Are your business transactions designed to minimize tax or to achieve genuine commercial objectives? In Hong Kong’s low-tax environment, this distinction matters more than ever. The Inland Revenue Department (IRD) is increasingly wielding powerful anti-avoidance rules to challenge arrangements that lack commercial substance, with audit outcomes that can devastate unprepared taxpayers. Understanding how Sections 61, 61A, and 61B of the Inland Revenue Ordinance work in practice is no longer optional—it’s essential for every business operating in Hong Kong.

Hong Kong’s Anti-Avoidance Framework: More Than Just Rules

Hong Kong maintains its competitive edge with low tax rates—corporations pay just 8.25% on their first HK$2 million of profits and 16.5% on the remainder—while implementing robust anti-avoidance provisions. The IRD has significantly ramped up enforcement, using these rules to challenge transactions that appear primarily motivated by tax considerations rather than genuine business needs. For taxpayers and advisors, understanding how these provisions affect audit outcomes is critical to maintaining compliance and avoiding devastating penalties.

The Legislative Arsenal: Sections 61, 61A, and 61B

Hong Kong’s anti-avoidance framework is codified in the Inland Revenue Ordinance (Cap. 112), with three key provisions forming the cornerstone of the IRD’s enforcement powers. Unlike many jurisdictions with a single general anti-avoidance rule, Hong Kong operates a dual GAAR system supplemented by specific provisions targeting particular transaction types.

Section 61A: The IRD’s Primary Weapon

Section 61A is Hong Kong’s comprehensive general anti-avoidance rule, providing the IRD with significant flexibility to address tax avoidance schemes. This provision applies the “sole or dominant purpose test,” examining seven statutory factors to determine whether a transaction was entered into primarily to obtain a tax benefit.

The Seven Statutory Factors Under Section 61A

Enhanced IRD Powers Under Section 61A

The critical distinction between Section 61 and Section 61A lies in the remedies available. Under Section 61A, the Commissioner has two powerful options:

1. Disregard the Transaction: Treat the transaction as if it never occurred (similar to Section 61)
2. Substitute with Hypothetical Transaction: Replace the actual transaction with a reasonable postulated alternative, typically an arm’s length transaction that would have been entered into absent tax considerations

Recent Case Studies: How Anti-Avoidance Rules Play Out

The 2024 BVI Management Company Case

A significant September 2024 case illustrates how the IRD applies Section 61A in practice. The taxpayer, engaged in manufacturing and trading fabric and yarn, appointed a BVI company as its management agent. The IRD successfully argued the BVI company was interposed with the sole or dominant purpose of siphoning off profits to avoid Hong Kong taxation.

• Management agreement provided for service fees “at a fixed rate or any other rate as may be mutually agreed upon”
• Amounts claimed for deduction were not calculated according to written agreement terms
• BVI entity had questionable commercial substance and operations
• Taxpayer failed to demonstrate genuine commercial rationale beyond tax savings

Patrick Cox Asia Limited v Commissioner (2024)

The Court of Appeal’s October 2024 judgment in this trademark sub-licensing case has important implications for source analysis and anti-avoidance considerations. The court held upfront payments under trademark sub-licensing arrangements to be revenue in nature and Hong Kong sourced, demonstrating judicial scrutiny of arrangements designed to shift income offshore.

Audit Red Flags That Trigger Anti-Avoidance Scrutiny

The Burden of Proof: Why Documentation Matters

A critical aspect affecting audit outcomes is the statutory burden of proof. Under Hong Kong tax law, the taxpayer bears the burden of proving that any tax assessment is incorrect or excessive. There is no corresponding burden on the IRD to prove that its assessment is correct.

2024-2025 Developments: Expanding Anti-Avoidance Scope

Global Minimum Tax and Domestic Minimum Top-Up Tax

Significant developments in 2024-2025 extended Hong Kong’s anti-avoidance framework to new international tax regimes. The Inland Revenue (Amendment) (Minimum Tax for Multinational Enterprise Groups) Bill was enacted on June 6, 2025, implementing:

• GloBE Rules: Global anti-base erosion rules aligned with OECD Pillar Two
• HKMTT: Hong Kong Minimum Top-Up Tax for multinational enterprise groups with revenue ≥ EUR 750 million
• Modified Section 61A Application: The sole or dominant purpose test applies, with modifications, to these new regimes as their GAAR

Foreign-Sourced Income Exemption (FSIE) Regime

Hong Kong’s foreign-sourced income exemption regime for dividends, interest, disposal gains, and IP income (expanded in January 2024) also incorporates anti-avoidance protections. Specific anti-abuse rules apply to the participation exemption, and Sections 61 and 61A continue to apply to FSIE cases. Audits increasingly focus on whether offshore structures claiming FSIE benefits have genuine economic substance in Hong Kong.

Practical Strategies for Audit Defense

Building Commercial Substance

To withstand IRD scrutiny under anti-avoidance provisions, focus on demonstrating genuine commercial substance:

• Business Rationale: Document non-tax commercial reasons for transaction structures
• Economic Substance: Ensure entities involved have genuine operations, employees, assets, and decision-making authority
• Arm’s Length Pricing: Support related party transactions with transfer pricing documentation
• Contractual Compliance: Ensure actual practices align with written agreements
• Contemporaneous Documentation: Maintain real-time records of business decisions and rationale

Documentation Best Practices

Penalty Considerations and Commissioner’s Powers

When the IRD invokes anti-avoidance provisions, the Commissioner possesses broad discretionary powers with significant financial implications:

• Additional Tax (Penalties): If Section 61A applies, the IRD can levy additional tax of up to three times the under-charged amount
• Protective Assessments: The Commissioner may issue assessments for very large amounts to secure tax pending appeal
• Holdover Discretion: The Commissioner has discretion whether to grant holdover of tax pending objection, and may require security (tax reserve certificates or bank guarantees)
• Interest Charges: From July 2025, interest on held-over tax is charged at 8.25%

In Hong Kong’s evolving tax landscape, anti-avoidance rules are no longer theoretical provisions—they’re actively enforced tools that can dramatically impact audit outcomes. The key to successful navigation lies in building genuine commercial substance, maintaining comprehensive documentation, and understanding that tax minimization must always be secondary to legitimate business objectives. As international tax cooperation increases and the IRD’s enforcement capabilities grow, proactive compliance is your best defense against costly audit challenges.