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- TAX
EFFICIENT E-COMMERCE IN HONG KONG
- HONG KONG PLANNING THE TAX
STRUCTURE
- WHAT TO LOCATE IN HONG KONG
- HONG KONG OFFSHORE OPTIONS
FOR E-BUSINESS PEOPLE
Hong
Kong Planning the Tax Structure
Many
countries consider Hong Kong an 'offshore' jurisdiction;
the attitude of the government however is that
the territory is not an offshore centre in the
traditional sense of the word but rather a low
tax area which levies tax according to the territorial
principle. Anyway, the result is that by using
an appropriate corporate structure, the profits
from most types of business activity can accrue
in Hong Kong without being taxed - only those
earning streams which directly result from activity
in Hong Kong itself are taxed, and even then at
a maximum of 16.5% (2008/9).
See
Direct Corporate Taxation
for a detailed analysis of Hong Kong's tax system.
The salient points for e-commerce activity are
as follows:
-
There
are no capital gains taxes, no withholding
taxes, no sales taxes, no VAT, no annual net
worth taxes and no accumulated earnings taxes
on companies which retain earnings rather
than distribute them. Taxes are only levied
on income "derived from or arising in"
Hong Kong and not on income sourced outside
the Territory. The residential or non-residential
status of an entity is irrelevant. Advance
tax rulings are available on the question
of whether or not for profits tax purposes
trading income is deemed onshore and taxable
or offshore and tax exempt.
- The
establishment of an office does not of itself
render a company liable to profits tax where
that office is not generating profits from within
the territory. A key criterion is the place
where the contract was negotiated and signed.
Income relating to a sale contract negotiated
by the seller from the territory by way of facsimile
or telephone where the negotiation did not require
travel outside the territory is deemed Hong
Kong source income for profit tax purposes.
Likewise if the contract is negotiated and signed
outside the territory and the goods sold are
not sourced from within the territory then any
income arising is not deemed Hong Kong source
income for profits tax purposes. This is often
achieved by utilizing an offshore company which
re-registers in the territory as a foreign company
but whose directors both remain non resident
and negotiate and execute the contract from
the offshore jurisdiction.
- Where
the Hong Kong entity is merely a booking center
in the sense that it does not negotiate or draft
the sale agreement (which is carried out abroad)
but merely issues an invoice on instructions,
operates a bank account and maintains accounting
records covering the transaction then the income
from such a transaction is not deemed Hong Kong
source income for profits tax purposes.
- An
entity whose business is to grant rights to
use a trademark, copyright, patent, know how
or other types of intellectual property pays
a flat profit tax of 1.75%, or 17.5% on 10%
(2007/8), of the payment received with all related
expenses being non tax deductible. If the recipient
of the payment is a related offshore licensing
company the Hong Kong company must withhold
and hand over 1.75% of the fee paid over.
- Income
from the international operations of shipping
companies is exempt from tax unless the ships
are operating in Hong Kong waters or proximate
to the same in which case only that proportion
of income earned in Hong Kong is subject to
local tax of 17.5% (2007/8, reduced to 16.5%
for 2008/9). Shipping profits meeting the conditions
of the double taxation agreement with the USA
are exempt from profits tax in Hong Kong.
- Dividend
income received by a Hong Kong parent company
from either a resident or foreign subsidiary
is not deemed income in the holding company's
hands and is thus not subject to an assessment
to profits tax
- Losses
can be carried forward indefinitely.
- There
are 100% first year allowances for computer
equipment;
Overseas
companies starting businesses in Hong Kong generally
either register themselves with the Inland Revenue
Department to set up "branch offices"
or to form locally incorporated subsidiaries.
Other permissible forms are partnerships and sole
proprietorships. Finally, a foreign company can
open a representative or liaison office in Hong
Kong.
The
choice of entity for an e-commerce operation
will be dependent on the type of trade being
carried on and the taxation situation of the
owners, so that professional advice will be
needed. However, it will normally be correct
to set up a local limited company. Profits tax
applies to 'persons' which includes all types
of entity, evidently, so the most important
structural issues will be those having to do
with the location of business activity. As noted
above, the main point will be to place the server
(or office) where the sale contract is concluded
out of Hong Kong, most likely in an offshore
jurisdiction so as to avoid corporation tax
or CFC problems in a high-tax jurisdiction.
In many situations, the Hong Kong facility will
be able to take advantage of 'booking centre'
rules to escape profits tax.
However,
in July 2001, the Hong Kong Inland Revenue Department
released new guidelines regarding the taxation
of e-commerce operations. The practice notes
state that a company's profits from e-commerce
are not subject to tax providing its business
operations are located outside of the jurisdiction.
This is regardless of whether or not the company's
ISP is based in Hong Kong. The Inland Revenue
also stated that companies which conduct their
business operations within Hong Kong but employ
an overseas ISP will be taxed.
Tax
rates applied to commercial operations have
generally depended on the profit source but
because the source of transactions conducted
online can be difficult to categorise, the majority
of the profit from e-business has escaped taxation.
However, that loophole was plugged with an amendment
to the company tax return form in 2001 requesting
information regarding e-transactions, website
hosts and the payment gateway providers involved.
Hong
Kong does not have many double
taxation treaties, although there are some
arrangements covering shipping with the UK and
the US, and some rules covering the Hong Kong/China
relationship (see Double Taxation). E-Commerce
operations accruing untaxed profits in Hong Kong
and having mother companies in high-tax jurisdictions
are therefore unlikely to be able to repatriate
profits tax-efficiently from Hong Kong, and may
even be caught by CFC rules on undistributed profits.
If the CFC rules cannot be escaped (see below)
there is therefore a case for entering contracts
in Hong Kong and paying the local 17.5% (2007/8,
16.5% from 2008/9) profits tax, which would be
deductible against corporation tax in many high-tax
jurisdictions, thus avoiding the need to have
an offshore 'contracting' company.
Many
businesses or their owners will however want to
take advantage of the opportunities offered by
e-commerce to try to establish a structure that
mitigates or completely avoids high taxation.
Such an owner who plans to transfer part or all
of a business to a low-tax area such as Hong Kong
must follow one of the following routes or some
more-or-less complicated variation or combination
of them (it must be understood that the right
solution will depend completely on the circumstances
of a particular business - these are just illustrative
possibilities):
- Set
up a new business in Hong Kong with ownership
which falls outside the CFC rules, eg don't
hold more than 40% from a high-tax country,
and put remainder of shares in trust for children
or in the hands of an offshore relative;
- Create
a joint venture with other onshore companies
or owners whereby ownership is sufficiently
distributed to escape CFC rules;
- Owner
(individual or company) move offshore (not necessarily
Hong Hong), move business to Hong Kong and outsource
high-tax area distribution (if physical);
- Transfer
existing business into trust or other offshore
ownership for inheritance tax purposes; set
up new offshore business to handle expanded
range of products or markets.
NB:
Any transfer of all or part of a business away
from a high-tax area is likely to trigger a disposal
for capital gains, gift or transfer tax purposes
- great care is needed to avoid this happening.
Companies may be in a better situation than individuals
to mitigate the effects of tax on a transfer;
equally, companies with international subsidiaries
may be able to make use of 'mixer' holding companies,
and thus may not be so much affected by the CFC
rules.
In
fact there are numerous possibilities for arriving
at an effective structure; it is normally possible
to improve the tax performance of a business substantially
by moving part or all of it offshore - but expert
professional guidance is essential, and the suggestions
above are no more than indications of the sort
of thing that may be effective in some circumstances.
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What
to Locate in Hong Kong
To
date, e-commerce companies have tended to focus
on marketing and selling as the most likely business
functions to locate offshore, but there is no
reason why procurement, administration, payroll
and other corporate functions should not be based
offshore.
Since
physical distribution can be outsourced, and in
some countries doesn't even amount to a taxable
presence, the use of offshore is by no means limited
to digitally-downloadable products. Still, there
is no doubt that the greatest cost and tax savings
are available to those companies whose products
can be delivered electronically, as in the following
list:
Retail
businesses dealing in intangibles or intellectual
property, such as software or music
Electronic publishing enterprises
Online reservations
Telecommunications services
Language translation services
Education and Internet-based training
Online gift certificates
Online
brokerages and other financial services, including
insurance
Legal services
Software and other technical support
Research and online information services
Internet Service Providers (ISPs)
Metamediaries and access portals
Corporate services
Data
warehouse centres for processing and storing data
Database management services
Certification and verification services for business
and consumer documents
Hubs for secure transactions and communications
Supply chain management centres
Communications and billing hubs for fibre optic
and satellite systems
Network monitoring facilities and services
In
the case of Hong Kong, its physical proximity
to China and other Asian markets, and its excellent
port and airport facilities mean that it can also
be used as a trans-shipment or physical distribution
centre for many types of product. Hong Kong's
attractions in this respect have been considerably
enhanced since its new, unproblematic relationship
to China has been established.
E-Commerce
in Hong Kong has so far been mostly a local phenomenon
- that's to say, existing trading companies have
begun to offer it on their web-sites, and local
dotcom start-ups have aped their counterparts
in the USA or Europe. International companies
importing or selling into China (or Taiwan, or
Vietnam etc) have historically chosen to establish
themselves in Hong Kong for the obvious reasons
of low taxation, access to services and so on;
what the advent of e-commerce does is to increase
dramatically the range of activities which they
can place in Hong Kong. Thus, it can be expected
that the number of international companies using
Hong Kong will increase, and that the scale of
their operations there will grow. All of this
of course subject to the doubts expressed above
about the speed and thoroughness with which the
SAR is adapting itself to the 'new economy'.
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Hong
Kong Offshore Options for E-Businesspeople
The
object of setting up an e-commerce business, or
part of one, in an offshore jurisdiction, is evidently
to make money, and if the tax structure is correct,
profits will accumulate in a local bank from which
they can be freely invested according to an individual's
preferences, either by being ploughed back into
expansion of the business, or into income- or
capital-generating investments.
There
are as many different offshore investment situations
as there are offshore investors, and anyone considering
making offshore investments must absolutely take
appropriate professional advice. But it can be
useful to have a first idea of what kind of investment,
and which offshore jurisdictions, might be suitable
before approaching professionals.
For
this reason, lowtax.net has opened a companion
web-site called www.investorsoffshore.com,
which explores the world of offshore investment
from the perspective of an individual with say
more than USD100,000 to invest. The site has sections
on the history of alternative investment and descriptions
of the main types of investment, along with hints
on how and where to invest.
Recognising
that investment strategies are heavily dependent
on a person's country of residence, life-style
and future plans, InvestorsOffshore
DIY Guide allows an individual to specify
the broad outlines of his or her offshore investment
profile, and receive in return some suggestions
as to the most suitable investment route to be
further explored with professional guidance.
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