In this blog we will explore the territorial source of profit. We will understand what is the meaning of carrying on business in Hong Kong and meaning of profits derived from or arising in Hong Kong. We will discuss some cases and seeing the decision of board of review, the Privy Council and Inland Revenue department on these cases to completely understand these above defined scenarios.  

Beside many other things it is required by the Section 14 (1) of Hong Kong tax law that, before charging of profit tax on a person two conditions should be satisfied:

  • Business, trade or profession is carried on by that taxpayer in Hong Kong.
  • The profit from business, trade or profession is derived from or arises in Hong Kong.

It is not sufficient to impose tax on a person that merely carries on business in Hong Kong. The profit also must have derived from or arise in Hong Kong. The meaning of this statement is that source of the trade, business or profession from which a person is deriving the profit should be in Hong Kong.

Carrying on Business in Hong Kong


The business in normally carried on by the company in the place where control of the company or central management of company is exercised. De Beers Consolidated Mines Ltd. was one of the leading case. It was located in South Africa. It operated diamond mines there. The meetings of directors held in both London and South Africa. It was held by the authorities that, the control and central management of company was in the United Kingdom. So the company was resident in United Kingdom and real business of company was carried on there. 

It was illustrated by the case of De Beers that, a business may be carried on by a company in more than one location. This fact was also supported by the case of Swedish Central Railway Co Ltd. In that case it was observed that, the major source of income of taxpayer was on rent which used to receive by leasing the Swedish Railway. The control and central management of company was in Sweden. However, its activities were not specific to Sweden as it also carried on its activities in London. Due to this reason it was also held that company was also resident in the United Kingdom.

Trading of Non-Resident through Agent

A non-resident person is a person from perspective of Hong Kong tax department that has no permanent residence in Hong Kong. A non-resident person can still run a business in Hong Kong through an agent. Let’s say, if on the behalf of a principal the agent enters into a business contract in Hong Kong and let assume runs an offshore incorporations HK limited, then it will be same as the principal trading in Hong Kong.


If a company makes its sales in a place like China or England, then it does not compulsory mean that trade is being carry on by a vendor in that location. In a case of Grainger and Son it was said by the Judge Lord Herschell that; ‘goods are exported by many manufacturers and merchants to all parts of the world, yet goods find customer’.

Profits Derived from or Arising In Hong Kong     


The Section 2 (1) of Hong Kong tax law for company incorporation HK only states the statutory definition of ‘profits derived from or arising in Hong Kong’. It is stated by this section that, all the profits from the business that transacted in Hong Kong is included in the definition of ‘profits arising in or derived from Hong Kong’. These businesses might be transacted through an agent or directly. Thus, if profit is generated by the business that was transacted in Hong Kong through an agent fall within the charge.

It was held by the law in case COT that, between ‘derived from’ or ‘arising in’ there is no major distinction. Important cases that were determined by the Privcy Council on the locality of profits consist of Hang Seng Bank Ltd, HK-TVB International Ltd and Orion Caribbean Ltd. This Privy Council is highest legal authority before reunification on 1 July 1997. The subsequent important cases that were determined by the Court of Final Appeal include Kwong Mile Services Ltd., Kim Eng. Securities (Hong Kong) Ltd. and ING Baring Securities.

Practical Hard Matter of Fact   

It is the basic principal that, the question of ‘source of profit’ is a practical firm matter of fact. This may be regarded by a practical man as a real source of income. The reference for this statement is taken from the case of Nathan.

Difficulty is not indicated by the word hard. In that sense of expression of being realistic it is used to mean hardnosed. In a case of Kwong Mile Services Ltd. it was observed that, the matter of source is judged as one of practical reality. It was decided by the Lord Millet NPJ in case of ING Baring that, the judging of profit of source is a commercial matter not a technical one.

There are no inflexible rules. In the determination of each case reference to all of its relevant facts must be used. These references usually determine the ‘totality of facts’.

Basic Rule

It was pointed out by the Privy Council in case of the Hang Seng Bank that, for the determination of locality of profit for the board guiding principle to earning the profit, one should see what the taxpayer had done in rendering Hong Kong company setup service. The judgement of this case was delivered by the Lord Bridge and was extremely important. The important part of this judgment is produced below in full:        

The main question is that, the profit that is resulting from the specific transaction derived from or arose in one place or another. This question is usually the last analysis question of fact. These type of questions depend upon the nature of transaction. The answer to these questions is usually determined by the precise rules of law and it is not possible to lay down these law. The board guiding principle is usually attested by many authorities. This principal looks to see that, to earn the profit in question, what the taxpayer has done in earning profit. A taxpayer rendering Hong Kong company setup service may also have engaged in an activity such as the manufacturers of goods. The profit will have derived or arisen from the place where the profit making activity carried on or service rendered. The profit can also be earned by the misuse of property assets such as by letting the property, dealing in securities or commodities or lending money by reselling and buying at profit, the profit is derived or arisen from the place of where property was leased, sales were effected or the money was lent. Hence, for example for items that are sale out of Hong Kong, the making and packaging process may be done in overseas and Hong Kong partially. In this type of scenario, lack of a particular provision for division in Ordinance will not prevent the requirement to division the on sale gross profit. Such profit on sale may have arisen partly outside Hong Kong and partly inside Hong Kong.

The courts pointed out in subsequent cases that in making the above defined statement, it was not planned by Lord Bridge to lay down a comprehensive list of tests to be applied in all cases for determination of whether the profit derived from or arose in Hong Kong or not. The reference for this statement is taken from the case of HK-TVB International. In the judgement of case of Orion Caribbean it was stated that, ‘No simple, single, legal test can be employed’. In another case of Kwong Mile Services Ltd. it was defined that ‘it is probably an impossible task to formulate a universal test’.

Operation Test

In the case of HK-TBI it was considered by the Privy Council that the reasonable approach was to assure, ‘what were the profit carrying operations and at what locations those operations took place’. The operation test that was expressed by Atkin LJ in Smidth and approved by the Privy Council for the taxpayer starting Hong Kong company establishment was that: at which locations the operations will take place from where the profit arise. It was considered by the judge Lord Millet in case ING Baring that, the operations to which Atkin LJ referred and from which the profits in substance arise must be taken as a taxpayer’s operation from which profit arise in substance. The profits arise in place where his service is provided or profit-making are carried on. There are two limitations:

  • The operation in question must not the operations of a separate person rather the operations of the taxpayer. For example, a parent company or subsidiary.
  • The whole of the operation of taxpayer is not included in the relevant operations. Only those operations are included in the relevant operations which produce the profit in question.

Totality of Facts Test

The totality of facts test was used by the Orion Caribbean. In the case of Consco Trading Company Ltd. this fact had been adopted by the board of review. The board of review looked at totality of facts in that case. It asked itself what could be attach to various activities of taxpayer who now performing company incorporation HK. It was concluded by the board that; occurrence of the activities was done in Hong Kong.

Profits mean ‘gross profit’

It was pointed out by the Privy Council in Hang Seng Bank case that, the distinction is made between offshore profits and Hong Kong profits by reference to the gross profits that are being raised from the individual transaction. This distinction is not made on net profit of the business. The aggregate income is as the result of income from all the sources. The net profit is ascertained by deducting aggregate expenses from that aggregate income. The offshore profits are not included in the assessable profits under Section 14 (1) of Hong Kong tax law. This sum that is not included is the gross offshore profit. This gross profit is less attributable, direct expenditures, and a proportion of over all expenses. It is meant by above explanation that, one looks in individual transaction rather whole business, in identifying whether particular profits are offshore or not. That is, source of profit is not known by the place where the business is carried out, and it can only be known by looking at where the respective operations take place.     

Non Essential Overseas Business or Branch

It was argued by the Inland Revenue department in case of Hang Seng Bank that, no part of profits of taxpayer can arise outside Hong Kong as long as he / she has a business or branch inside Hong Kong only. It was not held correct by the Privy Council in both cases. The fact was ignored by it that, either one rather two conditions are required by the Section 14 of Hong Kong tax law.


Before the case of Hang Seng Bank, it was thought that allocation of profits was impossible as in the Inland Revenue ordinance there was no provision of allocation. The following tests from an Australian case was approved by the court of appeal in case of The Hong Kong and Whampoa Dock Co Ltd.

‘In the non-presence of (‘a provision for allocation’), when it is not possible to identify how much of the profits is obtained at successive stage of the operations, the source is to be determined by considering which is fast upon the acts more rapid responsible of the profit’. The reference for this statement is taken from the case of per Justice Dixon in COT.      

Now in the case of Hang Seng Bank and Court of first instance it is accepted by the Privy Council that apportionment is possible.

Rare Cases

It was considered by the Privy Council in case of HK-TVBI that, offshore profits could only be derived by Hong Kong business in rare cases.

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