For years, people have incorporated offshore entities for the benefit of asset protection, privacy or tax reduction. Although an offshore company is a popular vehicle for people to carry a business from, it is surprising to see how many people tend to mix up the concept of an offshore entity with the concept of an offshore income for tax purpose.

Definition of Offshore Company

An offshore company being a corporate law concept may be defined as a company that is incorporated in a jurisdiction outside the jurisdiction of residence where the beneficial owner resides. In essence, an offshore company is simply a company that is incorporated in a country overseas or foreign jurisdictions.

As such, depending on where you are located, incorporation of an offshore company can have the following meaning:

• If you are located in Hong Kong, setting up an offshore entity means incorporating a company in a jurisdiction that is outside of Hong Kong; or
• If you are located in a country outside of Hong Kong, then setting up an offshore company may mean incorporating a company in Hong Kong.

There is no limitation as to where the offshore company is located, but some of the more commonly known/popular destinations to set up an offshore company is Curacao, British Virgin Islands (“BVI”), Turks and Caicos Islands (“TCI”) and the Republic of Seychelles (“Seychelles”).

 Advantages of Setting up an Offshore Company

Some of the advantages of setting up an offshore entity in Curacao, BVI, TCI and Seychelles can be shown in the table below:

Putting aside all the advantages, there are other factors which you need to consider when deciding where, outside of Hong Kong, you want to set up an offshore entity. Factors to consider includes:

• what is the purpose of incorporating such offshore entity
• whether there is any restriction on the type of activities that the offshore company can carry out
• whether you want your offshore company in a civil law jurisdiction or in a common law jurisdiction
• whether there is any potential challenge for the offshore company to open a bank account.

Corporate Law Concept of Offshore vs. Tax Law Concept of Offshore

As can be seen, under the corporate law concept, an offshore company is often seen as a company incorporated outside of its home jurisdiction. Whereas, under traditional tax law source rules, one looks at whether the income is sourced. In Hong Kong for example, the source rules determine that every Hong Kong company is subject to Hong Kong profits tax of 8.25%/16.5% unless the company can show that the income it derives is sourced outside of Hong Kong (i.e. offshore income).

Similarly, a company incorporated outside of Hong Kong is generally not subject to Hong Kong profits tax, unless it is shown that the income it derives is sourced in Hong Kong (i.e. onshore income).

In order for a Hong Kong company to claim the income it derived as offshore, the company will need to actively claim for this exemption within its profits tax return or apply for an advance ruling before commencing any business activities. That being said, this non-taxable offshore claim is subject to the IRD’s acceptance. However, in the event that the IRD denies the offshore the claim, a tax dispute or potentially even a tax audit and investigation may arise.

Conclusion

It is important to consider all the different factors carefully before deciding whether to incorporate an offshore entity or for example a Hong Kong company thereby claiming its income offshore. It is also important to note that incorporating a company outside of Hong Kong does not automatically means that the income it generates is not subject to the Hong Kong profits tax.