Economic Substance / CFC Hong Kong

[AJ888]

Hello Everyone,

I was wondering, what possibilities there are to create economic substance for a HK entity in terms of CFC rules (in case you are doing business on your own for the moment).

Would a virtual office in HK qualify for HK tax residency of the entity according to the IRD standards? If not, what would be a possible solution there?

This is important for me to know because qualifying for HK tax residency and paying corporate taxes in HK, while at the same time being in accordance with CFC rules and thus being able to proof the income generated by the HK entity as to be offshore income, would significantly benefit to my personal income tax rate.

Any ideas, comments or suggestions are highly appreciated, thank you!

 

[Tax Cow]

If your country of residence has no CFC rules, then a virtual office in HK, or simply the fact that a company is registered in HK may take precedence when it comes to corporate income taxing rights. In practice, there are very few countries that accept this. You need local expertise for a definitive answer.

When you live in EU,CA,US,UK - your HK company is treated as their company even if you purchase or rent a bricks n' mortar office and hire full time employees in HK. This will, by all counts, amount to "economic substance in HK". However, as the place of (top) management (where your a*s is located) is in EU/CA/US/UK, that (substantiated) HK company still gets taxed according to local rules and rates. Even worse, you're subject to bureaucracy. Where local companies just file an annual return, you, the "crooked offshore businessman" must file additional information forms and possibly undergo a mandatory audit every year (cough, French residents, LOL).

 

[Tax Cow]

...

From economic substance in HK, you only get the tax residency certificate which in turn makes you eligible for treaty rates as outlined in bilateral tax treaties. Treaties only eliminate double tax burden, but you still pay tax in one of the contradicting states, or a little bit in both, so there's not much point of establishing economic substance in HK if you as the top management live in a high tax country.

For best (tax) results, your HK company (substantiated or not) should be managed from a tax neutral jurisdiction such as the Cayman Islands, BVI, Monaco.

 

[AJ888]

Thanks for taking the time and your detailed answer!
OK I see your point about economic substance. I do live in a EU country, but will be moving to a non-EU country in the near future that will implement CFC rules soon. Local tax advisors over there have told me that in order to qualify for "offshore income", there needs to be enough substance in HK and the company needs to be managed from HK. This, like you said, will cost me the corporate tax in HK, but will save me a lot on the personal income tax level.
Now you mentioned that it would be even better to have it managed from a tax neutral jurisdiction like the ones you pointed out. Could you elaborate this a bit further please? Do you mean to hire a local director in one of those jurisdictions or do you mean I should move there? The latter is unfortunately not an option at this moment.

The following situation is fixed and cannot be changed:

1) EU national and tax resident
2) Moving to non-EU country (and becoming tax resident there)

Looking forward to your comments!

 

[AJ888]

*2）non-EU, implementing CFC soon, non of the above jurisdictions and not a low tax jurisdiction (not as high as in Europe but not comparable with the classical “low tax” jurisdictions)

 

[Tax Cow]

How soon are we talking in regards to "near future" and your residency change? Less than 2 years, and I'd fly under the radar - not reporting this company to authorities in your EU home country. Disclosure can only bring issues when you renounce your residency - possibly exposing you to costly exit taxes and audits. Non-disclosure, and getting caught pants down can be just as costly, so do not stay exposed to this risk for too long.

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"Now you mentioned that it would be even better to have it managed from a tax neutral jurisdiction like the ones you pointed out. Could you elaborate this a bit further please? Do you mean to hire a local director in one of those jurisdictions or do you mean I should move there?"

A local director (not just a nominee) in let's say BVI would legally make it a Hong Kong company managed from BVI. The HK company is then legally exempt from all corporate income and profit distribution taxes assuming the HK company earns it's income from outside HK. "Place of effective management" is also recognized by OECD.

Re-locating to a tax neutral jurisdiction and managing the company from there yourself would be even better for two reasons - no income taxes on personal level when profits are distributed (you're also the beneficiary), and no need to trust another person to act in your best interest.

If the place you're eyeing for your next residency is a banana republic, perhaps you can even get away with a classic nominee director (do not use highly popular names in charge of 1,000 companies). This solution would cross the line of legality as you remain the person in charge of day-to-day activities despite another name appearing on the paper. However, if the state has no ability or political will to investigate and prosecute illegal offshore structures, there is less reason to overpay for a legal solution. Cost/Risk/Benefit - consider all!

 

[fshore]

Hello Everyone,

I was wondering, what possibilities there are to create economic substance for a HK entity in terms of CFC rules (in case you are doing business on your own for the moment).

Would a virtual office in HK qualify for HK tax residency of the entity according to the IRD standards? If not, what would be a possible solution there?

This is important for me to know because qualifying for HK tax residency and paying corporate taxes in HK, while at the same time being in accordance with CFC rules and thus being able to proof the income generated by the HK entity as to be offshore income, would significantly benefit to my personal income tax rate.

Any ideas, comments or suggestions are highly appreciated, thank you!

You can't both be resident in Hk and be exempt for tax under offshore tax exemption.

Hk tax are not very low. Maybe another place like Labuan, US llc, UK Ltd will be cheaper and / or easier.

 

[AJ888]

“How soon are we talking in regards to "near future" and your residency change? Less than 2 years, and I'd fly under the radar - not reporting this company to authorities in your EU home country. Disclosure can only bring issues when you renounce your residency - possibly exposing you to costly exit taxes and audits. Non-disclosure, and getting caught pants down can be just as costly, so do not stay exposed to this risk for too long.”

Around six months from now - this is exactly what I was thinking.

About the place of effective management: In order to qualify for “offshore income” taxation on the personal income level in my next country of residency, I would have to proof that I paid the corporate taxes in HK and that it’s actually managed from there. Hiring a local director in for example BVI would be counterproductive as I would be totally tax exempt in HK and could not proof that I’ve been paying taxes anywhere, which would eventually lead to “normal” taxation of my personal income.

 

[AJ888]

You can't both be resident in Hk and be exempt for tax under offshore tax exemption.

Hk tax are not very low. Maybe another place like Labuan, US llc, UK Ltd will be cheaper and / or easier.

I don’t seek to be exempt for offshore income in HK, but the place of my residency. Meaning I need the HK entity to be tax resident in HK in order to qualify for offshore income tax exempt on a personal income level in my country of residency.

 

[Tax Cow]

About the place of effective management: In order to qualify for “offshore income” taxation on the personal income level in my next country of residency, I would have to proof that I paid the corporate taxes in HK and that it’s actually managed from there. Hiring a local director in for example BVI would be counterproductive as I would be totally tax exempt in HK and could not proof that I’ve been paying taxes anywhere, which would eventually lead to “normal” taxation of my personal income.

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This sounds a lot like Ecuador's system... they do not use tax credit system. In a nutshell, in Ecuador, if you can prove that any tax was paid overseas, no local taxes will apply on that income.

The solution to this kind of system is to incorporate a holding company in Montserrat or another place where the tax is low, but above zero.

1. Incorporate a Montserrat Holding company and elect to be subject to 1.75% corporate income tax
2. Incorporate a HK Operational company which is 100% owned by the Montserrat Holding company

You can also discard the HK OpCo and operate through a single Montserrat entity.

Have fun

 

[AJ888]

This sounds a lot like Ecuador's system... they do not use tax credit system. In a nutshell, in Ecuador, if you can prove that any tax was paid overseas, no local taxes will apply on that income.

The solution to this kind of system is to incorporate a holding company in Montserrat or another place where the tax is low, but above zero.

1. Incorporate a Montserrat Holding company and elect to be subject to 1.75% corporate income tax
2. Incorporate a HK Operational company which is 100% owned by the Montserrat Holding company

Have fun

Well it’s not Ecuador but interesting to know that Ecuador has a similar system
I had this kind of setup in mind, but then again I don’t see the solution to the effective place of management (maybe I’m not getting it?) If it’s still seen to be managed by me from my country of residence, then I’m still paying the full tax on the personal income level.

Let’s say the low tax Holding owns the HK operational company 100 % , who is controlling and managing the structure and from where? Also, in this case, what would you suggest in terms of banking / EMI for the holding and the operational Company? I could imagine that banks / EMIs do not like to see a HK company owned by a low tax holding ...

 

[Tax Cow]

There's no ideal solution to PoEM. Only 3 options are available, each with their pros and cons.

1. Legal - Rent/buy an office and hire a local director. Montserrat is significantly cheaper than BVI, but still, you should assume 50$K annual expense for anything that can withstand the test of tax investigator's visit. A minimum wage hipster director proficient in reggae rhythms working from underneath a beach umbrella won't work.
2. Legal (if documented flawlessly) - fly to Montserrat yourself to hold annual meetings and take all key management decisions from there. Keep meeting minutes (monologue with yourself), flight tickets as proof.
3. Illegal - Appoint a nominee director who doesn't really manage anything; play hide n' seek.

 

[AJ888]

Well thanks for this very clear answer