profits position.
(3) Commission, Agency, and Brokerage Businesses
If a company earns commission by finding buyers for a client, locating suppliers, or arranging transactions on behalf of a principal, then the source of that income will generally depend on where those commission-generating activities are carried out. If all of those activities take place outside Hong Kong, the commission income may in principle fall outside Hong Kong profits tax.
Put differently, if the actual work of introducing parties, facilitating transactions, coordinating between buyers and sellers, and pushing the deal forward is done in Hong Kong, then the fact that the principal and the counterparties are all overseas does not automatically make the commission income offshore. Only where those core activities can be shown to have taken place entirely outside Hong Kong will the offshore claim have a stronger foundation.
(4) Manufacturing or Processing Businesses
The manufacturing profits are generally sourced from the place where the goods are manufactured. If the manufacturing process takes place partly in Hong Kong and partly outside Hong Kong, then the profits attributable to the offshore manufacturing activities may not be regarded as arising in Hong Kong. In other words, for manufacturing profits, the key issue is not where the customer is located or where the finished goods are sold. The focus is on where the manufacturing activities themselves are carried out.
In the context of processing arrangements involving Mainland China, the Department generally accepts a 50:50 apportionment of profits in the case of processing with supplied materials. However, in cases involving processing with imported materials, or where the assembly work is simply subcontracted to independent Mainland subcontractors and the Hong Kong company itself has only limited involvement, profit apportionment may not be accepted. In some cases, the profits may even be treated as fully taxable in Hong Kong.
How Should Business Evidence Be Presented?
Since the Inland Revenue Department’s analysis focuses on the operations that generated the profits, the company must be able to reconstruct those activities through documents, records, and actual business workflows. The Department has also noted that, where a taxpayer would like more certainty on the source of profits under the territorial source principle, an advance ruling may be sought.
Common supporting documents for an offshore profits claim may include:
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customer and supplier contracts
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quotations, purchase orders, and email correspondence
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evidence showing where negotiations and contract signing took place
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travel records and meeting records
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bills of lading, customs declarations, and logistics documents
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bank statements and payment instructions
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internal records showing staff functions and execution responsibilities
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evidence relating to overseas offices, agents, or third-party service arrangements
Conclusion
A precise assessment of where the core profit-generating activities take place is one of the key factors in determining whether a Hong Kong company may qualify for an offshore profits claim. For businesses, what really matters is not how to make the structure “look offshore,” but rather how the profits are actually generated, where the key profit-generating activities took place, and whether those facts can be supported by sufficient and consistent evidence. Only when the core profit-generating activities are genuinely carried out mainly outside Hong Kong — and supported by proper documentation — will there be a stronger basis for treating the profits as non-Hong Kong sourced.
If you are considering doing business in Hong Kong, or would like to better understand how offshore tax exemption in Hong Kong and tax in Hong Kong may apply to your business in practice, Hongda’s accounting and tax team can help. Based on your business model, transaction flow, and supporting evidence, we can assist you in assessing the source of profits, evaluating whether an offshore profits claim may be available, and helping you prepare for tax filing and ongoing compliance.
