Hong Kong businesses who file profits tax returns may be subject to IRD audits or investigation. This article provides background on IRD processes resulting in such audits or investigations and answers some of the most common questions which taxpayer businesses may have in respect of such audits and investigations. For specific advice on IRD audits or investigations and Hong Kong profits tax issues, please contact one of our tax lawyers.
Frequently Asked Questions
- What happens if a taxpayer fails to make an objection to the IRD’s assessment of tax or file an appeal to a determination of his objection to such an assessment?
- Is a taxpayer required to pay tax demanded in a notice of assessment (or a notice of additional assessment) pending the outcome of an objection?
- Can I appeal the decisions of the Inland Revenue Department to the courts instead of the Board of Review?
Every person carrying on any trade, profession or business in Hong Kong is liable each tax year to profits tax chargeable on all assessable profits (except profits arising from the sale of capital assets) arising in or derived from Hong Kong from such trade, profession or business. In this regard, unless the IRD requires an earlier return, within 4 months of the end of each financial basis period for each tax year (i.e. the 12-month period ending March 31, or where the annual accounts are made up to any day other than March 31, the 12-month period ended on that day), every person chargeable to profits tax must file a profits tax return with the Inland Revenue Department (“IRD”) to provide information about the person’s assessable profits arising during that period. Typically, the IRD will issue returns in blank to corporations and partnerships in early April and to individuals subject to profits tax in early May.
After receiving a profits tax return, the IRD may:
accept the return and assess tax accordingly, or
instead of accepting the return, estimate the sum which is chargeable to profits tax and assess tax accordingly.
Before or after assessing tax, the IRD may request additional information by giving notice requiring the provision of fuller or further returns. A request for additional information may arise because the IRD’s computer system, known as the Assess First Audit Later (“AFAL”) system, has selected the return for post assessment audit and investigation. The IRD enters all data in profits tax returns into the AFAL system and the AFAL system then selects a set of returns for possible follow-up based on criteria set by the IRD. IRD assessing officers may then select specific returns from the AFAL generated set of returns for audit and investigation.
Even after the IRD has assessed tax, it may impose an additional assessment if it takes the view that tax has not been assessed or has been assessed at less than the proper amount in respect of chargeable profits. Such an additional assessment aims to ensure the final tax burden is at such amount which the IRD considers ought to have been assessed. The power is retroactive so that the IRD may request additional information in respect of the current tax year as well as any tax year within the past 6 years or, if the IRD suspects fraud or willful evasion, within the past 10 years. As a result, an IRD’s request for additional information even after tax has been assessed and paid for a tax year carries with it the risk of additional tax being imposed.
1. How serious is a request for additional information by the IRD?
IRD’s requests for information broadly fall into 2 categories, namely audits and investigations. The category in which the request falls provides some indication of the seriousness of the situation but in each case, a taxpayer should remember that the IRD may escalate the nature of its enquiry depending upon the information which the taxpayer presents.
Audits may take the form of a desk audit or a field audit.
Desk audits call for written enquiries to seek clarification. In a desk audit, the assessing officer seeks to determine whether profits reported by a taxpayer in a return are correct, paying particular attention to risk areas which may have led to the return being selected.
Field audits are similar to desk audits except they call not only for written enquiries but also on-site visits of the taxpayer’s business premises. Field audits are normally initiated when the IRD identifies irregularities or evidence of possible non-compliance with the Inland Revenue Ordinance (“IRO”). Field audits typically focus on the most recent year of assessment for which a return has been submitted but may extend to prior tax years.
Investigations are in-depth examinations where tax evasion is suspected. An investigation is typically backward looking and aims to determine whether penal action should be taken. As investigations may arise from suspicion of fraud or willful evasion, they may look back as far as 10 years.
2. What powers does the IRD have to request information?
The IRD has wide ranging statutory powers to collect information.
The IRO empowers the IRD to give notice in writing to require a person in possession or control of information or documents which may affect a person's tax liability to furnish in such form and manner such information or documents within such reasonable time as is stated in such notice. For reasons of privacy, the IRD typically gives notice to the taxpayer directly but, subject to an exemption to protect legal professional privilege, the IRD’s power in fact extends to compelling persons other than the taxpayer (e.g. the taxpayer’s bank) to provide such information or documents.
Typically, the IRD will set a deadline of 1-2 months for a taxpayer to comply with the notice.
Note that the IRD already receives information about a taxpayer’s bank account balances through an automatic reporting system.
Similarly, the IRO empowers the IRD to give notice in writing to require a person to attend an interview and to answer truthfully all questions put to him in respect of any matter which may affect liability to tax. Again, the power extends to persons other than the taxpayer and may include, for example, directors and employees of the taxpayer.
The IRO empowers the IRD to give notice in writing to require a person to attend and be examined at the taxpayer’s business premises and to furnish and produce information and documents relevant to an assessment of tax liability. A site visit enables the IRD to form a view as to the size and nature of a taxpayer’s business, the method of operation of the business and the adequacy and nature of the accounting and book-keeping system of the business.
If there are reasonable grounds to suspect that a taxpayer has made an incorrect return or has supplied false information to understate chargeable profits and the taxpayer has not done so as a result of innocent oversight or omission, the IRD may apply to court for a warrant to authorize the IRD to forcibly enter the taxpayer’s premises (or any other premises where documents relevant to an assessment of tax liability may be found) without notice to search and seize documents material to assessing tax liability.
3. What are the consequences for failing to respond or failing to properly respond to IRD enquiries?
Where a company does not respond to an IRD’s request for additional information or, due to insufficient response, enquiries raised by the IRD remain unanswered, there is a risk that the IRD may assess tax in such amount as the IRD considers is justified based on the information available to the IRD at that time or impose an additional assessment of tax so that the taxpayer will bear tax liability in such amount as the IRD considers is justified based on the information available to the IRD at that time.
The risk of additional assessment is not limited to the tax year for which the IRD has requested additional information. Where a taxpayer’s response suggests incomplete disclosure giving rise to understatement of chargeable income, the IRD may expand the scope of its enquiry and may consider the possibility of fraud or willful evasion.
At the same time, a person who, without reasonable excuse, fails to comply with an IRD’s request for additional information1 or makes an incorrect return by omitting or understating anything or by making an incorrect statement in connection with a claim for any deduction may commit an offence and be liable to a fine. In the case of an incorrect return, the taxpayer may be subject to an additional fine equal to 3 times the amount of undercharged tax or additional tax equal to 3 times the amount of undercharged tax.
Where a taxpayer files an incorrect return willfully with intent to evade tax, the taxpayer may commit an offence and may be subject to a fine as well as imprisonment.
Given these consequences, it is in a taxpayer’s interest to properly resolve any outstanding IRD enquiries to minimize the risk of undesired tax liability and, in some cases, penalty, and for this purpose, taxpayer’s receiving IRD enquiries should seek professional advice as soon as possible.
4. Can a taxpayer get a time extension to respond to IRD enquiries?
Yes. It is possible to request an extension of time to respond to IRD enquiries. The request should be supported by proper justification. Where multiple time extensions have already been sought, the IRD may refuse the request on the basis that the request is a mere delaying tactic.
5. What happens if a company has not kept records responsive to the IRD’s questions?
The IRO requires every person carrying on a trade, profession or business in Hong Kong to keep sufficient records for a period of not less than 7 years after the completion of the transactions, acts or operations to which those records relate to enable its assessable profits to be readily ascertained. A person who, without reasonable excuse, fails to comply with this requirement commits an offence and is liable on conviction to a fine.
The absence of sufficient records may prompt the IRD to assess tax based on alternatives to these records. These alternatives may, for example, be based on changes in the value of the taxpayer’s assets, bank deposits or profiles of comparable businesses.
Changes of shareholders or management team are generally not accepted as reasonable excuse for non-compliance with this requirement.
6. How should a taxpayer prepare for an IRD audit or investigation?
A taxpayer is well advised to seek professional advice so that he understands the concerns which the IRD has raised and can thus understand whether those concerns are valid. A professional adviser can help determine whether IRD concerns are valid. If so, it may be in the taxpayer’s interest to discuss settlement of understated tax liability with the IRD. However, if the IRD’s concerns may not be valid, a professional adviser can help identify what information or documentation may be relevant and to present such information or documentation so as to best demonstrate the taxpayer’s compliance with relevant tax laws.
7. Is it possible to object to an assessment (or an additional assessment)?
Yes. A taxpayer may object to the IRD’s assessment of tax. Objections may be made by giving notice of such objection in writing, stating precisely the grounds of objection to the assessment. In the absence of special circumstances, to be valid, such notice must be received by the Commissioner of Inland Revenue (“Commissioner”) within 1 month after the date of the IRD’s notice of assessment.
The Commissioner will consider a valid notice of objection and may confirm, reduce, increase or annul the assessment in respect of which the objection is made. In considering an objection, the IRD may require the objecting taxpayer to provide additional information and produce all books or other documents in the taxpayer’s custody or control relating to the matter and summon any person who in the Commissioner’s opinion is able to give evidence in respect of the assessment to attend an in-person examination.
If the Commissioner agrees with the objection, the Commissioner may adjust the assessment. However, if the Commissioner does not agree with the objection, within 1 month after his determination of the objection, he must provide to the taxpayer written reasons for refusing the objection and a statement of facts upon which the determination was based. Within 1 month of his receipt of the Commissioner’s determination (or such longer period as the Board of Review may allow), the taxpayer may appeal the Commissioner’s determination to the Board of Review (see Question 11 below).
8. What happens if a taxpayer fails to make an objection to the IRD’s assessment of tax or file an appeal to a determination of his objection to such an assessment?
Where a taxpayer fails either to make an objection or to appeal a determination of an objection, the IRD’s original assessment is final and conclusive except that:
The IRD has the right to make an additional assessment.
A taxpayer may apply to the IRD for a refund on the basis of an error or omission in any return or statement submitted or any arithmetic error or omission in any calculation. Such an application may be made at any time within 6 years of a tax assessment or within 6 months of a notice of assessment, whichever is later. Where the IRD refuses the application, the taxpayer may object on the same basis as it may object to a notice of assessment.
A taxpayer may apply to the IRD for a refund on the basis that he has paid tax in excess of the amount with which he was properly chargeable. Such an application cannot remedy any fatal procedural error in filing an objection or an appeal and must be made within 6 years of a tax assessment or 6 months of a notice of assessment, whichever is later.
9. Is a taxpayer required to pay tax demanded in a notice of assessment (or a notice of additional assessment) pending the outcome of an objection?
Yes. The IRO provides that tax shall be paid notwithstanding any notice of objection, unless the Commissioner orders that payment of tax (or any part thereof) be held over pending the result of such objection.
In this latter regard, a taxpayer must apply to the Commissioner for holdover of tax pending the result of an objection. The Commissioner has the discretion to decide whether or not to grant the holdover. In granting a holdover, the Commissioner may at his discretion, require the company to provide security for payment of the amount held over by either purchasing a tax reserve certificate or furnishing a banker’s undertaking.
10. What is the Board of Review?
The Board of Review is an independent statutory body constituted under the IRO to hear and determine appeals in respect of determinations by the Commissioner of objections lodged by a taxpayer to a tax assessment.
11. When does a taxpayer need to file an appeal to the Board of Review?
The right of appeal to the Board of Review can be exercised if the taxpayer has objected to a tax assessment and the Commissioner does not agree with the objection. In the absence of special circumstances, an appeal to the Board of Review must normally be made in writing to the Board of Review within 1 month after the Commissioner’s written determination, reasons and statement of facts as set out in Question 7 above.
12. How does a taxpayer file an appeal to the Board of Review?
An appeal to the Board of Review is made by giving a notice of appeal to the Board of Review and copying the Commissioner. A notice of appeal must be accompanied by a statement of the grounds of appeal and a copy of the Commissioner’s reasons for determination and the Commissioner’s statement of facts. In arguing an appeal, except with the consent of the Board of Review, an appellant taxpayer may only rely on the grounds set out in the statement of grounds of appeal. Consequently, it is important to seek professional advice at an early stage to ensure that any grounds of appeal are properly formulated.
13. What is the procedure at an appeal before the Board of Review?
An appellant taxpayer must attend the appeal hearing in person or by an authorized representative.
As the appellant taxpayer bears the onus of proving that the assessment appealed against is excessive or incorrect, it is often desirable for the authorized representative to be legally trained so as to ensure that any legal argument can be properly raised and evidence appropriate to the legal arguments can be properly presented and so as to ensure compliance with technical legal principles and rules as to procedures.
The presiding person of the Board of Review may give directions on the provision of documents and information in the hearing of the appeal. Failure to follow these directions may result in the presiding person refusing to admit in evidence any document or information which is tendered in non-compliance with such directions.
14. What are the powers of the Board of Review?
After hearing the appeal, the Board of Review may confirm, reduce, increase or annul the assessment appealed against or may remit the case to the Commissioner with its opinion. Where a case is so remitted, the Commissioner will revise the assessment in accordance with the opinion of the Board of Review.
In the course of making its decision, the Board of Review may make determinations as to the facts. These determinations of fact cannot be reversed or varied by a court in any subsequent appeal unless the Court finds that the conclusion to be erroneous in point of law. Given these limitations on the court’s jurisdiction, it is important for appellant taxpayers to seek legal advice at the Board of Review stage to ensure that any facts will be presented to the Board of Review in such manner as would best result in the conclusions as to questions of facts which favour the appellants.
15. Can I appeal the decisions of the Inland Revenue Department to the courts instead of the Board of Review?
Though less common in practice, after giving notice of appeal to the Board of Review, an appellant taxpayer or the Commissioner may, by notice in writing to the other party, request an appeal against the Commissioner’s assessment to be transferred to the Court of First Instance for hearing and determination (i.e. not be heard and determined by the Board of Review). If the other party agrees to such request, the appeal will be so transmitted.
In practice, taxpayers normally prefer to have their tax affairs considered by the Board of Review (whose members may have more specialized tax and commercial knowledge and experience) to preserve confidentiality and avoid publicity.
16. Can a taxpayer appeal a decision made by the Board of Review to the courts?
A decision of the Board of Review is final but can be appealed on a question of law. Either the appellant taxpayer or the Commissioner may make an appeal but to do so, the appellant must apply to the Court of First Instance for leave (i.e. permission) to appeal within 1 month of the decision of the Board of Review or, if the decision is notified in writing, the date of the communication by which the decision is notified. The Court of First Instance will not grant leave unless it is satisfied that the proposed appeal involves a question of law and that either the proposed appeal has a reasonable prospect of success or there is some other reason in the interests of justice to hear the appeal.
If the Court of First Instance grants leave to appeal, it will hear and determine the substantive issue(s) of the appeal unless either the appellant taxpayer or the Commissioner obtains leave of the Court of Appeal to make the appeal directly to the Court of Appeal. The Court of Appeal may entertain an appeal directly to it on the basis, for example, of the amount of tax in dispute, the general or public importance of the matter or its extraordinary difficulty.
In hearing an appeal against the Board of Review’s decision, the Court of First Instance or the Court of Appeal may draw any inference of fact, confirm, reduce, increase or annul the assessment made by the Board of Review, or remit the matter back to the Board of Review with any directions (including a direction for a new hearing) that the Court thinks fit. However, the Court cannot receive any further evidence, or reverse or vary any conclusion made by the Board of Review on questions of fact unless the Court finds that the conclusion is erroneous in point of law.