Hong Kong has an attractive tax system, which supports the city’s position as an international business hub. The tax system is simple, but not straightforward. Tax audits, also called field audits, are an essential aspect of the system and can cause concern for taxpayers.

In this article, we will go into tax field audits on companies in Hong Kong and how to navigate through them. It has to be noted that apart from the companies, their shareholder(s) might probably also be tax audited altogether.

What is a tax field audit?

A tax field audit or investigation is a process where the Hong Kong Inland Revenue Department (IRD) examines in detail a taxpayer’s financial records and tax positions, to ensure they comply with Hong Kong tax laws and regulations.

In the tax audit process, the authorities generally check whether the taxpayers have accurately and completely recorded their income and expenses in the financial accounts as well as properly made the tax claims/reporting in accordance with the tax laws. This is not only done by examining the books of accounts and records, but also by visiting the taxpayer’s premises and conducting an interview(s) with the taxpayer, to get a thorough understanding of its business operations.

Usually, the IRD will pick one or a few years of assessment for a tax audit, but it is also empowered to investigate as far back as 10 years to obtain information and documents as well as conduct tax assessments thereon.

Reasons to be selected

There are several reasons for a taxpayer to be selected for a tax audit. One may be chosen at random or based on a specific risk assessment conducted by the IRD.

Should there be any discrepancies or inconsistencies in taxpayers’ financial records and/or tax reporting, this may also be a reason to be subject to a tax audit.

Listed below are common situations, businesses or transactions that are often on the IRD’s radar for tax field audit or investigation:

• A company’s audited financial statements are heavily qualified or with a disclaimer thereon
• Transactions are mainly settled in cash, e.g. cash sales
• A business is in a gross loss position or has an unreasonably low turnover or profit when compared to prior years or to other businesses in the same industry
• Significant reduction in the profit as a result of restructuring
• A company received an injection of a large amount of capital from unknown sources
• A large scale of domestic and/or cross-border transactions, such as management fees, service fees and commissions, between a company and its associated companies
• Failure to submit the profits tax return on time
• Failure to maintain sufficient business records
• Being snitched by the relevant parties, such as former employees
• Other cases referred by other government departments

How to know you have been selected for a tax audit

Usually, you will not be notified by the IRD when they start looking into your tax affairs.

If they do decide to formally open a file to investigate you or your business, a letter will be sent from the IRD’s Field Audit Section or Investigation Section, to request information or inform you they have started a tax field audit or investigation and maybe invite you for an initial interview.

The process could also start with a desk audit. A desk audit can be initiated by asking for more information about the income or expenditure items reported in the tax return, or requesting information about a property transaction.

It is not uncommon for desk audits to escalate into a tax field audit or investigation, especially in cases involving more serious tax concerns and/or the information supplied during the course of desk audit is being considered inconsistent or unreliable by the IRD.

Field audit general procedure

In general, the procedure of a tax audit starts with the IRD reviewing a taxpayer’s financial records, including bank statements, receipts, and other financial documents. As mentioned before, the IRD often conducts an initial interview with the taxpayer to understand its background and business operation.

Then, the auditor will identify the tax issues or concerns and ask the taxpayer questions to clarify any discrepancies or inconsistencies in the records. Once the audit is complete, the IRD will issue a final assessment to the taxpayer demanding for tax underpaid, if any.

1. To collect taxpayers’ background information
2. To arrange an initial interview with the taxpayer
3. To issue a letter to the taxpayer requesting detailed information and documents, such as accounting records for the year(s) of assessment under investigation
4. To visit the taxpayer’s place of business and meet with senior management to understand their operation status
5. To obtain further information of taxpayers by the case assessor from third parties and other government departments
6. The case assessor will arrange a settlement interview with the taxpayer, negotiate resolutions on tax disputes, if any, and penalty level, if applicable, and try to reach a settlement agreement with the taxpayer
7. In the case of tax understatement, tax evasion and/or infringement of any tax laws/obligations, the case assessor will assess the assessable profits and tax that had been understated, if any, and impose a penalty on taxpayers
8. In the case of tax evasion, apart from imposing a penalty on taxpayers, the IRD may also transfer the subject case to the Department of Justice for criminal prosecutions (Note: Tax evasion is a criminal offence that is subject to a fine of $50,000, and treble the amount of the tax undercharged and 3-year imprisonment.)
9. To issue an assessment for additional tax payment and settle the case

Time required for a tax audit

The time required for completion of a tax audit depends on, amongst others, the complexity of the case and the volume of records involved. It could take several weeks, a few months or sometimes up to 2 or 3 years.

Should the IRD ask you to provide additional information, the length of the tax field audit can be substantially extended.

Tax field audit cases closed within 3 months of the initial interview’s date, or investigation cases closed within 6 months from the date of the initial interview are usually regarded as part of the category “Disclosure with Full Information Promptly on Challenge”. Hence, the taxpayer will be subject to a lower amount of penalty.

It is not uncommon that the IRD will impose penalties for the errors made by the taxpayers under the tax investigation. The scale of the penalty generally depends on various factors, such as the nature of the taxpayer’s omission or understatement of income or profit, the background and attitude of the taxpayer, the degree of the taxpayer’s cooperation and disclosure as well as the length of the offence period.

How HKWJ can help

If any irregularities in your tax affairs have come to your attention, or you worry that you may be investigated, it is vital to seek a tax lawyer as soon as possible.

A tax audit is a significant matter which may result in heavy additional tax liabilities and penalties, and even penal consequences, hence taxpayers should take the process seriously.

Moreover, a tax audit needs a lot of time and manpower, for which it is better to engage a professional tax lawyer.

Our tax professionals will listen to your situation to understand the full picture. We can assist in:

• attending the interviews with the tax assessor
• supplying relevant information, documents and grounds to the IRD
• negotiating the tax cases with the IRD to preserve your tax position
• developing and preparing a tax settlement proposal to reduce your tax burden as well as pleading no/lower level of penalties, if applicable.

We have wide experience in successfully handling tax field audits and investigations. We strongly recommend to consult with a tax professional or seek legal advice during the field audit process.

Contact us via the form below for a confidential initial consultation with our tax professionals.