Tax Substance: Why It is So Important When Doing Business in Hong Kong


For most entrepreneurs, the desire to see your enterprise morph into a revered multinational never leaves the minds. However, it is not easy because of the complexities associated with opening and running a business in Hong Kong. In Hong Kong, growing into a multinational becomes easy, cheap, and enjoyable if your enterprise can demonstrate tax substance. What exactly does tax substance mean? How do you demonstrate tax substance? Keep reading to get answers to these questions and a lot more about tax substance. 

What is Tax Substance? 

Before looking at the main activities that you can use to demonstrate tax substance in Hong Kong, let’s start by understanding what it is. Although there is no clear definition of tax substance in Hong Kong, the tax authorities will consider your enterprise to deliver substance if it contributes significantly to the growth of the island’s economy. For example, is your business paying all the required taxes on time? 

Because Hong Kong is a small island with very little land for agriculture or mineral exploration, it spares no effort in ensuring that businesses help to support its economy. This is why you need to understand tax substance. The idea of tax substance is a gentle notion of telling investors that, “see: this jurisdiction is yours to exploit for growth, but in return, make sure to support the economy.” 

What are the Risks of Not Demonstrating Tax Substance?  

If you fail to demonstrate tax substance in Hong Kong, there are three major risks that are likely to face your business: 

• Challenges Using Double Trade Agreements (DTA) Between Hong Kong and Other Jurisdictions 

As we indicated earlier, most entrepreneurs are always looking for ways to grow their enterprises and transform them into multinationals. After registering a company in Hong Kong, the best way to achieve this is to use double trade arrangements, but it will be a major challenge without demonstrating tax substance. The Hong Kong Internal Revenue Department (IRD) will only approve your company’s tax residency status after demonstrating tax substance so that you can use it to take advantage of DTAs.

• Risk of Double Taxation in Other Countries 

Hong Kong is very attractive to investors because of its low tax regime. However, efforts to expand to other jurisdictions could potentially raise the corporate tax if you do not have tax resident status.  Particularly, your company is likely to suffer from double taxation, which could shrink your overall profits. 

• Expanding to China Will Be Challenging 

When expanding business to Hong Kong, most investors have their eyes fixed on taking advantage of the large Chinese market of more than 1.4-billion people. Using the Closer Economic Partnership Arrangement (CEPA), your Hong Kong enterprise should be able to enjoy duty-free export and preferential access to different sectors in China. Well, you will get none of this without demonstrating tax substance. Do not risk this type of loss because you can use expert assistance. 

How to Demonstrate Tax Substance

Close up cropped image coffee table full with papers invoices cheque bills, female hands holding receipt calculating company expenses results of incomes, bookkeeper accountant doing paperwork concept

The risks we have listed above are only a few, but they can be more. For example, you do not want to risk your license renewal getting declined only to realize that the cause was failing to demonstrate tax substance. So, let’s address it, “how do you demonstrate tax substance?” Here are some useful strategies that you might want to consider

  • Meeting all the business tax obligations, including remitting taxes to IRD on time. 
  • Employing staff in line with the Hong Kong labor laws
  • Maintaining a physical office in Hong Kong. 
  • Holding meetings, such as annual general meetings and strategic meetings in Hong Kong. 
  • Buying products for your production from other businesses in Hong Kong
  • Partnering with other businesses to spur the growth of the Hong Kong economy.

As you can see, the process of demonstrating tax substance can be pretty complex because there is no clear definition, some businesses still fail to get the tax resident certificates after putting in a lot of effort. This is why you should consider working with an agency of experts to help you with developing clear strategies for growth,  application for tax residency, and a lot more, such as payroll management.

The views expressed in this article are those of the authors and do not necessarily reflect the views or policies of The World Financial Review.