Offshore Profits Claim in Hong Kong: The Source Test

At a glance

The source test, the claim procedure and the scope of FSIE are as published by the IRD in its latest guidance.

Three common misconceptions

1. “The company is registered in Hong Kong but all the customers are overseas, so it is exempt.”

Where a company is registered and where its profits arise are separate questions. You can be registered here with profits sourced overseas, or registered overseas with profits sourced here. The IRD is not looking at your certificate of incorporation.

2. “I collect the money into an offshore bank account, so it is offshore income.”

Where the money is received is simply not part of the test. This is the most expensive misconception — founders open an overseas account believing it settles the question, and end up with messier evidence instead.

3. “Customers and suppliers are all on the mainland, and I just place the orders from Hong Kong.”

If placing the orders, negotiating, signing and following up are things you do in Hong Kong, those profits are very likely sourced in Hong Kong. What you do while sitting in Hong Kong is exactly what the IRD is looking at.

What does the IRD actually ask?

After an offshore claim, a detailed questionnaire usually follows. Common requests include:

• Contracts — where the sale, purchase or service contracts were negotiated, where they were concluded, and who signed
• People — who finds the customers, negotiates, and follows up on orders, and where they are based
• Physical presence — whether there is an office, employees or inventory in Hong Kong
• Correspondence — emails and messages showing where the decisions were made
• Travel — directors’ and employees’ travel records
• Money — the routing and timing of receipts and payments

What all of these have in common: they are records that already exist in the ordinary course of business. Whether the claim succeeds depends on whether you are keeping them properly today, not on what you can assemble when asked.

Which situations hold up best?

Broadly, the less you do in Hong Kong, the stronger the claim:

• Goods shipped from an overseas supplier direct to an overseas customer, never entering Hong Kong
• Contracts negotiated and signed by staff stationed overseas
• Services actually performed by an overseas team
• The Hong Kong company being a holding entity, with no operational staff

Conversely, if a director sits in Hong Kong placing orders, handling customers and approving prices day to day, it is hard to argue the profits have nothing to do with Hong Kong.

Worth saying plainly: a successful offshore claim does not mean less work. The opposite — you have to maintain more records than an ordinary company, and do it every year.

FSIE: passive income runs on different rules

This is the biggest change of recent years, and a lot of older articles have not caught up.

The foreign-sourced income exemption (FSIE) regime, in force since 1 January 2023: a multinational enterprise entity carrying on business in Hong Kong that receives specified foreign-sourced passive income — interest, dividends, disposal gains on equity interests, and IP income — is treated as having Hong Kong-sourced income chargeable to profits tax, unless it meets the economic substance requirement, the nexus requirement or the participation requirement.

From 1 January 2024 the regime was extended to disposal gains on assets other than equity interests.

Which means: if you are part of a multinational group and the Hong Kong company mainly receives dividends or interest, or holds intellectual property, the old “this is overseas income so it is exempt” reasoning no longer applies. The economic substance thresholds have to be checked afresh.

A purely local SME with no group structure is generally unaffected, but the moment there is an overseas related company it is worth looking at carefully.

What has to be maintained after a claim?

Offshore status is not “approved once, valid forever”.

In practice:

• Reassess annually — a change in the business model (hiring Hong Kong staff, starting to negotiate with customers here) can change the conclusion
• Keep the records alongside — contracts, emails, travel, meeting notes, filed with the accounting records
• The audit report has to line up — what the claim says and what the audit report discloses cannot contradict each other
• The IRD can review at any time — a claim accepted years ago does not stop later years being questioned

If a letter arrives mid-stream, see how to respond to an IRD enquiry letter.

Is it worth doing?

Honestly: an offshore claim does not suit everyone.

What you put in is ongoing record-keeping and professional fees; what you get back is relief from profits tax. If your assessable profits are still in the lower band of the two-tiered rates (the first HK$2 million at 8.25%), the saving may not be worth the annual effort and the risk of review.

On the other hand, if the business genuinely operates entirely overseas, not claiming is money simply paid over.

That calculation depends on your actual business model — there is no general answer. Want someone to look at which situation your company is in? Talk to us.

This article is general information and does not constitute tax advice. The source test, the offshore claim procedure and the scope of the FSIE regime are governed by the Inland Revenue Ordinance, the IRD’s Departmental Interpretation and Practice Notes and its latest published guidance; individual cases warrant advice from a professional tax adviser.