Offshore loophole halves tax burden

HONG KONG companies can avoid the risk of double taxation by establishing overseas companies to handle their China business, say tax experts.

By incorporating a company outside Hong Kong, a group of companies can often convince the Inland Revenue Service that its China operations are not subject to profits tax.

At the same time, the group can continue to run its affairs from its Hong Kong headquarters, said David Southwood, director of taxation services for Edsaco (Hong Kong).

'Really, the problem shouldn't exist if you just step back and say, 'How can I organise the company so I won't be double taxed?' ' Foreign companies become particularly exposed to the risk of being taxed by both their home country and the Chinese Government when they have a processing agreement with a Chinese company or when they own a trading company in Hong Kong and contract out manufacturing in China.

If a foreign company has complete operational control of a Chinese manufacturer or uses Hong Kong staff to sell the manufactured goods in China, the Chinese Government may impose income taxes, said Wong Mun-Kit, tax partner at accounting firm Horwath and Co.

'You may hear that this is fine, and that a company has done it for five years and never has had a problem. But in time, China will be enforcing the law more strictly,' said Ms Wong.

'Any foreign party that presently has a processing arrangement should be well advised to reduce its exposure.' Under Hong Kong tax practice, 50 per cent of the profits from the sale of manufactured goods produced under a processing agreement are taxed, while the other half are exempt.