What is Offshore Income Exemption (Hong Kong)?

**The territorial basis of Hong Kong taxation**

Section 14 of the Inland Revenue Ordinance taxes only profits arising in or derived from a trade, profession, or business carried on in Hong Kong. Profits sourced entirely offshore are not subject to Profits Tax, regardless of whether the company is incorporated in Hong Kong.

**The source of profits test**

The IRD applies the 'operations test' to determine the source of profits:

For trading profits: the source is where the contracts for buying and selling are negotiated and concluded. If a HK company's staff travel to overseas locations to negotiate and sign contracts, and no purchasing or selling activity occurs in HK, the profits from those transactions are offshore.

For service income: the source is where the services are performed. A HK company providing consultancy services to overseas clients, where all consultants work exclusively outside HK, can claim the fees as offshore.

For manufacturing: split between where the goods are manufactured and where they are sold.

**IRD scrutiny and offshore claim process**

Offshore profit claims must be supported by contemporaneous documentation: - Board minutes showing directors and management meet outside HK - Travel records and expense reports evidencing overseas activity - Contracts showing overseas negotiation and signing locations - Staff records confirming no HK-based employees involved in relevant activities - Correspondence trails

The IRD has become significantly more scrutinous of offshore claims following OECD BEPS initiatives. Applications for advance rulings on offshore status are possible but costly (HKD 8,600+).

**Foreign-Sourced Income Exemption (FSIE) regime from 1 January 2023**

In response to the EU and OECD, Hong Kong introduced the FSIE regime from 1 January 2023. This targets specific types of passive income received in HK by multinational enterprise (MNE) constituent entities. FSIE applies to: - Dividends - Interest - Disposal gains on equity interests - Intellectual property income

For these categories, passive income brought back to or received in HK is taxable UNLESS the entity meets economic substance requirements (HK-based staff performing genuine decision-making, HK operating expenditure, etc.) or the income qualifies under the participation exemption.

Operating companies with active income from genuine business operations are largely unaffected by FSIE. It primarily impacts passive holding structures and IP holding companies using HK as a conduit.