Hong Kong taxes profits by where they are earned, not by where the company is registered. That is why a Hong Kong company can legitimately pay no Hong Kong profits tax at all. It is also why the Inland Revenue Department treats an offshore claim as something you have to prove, year after year, with documents. The exemption is real. It is not a setting you switch on at incorporation.
What the territorial principle actually says
Profits tax applies when three conditions are met together: the person carries on a trade, profession or business in Hong Kong; that business derives profits; and those profits arise in or are derived from Hong Kong. Miss the third and there is nothing to tax — even though the company is Hong Kong-incorporated, has a Hong Kong bank account and files Hong Kong returns.
The IRD applies one broad guiding principle to decide the third condition: what did the taxpayer do to earn the profits, and where did he do it? The question is about the profit-producing operations themselves, not about where the company is registered, where the directors happen to live, or where the bank account sits.
Incorporation is not the test. Residency is not the test. The test is where the work that produced the profit was actually done.
The test changes with the kind of income
- Trading profits. The IRD looks at where the purchase and sale contracts were effected — negotiated, concluded and carried out. Related operations count too: sourcing, order processing, shipping and financing arrangements. Trading profits are treated as wholly onshore or wholly offshore; the IRD does not normally apportion them.
- Service fees. Taxable where the services that earned the fee were performed. A consultant who does the work outside Hong Kong is in a different position from one who does it from a desk in Central.
- Manufacturing profits. Sourced where the goods are made. Where manufacturing is split between Hong Kong and elsewhere, profits are apportioned.
How a claim is actually made
There is no application form and no advance approval at incorporation. The sequence is ordinary and it repeats every year:
- the company keeps proper books and has them audited — an offshore claim does not remove the audit requirement;
- the audited accounts and the Profits Tax Return are filed, with the offshore position taken in the return and explained in the tax computation;
- the IRD issues an enquiry letter — a questionnaire about the transactions, the counterparties and the people involved. This is standard practice, not a signal that the claim is failing;
- the company answers with evidence: contracts, correspondence, shipping and travel records, and the banking trail;
- if the IRD accepts the position, the assessment issues on that basis. The claim is then made again for the next year.
An accepted claim is not permanent. Facts change, and each year of assessment stands on its own.
Where claims fail
- Documents that do not agree with each other. Invoices alone almost never carry a claim. The contracts, emails, shipping papers, travel records and bank statements have to tell one consistent story.
- Contracts concluded in Hong Kong. If the negotiation and signature happened while the decision-makers were physically in Hong Kong, the trading profit is likely to be Hong Kong-sourced — whatever the invoices say.
- A story built after the fact. The evidence has to exist at the time. Reconstructing it two years later, in response to a query letter, rarely convinces.
- Mixed operations, treated as if they were clean. Where part of the work genuinely happened in Hong Kong, the honest answer is often apportionment, not a full offshore claim.
The second gate: foreign-sourced passive income
Since 1 January 2023 a separate regime sits alongside the territorial rules. Under the foreign-sourced income exemption (FSIE), certain foreign income received in Hong Kong is treated as taxable unless the company meets specific conditions. It covers foreign interest, foreign dividends and, since 1 January 2024, gains on the disposal of property of any type. (A fourth category exists but rarely touches the structures our clients run.)
Two points matter in practice:
- It applies to MNE entities — broadly, an entity that is part of a group operating in more than one jurisdiction. A standalone Hong Kong company with no foreign affiliates is outside it. A Hong Kong company sitting under a Cyprus or overseas holding company is not.
- Substance is the way out. A pure holding entity needs premises and people in Hong Kong adequate to what it does; an operating entity needs qualified employees and real operating expenditure here. Outsourcing to a Hong Kong service provider is permitted, with proper oversight.
For foreign dividends and equity disposal gains there is also a participation exemption: broadly, a holding of at least 5% for at least 12 months, subject to an anti-abuse condition that the income has borne tax of at least 15% abroad.
What an offshore claim does not change
None of the annual machinery goes away. The company still renews its business registration, files its Annual Return, keeps its Significant Controllers Register, has its accounts audited and files a Profits Tax Return. And if the claim does not hold, the ordinary rates apply: 8.25% on the first HK$2 million of assessable profits and 16.5% above that, with only one company in a group of connected entities able to use the two-tier rate.
How we handle it
We say plainly whether a claim is arguable before the structure is built, not after the first query letter arrives. Where it is arguable, we set up the record-keeping so the evidence exists as the business runs — contracts, correspondence and travel logged as they happen — and we handle the IRD correspondence when it comes. Where it is not arguable, we say so: an 8.25% first tier on a properly filed company is a better outcome than a claim that collapses three years later with penalties attached.