Hong Kong: Profits found to be offshore-sourced, not subject to profits tax (court decision)

Court of First Instance decision overturning the decision of the Board of Review

Not subject to profits tax (court decision)

The Court of First Instance issued a decision in a case allowing a taxpayer’s appeal and overturning the decision of the Board of Review.

The Court of First Instance held that: (1) the taxpayer did not carry on a business in Hong Kong; and (2) its profits did not arise from commercial operations in Hong Kong. The profits were, therefore, held to be offshore-sourced and not subject to Hong Kong profits tax.

The case is: Newfair Holdings Ltd. v. Commissioner of Inland Revenue (20 April 2022)


The taxpayer—a Hong Kong-incorporated company within a group whose principal business was the distribution in Europe of electronic products sourced from manufacturers in the Far East—was interposed between a Dutch group company and the third-party suppliers for Dutch tax mitigation purposes.

The taxpayer filed an appeal from a decision of the Board of Review, and the Court of First Instance allowed the taxpayer’s appeal on the substantive issues involved in the case. 

Substantive issues

Issue 1: Whether the taxpayer carried on a business in Hong Kong

Board of Review’s decision: The Board of Review concluded that the taxpayer carried on a business in Hong Kong based on the following three “pivotal factors”—

  • A Hong Kong bank account was used to receive revenue and pay the suppliers (factor 1).
  • The suppliers were all Hong Kong-incorporated companies managing the shipments from Hong Kong (factor 2).
  • An inference was drawn that the contracting parties intended Hong Kong to be the principal place of business--where the acceptance of the orders was supposed to take place (factor 3).

Court of First Instance’s decision: The Court of First Instance held that the taxpayer did not carry on a business in Hong Kong based on the following findings:

  • “Carrying on of business” usually calls for some activities on the part of the taxpayer in the pursuit of commercial gains.
  • The transactions or operations that gave rise to the taxpayer’s profits were sales of goods, and all merchandise contracts were concluded outside Hong Kong.
  • The receipt of revenue and payment to suppliers (factor 1) were only incidental administrative acts and not revenue-generating activities—both activities could not show a business was carried on in Hong Kong.
  • The location where the suppliers managed the shipments or carried on their businesses (factor 2) was irrelevant to the location where the taxpayer carried on its business.
  • Designating a principal place of business (factor 3) was not the same as identifying the place where the profits actually arose.

The Commissioner of Inland Revenue’s argued that the taxpayer’s business model (i.e., the interposition of the taxpayer between the Dutch group and the suppliers) amounted to a profit-generating activity and the presence of the taxpayer together with the associated arrangements in Hong Kong was the effective cause of producing the taxpayer’s profits. However, the Court of First Instance held that these relate to the taxpayer’s role within the group but not its acts or operations that gave rise to profits. For imposing a profits tax liability, the court held that the critical issue is what an entity does, as opposed to what the entity is.

Issue 2: Whether the taxpayer’s profits derived from the Hong Kong business arose in Hong Kong

Board of Review’s decision: The Board of Review concluded the taxpayer’s profits were derived from Hong Kong because:

  • The taxpayer actively operated its Hong Kong bank account to pay the suppliers and receive revenue, which were an essential part of its chain of business activities.
  • The taxpayer’s legal title to the goods sold to the Dutch group amounted to valuable assets held in Hong Kong.
  • There was fiscal significance in the internal mark-up regime within the Dutch group, and the taxpayer’s business model did amount to identifiable profit-generating activity.

Court of First Instance’s decision: The Court of First Instance applied the various principles as established by the case law regarding the source of profits, and held that the taxpayer’s profits were not sourced in Hong Kong. In particular, the Court of First Instance pointed out that:

  • Profits arising from merchandise trade were to be taken as arising in or derived from the place where the contracts of purchase and sale were effected.
  • In the taxpayer’s case, the profit-generating transactions were the purchase of goods from the suppliers and then resale of the same at a fixed mark-up to the Dutch group, and the negotiations and conclusion of the purchase and contracts were effected outside Hong Kong.
  • The Court of First Instance found that: 
    • The operations of the Hong Kong bank could not amount to profit-producing operations.
    • The Board of Review’s finding regarding the taxpayer’s legal title to the goods was not supported by any evidence, so there was an error in law.
    • The Commissioner of Inland Revenue could not impose profits tax liability on what taxpayer was, but what it did—the tax planning was not a commercial operation that generates profits.

Accordingly, the Court of First Instance rejected the Board of Review’s decisions regarding both issues, and allowed the taxpayer’s appeal on both issues. 

KPMG observation

Tax professionals believe the decision of the Court of First Instance upholds the principles of Hong Kong’s territorial tax regime and reaffirms the proper test for determining the source of profits pursuant to case law. In instances regarding trading profits, the places where purchase and sale contracts are effected remain as the determining factor of the source of the profits.

More generally, the decision highlights the importance of identifying and focusing on the taxpayer’s own profit-generating activities in determining the source of profits. Other considerations—such as (1) a Hong Kong company being set up and used to facilitate/effect the transactions; (2) the suppliers are Hong Kong-incorporated companies; (3) no tax is being paid overseas or the profits are not subject to tax anywhere—would not be relevant. Although not mentioned in the decision, tax professionals note that it is important to make a distinction between “carrying on a business in Hong Kong” and “carrying on a business with someone in Hong Kong.”

This case could possibly have broad implications for the Inland Revenue Department’s current practice of assessing offshore claims. Whether the Commissioner will further appeal to a higher court is not yet known. In the meantime, taxpayers with any outstanding offshore claims pending before the Inland Revenue Department need to consider revisiting their issues and whether there are any fresh arguments to support their claims in light of the Court of First Instance’s decision in this case. 

For more information contact a KPMG tax professional:

David Ling | +1 609 874 4381 | davidxling@kpmg.com


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