Unlike most of the other countries in the world which have adopted global taxation principles, it includes, those overseas profits that is made taxable; Hong Kong, applied the principal of territorial source. It only bases on those sources of income derived from Hong Kong for profits tax, non-Hong Kong sources of income are not taxable, but it does not represent the country at which the source come from without taxation. Although the principle is clear, in practical application, it may sometimes cause a lot of controversy.
Determining the source of profits basic principles:
Over the past years, the courts have determined the source of profits for this verdict. The following principles are based on an authoritative court judgment flor establishment:-
1. Question of fact
Determining the source of profits are based on the facts of cases to decide. So no one can summarize for a variety of different situations in general. Whether profits arising in or derived from Hong Kong is according to its nature and the profits generated by the related profits are determined by the nature of the transaction.
2. Operation test
The basic guiding principle determining the source of profits is to identify the profits earned by the tax-payer that engage in the activities as well as the place the activity taken place. In other words, the correct approach is to identify the operation of generating profits and determine such operations that are undertaken. Source of profits must be attributed from the operation of the tax-payer which generate profits, rather than the other members of the group's operations.
3. Antecedent or incidental activities
For operation including those in the course of their business the activities carried out, the focus on determining the location of the tax-payer are subject to profitable transaction, such transaction and its previous and antecedent activities are considered separately.
4. Location to make decisions
Investment or business decisions are made everyday at different locations. To determine the source of profits is merely one of the factors to be considered. In general, it is not a decisive factor.
5. Gross profit from the transaction
To divide a transaction’s profit, to see whether the profit is arising from Hong Kong or outside Hong Kong is based on the gross profit resulting from transactions and decisions.
6. Overseas operations Office
A business unit may set up overseas offices outside Hong Kong for profit. However, if the unit has not set up overseas business offices, it does not represent all its profits must arise in or derived from Hong Kong. But, in most cases, if the unit's principal place of business is in Hong Kong and the overseas operations of that unit are not establishing offices, its profits are likely to be subject to profits tax in Hong Kong.
7. Sales and Purchase Contract
When determining the source of profits from the goods and commodity exchanges, it generally based on the place where reaching the agreements. “Fulfillment" is not construed execution legally. It means the negotiation, conclusion and implementation on the terms of the contract.
In the Court of Appeal, the case Magna Industrial Co. cv. the Commissioner, we have clearly understood that when determining the source of profits, we have to take into account an extensive consideration. The correct way is to earn profits from all of the underlying operations rather than just considering the sale of goods.
In the case, Megan Industries Limited v. the Commissioner, the Court of Appeal pointed out particularly that: "Where goods are bought and sold is clearly an important issue, but there are other issues to consider, for example, how the procurement of goods and storage? Related how to attract sales? The way the orders to be dealt with? How to arrange financing? How can I pay? “
8. How to consider the facts
When considering the facts, information about the nature and characteristics of business activities that engage in this activity, the frequency is more important to be considered. These activities and the causation of profits is the decisive factor.
9. Irrelevant facts
The commercial activities when establishing a source of profits, there is no direct relationship between the commercial activities to the fact, for example, renting office space, recruitment of general staff, establishing offices etc. are regarded as irrelevant.
10. General principles
(1) If the agreements are reaching in Hong Kong, the profits are taxable in Hong Kong
(2) If the agreements are reaching at a place outside Hong Kong, Hong Kong profits tax is not chargeable
(3) If the purchase contract or a contract of sale are reaching in Hong Kong, the initial assumption is that, the profits are subject to Hong Kong tax, but we must consider other relevant facts in order to determine the source of profits
(4) If the goods are sold to a customer in Hong Kong (including overseas buyers who establish office in Hong Kong), the relevant sales contracts are usually be regarded as fulfilled in Hong Kong
(5) If the person has not leave Hong Kong, but in Hong Kong, by telephone or other electronic media , including the Internet, conclude the sale contract, the contract will be deemed to be fulfilled in Hong Kong
(6) the profits earned from trade can only be classified as fully taxable in Hong Kong or not to be taxable in Hong Kong, the calculation of profit sharing do not apply