HKSC Principle of Taxation
Chapter 7 Profits Tax: Scope of Charge and Meaning of
Trade
1. Learning Objectives
1.1 Describe the scope of charge of profits tax.
1.2 Explain each of the badges of trade.
1.3 Explain what evidence is required to prove the intention alleged.
1.4 Explain the meaning of business.
1.5 Explain how to determine the date commencement or cessation of business.
2. Scope of Charge
2.1 KEY POINT
Profits tax is charged on every person:
(a) carrying on a trade ( 行 業、 生意 ), profession or business ( 業務 ) in Hong
Kong; and
(b) in respect of his assessable profits arising in or derived from Hong
Kong from such trade, profession or business.
(凡任何人在香港經營任何行業、專業或業務，而從該行業、專業或業務獲得按照本部被確定的其在有關年
度於香港產生或得自香港的應評稅利潤(售賣資本資產所得的利潤除外)，則須向該人就其上述利潤而按標準
稅率徵收其在每個課稅年度的利得稅。)
(c) The above criteria have the following implications:
(i) the place where a business is incorporated is irrelevant; and
(ii) the place where a business is carried on is not necessarily
the same place where an income from that business arises.
2.2 Profits arising from the sale of capital assets are excluded from the charge
(s 14(1)).
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2.3 DEFINITION
(a) The word person includes a:
(i) corporation
(ii) partnership
(iii) trustee (受託人), whether incorporated or unincorporated
(iv) body of persons (s 2(1)).
(b) Trade is defined in s 2(1) as including every trade and
manufacturing, and every adventure and concern in the nature of
trade.
3. Trade Carried on in Hong Kong
3.1 Whether a trade is being carried on is a question of fact to be determined by
looking at all the circumstances of the case.
3.2 KEY POINT
There are six badges ( 象 征 ) of trade that are considered to be relevant in
determining whether a taxpayer is carrying on a trade as arrived at by the UK
Royal Commission on the Taxation of Profits and Income in 1955 as follows:
(a) Subject matter
(b) Length of ownership
(c) Frequency of similar transactions
(d) Supplementary work on the property
(e) Circumstances responsible for disposal
(f) Profit-seeking motive.
(A) Subject matter of transaction
3.3 KEY POINT
If the asset yields income and not for personal enjoyment, it is likely to be
a trading asset.
3.4 EXAMPLE 1
(a) In CIR v Fraser (1942) 24 TC 498, a woodcutter made an isolated
transaction of buying and selling a large quantity of whisky. The
quantity of whisky was too large for his own consumption. The court
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held that it was an adventure (事業) in the nature of trade.
(b) In Rutledge v CIR (1929) 14 TC 490, an isolated purchase and resale
of a large quantity of toilet rolls was held to be an adventure in the
nature of trade.
(B) Length of ownership of the goods
3.5 KEY POINT
The shorter the period of ownership, the more likely that the asset is a
trading asset.
3.6 However, this factor alone may not be conclusive. In CIR v Beautiland Co Ltd
(1992) 3 HKTC 322, the taxpayer company acquired shares in a company was
engaged in a property development project at Tin Shui Wai. The shares were
acquired on 28 June 1979 and were then sold on 6 November 1979. The
transaction was held not to be trading.
3.6 Even a sale after a long period of holding may amount to trading depending
on the nature of the taxpayer’s business. In CIR v Sincere Insurance &
Investment Co Ltd (1973) HKTC 602, immovable properties held by an
insurance company for over 20 years before sale, were hold to be current
assets and thus the profit was taxable. This is because, for an insurance
company, investment assets are current assets which must be readily realizable
to meet possible claims.
(C) Frequency of similar transactions
3.7 KEY POINT
Repeated transactions of the same kind suggest that a trade may be
carried on.
3.8 EXAMPLE 2
A sole proprietor of a transaction business had entered into a transaction to
hedge the fluctuation price of nickel (鎳) for a related company.
The BoR noted that:
(a) the transaction was a one-off; and
(b) the company neither had a systematic operation nor its own trading
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account: there was not even the barest minimum for the carrying on of
a trade.
The loss was held to be not deductible (D 38/96).
(D) Supplementary work on the property
3.9 KEY POINT
If the owner incurs heavy expenditure to make the property more marketable
or exerts effort to promote the sale, it is likely that the property is acquired for
sale.
(E) Circumstances responsible for disposal
3.10 KEY POINT
The transaction will not be trading if the original intention was not resale but
an unexpected subsequent event, emergency or other factor caused the
taxpayer to change his intention, e.g. sudden need of cash.
3.11 EXAMPLE 3
In D 10/88, a taxpayer bought a unit in an uncompleted building. After
discovering that another property would be developed in front, thus blocking
the seaview of his unit, he sold the unit. The profit was held not to be taxable.
(F) Profit seeking motive
3.12 KEY POINT
This is perhaps the most important factor. If a person acquired property with
the intention of profit making by resale, it is very likely that the transaction
amounts to trading.
3.13 EXAMPLE 4
In Central Enterprises Ltd v CIR 2 HKTC 240, the taxpayer could not
provide satisfactory evidence that there was an intention to hold the property
for long-term investment and was held to be trading.
3.14 EXAMPLE 5
In Taylor v Good (1974) 49 TC 277, the taxpayer purchased a piece of land
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intending to build a house for use as his residence. However, his wife refused
to live in it and it was subsequently sold. It was held not to be trading as there
was no profit-seeking motive.
(G) Other relevant factors
3.15 KEY POINT
(a) Method of acquisition of the asset
If the asset is not acquired through purchase, but involuntary
acquisition such as inheritance from family members or group
restructuring, it is likely that the profit made from such transactions is
exempt from profits tax.
(b) Method of financing the acquisition of the asset
If the asset is acquired with short-term finance such as bank overdraft,
it is likely that the purchase is acquired with the purpose of quick
disposal, and the profit so made will be treated as a trading profit.
It was held in many BoR cases that if the purchase of a property was
financed by a loan obtained from a deposit taking company (not a
licensed bank), the profit-seeking motive would be obvious. It was due
to the reason that the interest rate of a deposit taking company is
generally higher than that of a licensed bank.
(c) Usage put to the asset
If a property is left vacant throughout the ownership period, or it is
sold during the construction period, it will be likely that the property is
acquired for trading purpose.
(d) Minutes supporting the intention for the purchase (if the taxpayer
is a corporation)
A corporation is an artificial person, and its intention for the purpose
of a property may be documented in the minutes of a directors’
meeting.
(e) How the asset is shown in the accounts or balance of a company
If the asset is shown as a current asset or trading stock in the balance
sheet, it will be very likely that the property is acquired for trading
purposes.
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4. Business Carried on in Hong Kong
4.1 DEFINITION
Section 2 of IRO defines business to include agricultural undertaking, poultry
and pig rearing and the letting or sub-letting by any corporation to any person
of any premises or portion thereof, and the sub-letting by any other person of
any premises or portion of any premises held by him under a lease or tenancy
other than from the Government.
(包括農業經營、家禽飼養及豬隻飼養、任何法團將任何處所或其部分出租或分租給任何人，及任何其他人將其根據租
契或租賃(但不包括政府租契或政府租約)而持有的任何處所或其部分分租。)
4.2 The definition of business is very wide. Any activities not falling within the
definition of trade and profession may be treated as a business under the IRO.
4.3 Section 2 specifically includes the following activities as carrying on a
business:
(a) agricultural undertaking,
(b) poultry and pig rearing,
(c) the letting of an immovable property by a corporation who is an owner
of the property,
(d) the sub-letting of an immovable property by a corporation, and
(e) the sub-letting of an immovable property by an individual or a
partnership.
4.4 KEY POINT
A company carries on business in the place where the central management
and control of the company is exercised.
4.5 EXAMPLE 6
The leading case is De Beers Consolidated Mines Ltd v Howe (1906) 5 TC
198. De Beers Co was incorporated in South Africa and operated diamond
mines there. The directors met in both South Africa and London. It was held
that as the central management and control was in the UK, the company’s real
business was carried on in the UK and it was resident there.
The De Beers case illustrates that a company may carry on business in more
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than one location. This is supported by Swedish Central Railway Co Ltd v
Thompson (1925) 9 TC 342. The sole source of income of the taxpayer
company was rent from a lease of a Swedish railway. Its central management
and control was in Sweden. However, it also carried out activities in London.
It was held that the company was also resident in Britain.
5. Trade or Business Carried on in Hong Kong by a Non-resident
(A) Trading with Hong Kong
5.1 When an overseas company sells goods directly to its customers in HK from
overseas, it is treated as trading with HK. In this situation, the overseas
company is not treated as carrying on a business in HK. It does not fall
within the charge of profits tax under Section 14 of the IRO.
(B) Trading within Hong Kong
5.2 When an overseas company establishes an office in HK to sell goods to its
customers in HK, it is traded as trading within HK. In this situation, the
overseas company is treated as carrying on a business in HK, and this
satisfies the requirement of Section14 of the IRO. The profit of the overseas
company derived from HK is chargeable with profits tax.
(C) The existence of a permanent establishment in Hong Kong
5.3 Inland Revenue Rule 5 (IRR 5) governs the charge of profits tax in respect of
a non-resident carrying on a business in HK. If a non-resident has a permanent
establishment in HK, it is treated as carrying on a business in HK.
5.4 DEFINITION
IRR 5(1) provides the definition of a permanent establishment (永久機構或常設機
構 ) means a branch, management or other place of business, but does not
include an agency unless the agent has, and habitually exercises, a general
authority to negotiate and conclude contracts on behalf of his principal or has
a stock of merchandise from which he regularly fills orders on his behalf.
(指分支機構、管理機構或其他營業地點，但不包括任何代理機構，除非該代理人有代其委託人進行合約洽談及訂立合
約的一般權能，並習慣上行使此等權能，或該代理人有一批商品存貨，並經常代其委託人從中按訂單付貨。)
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(D) The mere setting up of a buying office in Hong Kong
5.5 If an overseas company sets up a buying office in HK, it is not treated as
carrying on a business in HK. The reason is that what the overseas company
does in HK does not involve in the sale of goods, but solicit source of
purchases. Thus, the existence of a permanent establishment in HK does not
necessarily mean that the company carries on a business in HK within the
meaning of Section 14.
(E) Local agent with a general authority
5.6 If the agent of an overseas company has the general authority to conclude a
contract on behalf of the overseas principal in HK, and that contract is
binding on the principal, the principal is treated as carrying on a business
through the agent in HK. The profits earned by the principal in HK through
the agent is subject to HK profits tax.
(F) Local agent holding a stock of merchandise
5.7 Consignment sale – If a local agent keeps a stock of merchandise from which
he regularly fills orders on behalf on an overseas principal, the overseas
principal is regarded as having a permanent establishment under IRR 5(1) and
it is treated as carrying on business in HK.
5.8 How to charge profits tax on consignment sale
Under Section 20A(3), the overseas principal is charged with profits tax at
the rate of not more than 1% on the goods sold. As a matter of practice, the
IRD usually charges 1/2% of the sales proceeds as the profits tax payable
for the profits so made. The profit tax from such business is commonly known
as consignment tax.
5.9 How to collect profits tax from the non-resident
As the overseas principal is outside HK, it is not easy for IRD to collect tax
from an overseas company. The local agent is required to deduct an amount
sufficient to cover the profits tax payable from the sale proceeds remitted to
the overseas principal. In other words, the tax is collected by withholding.
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6. Branch and Subsidiary
6.1 Comparison of a branch and a subsidiary of a non-resident
(a) Legal entity – A branch is a separate taxation entity, but it is not a
separate legal entity.
(b) Charge of profits tax – A branch and a subsidiary are charged under
profits tax in the same way according to the rules provided in the IRO.
As long as a branch or a subsidiary carries on a business in HK, and its
profits are derived from HK.
6.2 A subsidiary of a non-resident is a separate legal entity, and it is required to
keep sufficient records for the purpose of audit and the requirements under
Section 51C of the IRO to arrive at the assessable profits from the records of
the subsidiary.
6.3 IRR 5(2) provides three methods of computing the profits tax liability for a
branch of a non-resident. Those three methods are as follows:
(a) If the records of the branch are readily available to arrive at the profit
figure of the branch, the assessable profits of the branch may be
computed with such records.
(b) If the records of the branch are not readily available to arrive at the
profit figure of the branch, the assessable profits of the branch may be
computed with the following formula:
HK branch turnover
HK branch’s profits = Worldwide profit ×
Worldwide turnover
(c) If the assessor is of the opinion that it would be impracticable or
inequitable to adopt the aforesaid two methods, he/she may compute
the amount of the profits arising in or derived from HK on a fair
percentage of the turnover of the branch in HK.
7. Other Scopes
(A) Illegal trading
7.1 Profits from illegal activities are taxable if the activities amount to a trade or
an adventure in the nature of trade.
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(B) Betting and gambling
7.2 Gambling which is mere entertainment is not trading, nor does it amount to a
business even though the gambling is habitual (慣常的).
7.3 However, gambling by connected person is likely to be trading. In D 55/87, a
gambling win of an amateur jockey was held not to be receipts from a trade,
business or profession. However, as connected persons, professional jockeys
or trainers are likely to be subject to tax on horse gambling wins.
(C) Electronic commerce
7.4 The CIR issued DIPN 39 in July 2001 explaining the IRD’s view on the
taxation of electronic transactions. The issue is whether the existence of a
server constitutes a permanent establishment.
7.5 The IRD’s view on the existence of a permanent establishment regarding a
server may be summarized as follows:
(a) A server without any human effort in HK
The location of a server does not constitute a permanent establishment.
Thus, the mere existence of a server in HK without any human effort
exerted upon the server does not constitute carrying on a business in
HK.
(b) A server with minimal human effort in HK
Whether the server constitutes a permanent establishment in HK is a
matter of degree. Each case is to be determined on its own facts.
(c) A server with substantial human effort in HK
This, most likely, constitutes a permanent establishment in HK. A non-
resident having a server in HK with substantial human effort in HK
would amount to carrying on a business in HK.
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