Hong Kong: E-Commerce
Tax Structure Planning
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% (2011).
See Domestic 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 centre 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 or know how pays a flat profit tax of 30% of 16.5% (4.95%, or 4.5% for an unincorporated business) 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 4.95 % 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 16.5% for 2009/10). 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.
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 the government is actively expanding its tax treaty network partly in response to renewed emphasis by the OECD on international tax cooperation. There are also arrangements covering shipping with the UK, the US, and other countries (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 16.5% (2010) 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, e.g. 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.
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'.
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.