Hong Kong offshore profits: the source test
IRO s.14 charges profits arising in or derived from Hong Kong. Source follows the operations that produced the profit. DIPN 21 sets out how the IRD looks at those operations, including after the assessment.
Legal basis
Section 14 of the Inland Revenue Ordinance charges profits tax only on profits arising in or derived from Hong Kong. Foreign-sourced profits are in principle not chargeable, but the position must be claimed in the return and accepted by the IRD. The standard rate is 16.5% (8.25% on the first HK$2 million of assessable profits under the two-tier regime), charged on assessable profits rather than turnover.
The operations test
Under DIPN 21 the IRD examines, case by case, where the substantive operations that produced the profit were carried out — where negotiation, contracting, decision-making, performance and risk-bearing sit. Those facts matter more than where the contract was signed, payment made or goods delivered. Each class of profit (trading, services, interest, rents) is tested separately.
Rules by class of profit
Each class carries its own considerations (see table). Manufacturing profits may be apportioned by contribution under DIPN 28, customarily 50:50. An industry label is not a substitute for the operations test.
Source rules by class of profit (DIPN 21/28)
| Class of profit | Source rule |
|---|---|
| Sale of goods | Where the purchase and sale contracts are effected (negotiation and conclusion) |
| Manufacturing | Apportioned by contribution (customarily 50:50, DIPN 28) |
| Service fees | Where the services are performed |
| Interest | Where the lender’s core operations producing the interest are carried on |
| Rents / royalties | Where the property or right that produces the income is situated or used |
| Listed securities | Where the transaction is effected (place from which the broker is instructed) |
Claim and review
The claim is made in the profits tax return (BIR51) and supplementary form S1. The IRD’s usual course is to assess first and review afterwards: it may call for papers explaining the operations, conduct a field audit, or open an investigation. Contested arrangements may justify an advance ruling under IRO s.88A (charged for; binds only that case).
Risks and consequences
Review of offshore claims on trading and e-commerce profits has tightened in recent years. Where the substantive operations — marketing, negotiation, decisions — sit in Hong Kong, the claim can be overturned, with back tax and penalties under ss.80/82A and possible prosecution. Complete operational records (travel, correspondence, decision papers) are the foundation of any claim; books and records must be kept for at least 7 years after the transaction (IRO s.51C).
The IRD’s review approach and allowances follow the DIPNs and assessment guidance then in force.
Case-specific decisions differ — book a consultation with our advisers.
The content of this page is general professional information and does not constitute tax, legal or investment advice. For specific cases, please consult a Hong Kong practising accountant or tax adviser, or refer to official publications of the IRD / SFC / HKMA / CR.