Determining whether a business is carried on in Hong Kong, and whether the relevant profits are Hong Kong sourced income arising from that business, are by their nature complicated matters.
Following the 2007 decision of the Court of Final Appeal (CFA) in Kim Eng1, there has been a concern that any income booked in Hong Kong could be charged to tax in Hong Kong, despite the underlying transactions taking place outside Hong Kong.
However, in the recent tax tribunal decision D31/11, the Board of Review (BOR) indicated that this is not necessarily the case if the income is only booked in Hong Kong for tax reasons and not to achieve any specific commercial purpose.
Nonetheless, determining whether a business is carried on in Hong Kong, and whether the relevant profits are Hong Kong sourced income arising from that business, are by their nature complicated matters. Clients should seek professional tax advice where appropriate.
The facts of the case are simplified and depicted in the diagram below.
Taxpayer and Company G were beneficially owned by the same principal.
Taxpayer was a company incorporated in Hong Kong and Company G was an overseas company operating in Country E.
Aside from maintaining a registered address in Hong Kong in compliance with the requirements of the Companies Ordinance, Taxpayer did not maintain any office or employ any staff in Hong Kong.
The activities undertaken by Taxpayer in Hong Kong were essentially limited to maintaining a bank account and instructing a presumably independent accounting firm to prepare accounts for it.
The instructions for operating the bank account, and preparing the accounts, were all given by a director of Taxpayer residing in Country E.
Despite Company G manufacturing the goods in Country E and making sales of the same to customers also located in Country E, the sales of the goods and the related cost of sales were, justified by way of certain internal agreements, reflected in the accounts of Taxpayer.
The apparent effect of these internal agreements was to treat Company G as the manufacturing and sales agent of Taxpayer in Country E, with Company G receiving only a fee for the agency services.
Taxpayer claimed that the arrangement was only to book the profits from the manufacturing and sales of the goods in the accounts of Taxpayer as part of a strategy to legitimately reduce the tax burden of Company G in Country E.
Taxpayer argued that it was not carrying on a business in Hong Kong and the booked profits were therefore not chargeable to tax in Hong Kong.
The Commissioner of Inland Revenue (CIR) disallowed Taxpayer’s claim and charged the relevant profits to tax in Hong Kong. Taxpayer appealed to the BOR.
1Kim Eng Securities (Hong Kong) Ltd v CIR  2 HKLRD 117