Paper P6 (HKG) Advanced Taxation (Hong Kong) Thursday 8 June Professional Level Options Module

Transcription

1 Professional Level Options Module Advanced Taxation (Hong Kong) Thursday 8 June 2017 Time allowed: 3 hours 15 minutes This question paper is divided into two sections: Section A BOTH questions are compulsory and MUST be attempted Section B TWO questions ONLY to be attempted Tax rates and allowances are on pages 2 and 3 Do NOT open this question paper until instructed by the supervisor. This question paper must not be removed from the examination hall. Paper P6 (HKG) The Association of Chartered Certified Accountants

2 SUPPLEMENTARY INSTRUCTIONS 1. You should assume that the tax rates and allowances shown below will continue to apply for the foreseeable future. 2. Calculations and workings should be rounded down to the nearest HK$. 3. Apportionments need only be made to the nearest month, unless the law and prevailing practice require otherwise. 4. All workings should be shown. 5. Ignore provisional tax and statutory tax reductions, unless specified otherwise. TAX RATES AND ALLOWANCES The following 2016/17 tax rates and allowances are to be used in answering the questions. Profits tax rates Companies 16 5% Unincorporated business 15% Salaries tax rates First $40,000 2% Next $40,000 7% Next $40,000 12% Remainder 17% Standard rate 15% Allowances $ Basic allowance 132,000 Married person s allowance 264,000 Single parent allowance 132,000 Child allowance 1st to 9th child (each) 100,000 Child allowance additional allowance in the year of birth (each) 100,000 Dependent parent/grandparent allowance basic 23,000/46,000 additional 23,000/46,000 Dependent brother/sister allowance 33,000 Disabled dependant allowance 66,000 Deductions $ Self-education expenses (maximum) 80,000 Home loan interest (maximum) 100,000 Elderly residential care expenses (maximum) 92,000 Mandatory provident fund contributions (maximum) 18,000 Depreciation allowance rates Initial allowance: Plant and machinery 60% Industrial buildings 20% Annual allowance: Computers 30% Motor cars 30% Furniture and fixtures 20% Machines 10% 30% Industrial buildings 4% or formula Commercial buildings 4% or formula 2

3 Stamp duty rates Stock 0 2% + $5 Immovable property Conveyance on sale and agreement for sale (ignoring marginal reliefs) Scale 1 Scale 2 Up to $2,000, % $100 $2,000,001 to $3,000, % 1 5% $3,000,001 to $4,000, % 2 25% $4,000,001 to $6,000, % 3 0% $6,000,001 to $20,000, % 3 75% $20,000,001 and above 8 5% 4 25% Conveyance on sale and agreement for sale chargeable with special stamp duty Holding period Not exceeding six months 15% or 20% as applicable Between six and 12 months 10% or 15% as applicable Between 12 and 24/36 months 5% or 10% as applicable Conveyance on sale and agreement for sale chargeable with buyer s stamp duty 15% Lease (a) Key money, construction fee etc only As for conveyances (above) Rent only (as a percentage of the average yearly rent) Undefined term 0 25% Not exceeding one year 0 25% More than one year but not exceeding three years 0 50% Exceeding three years 1 00% (c) Key money, construction fee etc and rent Key money, construction fee etc 4 25% of the consideration Rent As for rent-only lease (above) 3 [P.T.O.

4 Section A BOTH questions are compulsory and MUST be attempted 1 Fortune Jewel Ltd (FJL) is a company incorporated in Hong Kong, carrying on business in Hong Kong as a retailer in high-end jewels. In 2014, FJL reached its record turnover from operating a network of nine retail stores, mainly serving the increasing number of visitors from Mainland China. However, with the downturn in the visitor population in Hong Kong since 2015, FJL s turnover has dropped by 60% in the year ended 31 March 2017, as compared with Mr Ng is newly employed as FJL s chief executive officer (CEO), effective from 1 May After studying FJL s figures for the last few years, he has decided to initiate a business re-engineering exercise to secure FJL s sustainability. At the beginning of June 2017, he called a meeting to discuss various potential actions as follows: (1) Downsizing of retail operations Out of the nine stores, one self-owned store building will be closed and disposed of and three leased stores will be terminated and closed: 80% of the employees from the terminated stores will be made redundant. The statutory redundancy amount plus an additional gratuity representing two months salary will be paid. The other staff will be redeployed to the continuing stores. (2) Additional funding for continuing operations A proposal will be made to FJL s existing shareholder, Precious Stone Ltd (PSL), to inject additional funds into FJL. PSL is managed and controlled in Austria and has no activities in Hong Kong. The following alternative proposals for injecting the funds have been suggested: Three stores self-owned by FJL Six stores under current lease by FJL To continue 2 stores 3 stores To terminate 1 store 3 stores Actions: (a) To sell the terminated store at its market value. FJL s estimated value of the store is $30m (including 20% for the land portion). (a) To issue three-month termination notices to the landlords by 30 June 2017; termination to take effect from 1 October To assess the tax implication of the sale profit. The store s net carrying value at 31 March 2016 is $25m; it was bought from a property developer in March 2010 for $15m and tax depreciation has been claimed based on $12m. A loan from PSL to FJL bearing interest at 0 1% below the market rate; the loan money will be deposited into FJL s bank account in Austria. As consideration paid by PSL to acquire FJL s brand name, following which the brand name will be licensed back to FJL for continual use in its operation at a licence fee calculated based on FJL s monthly turnover. The brand name was created as a new one by FJL at no cost, and has been owned and used by FJL since the commencement of its operation more than 20 years ago. Mr Ng has approached a tax consultancy firm in Hong Kong to obtain tax advice on the major Hong Kong tax implications arising from his proposals for re-engineering FJL s business. To apply the three-month rental deposits held by the landlords to cover the rental payments and stop paying further rentals during the notice period. As per the lease terms, the rental deposits are refundable by the landlord or applied to rental payments in default. 4

5 As the tax adviser of the firm engaged by Fortune Jewel Ltd (FJL), prepare a report for the CEO addressing each of the following issues from a Hong Kong tax perspective, providing supporting calculations where appropriate. (a) (c) Termination of leases of three retail stores The tax implications for FJL arising from the application of the rental deposits to cover the lease rentals during the three-month notice period. (3 marks) Sale of retail store The tax implications for FJL of the profit arising from the sale of the store, including a calculation of the applicable depreciation adjustment in respect of the property in the year of disposal. (7 marks) The estimated annual depreciation allowance which might be available to the purchaser assuming that the store continued to be used by them upon acquisition. (2 marks) Termination of employment upon closure of store The tax implications for FJL of the redundancy payments and additional gratuities to be paid to the leaving staff. (4 marks) The tax implications for the leaving staff from the receipt of the redundancy payments and the additional gratuities. (3 marks) (d) Additional funding The tax implications for both FJL and its shareholder, Precious Stone Ltd (PSL), arising from the payment and receipt of the loan interest. (7 marks) The tax implications for both FJL and PSL arising from the sale and license back of FJL s brand name. (5 marks) Professional marks will be awarded in question 1 for the appropriateness of the format and presentation of the report and the effectiveness with which the advice is communicated. (4 marks) (35 marks) 5 [P.T.O.

6 2 You should assume that today s date is 1 March Jeff Young is the president of a US corporation, PC Gaming Inc (PCG), which produces computer games. Jeff wants to market the computer games throughout Hong Kong and South-East Asia. To do this, a subsidiary company called PC Gaming (HK) Ltd (PCG-HK) will be established in Hong Kong in April 2017, which will act as the local and South-East Asian distributor of the computer games. Jeff will appoint his son, Jack, to manage PCG-HK under a two-year contract from 1 April 2017 to 31 March Although stationed in Hong Kong, Jack will travel extensively back to the US and throughout the South-East Asia region. Jack s annual remuneration package will be $1,200,000. He will also be granted an option to purchase 30,000 shares in PCG-HK at a favourable option price. This option will be unconditional. Jack will be allowed to structure his two-year remuneration package as long as the total cost of the remuneration package to PCG-HK (other than the share options) does not exceed $2,400,000. Jack estimates his main annual expenses will be as follows: (1) Rent: $240,000; (2) Car and private transport: $200,000; (3) Utilities such as electricity and telecommunications: $60,000; (4) Personal expenses: $216,000 (mostly charged to a credit card); and (5) Medical expenses: $18,000 Jack plans to return to the US when the two-year contract expires on 31 March 2019 and only to exercise the share option after he returns to the US, as he believes that this will result in no Hong Kong tax liability. (a) Explain whether the income Jack Young will receive from PC Gaming (HK) Ltd (PCG-HK) will be liable to salaries tax in Hong Kong and, if so, the actions which PCG-HK and/or Jack could take to minimise any such liability. (8 marks) Assuming that Jack s employment with PCG-HK is considered to be a Hong Kong employment, advise him on: The ways in which his remuneration package might be structured so as to minimise the amount of salaries tax he will have to pay in Hong Kong. (12 marks) The salaries tax treatment of the share option. (5 marks) (25 marks) 6

7 Section B TWO questions ONLY to be attempted 3 Mr and Mrs Li (the couple), who are both Hong Kong permanent residents, are planning to emigrate to Canada in six months time. They both ceased their employments from 1 April 2017 and are exploring ways to deal with their residential property after they leave Hong Kong. The property is jointly held by the couple and is currently under a bank mortgage loan. The couple have been allowed a home loan interest deduction against their employment income for ten years. The mortgage loan is still outstanding and the couple intend to continue holding the property under the mortgage loan for the present and review the position next year once they have settled in Canada. The couple are considering the following options regarding their residential property: Option 1: lease the property for rental to an outside party at market rent, which is estimated to be $20,000 per month. The couple will continue to repay the bank mortgage loan. Option 2: lease the property to Mrs Li s uncle at below market rent or even for free. The couple will again continue to repay the bank mortgage loan. Option 3: the property will be occupied by the couple s son, who will remain in Hong Kong for work. The couple will not charge their son rent but he will take up the responsibility to repay the bank mortgage loan on behalf of Mr and Mrs Li. (a) Advise Mr and Mrs Li in respect of each of the three options as follows: Option 1: the Hong Kong tax and stamp duty implications, if any, of leasing the residential property, including whether a home loan interest deduction can continue to be claimed. Support your answer with an estimate of the annual property tax payable. (9 marks) Option 2: any change in Mr and Mrs Li s Hong Kong tax position, as compared to Option 1. (2 marks) (iii) Option 3: any change in Mr and Mrs Li s Hong Kong tax position, as compared to Option 1. (2 marks) State the statutory reporting obligations with which Mr and Mrs Li should comply before they leave for Canada. (2 marks) Advise Mr and Mrs Li of the possible actions the Inland Revenue Department may take in order to recover any outstanding tax due should they fail to comply with their reporting obligations and/or leave Hong Kong without having cleared all of their Hong Kong tax liabilities. (5 marks) (20 marks) 7 [P.T.O.

8 4 (a) The Association of Food Lovers Ltd (AFL) is a company limited by guarantee, established in 2016, with the purpose of providing facilities for its members to learn about and enjoy organic food. AFL owns premises for these purposes, and employs several staff. Members who join AFL pay an up-front fee of $100,000, and monthly fees of $1,000. There are currently 3,000 members. AFL buys high quality, organic food items and resells them to its members, as well as to their friends. AFL also has a restaurant on its premises which is open to both members and their guests. AFL s policy is to seek to cover its costs but not to make a profit. However, during the year 2016, it made a large profit, and Joey, AFL s treasurer, wishes to know whether AFL will have to pay tax on this profit. Explain the liability to tax of the profit made by The Association of Food Lovers Ltd (AFL) in Clearly specify the additional information (if any) needed in order to determine the position with certainty. (7 marks) State what steps AFL might take in order to avoid or minimise any future liability to profits tax. (2 marks) Ace Group (the Group) carries on a financial services business in different countries including Hong Kong. Due to a number of high profile fraud cases, the Group s management has been trying to negotiate a commercial crime insurance policy, but has failed to get the comprehensive cover which the Group requires. As an alternative, the Group management intends to incorporate its own insurance company to cover the uninsured risks of the Group. The insurance company, Ace Insurance, will be incorporated in the British Virgin Islands, and will charge insurance premiums to all the Group companies including Ace-Hong Kong (the company carrying on the financial services business in Hong Kong) based on an assessment of the risks involved and the value of the business at risk. Advise on the Hong Kong tax positions of Ace Insurance and Ace-Hong Kong respectively with respect to the insurance premium paid by Ace-Hong Kong to Ace Insurance. (11 marks) (20 marks) 8

9 5 HK Co Ltd (HK-Co) is a company carrying on business in Hong Kong. HK-Co commenced business in the year of assessment 2016/17 and based on its projected management accounts for the year of commencement, the finance manager has identified the following items which need to be examined before the company s profits tax computation for 2016/17 can be prepared. (a) Depreciation on computer systems of $30,000 (acquisition cost $100,000) Incorporation fee of $30,000 and business registration fee of $2,250. (c) (d) (e) (f) Mandatory provident fund (MPF) contributions of $50,000, including an initial lump sum of $20,000 to set up the fund. Compensation of $100,000 for a restrictive covenant agreed by an employee who resigned after six months of service for a promise not to join a competitor for a period of five years. An incentive of $80,000 paid to another employee who agreed to withdraw his resignation letter and remain in employment. Interest expense of $190,000 on a bank mortgage loan to acquire three residential units used as staff quarters. Explain the relevant tax rules and principles underlying the Hong Kong tax treatments of each of the items (a) to (f), including in each case a conclusion as to whether and if so, how it should be adjusted in the tax computation. Note: The following mark allocation is provided as guidance for this question: Item (a) item item (c) item (d) item (e) item (f) 4 marks 4 marks 3 marks 2 marks 2 marks 5 marks (20 marks) End of Question Paper 9