Tax Efficiency Profits of Hong Kong Manufacturing company – Operation Performed outside Hong Kong
The place of manufacture
The source of profits for a manufacturing business is the place where the goods are manufactured. The profits arising from the sale of goods manufactured in Hong Kong are fully taxable here. Where goods are manufactured partly in Hong Kong and partly outside Hong Kong like in Mainland China , that part of the profits which relates to the manufacture of goods outside Hong Kong will not be regarded as arising in Hong Kong. The place where the manufactured goods are sold is not relevant.
Manufacturing under a processing or assembling arrangement with an entity in the Mainland of China
In the Mainland, two types of processing trade normally involve Hong Kong companies: contract processing and import processing.
In contract processing, the document that governs the contractual relationship among the parties is the processing agreement. It sets out the rights and responsibilities of the Hong Kong company and the Mainland processing enterprise. The Hong Kong company is responsible for the supply of raw materials and machinery without consideration and to provide technical know-how while the Mainland processing enterprise is responsible for the provision of factory premises, utilities and labour force. In return for the processing service, the Hong Kong company pays a subcontracting charges to the Mainland enterprise. The legal title to the raw materials and finished goods remains with the Hong Kong company. Strictly speaking, the Mainland processing enterprise is a separate sub-contractor distinct from the Hong Kong company and the question of apportionment in respect of the latter's profits should not arise. In the Department's view, the Hong Kong company's operations in the Mainland complement its operations in Hong Kong. Recognising the operations of the Hong Kong company in the Mainland, an apportionment of profits on a 50:50 basis is usually accepted.
In import processing, the manufacturing operations are carried out by a foreign investment enterprise (FIE) incorporated in the Mainland and related to the Hong Kong company. The Hong Kong company sells raw materials to the FIE and buys back the finished goods from the FIE. The Hong Kong company engages in the trading of raw materials and finished goods whilst the FIE manufactures the finished goods. The legal title to the raw materials and the finished goods passes to/from the FIE. The Departments holds the view that the profits which accrued to the Hong Kong company from "trading transactions" carried out in Hong Kong cannot be attributed to the manufacturing operations of the FIE carrying on business in the Mainland. The source of the trading profits must be attributed to the operations of the Hong Kong company which produced them. Apportionment of profits is not appropriate.
Manufacturing by an independent sub-contractor in the Mainland of China
In cases where the assembly work is contracted to various contractors in the Mainland China , the jobs are numerous, small in value and of short duration and the Hong Kong company has minimal involvement in the assembly work, then the manufacturing in the Mainland is not regarded as having been carried out by the Hong Kong company. Given that the Hong Kong company does not carry out any manufacturing operations outside Hong Kong, its profits should be fully chargeable to profits tax without any apportionment.