Hong Kong Offshore Profits Claims: How the Territorial Source Principle Works in 2026

How the IRD decides where profits arise

Section 14 of the Inland Revenue Ordinance charges profits tax on anyone carrying on a trade, profession or business in Hong Kong, but only on profits arising in or derived from Hong Kong. The Inland Revenue Department states that profits arising abroad are not taxed, even if remitted to Hong Kong, and residence makes no difference. Source is a question of fact, decided transaction by transaction. The IRD’s guiding principle, in Departmental Interpretation and Practice Notes No. 21 (DIPN 21), is to ask what the taxpayer did to earn the profit and where: the operations test.

For trading profits, the IRD looks at where the purchase and sale contracts are effected, meaning negotiated, concluded and executed, not merely signed. Under DIPN 21, if both are effected in Hong Kong the profit is fully taxable; if both are effected abroad, none of it is; if either is effected in Hong Kong, the initial presumption is that all of it is taxable. Contracts made from Hong Kong by telephone, fax or similar means count as effected in Hong Kong, and the IRD does not apportion trading profits.

Other income follows its own rule. Service fees arise where the services are performed, and commission where the agent’s work is done. Manufacturing profits arise where goods are made, though DIPN 21 says a 50:50 split is usually accepted for contract processing in the Mainland. For lenders that are not financial institutions, interest is taxable if the funds are provided to the borrower in Hong Kong; financial institutions face a wider operations test.

Two related regimes sit alongside. Since 1 January 2023, the foreign-sourced income exemption (FSIE) regime has treated foreign interest, dividends, disposal gains and IP income received in Hong Kong by multinational group members as Hong Kong-sourced unless an exception is met; it does not change the test for trading or service profits. Onshore profits are then taxed at the two-tiered rates: 8.25% on a corporation’s first HK$2 million and 16.5% above.

Making the claim: the return, IRD enquiries and evidence

There is no pre-approval. The claim is made in the profits tax return: Note C1 to Form BIR51 requires a statement of reasons that can be substantiated by evidence if requested, and the return asks for the offshore income and its related expenses. The usual obligations still apply. Accounts must be audited, the IRD requires financial statements and a tax computation with the return, and it has ended the concession that let small corporations with gross income not exceeding HK$2 million file without them. For certainty in advance, an advance ruling on source is available for a fee.

The assessor may then accept the return, issue an enquiry letter or refer the case for a field audit. DIPN 21 stresses that the power under section 51(4) to seek full information is unrestricted, and that asking for detail on the operations behind a transaction is a reasonable demand. Expect questions on who negotiated each contract, from where and how; where directors and staff were during the year; how orders are handled and goods shipped; and which bank accounts receive the money. Replies should be complete, consistent and on time.

Build the evidence as the business runs, not after an enquiry arrives: signed contracts with the correspondence showing where terms were agreed, travel records matching the meetings claimed, employment contracts and leases for people working abroad, shipping documents, and invoices and bank records tied to each contract. Section 51C requires records to be kept for at least seven years, and under section 60 the IRD can raise additional assessments within six years after the year of assessment, or ten for fraud or wilful evasion.

Why offshore claims fail: a checklist before you file

• Negotiation happens in Hong Kong. Contracts agreed by people in a Hong Kong office, including by phone or email, count as effected in Hong Kong.
• Only the paperwork is offshore. An overseas signing location does not help if the real work is done in Hong Kong; DIPN 21 says the final step is not necessarily decisive.
• The overseas office has no people, while Hong Kong staff do the sourcing, selling or servicing.
• Travel records do not support the meetings cited as offshore.
• Evidence is assembled late or contradicts itself across contracts, invoices, accounts and bank records.
• Onshore and offshore results are mixed instead of being shown separately in the tax computation.
• Passive income is overlooked. Multinational group members must also test foreign interest, dividends, disposal gains and IP income under FSIE.
• Profits are booked offshore artificially. The IRD takes a serious view and may apply anti-avoidance provisions and penalties.