Case 1 - Bright Harvest Trading Ltd: offshore trading claim and the FSIE dividend
Bright Harvest Trading Ltd (BHT) is incorporated in Hong Kong and operates from a 600 sq ft office with four staff. It buys finished garments from an unrelated factory in Vietnam and sells them to customers in the United States and Germany. BHT's Hong Kong staff negotiate prices and payment terms, select and monitor suppliers, instruct a third-party inspection firm in Vietnam, and handle shipping documents and letters of credit. Title to the goods passes when they are loaded on board in Ho Chi Minh City, and the goods never enter Hong Kong. For the year ended 31 March 2025, turnover was HK$180 million, gross profit HK$36 million and Hong Kong operating expenses HK$9 million. BHT also received a HK$12 million dividend from its wholly owned Vietnamese manufacturing subsidiary, which it has held for six years; the dividend was paid into BHT's Hong Kong bank account. The tax manager proposes to treat the whole HK$36 million as offshore and the dividend as non-taxable simply because it is a dividend. The profits tax return is due next month.
1. Assess whether BHT can support a full offshore claim for the HK$36 million trading profit. State the test you apply, apply it to these facts, and list the evidence an assessor would look for.
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Test applied. Profits tax charges profits arising in or derived from Hong Kong (s.14 IRO). The courts apply the operations test: identify what the taxpayer did to earn the profits and where it did it. In ING Baring Securities (Hong Kong) Ltd v CIR the Court of Final Appeal rejected the place where the contract was effected as the sole or decisive test and confirmed a totality-of-facts approach; HK-TVB, Kwong Mile and Datatronic are to the same effect.
Application. Two facts favour BHT: title passes offshore and the goods never enter Hong Kong. Neither is decisive. Almost every value-adding operation sits in Hong Kong: price and credit negotiation, supplier selection and monitoring, quality control instruction, shipping documentation and trade finance. The Vietnamese factory is an unrelated supplier, so there is no offshore manufacturing operation of BHT to which part of the profit could be attributed. On a totality basis the profits are Hong Kong-sourced.
Evidence the assessor will seek.
- Who fixes prices, approves credit limits and bears bad debts, and where those people sit.
- Supplier and customer contracts, correspondence and board minutes.
- Travel records and any secondment or local presence in Vietnam.
- Job descriptions and authority limits of the four Hong Kong staff.
- How the inspection contract is negotiated and controlled.
- Bank records showing where receipts are managed.
Conclusion. A full offshore claim is not sustainable. Advising it would expose BHT to additional assessment, interest-type charges and a s.82A penalty. A partial claim is only credible if genuine decision-making operations are relocated offshore with real substance, not just a change in where documents are signed.
2. Explain how the HK$12 million dividend is taxed under the foreign-sourced income exemption (FSIE) regime, and identify which exception BHT should rely on.
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Why the old answer fails. Before 1 January 2023 a dividend from a non-resident was simply not chargeable. Since the FSIE regime, a foreign-sourced dividend received in Hong Kong by an MNE entity is deemed to be Hong Kong-sourced and chargeable unless an exception applies. BHT is an MNE entity because it is part of a multinational group (it has an overseas subsidiary), and the dividend was received in Hong Kong.
Two possible exceptions.
- Economic substance requirement - BHT must have an adequate number of qualified employees and adequate operating expenditure in Hong Kong for the relevant activities. For a pure equity holding company the requirement is relaxed: adequate human resources and premises in Hong Kong plus compliance with company law. BHT has four staff and an office, but those staff are engaged in trading; BHT would need to show substance around holding and managing the Vietnamese participation, not just trading.
- Participation exemption - BHT must hold at least 5% of the equity of the investee for at least 12 months (it holds 100% for six years, so this is met), and the subject-to-tax condition must be satisfied: the dividend, or the underlying profits, must have been subject to tax at a rate of at least 15% in Hong Kong or overseas. Vietnam's corporate income tax rate of 20% supports this. The anti-abuse rules (no main purpose to obtain a tax benefit; switch-over rule) must also be considered.
Recommendation. Rely on the participation exemption, supported by the Vietnamese subsidiary's tax returns, the shareholding register and evidence that the profits were taxed. Document why the dividend was received and confirm there is no main purpose to obtain a tax benefit. The economic substance argument is weaker and should be a fallback only.
3. The client asks whether BHT can simply agree a 50:50 apportionment with the assessor, and whether relocating the sourcing function to a staffed Vietnam office would remove the profit from Hong Kong. Advise.
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50:50 is not a statutory right. It is an administrative practice grounded in case law, used in some manufacturing cases where part of the manufacturing activity is offshore and part of the selling activity is onshore. BHT does not manufacture; it buys from an unrelated supplier. There is therefore no offshore manufacturing contribution to measure, and the assessor is unlikely to offer apportionment on these facts. Apportionment is a matter of agreement on evidence, not an election.
Relocation with substance. If BHT genuinely moved the profit-producing operations - pricing, supplier selection, credit risk and contract negotiation - to its own staff and premises in Vietnam, with authority actually exercised there, part of the profit could be attributed offshore. The assessor will test substance: who has authority, where decisions are made, whether the offshore staff bear risk, and whether the Hong Kong office is reduced to a support function. A brass-plate office or a nominee director will not succeed and risks a s.82A penalty and a s.61A anti-avoidance challenge.
Interaction with FSIE. This is a point many candidates miss: the FSIE regime only covers specified foreign-sourced income - interest, dividends, equity disposal gains and IP income. Trading profits are not within FSIE. So if profits are genuinely non-Hong Kong sourced, they remain outside the charge under the source rules and are not caught by FSIE. The correct sequencing is: determine source first; only then consider FSIE for the dividend.