In our April 2022 Issue of Newsletter, we will discuss certain important Hong Kong Tax Updates in First Quarter of Year 2022.
2. Court continues Hang Seng Bank case principle in determining source of profits
Newfair Holdings Limited (“Newfair”) won the offshore claim in the Court of First Instance (CFI) with the broad guiding principle
CFI over-ruled the decision by Board of Review in the case of Newfair Holdings Limited and Commissioner of Inland Revenue. Newfair is a typical Hong Kong trading company and procurement agent of a Multi-National Group. It purchased from 3rd-party suppliers in Hong Kong for onward sales to a group company in the Netherlands.
Board of Review Argument
- A Hong Kong bank account has been used to receive revenues and pay purchases;
- The Suppliers were Hong Kong incorporated companies and arranged shipment in Hong Kong;
Newfair never employed any staff. In other words, all the work has been performed by personnel of overseas group companies;
- The internal mark-up mechanism kind of suggests that Newfair earns the profits because of its status of being a Hong Kong company and the whole arrangements were for tax avoidance purposes; and
- No overseas tax has been paid in respect of the trading profits of Newfair.
Basically the CFI followed the broad guiding principle. When determining the source of profits, it should focus on what the taxpayer has done to earn the profits in question and where he has done it. The focus is to establish the geographical location of the taxpayer’s profit-generating activities, without being distracted by antecedent or incidental matters.
For trading profits, the profit-generating activities should be the initiation, negotiation and conclusion of sales and purchase contracts. In this case, as all of these activities were performed via email outside Hong Kong, the CFI considered that the trading profits should be offshore sourced and not subject to Hong Kong Profits Tax.
The judgement of Newfair Holdings Limited and Commissioner of Inland Revenue [HCIA 1/2021] for reference:
Points to note
The Broad of Review Arguments basically followed the prevailing practice of the Inland Revenue Department (“IRD”), while the CFI followed the broad guiding principle which is prevailing judgement of the court.
The latest court decision of Newfair suggested that Hong Kong still adopts the territorial-based taxation system. The fundamental source principle still applies. Taxpayers with significant amount of trading profits can still pursue offshore claim, despite the fact that the IRD is increasingly reluctant to grant the offshore claim.
Despite the CFI decision, in view of the current practice of the IRD, taxpayers are still strongly encouraged to implement tax planning to cater for the counter argument put forward by the IRD in the Newfair case in order to enhance the chance of success of offshore claim.