Hong Kong Manufacturing & Factory Tax — Expert Advisory

DIPN 21 (IRD Practice Note 21) provides that where a HK company carries on manufacturing through a mainland factory, and the HK company performs both buying (procurement) and selling activities while the factory performs production, 50% of the profits may be treated as offshore-sourced (manufacturing profit) and not subject to HK profits tax. The remaining 50% (trading profit) is taxable in HK. This requires genuine commercial substance in both HK and Mainland activities.

To qualify for the 50% offshore profit split, the HK company should genuinely perform: (1) Buying activities — supplier selection, price negotiation, quality standards, purchase contracts; (2) Selling activities — customer acquisition, sales negotiation, marketing, delivery terms. These activities must be conducted by HK staff or management and should be documented. Merely having a HK registered office while all activities are done in Mainland will not qualify.

Generally no. Capital allowances under the HK IRO apply to plant & machinery used in a HK trade or business. Factory equipment located in Mainland China and used in the Mainland factory operations is not eligible for HK capital allowances. However, any equipment used in the HK trading operations (office equipment, computers, display models) qualifies for HK capital allowances.

Warranty costs can be deducted when the liability crystallises (i.e., when the warranty claim is made and the cost is incurred). General warranty provisions made before claims are received are not deductible for HK tax purposes — the IRD requires an ascertained liability, not a general provision. Some manufacturers use historical claim data to argue for provisioning, but this is subject to IRD scrutiny.

Under HK's transfer pricing rules (Part 9A IRO, effective 2019), substantial transactions with related overseas parties require contemporaneous transfer pricing documentation if the entity exceeds certain thresholds (annual turnover >HKD 400M or cross-border related party transactions >HKD 220M). The documentation should establish that intercompany prices are at arm's length using one of the approved OECD methods. Smaller manufacturers should maintain basic documentation even if not legally required.