Post on 17-Mar-2018
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THE HONG KONG INSTITUTE OF CHARTERED SECRETARIES
THE INSTITUTE OF CHARTERED SECRETARIES AND
ADMINISTRATORS
International Qualifying Scheme Examination
HONG KONG TAXATION
DECEMBER 2012
Suggested Answer
The suggested answers are published for the purpose of assisting students in their
understanding of the possible principles, analysis or arguments that may be identified in
each question
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SECTION A
1.
Lifestyle Limited carries on a manufacturing and trading business in Hong Kong. The
company’s income statement for the year ended 31 March 2012 showed net income of
$7,200,000 which is after taking into account the following items:
Income: Note $
Dividend from a Hong Kong listed company 16,000
Interest income 1 85,000
Proceeds from assignment of rental income 2 900,000
Profit on disposal of patent 3 140,000
Expenses:
Bad debts 4 208,000
Contribution to retirement scheme 5 1,543,000
Depreciation 473,000
Donation 6 50,000
Exchange differences 7 41,000
Interest expenses 8 142,000
Legal and professional fees 9 100,000
Profits tax 785,000
Notes to the accounts:
1. Interest income: $
Interest on deposits placed with Hang Seng Bank in Hong Kong 32,000
Interest on deposits placed with HSBC in Singapore 48,000
Interest on tax reserve certificate 5,000
85,000
2. The company let a commercial unit in Kwun Tong to a tenant at $30,000 per month from April 2011 onwards for a fixed term of three years, and assigned the right to receive rental income under the lease to a finance company for $900,000. This amount was immediately recognised in the income statement.
3. The company acquired a patent 10 years ago for use in the production process at a cost of $300,000. The patent was disposed during the year for $440,000 and a gain of $140,000 was recognised in the accounts.
4. Bad debts expenses: Increase in allowance for doubtful trade accounts for which recovery action has been taken in vain
70,000 Increase in allowance for doubtful accounts based on 2% of the trade debts outstanding
26,000
Trade debts written off 112,000
208,000
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5. Contribution to recognised retirement scheme:
Contribution for employees (at 10% of salaries) 1,260,000
Contribution for directors (at 20% of directors’ fees) 300,000
Refund from the scheme for employees who have left the
company
(17,000)
1,543,000
6. The company has donated products with book value of $50,000 to an elderly care
home which is an approved charity in Hong Kong.
7. Exchange differences:
Exchange loss on conversion of foreign currency time deposits 22,000
Exchange loss on collecting trade debts 19,000
41,000
8. Interest expenses:
Bank interest paid to HSBC in Hong Kong* 97,000
Loan interest paid to a shareholder (unsecured) 45,000
142,000
* The borrowing was secured by the deposits placed with the same bank in Singapore
(see note 1 above) and personal guarantees given by the shareholders. At all material
times, the borrowing was greater than the amount of deposits.
9. Legal and professional fees:
Fees for annual audit and tax filing 60,000
Legal fees for new lease (see note 2 above) 3,000
Other (allowable) 37,000
100,000
Additional note:
Total depreciation allowances agreed with the Assessor for the year are $330,000.
Additional information:
The company plans to set up a branch in Mainland China to sell its products in the
Mainland. While the solicitation and negotiation of contracts will be conducted in the
Mainland, the production will continue be carried out in Hong Kong. The board of directors
would like to know if the profits from such sales could be claimed as offshore income. The
board understands that setting up a branch in the Mainland will create tax exposure under
the Corporate Income Tax Law in the Mainland. However, protection or relief is available
to a Hong Kong company under The Arrangement between the Mainland of China and the
Hong Kong SAR for the Avoidance of Double Taxation and the Prevention of Fiscal
Evasion with respect to Taxes on Income (Mainland/HK CDTA).
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REQUIRED:
1. (a) Prepare the Hong Kong profits tax computation for Lifestyle Limited for the
year of assessment 2011/12. Ignore provisional tax.
Ans (a) Lifestyle Limited
Profits tax computation
Year of assessment 2011/12
Basis period: Year ended 31 March 2012 (Section 18B(1))
$ $
Profit per accounts 7,200,000
Add: Depreciation 473,000
Donation in kind 50,000
Profits tax 785,000
Sales proceeds of patent 300,000
Increase in general allowance for doubtful
debts
26,000
Excess contribution for directors ($300,000 x
5%/20%)
75,000
Exchange loss on converting time deposits 22,000
Bank interest to HSBC 48,000
Loan interest to a shareholder 45,000
Legal fee for new lease 3,000 1,827,000
9,027,000
Less: Dividends (16,000)
Interest on deposits - Hang Seng Bank (32,000)
Interest on deposits - HSBC (48,000)
Interest on tax reserve certificate (5,000)
Profits on sale of patent (140,000) (241,000)
8,786,000
Less: Depreciation allowances (330,000)
Assessable profit 8,456,000
Profits tax payable at 16.5% 1,395,240
Less: Tax reduction (75%, max $12,000) (12,000)
Final profits tax payable 1,383,240
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1. (b) Analyse the proper tax treatments for all items given in notes 1 to 9 above.
Ans (b) Interest income
Interest income received or accrued to a corporation is taxable under section
15(1)(f) if the person carries on a business in Hong Kong and the interest
income is arising from Hong Kong
Lifestyle Limited carries on business in Hong Kong
Interest on deposit placed with Hang Seng Bank is sourced in Hong Kong
and chargeable to profits tax
However, interest can be exempt because the deposits were placed with a
financial institution in Hong Kong and they were not used to secure any bank
borrowing
Interest on deposits placed with HSBC in Singapore was sourced outside
Hong Kong and is not taxable
Interest on tax reserve certificates is exempt under section 26A(a)
Assignment of rental income
Sum received by a person as consideration in respect of the transfer of a
right to receive taxable rental income is deemed to be a taxable trading
receipt under sections 15(1)(m) and 15A unless the ownership of the
property is also transferred
$900,000 received by Lifestyle Limited is taxable
Disposal of patent
The cost of purchasing the patent should have been deducted under section
16E(1) when it was acquired 10 years ago
The sale proceeds are deemed to be a taxable receipt under section 16E(3)
Effective 2011/12, the taxable receipt is restricted to the deduction previously
claimed, i.e. $300,000 only
Bad debts expenses
Trade debts written off are deductible under section 16(1)(d) if they are
proved to have become bad and were included as taxable trading receipts
Allowance based on 2% of trade debts outstanding is not regarded as
“incurred” and cannot be deducted
Where recovery action has been taken on trade debts in vain, it can be
estimated to the satisfaction of the assessor that they have become bad and
are deductible
Contribution to retirement scheme
Annual contribution to recognised retirement scheme can be deducted up to
15% of the total emolument of the employee by virtue of section 17(1)(h)
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Contribution for the employees is not excessive and can be deducted in full
Contribution for the directors has to be reduced to the 15% limit
Refund from recognised retirement scheme is deemed to be taxable receipts
under section 15(1)(h) to the extent that the relevant contribution has been
allowed as a deduction
Donation
Donation to approved institution must be in money, not in kind
Donation of products is not “money” and cannot be deducted under section
16D
Exchange differences
Time deposits are capital investment of a company (CIR v Li & Fung);
exchange loss on conversion of foreign currency deposits is capital in nature
and not deductible
Exchange loss on collecting trade debts is revenue loss and deductible
Interest expenses
To be deductible, interest expenses must be incurred in the production of
chargeable profits under section 16(1)(a)
Bank interest paid to HSBC is interest on money borrowed from a financial
institution and satisfies the condition under section 16(2)(d)
Under the secured loan test, the borrowing was secured by deposits placed
in Singapore generating non-taxable interest income
Deduction has to be reduced by the amount of tax-free interest income by
virtue of section 16(2A); only $49,000 ($97,000 - $48,000) can be deducted
The shareholder loan was borrowed from a person other than a financial
institution and section 16(2)(c) has to be considered
Since the shareholder is likely not to be liable to profits tax for the interest
income received, the condition under section 16(2)(c) cannot be fulfilled and
no deduction is allowed
Legal and professional fees
Fees for annual audit and submission of tax return were incurred in the
normal course of business to discharge normal legal obligations of a taxpayer
and with a view to earn profit; they are deductible expenses
Fee for preparing new tenancy agreement is of a capital nature and
non-deductible
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1. (c) Advise the board on the Hong Kong issues relating to the plan of setting up
a branch in the Mainland and the protection or relief available under the
Mainland/HK CDTA .
Ans (c) Under section 14(1), a person is chargeable to profits tax if he carries on a
business in Hong Kong and the profits arise in or are derived from Hong
Kong
Only operations which directly produce the profits are relevant; one should
focus on the effective causes for earning the profits, activities that are
antecedent or incidental can be ignored
Although the sales contracts are effected outside Hong Kong, it is likely that
the IRD would regard the production process in Hong Kong to be the
profit-making activities
All the profits from selling the goods to customers in the Mainland would likely
be chargeable to Hong Kong profits tax
Under Article 7 of the Arrangement between the Mainland of China and the
Hong Kong SAR for the Avoidance of Double Taxation and the Prevention of
Fiscal Evasion with respect to Taxes on Income, the profits of a Hong Kong
enterprise shall be taxable only in Hong Kong unless the enterprise carries
on business in the Mainland through a permanent establishment situated
therein
However, in such a case only the profits attributable to that permanent
establishment may also be taxed in the Mainland
The term “permanent establishment” is provided in Article 5 to mean a fixed
place of business through which the business of an enterprise is wholly or
partly carried on
It also includes especially a place of management; a branch; an office; a
factory; a workshop; a mine, an oil or gas well, a quarry or any other place of
extraction of natural resources
If Lifestyle Limited sets up a branch in the Mainland selling its products, this
likely constitutes a permanent establishment and the profits attributable to the
branch will be subject to corporate income tax in the Mainland
To eliminate any double taxation, tax paid in the Mainland by a Hong Kong
resident shall be allowed as a credit against Hong Kong profits tax under
Article 21 if the profit is subject to Hong Kong profits tax.
However, the amount of the tax credit shall not exceed the amount of Hong
Kong tax on such profits computed in accordance with the tax laws and
regulations in Hong Kong
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SECTION B
2.
Henry Bao is the Vice-president - Engineering of Sapphire Limited (Sapphire), a company
carrying on business in Hong Kong. He provides you with the following information relating
to the year ended 31 March 2012:
1. He received a monthly salary of $50,000 for the year, and a discretionary bonus of
$85,000.
2. He was provided with company quarters at a nominal rent of $3,000 per month. He
also paid the management fee of $13,200 for the year.
3. He received a holiday package for his home trip to Taiwan, which was purchased by
Sapphire from Wing On Travel Agency for $10,000. The package can be redeemed for
cash after deducting a handling charge of $2,000.
4. He engaged a domestic helper at a monthly salary of $5,000 which was paid by
Sapphire on his behalf.
5. He was enrolled in Sapphire’s MPF-exempt retirement scheme. During the year, he
has made contribution at 5% of his monthly salary to the retirement scheme.
6. He was also enrolled in Sapphire’s group medical insurance scheme. During the
year, he obtained a medical refund of $8,000 from the insurance company, and
another $3,000 which was not covered by the insurance from Sapphire pursuant to the
terms of his employment.
7. On 1 April 2011, he was awarded 50,000 shares in Sapphire. The shares were vested
on him immediately with a sales restriction period of one year from the date of the
award. On 10 December 2011, he received dividend income of $5,000 from these
shares. He sold all these shares in the market on 15 May 2012.
8. On 2 February 2012, he was granted an option to subscribe for 100,000 shares in
Sapphire at a $3 per share. This share option was granted without condition. He sold
one half of the option on 9 March 2012 and received $180,000.
9. During the year, Henry paid a membership subscription of $1,900 to the Hong Kong
Institution of Engineers. He also paid $3,000 to attend continuing professional
development seminars organised by the Institution.
10. Henry is married and his wife, Annie, is a housewife. They have a son, aged 20,
attending university in the US. Annie’s parents, aged 57 and 63, reside in Hong Kong.
Annie paid them $6,000 per month in support of their living.
In September 2012, Henry was approached by a head-hunter and was offered a three-year
contract to work in a company based in Singapore. Henry resigned from Sapphire effective
from 1 December 2012 and will permanently leave Hong Kong by early January 2013. He
has not yet exercised the remaining share option mentioned in note 8 above.
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Sapphire’s shares were quoted on the stock exchange at the following prices on the
following dates:
1 April 2011 $6.00
2 February 2012 $8.00
9 March 2012 $7.00
1 April 2012 $7.50
15 May 2012 $7.20
30 November 2012 $6.50
REQUIRED:
2. (a) Prepare the Hong Kong salaries tax computation for Henry Bao for the
year of assessment 2011/12. Ignore provisional tax.
Ans (a) Henry Bao
Salaries tax computation
Year of assessment 2011/12 $ $
Salary ($50,000 x 12) 600,000
Bonus 85,000
Holiday journey 10,000
Salary of domestic helper ($5,000 x 12) 60,000
Medical refund 3,000
Share award (50,000 x $6 x 0.95) 285,000
1,043,000
Rental value [($1,043,000 - $1,900) x 0.1] 104,110
Less: Rent suffered ($3,000 x 12 + $13,200) (49,200) 54,910
Share option gain - Assignment 180,000
1,277,910
Less: Membership subscription (1,900)
Self-education expenses (3,000) (4,900)
1,273,010
Less: Contribution to retirement scheme (12,000)
1,261,010
Less: Personal allowances
Married person's allowance (216,000)
Child allowance (60,000)
Dependent parent allowance - aged 63 (36,000)
Dependent parent allowance - aged 57 (18,000) (330,000)
Net chargeable income 931,010
Salaries tax payable at progressive rates
146,271
Less: Tax reduction (75%, max $12,000) (12,000)
Final salaries tax payable
134,271
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2. (b) Advise Henry on the Hong Kong salaries tax treatment of the share-based
benefits received by him (notes 7 and 8), including the possible treatment
of dividends received during the sales restriction period and the share
option which has not yet been exercised, by reference to the assessing
practice of the Inland Revenue Department.
Ans (b) Shares obtained through share-based remuneration are taxable perquisites
under section 9(1)(a) forming part of a taxpayer’s employment income
According to DIPN No. 38, the 50,000 shares awarded to Henry will be
assessed to tax at the time of grant by the employer because the shares
were immediately vested in him (the upfront approach)
Market value at the time of grant will be used for valuation purposes
A 5% discount in valuation generally will be allowed as there is a one-year
sale restriction period
Dividends received during the restriction period are regarded as investment
income and are not taxable
For the share option, any gain realised on its exercise, assignment or
release will be subject to salaries tax under section 9(1)(d)
For the assignment of one half of the option on 9 March 2012, the taxable
amount is the consideration received; the market value is irrelevant
With a view to finalising the salaries tax liability of a person who is departing
permanently from Hong Kong, the IRD will, as a concession, allow him to
elect to have the liability ascertained on the basis of a notional exercise of
the option
Any tax liability can be finalised on the basis of the gain that would have
been realised if the option had been exercised on a day within seven days
before the date of submission of the person’s tax return for the final
assessment applicable to the year of assessment in which he permanently
departs from Hong Kong
As a further concession, the IRD will accept an election made within three
months from the date of permanent departure from Hong Kong if it has not
been made before departure; the date of departure will be taken as the date
of the notional exercise for calculating the gain in such case
No further liability will arise when the option is actually exercised, assigned
or released after his departure from Hong Kong
However, if it transpires that the gain in respect of the actual exercise, etc.
is less than the amount assessed in respect of the notional exercise, the
IRD will favourably consider any application for appropriate amendment
and re-assessment
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3.
Benson Wong is the sole beneficial owner of Ocean Limited, which in turn wholly owns
Reef Limited and partly owns Coral Limited. All companies are incorporated in Hong Kong.
The group structure is as follows:
REQUIRED:
Analyse the Hong Kong stamp duty implications arising from the following transactions
which have taken place during the year ended 31 December 2012. You should compute
the stamp duty payable where applicable and clearly identify the relevant charging heads.
3. (a) On 1 February 2012, Ocean Limited sold Property A, a shopping unit in
Causeway Bay, to Reef Limited for a consideration of HK$20 million. Reef
Limited financed the purchase consideration by borrowing $10 million from the
Bank of East Asia.
On 1 March 2012, Reef Limited let out Property A for a term of two years at a
fixed monthly rent of $50,000 plus a variable rent computed at 1% of the
turnover of the shop. The total monthly rent is not to exceed $70,000. The lease
was executed in duplicate.
Ans (a) The conveyance of immovable property in Hong Kong is chargeable to
stamp duty under Head 1(1)
Reef Limited is wholly owned by Ocean Limited and they fall within the
definition of associated bodies corporate; exemption from stamp duty can
be sought under section 45 for the transfer between associated bodies
corporate
100% 80%
Benson Wong
Reef Limited Coral Limited
100%
Ocean Limited
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Corporations are associated if one is the beneficial owner of not less than
90% of the issued share capital of the other
Section 45(5A) provides that exemption shall not apply if the instruments
are executed in connection with an arrangement under which part of the
consideration is provided by a person other than an associated body
corporate of the transferor or transferee
Although the consideration was partly provided by the bank, the Collector of
Stamp Revenue accepts that exemption will not be denied if the loan is
made in the ordinary course of the bank’s business and the bank does not
obtain any rights over the property other than as security
An agreement for the lease of immovable property in Hong Kong is subject
to stamp duty under Head 1(2)
Based on the contingency principle, if the consideration payable under an
instrument is uncertain at the time of its execution, stamp duty is chargeable
on the maximum of any specified amount
Rate for a lease of more than one year but less than three years is 0.5%
Stamp duty payable is: $70,000 (maximum) x 12 x 0.5% = $4,200
The duplicate copy is stampable at $5 under Head 4
3. (b) On 5 April 2012, Reef Limited executed a deed to transfer Property B, a
residential property in Quarry Bay which has been held by Reef Limited for five
years, to Coral Limited at a consideration of $7 million. The market value of the
property was $7.5 million on that date.
On 20 October 2012, Coral Limited signed a provisional sale and purchase
agreement to sell Property B to a third party at the fair market value of $9
million. The formal sale and purchase agreement was signed on 1 November
2012 and the assignment deed was executed on 1 December 2012.
Ans (b) Reef Limited and Carol Limited are not associated bodies corporate and no
exemption is available
As the stated consideration is below market value, the transaction is treated
as a voluntary deposition inter vivos and stamp duty is charged at the full
market value
Stamp duty payable under Head 1(1) is: $7.5 million x 3.75% = $281,250
The provisional sale and purchase agreement of residential property would
be subject to stamp duty under Head 1(1A)
However, it was superseded by the formal sale and purchase agreement
within 14 days and the later became the dutiable instrument
Stamp duty payable is: $9 million x 3.75% = $337,500
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If the sale and purchase agreement is duly stamped, the deed of
assignment will be subject to stamp duty of $100 only under Head 1(1)
Since the property was acquired by Coral Limited on or after 20 November
2010 and was disposed of with 24 months of the date of acquisition, special
stamp duty is payable under Head 1(1B)
The rate is 10% as the property has been held for six months or more but
less than 12 months
Special stamp duty is: $9 million x 10% = $900,000
3. (c) On 3 December 2012, Ocean Limited sold 15% of its shareholding in Reef
Limited to a third party at a consideration of $15 million.
Ans (c) Transfer of shares in a Hong Kong company must be registered in Hong
Kong and hence chargeable to stamp duty under Head 2(1)
Stamp duty payable is: $15 million x 0.2% = $30,000
A fixed duty of $5 is payable for the instrument of transfer under Head 2(4)
After the disposal of the 15% interest in Reef Limited, Ocean Limited and
Reef Limited ceased to be associated bodies corporate
Section 45(4)(a) provides that a stamp duty exemption will be withdrawn if
the transferor and the transferee cease to be associated due to a change in
shareholding in the transferee within two years following the date of transfer
Hence, stamp duty must be paid for the conveyance of Property A from
Ocean Limited to Reef Limited
Stamp duty is: $20 million x 3.75% = $750,000
The Collector shall be notified within 30 days of such cessation
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4.
Barry Tong received a notice of estimated profits tax assessment in respect of his sole
proprietorship business, Barry & Co., in which profits of $1,000,000 was assessed for the
year of assessment 2011/12. The notice was dated 20 November 2012. Barry has not
submitted a tax return for the year and he noted that the estimated profit was more than his
actual profit earned. Therefore, he came to your office for advice.
After meeting Barry, you have ascertained the following information:
1. The accounting profits of Barry & Co. for the year ended 31 March 2012 was
$550,000. This figure was arrived at after charging the following items:
(i) salary paid to Barry of $360,000;
(ii) mandatory contribution to MPF scheme for Barry of $18,000; and
(iii) donation of moon cake costing $8,000 to an elderly centre operated by Tung
Wah Group of Hospitals, an approved charitable institution.
2. Barry also carries on a partnership business (named “Leung Tong Kee”) with
Fanny Leung, sharing profits or losses equally. During the year ended 31
December 2011, the agreed tax loss of the partnership is $340,000.
3. Barry solely-owned a property in Lam Tin which was acquired in January 2011 and
let out for rental income from 1 March 2011 onwards for a term of two years at a
monthly rent of $12,000. A lease premium of $50,000 was received from the
tenant. Barry paid Government rent and mortgage loan interest of $4,300 and
$97,000 respectively for the year ended 31 March 2012 in respect of this property.
He also spent $7,000 to replace the window damaged by typhoon in September
2011.
4. Barry is single and ordinarily resides in Hong Kong. His mother, aged 70, resides
in a registered elderly care home. During the year, her residential fee of $80,000
was paid by Barry.
REQUIRED:
4. (a) (i) Without any computation, explain whether it is advantageous for
Barry Tong to elect for personal assessment for the year of assessment
2011/12.
Ans (a) (i) Because there is a share of partnership loss and unrelieved mortgage
interest expense on the rental property, it is clear that Barry Tong will be better
off in electing for personal assessment.
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4. (a) (ii) Calculate the Hong Kong tax liability for Barry Tong under personal
assessment for the year of assessment 2011/12.
Ans (a) (ii)
Barry Tong
Personal assessment
Year of assessment 2011/12
$
Net assessable value (see note 1) 135,200
Assessable profit (see note 2) 924,000
Total income 1,059,200
Less: Interest expense (97,000)
Elderly residential care expense (72,000)
890,200
Less: Share of partnership loss (170,000)
720,200
Less: Basic allowance (108,000)
Net chargeable income 612,200
Tax at progressive rates 92,074
Less: Tax reduction (12,000)
Final tax charged under personal assessment 80,074
Note 1: Net assessable value
Rent ($12,000 x 12) 144,000
Lease premium ($50,000 x 12/24) 25,000
Assessable value 169,000
Less: 20% statutory deduction (33,800)
135,200
Note 2: Assessable profit
Accounting profit 550,000
Add: Barry’s salary 360,000
MPF contribution 6,000
Donation 8,000
924,000
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4. (b) Advise Barry any penalties applicable to him and what he should do with
the notice of assessment received.
Ans (b) As Barry has not submitted a tax return, he failed to comply with the
requirement under section 51(1) and is guilty of an offence under section
80(2)
He will be subject to a fine at level 3 ($10,000) and a further fine of treble
the amount of tax which has been or would have been undercharged in
consequence of such non-compliance
However, the Commissioner may compound the offence
If no prosecution has been instituted under section 80(2), the Commissioner
may seek to impose additional tax under section 82A to an amount not
exceeding three times of the tax undercharged
Barry should note that the assessable profit of his sole-proprietorship
business is in fact greater than (instead of lower than) the estimated profits
as certain expenses are not deductible under profits tax
He should be advised to lodge an objection immediately, and in any event
not later than one month after the date of notice of assessment (section
64(1)), i.e. 20 December 2012
In this case where the estimated assessment was issued due to the
absence of a tax return, the objection will not be valid unless the duly
completed tax return is also submitted
The objection should contain the ground of objection, i.e. that the estimated
assessment is not in accordance with the amount disclosed in the tax return
submitted
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5.
Cambridge Trading Limited (Cambridge) carries on a trading business in Hong Kong and
its trading profits are chargeable to Hong Kong profits tax. In addition to trading, it has
entered into a number of agency contracts with overseas customers by providing sourcing
and other services in return for commission income. All these contracts were concluded by
the staff in Hong Kong.
Under these contracts, Cambridge is responsible for locating suppliers to manufacture the
goods for the clients, monitoring the production, maintaining quality control and arranging
the shipment of goods. Cambridge has in turn engaged agents in Mainland China and
Thailand to perform these services outside Hong Kong. Cambridge’s major roles are to
negotiate and enter into contract with the customers, liaise with the overseas agents and
monitor the status of these projects.
Upon delivery of the finished goods to the overseas customers, Cambridge is paid a
commission equal to 7% of the value of the export sales. Cambridge remunerates the
overseas agents at 5% of the value of the goods in consideration for their services.
The management of Cambridge is of the view that the commission income received from
these agency contracts should not be subject to profits tax in Hong Kong as the relevant
services which earned the income were performed by the agents outside Hong Kong.
As a separate issue, Cambridge is considering the purchase of certain designs to be used
in some of the products in trading to enhance their competitiveness in the market. The
management understands that acquisition of intellectual property right currently receives
favourable tax treatment, but is also subject to certain constraints. With a view of getting
the maximum tax relief, they wish to know more about the relevant provisions before
proceeding with the purchase.
REQUIRED:
5. (a) Advise the management on how the source of the commission income is
to be determined and evaluate if the income will be chargeable to Hong
Kong profits tax.
Ans (a) Section 14(1) imposes three conditions for a profit to be chargeable to
Hong Kong profits tax, namely:
- a person must carry on a trade, profession or business in Hong Kong;
- a profit is derived from that trade, profession or business; and
- the profit is arising in or derived from Hong Kong
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Cambridge carries on a business in Hong Kong and has earned
commission income from the business carried on in Hong Kong; the income
will be taxable if it is sourced in Hong Kong
In determining the locality of profits, the board guiding principle laid down in
CIR v Hang Seng Bank is that “one looks to see what the taxpayer has
done to earn the profit in question and where he has done it”
In ING Baring Securities (Hong Kong) Limited v CIR, the court emphasised
the need to grasp the reality of each case, focusing on effective causes
without being distracted by antecedent or incidental matters; the focus is on
establishing the geographical location of the taxpayer’s profit-producing
transactions as distinct from activities antecedent or incidental to those
transactions
Cambridge provided buying services to its overseas customers in return for
the commission income; for service income, the source is the place where
the services are performed which give rise to the service fees (paragraph
45(e) of DIPN No. 21)
The overseas agents were responsible for locating suppliers to
manufacture the goods, monitoring the production, maintaining quality
control and arranging shipment of goods; all these activities were
performed outside Hong Kong and without them Cambridge would not be
able to earn the commission income
Cambridge negotiated and entered into agency contracts with its customers
in Hong Kong, liaising with the overseas agents and monitoring the status
of the projects
There is an important distinction between the taxpayer managing its
business in Hong Kong and performing its profit-producing activities outside
Hong Kong; only the latter is relevant in determining the source of income
The activities performed by Cambridge in Hong Kong, although
commercially essential to the operations and profitability of the company,
could be regarded as antecedent or incidental to and not the profit-making
activities
On this basis, the 7% commission earned by Cambridge should be sourced
outside Hong Kong and non-taxable
The facts in this question resemble those in the Li & Fung (Trading) Limited
case in which the Court of Appeal has decided that the commission income
was not taxable
However, the IRD has indicated that the courts did not have the opportunity
to consider the entire facts of the case, and therefore the judgment does
not have wider application to other source cases
The Court of Final Appeal in Ngai Lik Electronics Co Ltd v CIR clearly
stated that sourcing and agency activities in Hong Kong might give rise to
assessable profits
19
The IRD may contend that the relevant profit-producing activities were
Cambridge entering into the contractual arrangements in Hong Kong with
its customers and agents; furthermore, without its supervision and
management, Cambridge would not be able to carry out the buying
contracts and earn the commission income
It is therefore open for the IRD to argue that the overseas agents earned
the 5% commission income for their operations performed outside Hong
Kong, whereas Cambridge earned the remaining 2% commission for the
supervision and management services performed by the staff in Hong Kong
5. (b) Advise the management on the new legislation relating to the purchase
and disposal of registered design, including the related anti-avoidance
provisions.
Ans (b) Effective from the year of assessment 2011/12, expenditure incurred in the
purchase of copyright, registered design and registered trademarks for use
in the production of chargeable profits can be deducted under section
16EA
The design must be registered, which could be made either in Hong Kong
or overseas
The design must be used in Hong Kong by the taxpayer. In this case as the
trading activities are carried out in Hong Kong, the design is likely to be
used in Hong Kong.
Deduction is by five equal amounts over five years of assessment, starting
from the year in which the expenditure is incurred, provided that the
registered design is owned at the end of the basis period for that year
If the registered design has an expiry period of less than five years, the
purchase cost can be deducted in equal amount over the number of
remaining years of protection
A proportionate part of the expenditure is deductible if it is used partly for
producing chargeable profits
The deduction also includes legal and valuation fees incurred on the
acquisition of the design
Upon disposal, the proceeds are treated as trading receipts and the
difference is deductible if the sales proceeds are less than the unallowed
expenditure, and taxable if the sales proceeds are greater than the
unallowed expenditure (but restricted to amount already deducted)
No deduction is allowed if the design is acquired wholly or partly from an
associate; is under sale and license back arrangement; is licensed for use
wholly or principally outside Hong Kong by a person other than the
taxpayer; or where the whole or predominant part of the consideration was
financed directly or indirectly by a non-recourse debt
20
6.
River Limited commenced business in Hong Kong ten years ago. Initially it prepared its
accounts to 31 December annually. In 2010, it changed its accounting date to 30 June. On
30 April 2012, the company ceased business. The adjusted profits before depreciation
allowance for the relevant years are as follows:
Year ended 31 December 2009 $2,300,000
6 months ended 30 June 2010 $1,500,000
Year ended 30 June 2011 $870,000
10 months ended 30 April 2012 $120,000
As at 30 June 2011, the reducing values of the pooling system are as follows:
20% pool $230,000
30% pool $170,000
The following information is extracted from the company’s records:
1. On 10 July 2011, the company acquired an electric car for $300,000. It was
subsequently sold on 5 March 2012 for $210,000.
2. On 15 August 2011, the company acquired a second-hand photocopier for $30,000
(asset ranking for depreciation allowance at 20%).
3. On 30 April 2012, the company sold all the assets under the 20% pool to Lake
Limited, a fellow subsidiary, for a consideration of $280,000.
4. The motor vehicles under the 30% pool were not sold at the time of cessation. The
market value of the vehicles was $120,000 as of 30 April 2012.
REQUIRED:
6. (a) Analyse the adjusted profits before depreciation allowance of River
Limited for the years of assessment from 2009/10 to 2012/13, showing
clearly the basis period for each year of assessment. Identify the year of
change and explain the basis of assessment for this year. Would your
answer be different if the change in accounting date in 2010 was due to
the alignment of the accounting date of River Limited with that of the
holding company?
Ans (a) Year of assessment 2009/10
Basis period: 1 January 2009 to 31 December 2009
Adjusted profits: $2,300,000
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Year of assessment 2010/11 (Year of change)
Basis period: 1 July 2009 to 30 June 2010
Adjusted profits: $2,300,000 x 6/12 + $1,500,000
= $2,650,000
Year of assessment 2011/12
Basis period: 1 July 2010 to 30 June 2011
Adjusted profits: $870,000
Year of assessment 2012/13
Basis period: 1 July 2011 to 30 April 2012
Adjusted profits: $120,000
The year of change is the year of assessment 2010/11, where the
company fails to make up an account to the corresponding day in the
following year of assessment – section 18E(1)(a)
The Commissioner is empowered to compute the profits for the year of
change and the preceding year on such basis as he think fit
Assessment is normally based on a 12-month period; for the year of
assessment 2010/11, profit for six months from 1 July 2009 to 31
December 2009 would be included and hence assessed twice
As a concession, the IRD may limit the basis period to a period of less than
12 months if the change of accounting date is for “compelling reasons” and
is not tax-motivated
If the change of the accounting date in 2010 was due to the alignment of
the accounting date with that of the holding company, it is possible that the
IRD may accept a basis period of six months from 1 January 2010 to 30
June 2010, and the adjusted profit will be $1,500,000 only
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6. (b) Calculate the tax reliefs or charges for River Limited for the year of
assessment 2012/13 based on the information given. Advise if any
aspects of your computation may need to be adjusted if (i) the assets
sold to the fellow subsidiary are found to be appreciably below the
market value of the relevant assets; and (ii) the motor vehicles in the 30%
pool were sold for $100,000 in November 2012.
Ans (b) Depreciation allowances on plant and machinery
20% Pool 30% Pool
$ $
W.D.V. b/f 230,000 170,000
Add: Photocopier 30,000
Less: Initial allowance (60%) (18,000) -
242,000
170,000
Less: Sale proceeds (280,000)
Market value of vehicles - (120,000)*
Balancing charge (38,000)
Balancing allowance 50,000*
* see explanation below
The electric car qualified as environmentally-friendly vehicle and the
purchase cost of $300,000 can be deducted under section 16I(2)
On subsequent disposal, the sale proceeds of $210,000 is taxable under
section 16I(2A)
Where assets qualifying for depreciation allowance are sold and both the
buyer and seller are persons over both of whom some other person has
control, the Commissioner shall determine the true market value for the
sale price of such assets for the purposes of calculating the balancing
allowance or charge, if the sale price does not represent the true market
value (section 38B); the assets sold to Lake Limited (which is a fellow
subsidiary of River Limited) at an under-value may need to be adjusted
upwards to the true market value
When the business has ceased and there is no sale, the Commissioner will
estimate the open market value of the vehicles and deem the amount to be
received immediately prior to the cessation (section 39D(4))
If the sale is made within 12 months of the cessation, the taxpayer may
claim adjustment of any balance allowance or charge (section 39D(5));
hence, balancing allowance for River Limited would be adjusted to $70,000
when the vehicles were sold in November 2012
END