THE HONG KONG INSTITUTE OF CHARTERED SECRETARIES THE INSTITUTE OF CHARTERED SECRETARIES AND ADMINISTRATORS

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1 THE HONG KONG INSTITUTE OF CHARTERED SECRETARIES THE INSTITUTE OF CHARTERED SECRETARIES AND ADMINISTRATORS International Qualifying Scheme Examination HONG KONG TAXATION JUNE 2011 Suggested Answers 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 1

2 SECTION A Q1. Mr. Lee has approached you, a tax consultant, for your advice in respect of his Hong Kong tax affairs. In a meeting on 30 May 2011 with Mr. Lee, you obtained the following information from him: 1. Mr. Lee was born and raised in Hong Kong. During the 1990s, Mr. Lee emigrated to the (US) and has subsequently become a US citizen. Meanwhile, he still retains his Hong Kong permanent resident identity card, his bank accounts and driver s license in Hong Kong. 2. In the US, Mr. Lee was employed by Golden Gate Electronics (US) Limited, a large multinational company based in the US, as an engineer. Golden Gate has subsidiaries in Hong Kong and Mainland China. In order to develop the engineering capability in Mainland China, Golden Gate Electronics (US) Limited decided to transfer Mr. Lee to oversee the Shenzhen factory, which is Golden Gate Electronics (US) Limited s subsidiary in Mainland China. 3. For administrative convenience, Mr. Lee was attached to Golden Gate Electronics (HK) Limited, the Hong Kong subsidiary of Golden Gate Electronics (US) Limited, because it has an experienced team of accounting and human resources professionals. 4. The Hong Kong subsidiary issued, under its own letterhead, a Letter of Transfer to Mr. Lee. The letter documents that Mr. Lee is to transfer to the Shenzhen factory for the period from 1 April 2010 to 31 March The letter also set out Mr. Lee s salary and benefits in detail. In particular, he is entitled to a monthly salary of HK$60,000 and a monthly overseas allowance of HK$40,000. After deducting for the relevant PRC Individual Income Tax (IIT), the net amount is to be paid into Mr. Lee s bank account in Hong Kong. 5. Due to an agreement with the Shenzhen Local Tax Bureau, Mr. Lee s overseas allowance is not subject to IIT. 6. Mr. Lee arrived in Shenzhen on 1 April 2010 to carry out his employment duties. Because of the proximity between Shenzhen and Hong Kong, Mr. Lee occasionally crosses the border and spends the weekend in Hong 2

3 Kong. During the year ended 31 March 2011, he spent 305 days in Shenzhen and 60 days in Hong Kong. Sometimes, he brings documents and samples from the Shenzhen office to the Hong Kong office and vice versa in order to save time and shipping expenses. 7. While in Shenzhen, Mr. Lee felt in love with his assistant, who also came from Hong Kong. As a result, Mr. Lee decided that he would not go back to US at the end of the transfer period. In February 2011, Mr. Lee tendered his resignation and his last working day was 31 March At the end of the working day on 31 March 2011, Mr. Lee came back to Hong Kong and has been living in his girlfriend s apartment since then. 9. In addition, Mr. Lee made some investments in Hong Kong as follows: a) He purchased 2,000 shares in a public company listed on the Hong Kong stock market for $40,000 in December In January 2011, he gave all these Hong Kong shares to a Hong Kong charitable institution. The market value of the shares at the date of gift was $25 per share. b) He acquired a flat in Hong Kong for $7 million in January The provisional and final agreements for sale were signed 21 days apart. On 1 February 2011, Mr. Lee leased the apartment to a tenant on the following terms: (i) Lease period: 1 February 2011 to 31 January (ii) Monthly rent of $10,000, payable on the first day of each month starting February (iii) Rent deposit of $20,000 payable at the start of the lease. (iv) Premium of $20,000 payable at the start of the lease. 10. In April 2011, Mr. Lee received a letter from Golden Gate Electronics (HK) Limited. The letter enclosed a copy of the Employer s Return form IR56F in which Golden Gate (HK) reported Mr. Lee s salary and benefits to the Hong Kong Inland Revenue Department for the year ended 31 March In early May 2011, Mr. Lee received a green envelope from the Inland Revenue Department which contained his Individual Composite Tax Return form BIR60. Mr. Lee believes that he can ignore his tax return because he did not work in Hong Kong during the year ended 31 March 2011, and he has come to you for advice. 3

4 REQUIRED: Q1 (a) Advise Mr. Lee whether, and if so to what extent, he will be subject to Hong Kong salaries tax for the year ended 31 March Specifically, you should advise Mr. Lee about his source of employment and his entitlement to all possible reliefs, including exemptions, under the Inland Revenue Ordinance. You should also advise Mr. Lee how much of his income would be subject to Hong Kong salaries tax under the various scenarios; however, you are not required to perform any salaries tax computations. Note: Even if you consider that Mr. Lee is not entitled to a particular relief, do not skip it. You should also identify the relief and discuss why Mr. Lee may not be entitled to claim it. Ans (a) According to the Goepfert case and DIPN No. 10, the source of employment is generally determined by the following three factors: the residence of the employer; the place where the contract of employment was negotiated, and entered into, and is currently enforceable; and the place where the employee s remuneration is paid to him. In Mr. Lee s case, it is clear that his employment during the period 1 April 2010 to 31 March 2011 is with Golden Gate Electronics (US) Limited s subsidiary in Mainland China. This would be considered a non-hong Kong employment. The issue is whether there was a change in employer (from Golden Gate Electronics (US) Limited to its subsidiary in Mainland China) when he was transfer to the Shenzhen factory: in either case, it is a non-hong Kong employment. Although Mr. Lee s remuneration was paid to him in Hong Kong, this factor is not a determinative factor when viewed on its own. It could be argued that the Letter of Transfer issued by the Hong Kong subsidiary represents a new contract, and therefore Mr. Lee s employer had been changed to the Hong Kong subsidiary. On the other hand, it could be argued that the letter did not represent a new contract as sometimes such a letter is required to support visa applications. 4

5 (Note: It is acceptable for candidates to suggest for a Hong Kong employment with appropriate arguments.) If Mr. Lee had a non-hong Kong employment, only his income related to services rendered in Hong Kong would be subject to Hong Kong salaries and in practice this means his total salary could be subject to the time-apportionment claim. Mr. Lee s total salary would be subject to time apportionment because some services have been rendered in Hong Kong (see discussion below). On the other hand, Mr. Lee would be entitled to claim the no-services-rendered exemption if he did not render any services in Hong Kong. If successful, Mr. Lee would be fully exempt from Hong Kong salaries tax. Based on the information in the question, Mr. Lee occasionally brought documents and samples to and from the Shenzhen and Hong Kong offices. Whether the activities in Hong Kong are considered as part of employment services is fact-specific as indicated in different decisions by the Board of Review. In D129/98, the Board of Review held that such activities by the taxpayer were purely gratuitous and were not duties of the taxpayer s employment. However, in D39/04, the Board of Review considered that the taxpayer cannot be exempt unless he did not carry out a single jot of services in Hong Kong. The fact that Mr. Lee carried the documents and samples in order to save the company s time and shipping expenses could arguably be not gratuitous. As such there are services rendered in Hong Kong. If Mr. Lee did perform some services in Hong Kong, he would also be entitled to claim the 60-day exemption if he visited Hong Kong for not more than 60 days during the relevant year of assessment. If this is case, Mr. Lee would be fully exempt from Hong Kong salaries tax. Based on the question, Mr. Lee came to Hong Kong for exactly 60 days so he would meet the number-of-days requirement. However, Mr. Lee s coming to Hong Kong must be considered visits : this term is not defined in the IRO and must be given its natural meaning. The fact that Mr. Lee held a Hong Kong permanent ID card, and maintained bank accounts and a driver s license in Hong Kong are not determinative. However, the fact that Mr. Lee returned to Hong Kong on 31 March 2011 to start a long period of residence is likely to be devastating to his argument. 5

6 Finally, Mr. Lee is entitled to claim the foreign tax paid exemption under section 8(1A)(c) because he paid PRC Individual Income Tax (IIT) on his salary. If successful, Mr. Lee could exclude the part of his income that had been subject to PRC IIT. In other words, his overseas allowance of $40,000 per month would still be subject to Hong Kong salaries tax. (Note: However, in practice, this exemption would be irrelevant if Mr. Lee had a non-hong Kong employment because time apportionment claim would generally be more beneficial.) Q1 (b) Other than possible penalties for non-compliance, advise Mr. Lee the consequences if he chooses to ignore his tax return and refuses to pay any tax subsequently demanded by the Inland Revenue Department. (Note: You are not required to discuss the penalty provisions under the Inland Revenue Ordinance.) Ans (b) Consequences: The IRD will issue an Estimated Assessment to Mr. Lee based on the information provided by the employer on the Employer s Return. If the Estimated Assessment demands tax payment, tax not paid by the due date shall be deemed to be in default and a surcharge of 5% shall be added. If any part of the tax and surcharge remain in default for a further six months or more, a further surcharge not exceeding 10% on the unpaid amount shall be added. The CIR may also recover tax in default by taking civil action in the district court, recover tax from a debtor of Mr. Lee (e.g. banker) and apply to a district judge for the issue of a departure prevention direction to prevent Mr. Lee from leaving Hong Kong. Q1 (c) Advise Mr. Lee whether, and if so to what extent, the documents executed for the transactions in item 9 above attract Hong Kong stamp duty. Ans (c) Stamp duty: The sale and purchase of Hong Kong stock is subject to stamp duty under Head 2. 6

7 The stamp duty payable = $40,000 x 0.2% + $5 = $85. Gifts of Hong Kong stock to a Hong Kong charitable institution is exempt from stamp duty under section 44(1) of the Stamp Duty Ordinance (SDO). An agreement for sale of residential property is subject to stamp duty under Head 1(1A). Since the provisional and final agreements are 14 days apart, the first agreement is chargeable with ad valorem stamp duty and the second agreement is chargeable with a fixed stamp duty of $100. The ad valorem stamp duty = $7m x 3.75% = $262,500. The stamp duty on conveyance is subject to stamp duty under Head 1. Since the conveyance is executed in conformity with the agreement for sale which is stamped, the conveyance is chargeable with stamp duty of $100 only. A lease of immovable property in Hong Kong is chargeable with stamp duty under Head 1(2). The stamp duty payable on the lease = $20,000 x 4.25% + $10,000 x 12 x 0.5% = $850 + $600 = $1,450 7

8 SECTION B (Answer THREE questions from this section) Q2. In the 2010/2011 Budget, the Financial Secretary said (at paragraph 30): The Inland Revenue Department (IRD) has established procedures to track property transactions involving speculation and will follow up each case closely. If it is found that such transactions constitute a [trade or] business, the IRD will levy profits tax on the persons or companies concerned for profits arising from such transactions. REQUIRED: Q2 (a) Explain, critically, the definition of a trade and a business with reference to the Inland Revenue Ordinance. Ans (a) Trade is defined in section 2(1) of the Inland Revenue Ordinance (IRO) as including every trade and manufacture, and every adventure and concern in the nature of trade. However, the definition is circular and does not assist in defining the term. As a result, one usually resorts to the case law (see answer to part (b)) to determine whether a taxpayer is carrying on a trade. Business is defined by section 2(1) to include agricultural undertaking, poultry and pig rearing and the letting or sub-letting by any corporation to any person of any premises or portion thereof, and the sub-letting by any other person of any premises or portion of any premises held by him under a lease or tenancy other than from the Government. However, the definition is not exhaustive. It appears that business covers a wider scope than trade. Q2 (b) Analyse when profits arising from property transactions will be subject to profits tax, with reference to the six badges of trade. Ans (b) The six badges of trade are: Subject matter of transaction Length of ownership Frequency of similar transactions 8

9 Supplementary work on the property Circumstances responsible for disposal Profit-seeking motive The candidates should discuss each badge in the specific circumstances of a real property transaction. Q2 (c) If profits arising from a property transaction are subject to profits tax but the seller fails to notify the IRD of his chargeability to tax without reasonable excuse, explain the potential consequences and penalties under the Inland Revenue Ordinance. Ans (c) Any person who without reasonable excuse fails to comply with section 51(2) is liable to prosecution under section 80(2). The Commissioner may compound such an offence. If the person is prosecuted and convicted under section 80(2), a fine at level 3 ($10,000) plus treble the amount of tax undercharged will be imposed. Alternatively, the IRD can impose a penalty in the form of an additional tax under section 82A. If an additional tax under section 82A is made, no prosecution will be instituted under section 80(2). Under section 82A, the maximum amount of additional tax is treble the amount of tax undercharged. 9

10 Q3. Consider the following employment benefits and expenditures: (i) (ii) (iii) (iv) (v) (vi) (vii) (viii) (ix) Amount paid by an employer in connection with the education of a child of an employee. Company car made available by an employer for the private use of an employee with an option to receive transportation allowance (in cash) in lieu of using the car. Payment of an employee s utilities by the employer. Loans provided to employees at less than market interest rates either from the employer s own funds or from money borrowed from the bank at market rates by the employer. Benefits from the use of corporate credit cards for private purposes by an employee. Travelling expenses of an employee. Subscriptions to professional associations by employees. As specified in the employment contract, a sum equivalent to one month salary is required to paid by an employee to the employer in lieu of proper notice of resignation." Depreciation of the cost of a computer purchased by an employee for employment purposes. REQUIRED: For items (i) to (v) above, fully explain, with reasons, whether they are assessable under Hong Kong salaries tax. For items (vi) to (ix) above, fully explain, with reasons, whether they are deductible under Hong Kong salaries tax. Consider all possibilities and make any necessary assumptions. Ans (i) An amount paid by an employer in connection with the education of a child of an employee is specifically assessable by virtue of section 9(2A). It is irrelevant whether the liability is that of the employer or the employee. (ii) When an employee is allowed to use for private purposes a car owned by his employer, the benefit is not assessable, provided that the employee is 10

11 not in any way able to convert the benefit into money. If the employer was given a choice to receive cash or use the car, the cash offered is assessable even though the employee chose to use the car. (iii) Payment of utilities by the employer is not assessable if it is not a discharge of the employee s personal liability, e.g. when the utilities are registered in the employer s name. On the other hand, the benefit is assessable if it is a discharge of the employee s personal liability. (iv) Low-interest loans provided to employees are not chargeable provided that the employee cannot convert the benefit into cash. Likewise, if the employer borrows money from a bank at a market rate and re-lends it to the employee at a preferential rate, there is no taxable benefit unless the employee guarantees the repayment of the loan. (v) In DIPN 16, the IRD states that where the card is used for private purposes by an employee, the benefit obtained is chargeable to salaries tax. However, this is not necessarily correct. Whether the benefit is chargeable depends on whether the liabilities (of the purchases) are those of the employer or the employee. To ensure that the benefit is not taxable, the employee should make clear to the supplier of goods and services before entering into contract that he is making the contract on behalf of his employer. (vi) Travelling expenses between home and place of employment are not allowable. But the expenses for travelling from one place of employment to another are allowable. (vii) Strictly speaking, professional subscriptions are not deductible under the IRO. However, by concession, the IRD allows the deduction of one professional subscription which is related to the taxpayer s employment. Only full membership fees are deductible. (viii) The payment in lieu of notice is not incurred in the production of assessable income and thus not allowable (CIR v Sin Chun Wah HCIA000004/1987). (ix) This depends. Depreciation allowances are granted in respect of plant 11

12 and machinery, the use of which is essential to the production of assessable income. An item of plant and machinery used by an employee does not qualify for depreciation allowances if it merely facilities his work and he can still perform his duties without the asset. Depreciation allowances can only be granted if the employer does not provide the equipment. 12

13 Q4. Dolly Limited was incorporated in Hong Kong. It carries on a business as a stationery trader in Hong Kong. For the year ended 31 December 2010, its profit and loss account is as follows: Notes $ $ Income Turnover 6,000,000 Less: Cost of goods sold (4,200,000) Gross profit 1,800,000 Unrealised exchange (i) 200,000 gain Compensation income (ii) 250,000 2,250,000 Expenses Administrative expenses 20,000 Bad debt expenses (iii) 40,000 Depreciation charges 80,000 Donations (iv) 1,000,000 Employee expenses (v) 400,000 Legal and professional fees (vi) 30,000 Other expenses 50,000 (1,620,000) Net profit for the year 630,000 Dolly Limited also provides you with the following additional information: (i) The unrealised exchange gain arises from the conversion of accounts receivable in foreign currency to local currency at the end of the accounting period. (ii) Compensation income represents insurance compensation for the total loss of a company car (original cost: $400,000; 30% pool) that was involved in a traffic accident. (iii) Bad debt expenses: $ Write-off of a loan made to a director 60,000 13

14 Less: Recovery of bad debt previously allowed (20,000) 40,000 (iv) Donations: $ Cash donations to Community Chest, Hong Kong 800,000 Donations in kind to Community Chest, Hong Kong 200,000 1,000,000 (v) Employee expenses: $ Salary 250,000 Payments to a retiring director for agreeing not to compete with the company 150, ,000 (vi) Legal and professional fees: $ Audit fees 10,000 Tax return preparation 5,000 Objection against 2008/09 Notice of Assessment 15,000 30,000 Additional information: As at 1 January 2010, the tax written down values of the plant and machinery used in the business to produce assessable profits were as follows: 20% pool: $200,000 30% pool: $550,000 On 1 July 2010, the company purchased two identical pieces of office furniture (20% pool). The purchase price of furniture item #1 of $50,000 was settled in full in cash. Due to cash flow problems, furniture item #2 was financed by instalments with a $20,000 upfront payment and 12 instalments of $3,000 each. On 31 December 31, 2010, furniture item #1 was sold for $60,000. On 1 September 2010, the company purchased a computer (30% pool) for $30,000. REQUIRED: 14

15 Q4 (a) Prepare Dolly Limited s profits tax computation for the year of assessment 2010/11. (Ignore provisional tax.) Ans (a) Dolly Limited Profits tax computation Year of assessment 2010/11 $ $ Net profit per accounts 630,000 Add: Bad debt expenses 60,000 Depreciation charges 80,000 Donations 1,000,000 Employee expenses 150,000 Legal and professional fees 15,000 1,305,000 1,935,000 Less: Compensation income 250,000 Depreciation allowance (Note 1: 154, , ,000) 210,800 (460,800) 1,474,200 Less: Donations (Limited to 35% of 1,474,200) (515,970) Assessable profits 16.5% Profits tax payable for 2010/11 158,107 Note 1: Depreciation allowance 20% Pool 30% Pool Total WDV b/f 200, ,000 Addition (after IA of 60% x $50,000 = $30,000) 20,000 30,000 Less: Disposal (50,000) (250,000) Sub-total 170, ,000 AA (34,000) (90,000) 124,000 15

16 WDV c/f 136, , ,000 furniture Allowances under HP Addition 50,000 IA: 60% on 35,000 (21,000) 21,000 29,000 AA: 20% on 29,000 (5,800) 5,800 WDV c/f 23,200 Total allowances for car under HP 26,800 The cost of the computer, i.e. 30,000, is fully deductible as it is a prescribed fixed asset under section 16G. Q4 (b) Explain the tax treatment that you have applied to items (i), (ii), (iv) and (v). Ans (b) (i) According to DIPN No. 42, if an exchange gain/loss is recognised in the income statement, it cannot be excluded from the tax computation on the ground that it is unrealised. Since accounts receivable record trading receipts, the exchange gain is revenue in nature and therefore taxable. (ii) Compensation for permanent loss of a fixed asset is capital in nature, therefore not taxable. However, the amount received up to the original cost of the asset should be removed from the depreciation pool. (iii) Donations must be donations of money to a recognised charity. Donations in kind do not qualify for a deduction. (iv) The payment is capital expenditure because it increases the company s goodwill. Therefore, the payment is not deductible. 16

17 Q5. The following information pertains to Eric for the year ended 31 March 2011: (i) Eric received a monthly basic salary of $45,000 from his employer, which is a Hong Kong company. (ii) During the first half of the year, Eric lived in a flat provided by his employer. During the second half of the year, Eric lived in his newly purchased apartment in Tai Koo Shing and received a monthly housing allowance of $6,000 from his employer. (iii) Eric owned a flat in Ma On Shan. On 1 April 2009, Eric rented this flat to a tenant for $9,000 per month. In addition, Eric received non-refundable rent of $18,000 up front. The rental period is for two years. (iv) During the year, Eric earned $80,000 teaching guitar on a private basis. (v) Eric paid $100,000 and $120,000 to a bank: this represents the mortgage interest payments in respect of the Ma On Shan property and the Tai Koo Shing property respectively. (vi) Eric paid $2,500 per quarter and $3,000 per quarter to the government for rates in respect of the Ma On Shan property and the Tai Koo Shing property respectively. (vii) During the year, Eric made various charitable donations totalling $250,000 to approved charitable organisations. (viii) Eric is single with no dependents. REQUIRED: Q5 (a) Show whether or not it is more beneficial for Eric to elect for personal assessment for the year of assessment 2010/11. Support your answer with detailed computations. Ans (a) Eric Salaries tax computation 17

18 Year of assessment 2010/11 $ Salary ($45,000 x 12) 540,000 Housing allowance ($6,000 x 6) 36, ,000 Add: Rental value ($45,000 x 6 x 10%) 27,000 Assessable income 603,000 Less: Charitable donations (211,050) (Limited to 35% x 603,000) Home loan interest (100,000) Net assessable income 291,950 Basic personal allowance (108,000) Net chargeable income 183,950 Tax at standard 43,792 Tax at progressive rates 19,271 Tax payable 19,271 Eric Property tax computation Year of assessment 2010/11 Premium ($18,000 x 12/24) 9,000 Rent ($9,000 x 12) 108,000 Assessable value 117,000 Less: Rates ($2,500 x 4) (10,000) 107,000 Less: Statutory deduction (20%) (21,400) Net assessable value 85,600 Property tax (15%) 12,840 Eric Profits tax computation Year of assessment 2010/11 Net assessable profits 80,000 Profits tax (15%) 12,000 18

19 Eric Personal assessment computation Year of assessment 2010/11 Net assessable income (before deduction of concessionary 603,000 deductions) Net assessable profits 80,000 Net assessable value (NAV) 85,600 Total income 771,000 Less: Interest on rental property (limited to NAV) (85,600) Total income after deduction of interest 683,000 Less: Charitable donations (239,050) (Limited to 35% x 683,000) Home loan interest (100,000) Reduced total income 343,950 Less: Single person allowance (108,000) Reduced total income after personal allowance 235,950 Tax at standard 51,592 Tax at progressive rates 28,111 Tax payable 28,111 Q5 (b) Explain why it is/is not more beneficial for Eric to elect for personal assessment for the year of assessment 2010/11. (Note: Ignore provisional tax and any rebate announced in the 2011/12 Budget in your answers.) Ans (b) Comparing the tax payable under personal assessment (28,111) vs separate assessments for different incomes (19, , ,000 = 44,111), it is more beneficial for Eric to elect for personal assessment. It is more beneficial for Eric to elect for personal assessment because (1) he is entitled to a larger charitable donations limit, and (2) he can deduct the mortgage interest in respect of the rental property under personal assessment. 19

20 Q6. Taxpayers may set up service company arrangements to minimise their Hong Kong tax liabilities. Two types of arrangements have been identified as causing particular concern. The Inland Revenue Department (IRD) has classified these two types of service companies as Type I and Type II. Section 9A of the Inland Revenue Ordinance (IRO) was enacted to deal with Type I cases, while Type II cases are dealt with in Department Interpretation and Practice Notes (DIPN) No. 24. Q6 (a) Explain how and why taxpayers structure Type I service companies. Explain how section 9A of the IRO deals with Type I service company arrangements. Ans (a) Type I service companies The nature of Type I service companies is where an individual or any of his associates controls a service company and the company enters into a service agreement with another person to provide the services of the individual. The purpose is to disguise an employer-employee relationship so that the income so derived is subject to profits tax instead of salaries tax. To deal with Type I companies, section 9A of the Inland Revenue Ordinance (IRO) has been enacted. Under section 9A, the remuneration received by the service company under the service agreement is deemed to be the income of the individual chargeable to salaries tax. Section 9A does not apply if ALL of the following six criteria are satisfied: 1) the service agreement does not provide for fringe benefits which are commonly provided in an employment; 2) the individual provides services for other person during the term of the agreement; 3) the individual is not subject to any control or supervision commonly exercised by an employer; 4) the remuneration is not paid periodically or calculated on a basis commonly used in employment contracts; 5) the payer has no right to dismiss the individual as if he is an employee; and 20

21 6) the individual is not held out to the public to be an officer or employee of the payer. Q6 (b) Explain how and why taxpayers structure Type II service companies. Explain how DIPN No. 24 deals with Type II service company arrangements. Ans (b) Type II service companies The nature of Type II service companies is where a service company controlled by the proprietor or partners of a professional firm provides services to the firm in return for management fees. The purpose is to reduce the overall tax liability of the total income derived by the same person through the professional firm and the service company. The method makes use of the deduction of expenses, which is available to the service company, while such expenses are not allowed in the professional firm under section 17 of the IRO. At the same time, the proprietor or partners of the professional firm are also directors of the service company and they can make use of the remuneration package such as provision of accommodation, refund of rent, etc. to minimise their salaries tax liabilities. DIPN No. 24 sets out the minimum requirements which must be satisfied to support a management fee claim, and what deductions can be allowed. For non-professional services rendered to the professional firm, the expenses plus a mark-up can be deducted by the firm. The IRD considers a mark-up of 12.5% to be reasonable. For professional services rendered to the professional firm, the expenses without any mark-up can be deducted by the firm, except remuneration paid to the proprietor or partner of the professional firm. END 21

22 Tax Rates and Allowances 2010/11 Personal Allowances $ Basic 108,000 Married Person 216,000 Child 1 st and 9 th (each) year of birth 100,000 other years 50,000 Dependent Brother or Dependent Sister Allowance 30,000 Dependent Parent Aged 60 or more 30,000 Aged between 55 and 59 15,000 Additional Dependent Parent Aged 60 or more 30,000 Aged between 55 and 59 15,000 Dependent Grandparent Aged 60 or more 30,000 Aged between 55 and 59 15,000 Additional Dependent Grandparent Aged 60 or more 30,000 Aged between 55 and 59 15,000 Single Parent Allowance 108,000 Disabled Dependant Allowance 60,000 Salaries Tax and Personal Assessment Tax Rates 2010/11 Progressive Rates: First $40,000 2% Next $40,000 7% Next $40,000 12% Remainder 17% Standard Rate 15% Profits Tax Rates (2008/09 onwards) Unincorporated Business 15.0% Corporation 16.5% Property Tax Rates (2008/09 onwards) 15.0% Depreciation Allowances (2004/05 onwards) Plant and Machinery Initial Allowance 60% Annual Allowance 10%, 20% or 30% (as specified in question) 22

23 Industrial Building Initial Allowance 20% Annual Allowance 4% Commercial Building 4% Stamp Duty Payable (2010/11 onwards) Head 1(1) $1 - $2,000,000 $100 & $2,000,001 - $2,351,760 $ % of value above $2,000,000 Head 1(1A) $2,351,760 - $3,000, % of consideration $3,000,001 - $3,290,320 $45, % of value above $3,000,000 $3,290,321 - $4,000, % of consideration $4,000,001 - $4,428,570 $90, % of value above $4,000,000 $4,428,571 - $6,000,000 3% of consideration $6,000,001 - $6,720,000 $180, % of value above $6,000,000 $6,720,001 - $20,000, % of consideration $20,000,000 - $750, % of value above $21,739,120 $20,000,000 Above $21,739, % of consideration Head 1(2) Premium Same as under Head 1(1) Rent: Uncertain term 0.25% of annual rent Term of less than a year 0.25% of total rent Term of 1 year to 3 years 0.5% of annual rent Term of more than 3 years 1% of annual rent Head 2(1) 0.1% of the consideration Head 2(2) $5 Head 2(3) $ % of value Head 2(4) $5 Head 3(1) 3% of market value Head 3(2) $5 23