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

Hong Kong charges profits tax only on profits arising in or derived from Hong Kong. The residence of the taxpayer is irrelevant. A Hong Kong company may therefore lawfully pay no profits tax where the operations that produced the profits were carried out outside Hong Kong. That position is asserted through an offshore claim, which is neither a relief nor a permissive procedure: it is the application of section 14 of the Inland Revenue Ordinance (Cap. 112).

The Inland Revenue Department’s practice is set out in Departmental Interpretation and Practice Notes No. 21 (Revised), "Locality of Profits", issued in July 2012 by Commissioner CHU Yam-yuen and replacing the December 2009 edition. The document runs to 62 paragraphs and remains the operative guidance.

The prevailing misconception of 2026: that the FSIE regime displaced the territorial principle. The Inland Revenue Department’s own FAQ states it directly: Hong Kong continues to adhere to the territorial source principle of taxation, and the determination of the source of profits is not affected by the introduction of the economic substance requirement under the FSIE regime. In-scope taxpayers can still make offshore claims and be tax-exempt so long as they meet the economic substance requirement, with source of profits and compliance with that requirement considered in distinct and separate contexts.

What follows works from the primary text of DIPN 21: the three conditions for liability, the fifteen principles for determining source, the seven rules for trading profits, why trading profits are not apportioned, the processing arrangements, the table of other income types, the handling of claims and the assessor’s powers.

1. The Legal Framework

•     Inland Revenue Ordinance (Cap. 112), section 14. Provides that only profits arising in or derived from Hong Kong are chargeable to profits tax. The word "source" does not appear in the section itself: the courts derived the concept of source from the words "arising in or derived from".

•     DIPN No. 21 (Revised) — Locality of Profits. A statement of the Department’s practice, July 2012, replacing the December 2009 edition. It is not legislation: a taxpayer’s right of objection against an assessment and right of appeal to the Commissioner, the Board of Review or the courts are not affected by its application.

•     Related DIPNs and the editions in force. Per the Department’s official list: No. 13, "Taxation of interest received", December 2004; No. 28, "Deduction of foreign taxes", July 2019; No. 31, "Advance rulings", April 2020; No. 39, "Digital Economy, Electronic Commerce and Digital Assets", March 2020; No. 44, August 2008; and No. 22, "Taxation of royalties and other income from intellectual properties", August 2020.

•     The case law. Privy Council decisions in CIR v. Hang Seng Bank Limited [1991] 1 AC 306, HK-TVB International Limited v. CIR [1992] 2 AC 397 and CIR v. Orion Caribbean Limited [1997] HKLRD 924, together with Court of Final Appeal decisions in Kwong Mile Services Limited v. CIR [2004] 3 HKLRD 168, Kim Eng Securities v. CIR [2007] 2 HKLRD 117 and ING Baring Securities v. CIR [2008] 1 HKLRD 412.

In the closing paragraph 62 of DIPN 21 the Department itself noted that an update, particularly as regards trading profits, might be helpful. None has been issued since: the Department’s official list of Departmental Interpretation and Practice Notes shows July 2012 against No. 21, "Locality of profits", and that is the edition in force.

DIPN No. 60, "Attribution of Profits to Permanent Establishments in Hong Kong" (July 2019), confirms expressly that the positions in DIPN No. 21 are not affected by the enactment of Rule 2 in Part 8AA of the Inland Revenue Ordinance. DIPN No. 39 (March 2020) states that DIPN No. 21 is equally applicable in deciding the locality of profits where e-commerce is involved.

Two of the cross-references inside DIPN 21 point to editions that no longer exist. The 2012 text refers to DIPN No. 28 on the deduction of foreign taxes and to DIPN No. 49, Part B, on royalties. DIPN No. 28 was revised in July 2019, and royalties and other intellectual property income are now covered by DIPN No. 22 in its August 2020 edition, while the current DIPN No. 49 (August 2020) deals with the deduction of capital expenditure on patent rights and rights to know-how. On those points, open the current documents rather than following the DIPN 21 references literally.

2. The Three Conditions for Liability

Lord Bridge in Hang Seng Bank set out three conditions that must be satisfied together before a profits tax liability arises. DIPN 21 reproduces them in paragraph 3.

1.  The person carries on a trade, profession or business in Hong Kong.

2.  The profits to be charged arise from that trade, profession or business carried on by the person in Hong Kong.

3.  The profits arise in or are derived from Hong Kong.

An offshore claim concerns the third condition alone. The first two are usually satisfied: a Hong Kong company with an office and a director carries on business in Hong Kong. The dispute is about where particular profits arose, not about whether there is a business.

3. The Broad Guiding Principle and the Operations Test

Lord Bridge’s formulation in Hang Seng Bank: "one looks to see what the taxpayer has done to earn the profit in question". Lord Jauncey in HK-TVBI expanded it by reference to F. L. Smidth & Co. v. Greenwood: "where do the operations take place from which the profits in substance arise?" In its settled form the principle reads: one looks to see what the taxpayer has done to earn the profit in question and where he has done it.

DIPN 21 stresses that this is a principle, not a rule. A rule attaches a definite consequence to a detailed set of facts and either applies or does not. A principle is broad, general and unspecific: an authoritative starting point inclining towards a particular decision without necessarily compelling it.

Antecedent and incidental activities

Ribeiro PJ in ING Baring emphasised the need to grasp the reality of each case, focusing on effective causes without being distracted by antecedent or incidental matters. The focus is on establishing the geographical location of the taxpayer’s profit-producing transactions, as distinct from activities antecedent or incidental to those transactions.

4. The Fifteen Principles of Paragraph 17

Paragraph 17 of DIPN 21 distils the case law into fifteen principles, (a) to (o). Those that most often decide a dispute are set out below.

Principle	Substance
(a) A question of fact	The locality of profits is a hard, practical matter of fact. No universal judge-made test will cover every case
(c) Transaction by transaction	Transactions must be looked at separately and the profits of each considered on their own
(e) The taxpayer’s own operations	The operations in question must be the operations of the taxpayer
(f) Only profit-producing operations	The relevant operations are not the whole of the taxpayer’s activities but only those which produce the profit in question
(i) Investment decisions	The place where day-to-day investment decisions are taken does not generally determine the locality of profits
(j) The group does not help	Source must be attributed to the operations of the taxpayer, not to those of other group members. The operations of the group are not looked at on the question of source
(k) Circumventing trade barriers	Where an arrangement is implemented in Hong Kong to free transactions from overseas regulation or overcome trade barriers, that in itself does not make the profits offshore-sourced
(n) No overseas permanent establishment	The absence of one does not, of itself, mean that all the profits of the business arise in Hong Kong
(o) Place of business	The place where profits arise is not necessarily the place of business. But, per Lord Jauncey in HK-TVBI, it can only be in rare cases that a taxpayer with a principal place of business in Hong Kong can earn profits that are not chargeable

Principle (j) closes off the most common structure. Justifying an offshore claim by pointing to the activity of a related company abroad does not work: the courts firmly rejected the proposition that "commercial reality" allows the source of one group member’s profits to be ascribed to another’s activities. The exception is narrow — where a related company is in fact acting on behalf of the taxpayer, its activities will be considered to see whether appropriate weight should be accorded to them.

5. Trading Profits: the Seven Rules of Paragraph 23

For trading companies DIPN 21 sets out the Department’s assessing practice in seven sub-paragraphs of paragraph 23. This is the most practically applicable block in the document.

Situation	Consequence
Both the contract of purchase and the contract of sale effected in Hong Kong	The profits are fully taxable
Both contracts effected outside Hong Kong	No part of the profits is taxable
Either contract effected in Hong Kong	The initial presumption is that the profits are fully taxable. All the circumstances are then examined: how the goods were procured and stored, how sales were solicited, how orders were processed, how goods were shipped, how financing was arranged and how payment was effected
Sale to a Hong Kong customer, including the Hong Kong buying office of an overseas customer	The sale contract will usually be taken as effected in Hong Kong
Purchase from a Hong Kong supplier or manufacturer	The purchase contract will usually be taken as effected in Hong Kong
Effecting the contracts requires no travel outside Hong Kong and is carried out by telephone, fax and the like	The contracts are considered as effected in Hong Kong
The general rule	The purchase and sale contracts are important factors, but all relevant operations producing the trading profits must be looked at

The Department states expressly that it does not merely look at the place of contract. Where a contract is made by exchange of letters, by fax or by email, applying contract law and private international law as to where the contract is made may produce results that are entirely fortuitous.

Why trading profits are not apportioned

Paragraph 24: the question of apportionment does not arise for trading profits. Trading profits will be either wholly taxable or wholly non-taxable. There is no room to substitute a mixed source for a Hong Kong source even though there might be some overseas activities. This is the key difference from manufacturing profits and service income, where apportionment is available. For a trading company the offshore claim is an all-or-nothing proposition.

Where it is claimed that contracts were effected wholly outside Hong Kong by employees of the Hong Kong business travelling abroad, assessors will additionally require details of travelling, hotel and subsistence expenses in respect of each individual transaction. Where contracts are said to be effected by overseas agents, agency agreements or other supporting evidence will be required.

6. Manufacturing Profits and Processing in Mainland China

Where goods are manufactured in Hong Kong, the profits from selling them are fully taxable, because the profit-making activity is the manufacturing operation carried out in Hong Kong — including procurement of raw materials, employment of labour, product design and the use of machinery and plant. Having sales staff based overseas does not give any part of the profits an overseas source.

Contract processing

In contract processing the Hong Kong company supplies raw materials and machinery without consideration and provides technical and managerial know-how, while the Mainland processing enterprise provides factory premises, utilities and labour. Legal title to the raw materials and finished goods remains with the Hong Kong company. Recognising the operations in the Mainland, the Department usually accepts an apportionment of profits on a 50:50 basis.

Import processing

In import processing the manufacturing operations are carried out by a foreign investment enterprise (FIE) related to the Hong Kong company and incorporated as a separate legal entity in the Mainland. The Hong Kong company sells raw materials to the FIE and buys back the finished goods. Legal title passes to and from the FIE.

The distinction between the two arrangements decides the outcome entirely. In import processing the FIE’s manufacturing operations are not performed on behalf of, or for the account of, the Hong Kong company, even where both sit in the same group. In CIR v. Datatronic Limited [2009] 4 HKLRD 675 the Court of Appeal held that the profit-producing transactions were the purchase of goods from the FIE and the subsequent sale, and that those activities took place in Hong Kong — so the profits were Hong Kong sourced. That the FIE was a wholly-owned subsidiary and dealt other than at arm’s length did not detract from the legal effect of the transactions. The 50:50 apportionment does not apply to import processing.

7. Buying Offices and Re-Invoicing Centres

A trading company carrying on business outside Hong Kong may set up a Hong Kong branch as a buying office. Where the branch’s activities are confined to purchasing goods or collecting information and it is not involved in their sale, in Hong Kong or elsewhere, no profits tax liability arises. The same functions may be performed by a subsidiary or an agent, subject to the same condition of non-involvement in the sale. Any commission or other remuneration earned by that subsidiary or agent for services performed in Hong Kong is, however, fully taxable.

Commission income or profit accruing to a re-invoicing centre for services rendered is chargeable to profits tax. Profits from buying and selling goods are not service income: the transaction involves commercial risks — product, inventory, credit, exchange and capital risks — different from those attaching to a service. Confirmation of sales and issue of purchase orders indicate a trading transaction. The label "re-invoicing centre" does not in itself provide the answer.

8. Other Income Types: the Paragraph 45 Table

Type of income	Locality of source
Rental income from real property	Location of the property
Profits derived by an owner from the sale of real estate	Location of the property
Profits from the purchase and sale of listed shares and other listed securities	Location of the stock exchange where they are traded. Where the trade is over-the-counter, the place where the contracts of purchase and sale are effected
Profits from unlisted shares and securities	Place where the contracts of purchase and sale are effected, except financial institutions where section 15(1)(l) applies
Service fee income	Place where the services giving rise to the fees are performed
Interest earned by persons other than financial institutions	Determined on the basis set out in DIPN No. 13
Royalties outside section 15(1)(a), (b) or (ba)	Place of acquisition and granting of the licence or right of use. DIPN 21 refers to DIPN No. 49, Part B; the document now in force on royalties is DIPN No. 22, August 2020 edition
Cross-border land transportation income	Normally the place of uplift of passengers or goods. Where the contract of carriage does not distinguish outward from inward transportation, apportionment is not permitted

A separate caveat applies to investment advisers: where an adviser’s organisation and operations are located only in Hong Kong, profits from managing clients’ funds are treated as Hong Kong sourced. Chargeable sums include not only management and performance fees but also rebates, commissions and discounts received from brokers in Hong Kong or elsewhere on securities transactions executed for clients.

9. Sale and Purchase Commission

This covers situations where commission income is earned both by securing buyers for a manufacturer’s products and by securing manufacturers to make products required by customers. The commission is typically a percentage of the invoiced value of the goods. The Department considers that the activity giving rise to the commission is the arrangement of the business to be transacted between principals, and that the source of the income is the place where the commission agent’s activities are performed.

Where the principals sit is irrelevant — but a low-tax jurisdiction draws attention. Under paragraph 49, the place where the principals are located, how the agent identifies them and where incidental activities are performed before or after the commission is earned are not generally relevant. However, where substantial business activities are performed in Hong Kong for a principal incorporated overseas, in particular in a no-tax or low-tax jurisdiction, the Department will examine the case more thoroughly to determine whether the principal itself has a liability under section 14.

10. The Mechanics of Apportionment

The Department accepts that, notwithstanding the absence of a specific apportionment provision in the Inland Revenue Ordinance, there are situations in which apportioning the chargeable profits is appropriate. Beyond manufacturing profits, service fee income earned partly in and partly outside Hong Kong is the other example.

In contract processing cases a 50:50 basis is applied as the norm, in view of the contractual conditions imposed on the parties. In other cases where apportionment is appropriate, the basis depends on the facts: the Department will consider any rational basis put forward by the taxpayer.

General expenses must be scaled down, and the basis explained in the computation. In calculating the portion of profits derived from Hong Kong, claims for general expenses of the business that contribute indirectly to earning both the Hong Kong and the offshore profits must be scaled down. General expenses here means all indirect expenses. In the tax computation the taxpayer should explain clearly the basis on which they have been scaled down. In most cases it is appropriate to apportion by reference to gross profits rather than assets.

Reopening earlier years to permit apportionment is not available: DIPN 21 states that requests to re-open previous years’ assessments to permit apportionment will not be entertained, citing the prevailing practice under section 70A. The apportionment structure is decided before filing, not after an assessment lands.

11. Group Service Companies

Where a Hong Kong company renders support services — marketing, training — to group members across the Asia-Pacific region and the services are rendered substantially in Hong Kong, inter-group charges are typically made at a mark-up of 5% to 10% of cost. The Department regards the profits represented by that mark-up as wholly assessable.

DIPN 21 states that where inter-group charges have been grossed up to reflect withholding tax imposed on the service charges by the recipient’s country, the Department allows the Hong Kong company to deduct the foreign withholding tax paid from the service fee charged, so that it is assessed on the net amount. That position rests expressly on DIPN No. 28.

This is where the DIPN 21 cross-reference is out of date in substance, not merely in numbering. DIPN No. 28 was revised in July 2019, and on professional analysis the revised edition takes the view that foreign income taxes imposed on gross income — withholding tax on gross royalties, service fees and management fees, for example — are generally not deductible under section 16(1). That is a material departure from the earlier practice. The DIPN 21 statement about assessment on the net amount should be checked against the current text of DIPN No. 28 rather than taken from the 2012 wording.

Financial institutions operate under a separate treatment agreed between the Department and practitioners in 1986 and maintained in the interest of certainty after Hang Seng Bank and Orion Caribbean. For interest on loans it distinguishes four situations: offshore loans initiated, negotiated, approved and documented by an associated party outside Hong Kong and funded outside Hong Kong are 100% non-taxable; loans initiated and funded by the Hong Kong institution from Hong Kong are 100% taxable; loans initiated by an overseas associate but funded by the Hong Kong institution are 50% taxable; and loans initiated by the Hong Kong institution but funded by offshore associates are also 50% taxable, that last category applying only to start-up positions where the Hong Kong institution has yet to establish a market presence.

12. The Rates if the Offshore Claim Is Not Accepted

Taxpayer	First HKD 2,000,000 of assessable profits	Above HKD 2,000,000
Corporation	8.25 per cent	16.5 per cent
Unincorporated business — partnership, sole proprietorship	7.5 per cent	15 per cent

The lower tier goes to one company per group. Under section 14AAB of the Inland Revenue Ordinance, where a corporation has one or more connected entities as defined in section 14AAC, only one entity in the group may elect to apply the two-tiered rates in any given year of assessment. The others pay 16.5 per cent from the first dollar of profit. For a multi-entity structure, nominating the entity that takes the benefit is a decision in its own right and should be recorded.

13. FSIE: What Changed and What Did Not

The Foreign-Sourced Income Exemption regime has applied since 1 January 2023 and was expanded from 1 January 2024. It covers passive categories of income — interest, dividends, disposal gains and intellectual property income — received in Hong Kong by entities of multinational groups.

The Inland Revenue Department’s FAQ answers the conceptual question about the relationship between the two tests directly: the determination of the source of profits continues to be based on the existing provisions of the Inland Revenue Ordinance (Cap. 112) and common law principles, and source of profits and compliance with the economic substance requirement are considered in distinct and separate contexts.

The practical consequence differs by company type. For a trading or service company earning active income, FSIE changes nothing: the question is still resolved under section 14 and DIPN 21. For a holding structure receiving dividends, interest, disposal gains or royalties, a second hurdle is added: even with a foreign source, exemption requires satisfying the economic substance, participation or nexus requirement, depending on the category of income.

14. How the Claim Is Made and What the Assessor Will Ask For

Paragraph 56 of DIPN 21: taxpayers should be ready to prove in their returns, with supporting documentary evidence, that a profit from a transaction was derived outside Hong Kong. The assessor has a statutory obligation to raise assessment and to make enquiry, and under section 51(4) has power to seek full information on any matter which may affect any liability, responsibility or obligation of any person.

The Department stresses that a request for detailed information about the operations of a transaction in an enquiry constitutes a reasonable demand, as the public interest so requires, and that the information-seeking power under section 51(4) has not been restricted or reduced in any way after ING Baring.

Form IR1475 marks the move to a substantive examination. Where the Department decides to examine an offshore claim in detail, it issues Form IR1475. On practitioner accounts this is not a routine filing or a standard information request but a formal demand for substantive evidence that the profits were genuinely sourced outside Hong Kong; receiving it signals an intention to scrutinise the claim closely. This point comes from professional sources rather than from the text of DIPN 21.

Paragraph 57 removes a common shortcut: the final step of the profit-generating process should not necessarily be treated as determinative of the locality of the source. The fallacy of the lower courts, in Lord Davey’s words in COT v. Kirk, was to leave the initial stages out of sight and fasten attention exclusively on the final stage in the production of the income.

15. Booked Profits and Anti-Avoidance

Paragraph 60 of DIPN 21 states the Department’s position bluntly: it takes a serious view of schemes and devices which seek to "book" Hong Kong profits offshore, will not hesitate to apply the general anti-avoidance provisions in such instances and, where appropriate, will impose penalties in blatant cases involving non-disclosure of relevant facts.

The same paragraph notes that performing in Hong Kong activities which do not of themselves give rise to the profits — renting office premises, recruiting general staff and the like — does not in itself determine the locality of profits. But where commissions, fees and profits on sales relate to sales to, or services rendered to, Hong Kong customers, the resulting profits will generally continue to be liable to profits tax.

16. The Advance Ruling as a Way to Remove Uncertainty

Paragraph 61 of DIPN 21: to provide certainty in this area, the Department provides advance rulings on the locality of profits to businesses. The service is subject to payment of a fee, with details in DIPN No. 31, whose edition in force is dated April 2020.

When an advance ruling earns its cost. The territorial principle is resolved on the facts, and DIPN 21 warns expressly that there is no simple legal test that can be employed in all cases. For a structure with material turnover and a non-obvious geography of operations, the cost of a ruling is usually lower than the cost of a dispute with the Department after the fact, once the position has already been fixed by several years of actual conduct.

17. Common Mistakes

Mistake 1. Justifying the claim by a related company’s activity

Principle (j) of paragraph 17 requires source to be attributed to the taxpayer’s own operations, not to those of other group members. The courts firmly rejected the argument that "commercial reality" allows one member’s source to be ascribed to another’s activities. The cost: the claim fails in full rather than in part, because trading profits are not apportioned.

Mistake 2. Relying on where the contract was formally signed

The Department does not look only at the place of contract and notes expressly that where contracts are made by letter, fax or email, applying contract law may produce a fortuitous result. The cost: signing documents abroad while negotiating, processing orders and arranging shipment from Hong Kong does not deliver offshore status.

Mistake 3. Confusing contract processing with import processing

The 50:50 apportionment applies to contract processing, where legal title to raw materials and finished goods stays with the Hong Kong company. In import processing, where title passes to the FIE, the profits are trading profits and fully taxable. The cost: a structure documented as sale and purchase with a Mainland factory loses the apportionment it was counting on.

Mistake 4. Selling to Hong Kong customers while claiming offshore status

A sale to a Hong Kong customer, including the Hong Kong buying office of an overseas customer, means the sale contract is usually taken as effected in Hong Kong. Paragraph 60 adds that profits on sales to Hong Kong customers generally remain liable. The cost: a portion of revenue from local customers undermines the claim across the whole trading activity.

Mistake 5. Not documenting each transaction separately

Transactions are looked at separately and the profits of each considered on their own. Where contracts are said to be effected abroad by employees, the assessor will require travel, hotel and subsistence details for each individual transaction. The cost: aggregated records cannot answer a transaction-level enquiry, and the claim fails for want of proof.

Mistake 6. Assuming FSIE settled the source question

The Department stated expressly that source of profits and the economic substance requirement are distinct and separate contexts. The cost runs both ways: an active trading company builds economic substance instead of documenting its operations, while a holding structure relies on foreign source without testing the economic substance requirement for its category of income.

18. Who Can Realistically Claim Offshore Status

Strong prospects

•     Trading companies with no Hong Kong counterparties. Both contracts effected outside Hong Kong, with neither supplier nor customer in Hong Kong. Under paragraph 23(b) no part of the profits is taxable.

•     Buying offices. A branch of an overseas trading company confined to purchasing goods or collecting information, and not involved in the sale, creates no liability.

•     Owners of overseas property and listed securities. Source follows the location of the property or the exchange, not the place where decisions are taken.

•     Manufacturers using contract processing. Where title to raw materials and finished goods is retained, the 50:50 apportionment is usually accepted.

Weak prospects

•     Companies selling to Hong Kong customers. The sale contract is taken as effected in Hong Kong, including where the customer is an overseas buyer’s Hong Kong buying office.

•     Import processing structures. The profits are trading profits attributable to the Hong Kong company’s operations, not to the factory’s.

•     Group service companies. The mark-up on services rendered substantially in Hong Kong is fully assessable.

•     Companies operating from Hong Kong by phone and email. Where effecting the contracts requires no travel, the contracts are considered effected in Hong Kong.

19. Step-by-Step Preparation

4.  Classify income by type: trading profits, manufacturing profits, service income, commission, interest, royalties, property or securities income — the applicable test follows the type.

5.  For trading profits, establish transaction by transaction where the purchase contract and the sale contract were effected, and check for any Hong Kong supplier or Hong Kong customer.

6.  Assemble, for each transaction, the Magna Industrial answers: how the goods were procured and stored, how sales were solicited, how orders were processed, how goods were shipped, how financing was arranged and how payment was effected.

7.  Where contracts are said to be effected abroad by employees, prepare travel, hotel and subsistence details for each individual transaction; where agents are used, prepare the agency agreements.

8.  Check that the justification does not rest on a related company’s activity: source must attach to the taxpayer’s own operations.

9.  For manufacturing structures, determine which arrangement applies — contract processing with title retained, or import processing with title passing.

10.     For passive income categories, separately test the FSIE regime and the economic substance, participation or nexus requirement.

11.     Decide which group company elects the two-tiered rates under section 14AAB, in case the offshore claim is accepted only in part or not at all.

12.     Retain source documents for at least seven years and build the records so that enquiries can be answered transaction by transaction rather than in aggregate.

13.     Where turnover is material and the geography of operations is not obvious, consider an advance ruling under DIPN No. 31 before, not after, the factual position has been fixed.

20. Frequently Asked Questions

Does a Hong Kong company pay tax if all its customers are abroad?

The absence of Hong Kong customers does not by itself settle the question. What is taxed is profit arising in or derived from Hong Kong, determined by what the taxpayer did to earn the profit and where. If the purchase and sale contracts are effected from Hong Kong by telephone or email, they are considered effected in Hong Kong.

Can trading profits be split between Hong Kong and offshore portions?

No. Paragraph 24 of DIPN 21 states that the question of apportionment does not arise for trading profits: they are either wholly taxable or wholly non-taxable. There is no room for a mixed source even where some activity took place abroad.

Did the FSIE regime replace the territorial principle?

No. The Inland Revenue Department’s FAQ states that Hong Kong continues to adhere to the territorial source principle, that the determination of source continues to be based on the Inland Revenue Ordinance and common law principles, and that source of profits and the economic substance requirement are considered in distinct and separate contexts.

Does it help that a related company abroad performs the operations?

No. Source is attributed to the taxpayer’s own operations, not to those of other group members. The exception is narrow: where a related company is in fact acting on behalf of the taxpayer, its activities will be considered to see whether appropriate weight should be accorded to them.

What rate applies if the offshore claim is not accepted?

For corporations, 8.25 per cent on the first HKD 2,000,000 of assessable profits and 16.5 per cent above; for unincorporated businesses, 7.5 and 15 per cent. Where connected entities exist under section 14AAC, only one entity in the group may elect the two-tiered rates in a given year of assessment.

What is the 50:50 apportionment and when does it apply?

It is the norm for apportioning profits in contract processing in Mainland China, where the Hong Kong company supplies raw materials and machinery without consideration and retains legal title to the raw materials and finished goods. It does not apply to import processing, where title passes to the foreign investment enterprise.

Can the position be confirmed in advance?

Yes. The Department provides advance rulings on the locality of profits; the service is subject to a fee, with the procedure set out in DIPN No. 31.

21. Key Takeaways

•     The basis is section 14 of the Inland Revenue Ordinance (Cap. 112): only profits arising in or derived from Hong Kong are chargeable, and residence is irrelevant.

•     The practice is set out in DIPN No. 21 (Revised) of July 2012, replacing the December 2009 edition; the document runs to 62 paragraphs.

•     The broad guiding principle: one looks to see what the taxpayer has done to earn the profit and where he has done it.

•     Transactions are looked at separately; only the taxpayer’s own profit-producing operations are relevant, not the group’s.

•     Trading profits are not apportioned: they are either wholly taxable or wholly non-taxable.

•     A sale to a Hong Kong customer and a purchase from a Hong Kong supplier generally mean the contract was effected in Hong Kong.

•     Contract processing yields a 50:50 apportionment; import processing yields full taxation as trading profits.

•     A buying office not involved in the sale creates no liability; a group service company’s mark-up is fully assessable.

•     Rates: 8.25 and 16.5 per cent for corporations, 7.5 and 15 for unincorporated businesses; the two-tiered rates go to one entity per group under sections 14AAB and 14AAC.

•     The FSIE regime did not displace the territorial principle: source of profits and the economic substance requirement are separate contexts.

•     The assessor may seek full information under section 51(4); that power was not restricted after ING Baring.

•     The Department warns expressly that it will apply the general anti-avoidance provisions, and penalties, to schemes that "book" Hong Kong profits offshore.

22. Summary 

Hong Kong applies a territorial source principle: under section 14 of the Inland Revenue Ordinance (Cap. 112) only profits arising in or derived from Hong Kong are chargeable to profits tax, and the residence of the taxpayer is irrelevant. The Inland Revenue Department’s practice is set out in Departmental Interpretation and Practice Notes No. 21 (Revised), "Locality of Profits", of July 2012, replacing the December 2009 edition. Liability arises where the three Hang Seng Bank conditions are met: the person carries on business in Hong Kong; the profits arise from that business; and the profits arise in or are derived from Hong Kong. The broad guiding principle is that one looks to see what the taxpayer has done to earn the profit in question and where he has done it. Transactions are looked at separately, and only the taxpayer’s own profit-producing operations are relevant, not those of other group members. For trading profits, paragraph 23 provides: where both the purchase and sale contracts are effected in Hong Kong the profits are fully taxable; where both are effected outside Hong Kong no part is taxable; where one is effected in Hong Kong the initial presumption is full taxability, followed by examination of all the operations; a sale to a Hong Kong customer and a purchase from a Hong Kong supplier are usually taken as contracts effected in Hong Kong; and contracts effected by telephone or fax without travel out of Hong Kong are considered effected in Hong Kong. Under paragraph 24 trading profits are not apportioned: they are either wholly taxable or wholly non-taxable. In contract processing in Mainland China, where legal title to raw materials and finished goods remains with the Hong Kong company, a 50:50 apportionment is usually accepted; in import processing, where title passes to a foreign investment enterprise, the profits are trading profits and fully taxable. A buying office not involved in the sale creates no liability; a group service company’s mark-up of 5% to 10% is wholly assessable. Profits tax rates are 8.25 per cent on the first HKD 2,000,000 and 16.5 per cent above for corporations, and 7.5 and 15 per cent for unincorporated businesses; under sections 14AAB and 14AAC only one entity in a group of connected entities may elect the two-tiered rates in a year of assessment. The Foreign-Sourced Income Exemption regime, in force since 1 January 2023 and expanded from 1 January 2024, did not displace the territorial principle: per the Department’s FAQ, the determination of source continues to be based on the Inland Revenue Ordinance and common law, and source and the economic substance requirement are considered in distinct and separate contexts. The taxpayer must prove the offshore source with documentary evidence, and the assessor may seek full information under section 51(4). Advance rulings on the locality of profits are available for a fee under DIPN No. 31.

23. Sources

Tier 1 — the regulator and primary documents

•     Inland Revenue Department — DIPN No. 21 (Revised): Locality of Profits, July 2012 (PDF)

•     Inland Revenue Department — official list of Departmental Interpretation and Practice Notes with the dates of the editions in force

•     Inland Revenue Department — DIPN No. 60: Attribution of Profits to Permanent Establishments in Hong Kong, July 2019 (PDF)

•     Inland Revenue Department — DIPN No. 39: Digital Economy, Electronic Commerce and Digital Assets, March 2020 (PDF)

•     Inland Revenue Department — FAQ on the Foreign-Sourced Income Exemption regime

•     Inland Revenue Department — FAQ for companies incorporated outside Hong Kong (PDF)

Tier 2 — professional commentary

•     Sovereign Group — Hong Kong Profits Tax Services: the two-tiered rates

•     Statrys — Hong Kong Corporate Tax Rate: connected entities and the two-tiered rates

•     IMSG — Hong Kong Profits Tax Explained: sections 14AAB and 14AAC

Related UPPERSETUP analysis

•     Hong Kong Company Registration 2026: Requirements, Procedure, Taxes and Annual Compliance

•     Mandatory Annual Compliance for Hong Kong Companies 2026: Annual Return (NAR1), Audit and Profits Tax Return (BIR51)

•     Hong Kong + UAE: Dual Structure for International Business 2026

•     Corporate Bank Accounts in Hong Kong for Non-Residents 2026

Planning an offshore profits claim? UPPERSETUP supports Hong Kong structures alongside the UAE and Kazakhstan: classifying income by type, working through purchase and sale contracts transaction by transaction, assessing the processing arrangement, preparing documentation for an assessor’s enquiry and evaluating whether an advance ruling is worth taking. Discuss your project with UPPERSETUP

Disclaimer

This material is provided for informational purposes only and does not constitute legal, tax, financial, investment or consulting advice. The source of profits is determined on the facts of each case; DIPN No. 21 states expressly that there is no simple legal test that can be employed in all cases. Obtain individual professional advice before acting. Information is current as of August 2026.