One of the primary reasons that make Hong Kong attractive to foreign investors is the favorable tax treatment. With low taxes, it implies that a business is able to keep more profits, pay higher dividends, and plough back more money to grow the brand.
When you open a company in Hong Kong, the business is considered a tax resident. However, you will need to demonstrate tax substance (call it economic substance) to enjoy all the benefits that come with running a business in Hong Kong.
Having known that Hong Kong does not provide any clear definition of tax or any kind of economic substance. Some of the Hong Kong residents who need proof of their resident status might also need a tax residency certificate. Then it is the responsibility of the tax residency to assess the activity and commercial operations of the company to determine whether it has any substance or not.
A Closer Look at Tax Substance in Hong Kong
Although there is no clear definition of tax substance, it is easier to understand it from an economic viewpoint. In Hong Kong, an island with no land for agriculture or mining, the main source of income is through business activities.
In this respect, as mentioned on GuideMeHongKong, a company is considered to have tax substance if it is making a significant economic contribution. To demonstrate tax substance, here is what you need to do:
- Make sure the business is run from Hong Kong, or at least most of the operations.
- Ensure part or all the management staff stays in Hong Kong.
- Hold meetings for your company in Hong Kong.
- Maintain an active office with staff and other requirements of a busy office.
- Maintain bank accounts in Hong Kong
- Acquire assets in Hong Kong.
- Partner and promote other businesses in Hong Kong.
- Pay taxes on time.
Dangers of Not Demonstrating Tax Substance for Your Company in Hong Kong
As we mentioned earlier, Hong Kong encourages companies to demonstrate tax substance as a way of spurring economic growth. When you fail to demonstrate tax substance, here are the risks that your company is subjected to:
Exposure to Double Taxation when Working in Foreign Countries
When your company fails to demonstrate tax substance, you are likely to be subjected to heavy taxation when operating in other jurisdictions away from Hong Kong. The results will be the high cost of running your business, a fact that can easily shrink your profit and kill your company.
Difficulty in Getting Tax Residency Certificate
If your company based in Hong Kong wants to take advantage of other markets, such as Mainland China, Japan, and Malaysia, among others, it will be pretty easy because Hong Kong has signed a lot of bilateral trade arrangements. However, you need to get a tax resident certificate from the Inland Revenue Department (IRD), which requires that you demonstrate tax substance.
To get your tax resident certificate, you need to make an application to the Inland Revenue Department (IRD), but it is important to start with ensuring your business is operated well. Particularly, ensure to always file your taxes on time and use every available opportunity to promote business growth in your niche.
What is an Economic Substance?
A business in a global economy may decide where they want to establish their base and where to extend their business to anf from. However, the choice of what is right and what is wrong must depend on some of the factors which are needed to be clarified. The jurisdiction of the company may be required from a commercial and economic point of view. But the tax consideration can also be taken into account and it is not the sole concern.
Each country has its own guidelines and definition of corporate tax residence and substances. The tax authorities are paying more mind into all of these and pay more attention to various requirements.
What is the economic substance requirement in Hong Kong?
Hong Kong enters the CDTA and other treaty partners are important. The resident of this place and the companies of Hong Kong are defined differently, mostly as “a Hong Kong incorporated company.” It can be explained in a very simple way like a company which is situated outside Honk Kong but can be managed and controlled by Hong Kong residents. A Hong Kong incorporated company may be famous to obtain some TRC. Actually the IRD requires various documents which would be proof of the management of the applicant. This kind of control is mainly practiced in Hong Kong largely.
There is various substance test and each of the substance tests is conducted by depending on the type of the case which means that it varies from case to case largely.
List of Information asked by the IRD
There is various kind of information the IRD looks for but among them, the major ones have been mentioned here below.
Structure of the Board – Checks if the board members have a residence at Honk Kong or not.
Board Meetings – Decides where the board meetings will be held, what has to be discussed and resolved, how the describe and solve the issues are handled. It also includes other areas such as contract values, place of operation, etc.
Business Location – The lease agreement of Hong Kong must be provided to make the procedure easier
Staff and Management – Employment visas and Employment contracts must be managed correctly, submit the required document, and carry out all work efficiently.
Business Activities – It is to determine the type of income, hence the business activity has to be accounted for.
To make your company’s operations smooth and grow rapidly, it is important to ensure you demonstrate tax substance. You will find it particularly important in reducing exposure to forex taxes when operating away from Hong Kong. The surest way to understand more about tax substance and how to use a resident certificate to grow your business beyond Hong Kong is working with experts. Reach us today, and we will be very happy to help you.