To combat tax evasion, avoidance, and concealment, the Hong Kong Inland Revenue Department employs a "tax first, review later" assessment mechanism for taxpayers' tax returns and other supporting documents. The Inland Revenue Department leverages information technology to identify most cases that do not require review and then performs automatic assessments.
Reasons for Tax Audit or Investigation
A qualified opinion from the auditor on the company's accounts.
Industries with predominantly cash-based transactions.
Compared to the same industry, the company's turnover or profit is unreasonably low.
Past taxpayers have failed to file tax returns on time or at all.
The company has not maintained adequate business records.
The company engages in numerous local and cross-border transactions with related companies.
The company's profits have been consistently low or even at a loss, yet it continues to operate.
The company's profits have dropped significantly due to changes in its group structure.
The taxpayer has purchased valuable assets or injected large amounts of capital into its business, and the source of these funds is unclear.
Referral from other government departments or reports from third parties.
Random audits by the tax authorities.
The Inland Revenue Department (IRD) conducts tax audits or investigations on taxpayers for various reasons. When receiving an audit notice, it is recommended that taxpayers consult with a tax representative or professional accountant to identify the cause of the audit. This will help in finding more effective solutions.
3-Step Tax Audit Method
1. Desk Review
For cases assessed automatically by the system, assessors will review the selected risk categories and conduct a comprehensive review of the case. When clarification is required from the taxpayer, the assessors will issue a written inquiry, and the taxpayer must comply with the notice issued by the assessors.
2. On-site Audit
When signs of irregularities are found, the IRD will send personnel to conduct an on-site audit of the taxpayer's accounts and business operations to confirm the accuracy and completeness of the tax returns. The audit will begin with the most recent tax year and will calculate the discrepancies from previous tax years based on the results to determine the potential underreporting of profits.
3. Tax Investigation
When a taxpayer is suspected of tax evasion or more serious issues, the Inland Revenue Department will conduct a more in-depth investigation. The investigation typically covers the six tax years preceding the tax year in which the investigation begins. In cases involving fraud or intentional tax evasion, the investigation may extend to ten tax years prior.
Common Tax Assessment Methods:
1. Asset Betterment Method
2. Bank Account Analysis Method
3. Income Projection Method
Tax Investigation Process
Collecting and investigating the taxpayer's background information, including accounting records and bank records;
Initial meeting with the assessor;
The assessor conducts on-site inspections of relevant locations to understand the company's operations;
The assessor further collects and investigates the taxpayer's information;
The assessor negotiates solutions with the taxpayer regarding tax disputes and penalties to reach a consensus. If underreporting/tax evasion is discovered, penalties will be imposed or a supplementary assessment will be issued.
Imposing Penalties
If a taxpayer is involved in tax evasion, in addition to penalties, the case may be transferred to the Department of Justice for criminal prosecution (tax evasion is a criminal offense, punishable by a maximum penalty of HK$50,000, a fine of three times the amount of underpaid tax, and imprisonment for up to 3 years). The assessor will meet with the taxpayer again to negotiate a solution to the tax dispute and penalty issues, issue a supplementary assessment, and close the case.
If you receive a letter from the Hong Kong Inland Revenue Department notifying you or your company that you have been selected for a tax on-site audit or investigation, please contact us immediately for our professional advice. We are happy to provide you or your company with careful assistance.