Computation of business profits
The Comprehensive Arrangement does not expressly specify the
method for computing business profits, but instead sets out some principles which must be followed. Both Sides may compute profits in accordance with their own relevant domestic law, provided that such principles are followed. In Hong Kong, assessable profits are based on profits computed by enterprises in accordance with the prevailing generally accepted principles of commercial
accounting as adjusted in conformity with the provisions of the Ordinance.
The principles stipulated in the Comprehensive Arrangement are set
out in paragraphs 2 and 3 of Article 7. Paragraph 2 stipulates that a permanent establishment will be considered as a distinct and separate enterprise, while paragraph 3 contains provisions in relation to the deduction of expenses and the
treatment of income.
Where a permanent establishment situated in the Other Side carries
on business with the head office or other offices of the enterprise of which it is a permanent establishment, it should do so in accordance with the arm’s length principle as between two entirely independent enterprises engaged in the same or similar activities. There will in each Side be attributed to that permanent establishment the profits which it might be expected to make under such conditions. For information concerning transfer pricing and the arm’s length principle, see the relevant Departmental Interpretation and Practice Notes
issued by the Inland Revenue Department.
In computing the profits of a permanent establishment, there will be
allowed as deductions expenses (wherever incurred) that are incurred for the purposes of producing the relevant profits, including executive and general administrative expenses so incurred (including a reasonable share of the administrative expenses of the head office). Relevant expenses which can be clearly attributed to that permanent establishment can be deducted. Otherwise, an allocation of the relevant expenses should be made. The allocation can be based on the proportion of the business turnover or gross profit of the permanent establishment to that of the enterprise. The resultant expenses will be considered as the expenses actually incurred by the permanent establishment,
though possibly not the amount actually paid by it.