Sources of Hong Kong Tax Law and Scope of charges on Salary Tax for Company Incorporation Hong Kong

In this article we will discuss about the different sources of Hong Kong Tax Law, application of foreign tax cases and scope of charges on salary tax. In the discussion we will also go through the proceeding of courts on some tax cases, decisions of BoR on different tax cases and income tax exception for certain organizations. So, this is a key article to understand whole legal framework of Hong Kong Taxation system.

Legal Structure of Hong Kong

There are two major sources of Hong Kong tax law:

• Statue law
• Case law

One has to be familiar with these sources of tax law before starting a company in Hong Kong.

Statue Law

The applicable tax statues are given below.

• IRO is responsible to deal with earnings and taxes on income.
• Inland Revenue Rules (Cap 112A) are defined to carry out the provisions of Inland Revenue Ordinances.
• Stamp Duty Ordinance (Cap 117).

Case Law

A taxpayer has right to appeal to board of revenue if he/she is not satisfied with an assessment. A taxpayer can also appeal against the decision of BoR to the court of first assistance of high court, then to the court of appeal and then to court of final appeal. The decisions made by courts and BoR are reported and case law is included in their decisions.

As BoR is not a court so its decision is not unalterable or final. But its decision may worth as a reference. This is because not all tax disputes are resolved by the courts. The majority of cases are resolved between taxpayer and assessors that carryout assessment. Those disputes are usually resolved at objection stage.

Decision made by court of appeal (CA) and court of final appeal (CFA) include judicial model. Decision made by CFA is final as it is the highest authority and ultimate court of appeal.

Foreign Tax Cases Applications in Hong Kong

In Hong Kong, courts are free to made decisions and have no binding force. Like many other countries in the world the tax ordinances of Hong Kong are based on model of Commonwealth countries (South Africa, Australia) and Britain etc. so decision made by courts of these countries may be accepted by courts in Hong Kong as a model authority.

Tax Cases and Decisions by BoR

While reconciling the different BoR decisions and tax cases, student usually get puzzled as why two tax cases with having many aspects in common produced opposing results. For example, Pritchard (1971) 47 TC 680 and Shilton case (1991) STC 88 dealt with payments to a taxpayer. The payment was held to be free from tax in second case while taxable in first case. So for the case analyzers and law students it become difficult to deduce some results from these cases and seem to apply different rules on same matter. In order to understand the decision of these tax cases one have to study the case thoroughly and find the differences in facts to identify the reason of contradicting decisions in both cases. 

One has to understand that as discussed in principal of judicial precedent, the decision of lower court is bonded by high court. So decision of court of appeal is bonded by decision of court of final appeal.

Tax Statues’ Interpretation

Ordinary meanings are given by words:

In the tax statues words should be given their natural and ordinary meanings. While interpreting the meaning of word ‘agent’, In CIR case (1987) 2 HKTC 198, it was statement of Justice Mortimer that: Words in an ordinance….….then the court would strive to give those words a proper meaning.…

No arrogance in tax  

If something is said clearly then one has to look barely. No intendment is allowed. For tax there is no equity. Nothing is to be suggested as legal consequences and nothing is to be read. One can just look justly at language used (per justice Rowlatt in Cape Brandy Syndicate case).

It was showed in CIR case that, it is duty of court to look at the legislation scheme, legislation purpose and context in interpreting tax statues.

Practice Notes and Departmental Interpretation

In order to interpret tax statues and concession in departmental understanding and practice notes, and extra-statutory practices, IRD issues the explanations of its own departmental practice time to time. These notes are only issued for guidance and information of taxpayers and have no legally binding force. These also have no effect on right of taxpayer to appeal or object to an assessment.

Here is the link to download departmental interpretation and practice notes (DIPNs).

www.ird.gov.hk/eng./ppr/dip.htm

It is recommended for locals and foreigner to take the services of professional firms to create a company in Hong Kong in order to avoid any legal consequences

Income Tax Exceptions for Certain Company Incorporation Hong Kong

Authority of Chief Executive to Exempt

Under the Section 87 of Inland Revenue Ordinance, chief executive of council has authority to exempt any institution, person or office from whole or any portion of chargeable tax.

For example, order 1998 in 1998 and 2003 were issued by chief executive to exempt the profit tax and tax exemption respectively. Under first order, the bank interest income which receive over time on/after 22 June 2018 are set free from profit tax. Under the second order the payable tax for assessment year 2001/02 is reduced by 50%.

Charitable Bodies Exemption

There is no payable tax on a trust of public character and a charitable institution. But there would be no tax on the business done by charitable institution and trust of public character if:

• The benefits of such business are used solely for charitable purposes.
• Such benefits are only related to after a company create in Hong Kong and not expended outside significantly.
• If the company is for charity purpose and none of the personal benefits are associated with it and all the given criteria are fulfill, then your company would be exempted from all types of tax. Moreover, starting a company in Hong Kong for such national cause is much appreciated by government of Hong Kong. On key thing to note here is that to register offshore company in Hong Kong is subjected to same tax laws as a local company in Hong Kong.
• Salaries Tax: Scope of Charge
• In this section we will discuss in detail the different types of tax that are applied on salaries by Board Inland Revenue of Hon Kong.
• Scope of Charge
• If the income of a person in Hong Kong is raised from any of source given below, he/she would be liable to pay salary tax. And sources are:
• Employment
• Any pension
• An office

Scheme of Taxation for Income from Employment in Salaries Tax

By the discussion it would be clear that different tax rules are applied to the taxation of income from different sources. These resource can be office, employment and pension. If the income of taxpayer is derived from or rises in Hong Kong, he/she would be liable to pay income tax.

If employment of tax payer is located in Hong Kong even though some of services of taxpayer were carried out outside the Hong Kong, the income is fully taxable. If he/she visits Hong Kong for not more than 60 days in a year assessment and his/her services in respect to employment are outside Hong Kong, his/her income is fully tax free. If the employment of a person is outside Hong Kong but he/she derives income from the resources present in Hong Kong will be taxable due to rules defined in law.

Practice Notes 10 and Departmental Interpretation

It is accepted by Inland Revenue Department that employment is only located outside Hong Kong in majority of cases if these three factors are present there (DIPN 10):

• Salary of employee is paid to him outside the Hong Kong.
• The agreement for employment was negotiated and is executable outside Hong Kong.
• The employee is living outside Hong Kong.

There can be some scenarios where IRD have to look further than the external features of employment. One key point to note here is that, to look in above discussed three points is common practice of IRD. Totality-of-facts test is preferable by board of revenue (D 40/90, D59/03).

IRD is not bounded to follow that ‘three factors test’ strategy in all cases. The ‘totality-of-facts’ test is usually followed by IRD in the specific cases.

In Lee Kwong case (2005, it was stated by deputy judge To at para 26, while determining the source of employment income, contract of income must be regarded first. He also stated that: This must include consideration……. …….as totality test.

Employment Contract

Written Contract

The only contract of employment that is to be considered by IRD is that which is:

• Basis of relationship existing between employer and employee in the form of master and servant.
• Currently in force.

Locality of employment may keep on changing if certain terms in the agreement have been changed subsequently. In that case addition and changes to initial agreement should also be taken into account. A properly executed copy of contract between employer and employee is required by the IRD in order to examine the locality of employment of an employee. In case if written contract between employer and employee does not exist:

• It is duty of employee to provide a certificate from his/her employer certifying:
• The effective date of appointment etc.
• The terms of his/her appointment.
• These documents should be signed by both parties (DIPN 10, para 8).

Parties to the Contract

The genuineness of relationship between employee and employer in a contract of employment is verified by the IRD if warranted by conditions.

For example, let’s consider a scenario in which a company sponsors an employee from outside the Hong Kong as an employer and has represented to other departments of government to that effect. In this case IRD have to verify along with some other factors that whether an employee-employer relationship still exist or not between employee and sponsor.

In order to verify whether a true employee-employer relationship exists between two parties, IRD have to consider:

• Who can have control over the employee legally.
• Whether employee is recognized by the employer as part of his/her organization.
• The capacity of employee in which third parties recognize him/her.

Contract Negotiated and Concluded

Following information is required by IRD from a taxpayer who want to provide evidences as a claim of non-Hong Kong employment.

• Where and when the dialog between parties took place.
• The parties that took part in negotiation.
• The agenda discussed.
• The terms that were agreed.

Employers’ Residence

Residence of Corporation

IRD have to take into account while determining the residence of corporation that where the control and central management of corporation is located. By considering this principal, a company is located where its real business is carried on. The real business of company is carried on where control and central management of company is observed in actual. The central management and control of a company is exercised through medium that consists of place of board meeting.

Hong Kong branch of foreign corporation

A person may have a Hong Kong employment if he/she is employed by a Hong Kong branch of foreign corporation. IRD may do not accept the claim of non-Hong Kong employment by employer that is resident of Hong Kong even if:

• Negotiation between employer and employee took place outside the Hong Kong.
• A contract between both parties signed outside the Hong Kong.

Parent and Subordinate

If IRD is going to apply ‘central management and control’ test in situation of secondary company and its parent operating in other country, it would consider the both secondary company and its parent as separate legal entities being managed and controlled by their own board of directors.

While it is normal practice that, parent company exert influence and pressure over secondary company but it is not mandatory that secondary company exists in same territory as the parent. Board of directors in the secondary company also deal with the matters such as procurement, production, investment and marketing on their own without reference to parent.

Establishing employer’s residence

IRD would require information given below in order to support of their claims that, employers are controlled and centrally managed outside the Hong Kong.

• The capacities and identities of those persons are required by IRD who are responsible in
• employer’s organization for control and central management of company.
• A complete information of the tasks that are undertaken by these persons is required.
• The information about where those persons are located while exercising the control and management etc.

As far as documentary proof about the location, identities and responsibilities and capacities of these persons are concerned, only minutes of meetings and certified copies of reports of directors are accepted by Inland Revenue Department.