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Hong Kong--Neil Thomson


1. Hong Kong has no local taxes nor any sales tax or value added taxes. The basis of taxation is principally from Profits tax (applicable to individuals and corporations), salaries tax which has high exemption levels and applies to a minority of the working population, and property tax which is of minor impact. Government Revenue is substantially land based. All land in Hong Kong is held on lease from the Government (with the sole exception of the land on which stands St John’s cathedral). Land sales form a substantial proportion of government revenue. Stamp duties are also significant. Horse racing betting levy collected by the Hong Kong Jockey Club monopoly, is also substantial. While Hong Kong is largely duty free, excise duties are levied on alcohol, tobacco and motor fuels. The principal area of interest is therefore profits tax.

2. The Hong Kong taxation system has territoriality as the basis. Tax is levied on profits sourced in Hong Kong. Source is the basis not residence (which is irrelevant subject to a few minor exceptions). Thus a Hong Kong company may have its head office in the territory yet be exempt from Hong Kong taxation in respect of profits arising overseas (including income arising in mainland China). The concept is simple but it continues to give rise to litigation as the Hong Kong Inland Revenue Department (IRD) seeks to broaden the taxation base. The established criterion is the ‘operations test’ i.e. where in substance are the operations from which the profits derive take place carried out. The proposition has been set out in numerous cases a leading case being the Privy COuncil decision in CIT, Bombay Presidency and Aden v Chunilal B Mehta of Bombay (1938) LR 65 IA 332;

"The broad guiding principle … is that one looks to see what the taxpayer has done to earn the profit in question. If he has rendered a service or engaged in an activity such as the manufacture of goods, the profit will have arisen or derived from the place where the service was rendered or the profit making activity was carried on. But if the profit was earned by the exploitation of property assets as by letting property, lending money or dealing in commodities or securities by buying and selling at a profit, the profit will have arisen in or derived from the place where the property was let, the money was lent or the contracts of purchase and sale were effected. …"

It will readily be seen that ecommerce has substantial implications for such a system.

3. The concept has already been strained under the impact of modern financial transactions see CIR v Orion Caribbean Ltd. (1997) HKRC ¶90-089 In which the operations test was applied. The Taxpayer allowed itself to be interposed between the lender, which was an associated Hong Kong company, and the borrower in the lending of funds raised in HK. Loan agreements were reached in HK by the associate. The Privy Council found that the operations giving rise to the income were those carried out by the associate in Hong Kong and therefore the source was in Hong Kong.

4. This contrasts with the result in Magna Industrial Co v CIR (1997) HKRC ¶90-082 where a Hong Kong based subsidiary of the taxpayer company would source products overseas and ship them to Hong Kong. The taxpayer appointed export managers with authority to arrange distribution overseas. Price lists were supplied but the export managers could deviate from the lists. The export managers effected sales by signing contracts as agent for the taxpayer. They sent order forms to HK for processing and the goods would be shipped from the subsidiary’s HK warehouse to the customer. The taxpayer’s account would be debited for the goods. Here the source was held to be the sales effort and contract negotiation by the export managers and no HK tax was due despite the considerable nexus with Hong Kong.

5. Before continuing I should provide background on some other features of the HK tax system. It is of course a subsidiary jurisdiction, previously colonia,l and now a subsidiary jurisdiction of China under the ‘one countries two systems’ concept. But while subsidiary it is entirely separate from the PRC system and administered by an autonomous government. A clear example of this is that China’s atx treaties ahve no application in Hong Kong.

6. There has been great reluctance to use tax measures to pursue non tax objectives. Other than a reasonably generous system of allowances for capital expenditure tax incentives are not used. IN any event the impact of tax incentives would be much diminished by the low rate of taxation (16% on companies). There are no enterprise zones, tax free periods or other fiscal incentives. The chief deviation from this principle exists in relation to stamp duty measures introduced a few years ago to dampen speculation in real estate. There is no favouring of one taxpayer over another but distortions do arise from the government ownership of land rights and use of lease sales to gather revenue. Despite the narrow tax base the policy has always been to have a balanced budget - in practice surpluses arose for many years. In the wake of the Asian financial crisis there has been a new problem of budget deficits due to recession, but it is anticipated that there will be a return to surpluses in the near term.

7. Turning to the headings

III. US State and Local Sales and Use Tax.

There is no VAT or sales tax in HK. There has been discussion of introducing VAT in the context of broadening the tax base. There are some minor taxes such as a levy on occupation of hotel rooms, airport departure taxes and a soon to be introduced and controversial land departure tax on journeys between the HK Special Administrative Region and Mainland China. These taxes are minor both in terms of overall revenue generation and in absolute terms.

As mentioned above, duty is levied on certain items, alcoholic drinks, motor fuel, motor cars and some other items but HK is essentially a duty free port.

8. Conflict of laws

Hong Kong follows the English common law cases on conflict of laws. As to revenue matters there are no tax treaties in effect.

Jurisdictional issues for comment

1. What is the jurisdictional relevance of the presence on a state's territory of the Internet network infrastructure, such as a server?

The mere presence of a server would not necessarily found the source of profit in Hong Kong, though it might create a presumption that there are operations taking place on the server giving rise to profit. In some cases a server may be a mirror server (especially as HK is an Asian hub). The Electronic Transactions Bill now before the Legislative Council, in its present form, makes it possible for two computers to make a contract. If that contract were to be formed on a server in Hong Kong there would again be a nexus with Hong Kong. However, while the place of formation of a contract is important in determining source it is certainly not conclusive in fixing the source of a transaction. Arguably, if computers were programmed to accept contracts within certain parameters, the operations giving rise to the profit would be where the parameters were determined rather than the programmed response in Hong Kong.. Source is always a ‘hard practical matter of fact’ per Isaacs J. Nathan v FCT (1918) 25 CLR 183. at 189-190.

2. What is the jurisdictional relevance of maintaining a web site?

Similar considerations arise in relation to a web site as to those relating to a server. Additonal points are that interesting discussion might arise as to what are the key elements which might source the profits arising from a web site. Assuming the site is free, does the revenue and thus any profit derive from the maintenance of the site, from measuring the nature and number of hits or from the negotiation of contracts with advertisers? Again this is a factual issue - a hard practical matter of fact

3. If a web site author cannot prevent access to its site from any country, what is the jurisdictional effect of a geographic disclaimer on the site?

The courts of Hong Kong apply English conflict of law rules. While an agreement between the parties would carry weight, the courts still are much concerned with nexus. A unilateral attempt to fix jurisdiction would be noted but would not be conclusive or even carry much wieght. In tax terms it would be utterly irrelevant. Agreement or unilateral terms will not move source out of the jurisdiction.

4. If parties to a transaction agree at the outset that the law of a given state will apply to any future disputes or that any future dispute will be litigated in the courts of a chosen state, is that agreement enforceable?

See above 3.

5. Is it possible to identify a state in which transactions occur?

The problem in Hong Kong would not differ from those elsewhere. There is no statutory or case law guidance in Hk.

6. Are analogies to prior technology, such as print media, telephone, television, radio or satellite transmissions, possible and useful?


7. If a plaintiff obtains a judgment in one country against a defendant with no assets there, where and how can that judgment be enforced?

Hog Kong does have reciprocal enforcement of judgment agreements which are generally observed (A a side note a district judge in the US has recently refused to enforce a HK judgment as not being a sovereign state). HK will enforce overseas judgments against person with assets in the jurisdiction where the formalities are properly observed.

8. Does the Internet change the basis upon which commerce should be taxed?

Ecommerce poses a source based jurisdiction such as Hong Kong with considerable threats. HK has a largely service based economy (80% or more of GDP is from services). A substantial share of GDP is generated by financial services. It would not be hard to envisage that a latter day Orion Caribbean planning of loan syndications would utilize the internet and might be more successful. Hong kOng faces a difficulty in changing the basis. The present formula has bene highly successful. Adopting a residence basis might well drive some businesses elsewhere and in the absence of double tax treaties might lead to substantial double taxation. The last might well be more harmful than the loss of taxation base to ecommerce.


Neil Thomson
Des Voeux Chambers
10th Floor, Bank of East Asia Building
10, Des Voeux Road Central
Hong Kong, SAR
Tel: +852 2526 3071
Fax: +852 2810 5287



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