Global Watch - Revised Departmental Interpretation and Practice Notes ("DIPN") No.10: Determining the source of employment 

Background
 
Time apportionment allows an employee with a "non-Hong Kong employment" to be taxed on income attributable to services in Hong Kong only.  This is calculated by taking the total income and reducing it pro-rata by the number of overseas days (working and a proportion of vacation days) in the tax year.
 
The "Three-factor Test"
 
It is not explicitly stated in the Inland Revenue Ordinance what constitutes a non-Hong Kong employment.  However, in the past, it was generally the IRD's practice to accept that a non-Hong Kong employment exists if the following three factors are present:

• The contract of employment was negotiated and entered into, and is enforceable outside Hong Kong;
• The employer is resident outside Hong Kong; and
• The employee's remuneration is paid outside Hong Kong.

In the past, the IRD has regarded the third condition above as being less important than the first two conditions.  Where the IRD has been satisfied that an overseas contract with a non-Hong Kong resident employer exists, this has, generally, outweighed the payment of remuneration taking place in Hong Kong.
 
The IRD recognises that the simplicity of these three main conditions could enable a non-Hong Kong employment to be created in form where, in substance, the employment is a Hong Kong employment.  The IRD, therefore, has the right to review the "totality of facts" of the case if it deems this to be necessary or appropriate.
 
Revised DIPN 10
 
In the revised DIPN 10, the IRD emphasised that the above three factors will remain as major factors in determining source of employment.  In addition, they will also review "totality of facts" approach which may include but not limited to the following:

• whether the employment contract supports the locality of employment to be offshore.  If no employment contract exists, the IRD would require a document from the employer certifying the terms of appointment, the effective date of the appointment, etc. to be signed by both parties;
   
• whether the employer carries on business in Hong Kong;
   
• where is the employee's immediate supervisor based and what is the location of the person who conducts appraisals and determines remuneration for the employee;
   
• where are the employee's immediate subordinates based;
   
• who is the employer indicated on other declarations made by or for the employee in Hong Kong.  The IRD has pointed to declaration forms submitted to other government bureaux (including the Immigration Department and Securities & Futures Commission) as evidence that the individual is employed by the Hong Kong entity (which coincides with the decision in the Board of Review case No.35/05).

Observation
 
Though the revised DIPN 10 emphasised the three factors are still the main factors in determining time apportionment claim, it would not be uncommon for the IRD to expand their scope of review to other factors.  Since the issuance of the last DIPN 10 version in 1987, the Board of Review had heard over 30 cases on the source of employment.  While most Boards had taken into account the three factors in their decision, some Boards had expressed the view that the 1987 revision was inaccurate and misleading to the three factor test and contrary to the "totality of facts" test set out by MacDougall, J. in the Goepfert decision (which remains the highest authority in determining locality of employment for Hong Kong salaries tax purpose).
 
Whilst time apportionment claims are still possible in appropriate circumstances, the IRD will look deeper than the external or superficial features of the employment, whether relating to the three main factors or other supporting factors.  Where a negative factor (i.e. a factor that indicates the existence of a Hong Kong employment) is identified, the time apportionment claim may be challenged, even though the three main factors may have been satisfied.
 
Therefore, the "form" is as equally important as the "substance" for a successful time apportionment claim.  Employers need to look closely at their administrative procedures for transferring employees to Hong Kong and ensure that all relevant documentation consistently reflects the ongoing overseas employment.
   
Note: This bulletin is designed for the information of readers.  Whilst every effort has been made to ensure accuracy, information contained in this bulletin may not be comprehensive or may not yet be passed into law.  Recipients should not act upon it without seeking professional advice.