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

Transcription

1 THE HONG KONG INSTITUTE OF CHARTERED SECRETARIES THE INSTITUTE OF CHARTERED SECRETARIES AND ADMINISTRATORS International Qualifying Scheme Examination HONG KONG TAXATION JUNE 2014 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 1

2 SECTION A 1. Affluence Electronics Limited (Affluence) carries on a business of manufacturing and trading electronic products in Hong Kong. Affluence has a wholly owned subsidiary, Treasure China Limited (Treasure), which carries on a manufacturing business in Mainland China. Affluence has entered into an import processing arrangement with Treasure under which Affluence will provide raw materials, product design, technical knowhow and production machines while Treasure will provide factory and labour for producing the goods required by Affluence. Affluence sources its raw materials from suppliers outside Hong Kong. While sales are made to customers in the United States and Europe, sales orders are mostly received by the company s office in Hong Kong. For the year ended 31 March 2014, Affluence had profits before taxation of $5,500,000, which were arrived at after taking into account the following items: Note $ Income: Dividend income 23,000 Interest income 1 116,000 Profit on disposal of patent 2 300,000 Rental income 3 420,000 Expenses: Bad debts 4 223,000 Depreciation 411,000 Contributions to MPF scheme 5 950,000 Exchange differences 6 96,000 Interest expenses 7 179,000 Salaries 7,200,000 Notes to the accounts: 1. Interest income: Interest on deposits placed with Shenzhen branch of Bank of China 82,000 Interest on qualifying debt instruments with maturity date of 5 January 2018 (issued on 6 January 2010) 30,000 Interest on tax reserve certificates 4,000 $ 116,000 2

3 2. Profit on disposal of patent: The patent was acquired in April 2005 for $700,000 from an unrelated party and used in the company s manufacturing operations. It was sold for $1,000,000 during the year. 3. Rental income: The company let an office premises in Cheung Sha Wan to a tenant and received rental income of $420,000 during the year ended 31 March Provisional property tax of $50,400 on this property for the year of assessment 2013/14 was paid in October Bad debts: Increase in general allowance for doubtful trade accounts 71,000 Provision for trade debts for which recovery action taken in 52,000 vain Deposit forfeited by a supplier 100, ,000 The deposit was paid to a supplier for the manufacture of a special machine. Due to the cancellation of the production order, the contract was cancelled and the deposit was forfeited by the supplier. 5. Contribution to MPF scheme: Payment of ordinary contribution 450,000 Payment of special contribution 500, , Exchange differences: Realised gain on conversion of trade debts (17,000) Unrealised loss on translation of trade debts at year-end date 39,000 Realised loss on conversion of foreign currency time deposits 74,000 96, Interest expenses: Bank overdraft interest paid to HSBC; the facility was secured by a property owned by Affluence Loan interest paid to Bank of China (Hong Kong); the loan was secured by time deposits of a smaller sum placed with Bank of China (see note 1 above) 66, , ,000 3

4 Additional note: Total depreciation allowance for profits tax purposes for the year is $668,000. Additional information: In Affluence s recent board meeting, one of the directors raised an issue about the possibility of claiming part or all of the company s manufacturing profits to be offshore and exempt from Hong Kong profits tax, given that the essential part of the manufacturing operations was carried out in Mainland China. Furthermore, he has heard of complaints from the staff who had been seconded to work in the Mainland factory that they were required to pay tax twice on their salary income, both in Hong Kong and in Mainland China. Affluence has sent a production manager and two supervisors to be stationed in Treasure s factory in the Mainland to monitor the production and to supervise and train the local workers. They come back to Hong Kong once every month and take leave for about five days. REQUIRED: 1. (a) Assuming that Affluence Electronics Limited is fully chargeable to Hong Kong profits tax, calculate its profits tax liability for the year of assessment 2013/14. Ignore provisional tax. (10 marks) Ans (a) Affluence Electronics Limited Profits tax computation Year of assessment 2013/14 Basis period: Year ended 31 March 2014 (Section 18B(1)) $ $ Profit per accounts 5,500,000 Add: Depreciation 411,000 Sale proceeds of patent 700,000 Increase in general allowance for doubtful accounts 71,000 Deposit forfeited by supplier 100,000 Special contribution to MPF scheme 400,000 Deposit forfeited by supplier 100,000 Special contribution to MPF scheme 400,000 Realised loss on conversion of deposits 74,000 Loan interest to Bank of China (Hong Kong) 82,000 1,838,000 7,338,000 4

5 Less: Dividend (23,000) Interest on bank deposits (82,000) Interest on qualifying debt instruments (30,000) Interest on tax reserve certificates (4,000) Profits from disposal of patent (300,000) (439,000) 6,899,000 Less: Depreciation allowances (668,000) Assessable profit 6,231,000 Profits tax payable at 16.5% 1,028, (b) Analyse the proper tax treatment for all items given in notes 1 to 7 above. (14 marks) 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 Affluence carries on a business in Hong Kong However, interest on deposits placed with the Shenzhen branch of the Bank of China is sourced outside Hong Kong and is not chargeable to profits tax Income on long-term qualifying debt instruments is exempt from profits tax under section 26A(1)(h) Long-term instrument refers to a debt instrument issued on or after 5 March 2003 and which has an original maturity of not less than seven years from the date of its issue Interest on tax reserve certificates is exempt from profits tax under section 26A(1)(a) Profit on disposal of patent The cost of the acquisition of patent used in the production of chargeable profit is deductible under section 16E(1) Since the patent was used in the company s manufacturing operation, the acquisition cost should have been deducted in the year of assessment 5

6 2005/06; hence, the subsequent sale proceeds is treated as a taxable trading receipt under section 16E(3), but limited to the amount of deduction previously allowed Rental income Letting of premises by a corporation is a business carried on in Hong Kong, and the rental income is chargeable to profits tax Being the owner of a property situated in Hong Kong, rental income is also chargeable to property tax under section 5(1) Affluence may apply for an exemption from property tax under section 5(2)(a) for the year of assessment 2013/14 and obtain a refund of the provisional tax paid However, if property tax has already been paid, it can be offset from the profits tax payable under section 25 Bad debts Bad debts incurred are deductible under section 16(1)(d) if the trade debts are proved to have become bad, or are estimated to the satisfaction of the assessor to have become bad during the basis period, and they have been included as taxable trading receipts A general allowance for doubtful accounts which is estimated based on rough estimation is not regarded as incurred and cannot be deducted Where recovery action has been taken on trade debts in vain, the specific provision is deductible The purchase of production machinery is capital in nature; the deposit which is used to acquire a capital asset is also capital in nature and the write-off is not deductible Contribution to MPF scheme Any ordinary contribution to a recognised retirement scheme for employees is deductible, up to 15% of the employee s remuneration 6

7 The salary of the individual employee was not provided in the question, but the amount seems not to be excessive with reference to the overall salary expense Payment of a special contribution can be deducted over five years of assessment under section 16A Exchange differences Any exchange gain or loss arising from trade debts is revenue in nature and is taxable/deductible Whether the gain or loss is realised or not is irrelevant; it is taxable/deductible if it has already been reflected in the income statement (See DIPN 42) However, an exchange loss on conversion of foreign currency time deposits is capital in nature and therefore is not deductible under section 17(1)(c) Interest expenses To be deductible, under section 16(1)(a) interest expenses must be incurred in the production of chargeable profits Interest paid to HSBC is interest on money borrowed from a financial institution and satisfies the condition under section 16(2)(d) The restriction under section 16(2A) and 16(2B) does not apply, and the full amount can be deducted Interest paid to the Bank of China is interest on money borrowed from a financial institution and satisfies the condition under section 16(2)(d) subject further to section 16(2A) and section 16(2B) The bank loan was secured by the deposits placed outside Hong Kong earning non-taxable interest income; the deduction shall be reduced by the related interest income under section 16(2A) (See DIPN 13A) The amount deductible is $113,000 - $82,000 = $31,000 7

8 1. (c) Advise the board of directors on the following issues: (i) Whether or not it is possible for Affluence Electronics Limited to claim a full or partial exemption from Hong Kong profits tax. You should analyse how the source of its profits is to be determined. (10 marks) (ii) Whether or not tax exemption or relief is available to those employees who are required to be stationed and work in Mainland China. You should consider the provisions of the Inland Revenue Ordinance and the relevant double taxation arrangement. (6 marks) (Total: 40 marks) Ans (c) (i) Section 14 imposes a charge to Hong Kong profits tax if a person carries on a trade or business in Hong Kong and the profits from such trade or business arises in or is derived from Hong Kong For manufacturing profit, the profit-making activity is the manufacturing operations Under a contract processing arrangement where a Hong Kong company provides raw materials, technical knowhow, machinery, etc., while the Mainland processing enterprise is responsible for the provision of factory premises and labour, the IRD generally accepts that chargeable profits can be apportioned on a 50:50 basis if the Hong Kong company has substantial involvement in the manufacturing operations in the Mainland (DIPN No. 21, paragraphs 33-34) In this case, Affluence has entered into an import processing arrangement with Treasure (as opposed to a contract processing arrangement) Under this arrangement, the Hong Kong company is regarded as selling raw materials to the Mainland enterprise and buying back the finished goods; the Hong Kong company engages in the trading of raw materials and finished goods whilst the Mainland enterprise manufactures the finished goods (DIPN No. 21, paragraphs 39-40) IRD holds the view that the profits accrue to the Hong Kong company from 8

9 trading transactions carried out in Hong Kong and cannot be attributed to the manufacturing operations of another enterprise carrying on business in Mainland China In CIR v Datatronic Limited (2009), where the arrangement between the taxpayer and its Mainland subsidiary was an import processing arrangement, the Court of Appeal held that the profit-producing transactions were the purchase of goods from the subsidiary by Datatronic and the subsequent sale, and that these activities took place in Hong Kong; a similar conclusion was reached in CG Lighting Limited v CIR (2011) Hence, Affluence may not be able to claim a full or partial exemption from Hong Kong profits tax on the premise that the manufacturing operations were carried out outside Hong Kong, since the 50:50 profit apportionment does not apply to an import processing arrangement In case of a trading profit, the place where the contracts of purchase and sale were effected is the important factor Where both the contract of purchase and contract of sale are effected in Hong Kong, the profits are fully taxable, and vice versa Where either the contract of purchase or contract of sale is effected in Hong Kong, the initial presumption will be that the profits are fully taxable, subject to consideration of other factors such as solicitation of orders, negotiation, conclusion, trade financing, shipment and performance of the contracts In the IRD s view, profit apportionment will not apply to trading profit, which will be either wholly taxable or wholly non-taxable Where the effecting of the purchase and sale contracts does not require travel outside Hong Kong but is carried out in Hong Kong by telephone, fax, etc., the contracts will be considered as having been effected in Hong Kong Affluence is regarded as having purchased the finished goods from a non-hong Kong manufacturer for resale purposes, so the relevant purchase orders/contracts have to be looked into to determine whether they were effected in Hong Kong 9

10 Currently, the sales orders are mostly received by Affluence s office in Hong Kong; the sales contracts would therefore be considered as having been effected in Hong Kong unless Affluence could prove that the relevant contracts were in fact negotiated and concluded by its staff with full authority or agents outside Hong Kong It seems quite likely that the IRD would regard the trading profits as sourced in Hong Kong and therefore fully chargeable to profits tax (ii) Staff employed by Affluence prima facie have a Hong Kong sourced employment and all their income is fully chargeable to Hong Kong salaries tax under section 8(1)(a) They could be exempt from Hong Kong salaries tax if they have not rendered any services in Hong Kong section 8(1A)(b) An exemption is also available if an employee rendered services in Hong Kong during visits of not more than 60 days section 8(1A)(b) and 8(1B) Further facts may need to be gathered if those employees have rendered any services in Hong Kong and the actual number of days they have spent in Hong Kong (if the IRD accepts that that their presence in Hong Kong qualifies as visit) to consider if they can be exempt from Hong Kong salaries tax According to the HK-Mainland Comprehensive Double Tax Arrangement it seems unlikely that the employees will be exempt from income tax in the Mainland, as the following conditions have to be satisfied for the exemption of individual income tax in the Mainland: - a Hong Kong resident is present in the Mainland for not more than 183 days in any 12-month period; - his remuneration is not paid by a Mainland employer; and - his remuneration is not borne by a permanent establishment in the Mainland If the employees have paid income tax in the Mainland for their services rendered in the Mainland, their salary income which has been chargeable to 10

11 tax in the Mainland can be excluded from being assessable in Hong Kong (section 8(1A)(c)), thus eliminating any double taxation Alternatively, as Hong Kong has signed a double taxation arrangement with Mainland China, income tax paid in the Mainland can be allowed as a tax credit against the salaries tax payable in Hong Kong: section 50(1) 11

12 SECTION B 2. Jason Lee is the accounting manager of Rocket Holdings Limited. He has provided you with the following notes for the year ended 31 March 2014: 1. He received a monthly salary of $55,000 and a bonus of $70,000 for the year. 2. He was provided with a flat in North Point which was leased by his employer from the landlord for $18,000 per month. Jason was required to pay a nominal rent of $5,000 which was deducted directly from his monthly payroll. 3. He was also provided with the free use of a company s motor car. Jason incurred fuel and parking expenses of $34,000 for the year. He was refunded for one-half of these expenses. The assessor agreed that 20% of the car use was for business purposes. 4. He was granted a share option on 2 August 2013 to subscribe for 20,000 shares in the company at $5 each. He paid $20,000 for the share option. On 5 October 2013, he exercised the option to subscribe for 10,000 shares which were subsequently sold at a profit on 10 December On 20 February 2014, he sold the remaining option to a colleague and received $60,000. The shares were quoted on the stock exchange at the following prices: 2 August 2013 $12 5 October 2013 $14 10 December 2013 $15 20 February 2014 $13 5. He was enrolled in the company s medical scheme. During the year, he received a medical refund of $36,000 from the insurance company. 6. He joined the employer s MPF scheme and has contributed $2,750 per month to the scheme. 7. In June 2013, he travelled to Japan for a business trip. He extended his stay in Tokyo for another two days for sightseeing. The costs of air tickets of $3,800 and hotel accommodation of $7,500 for five days (including two 12

13 days extended for sightseeing) were fully paid by his employer. 8. He is a member of the Hong Kong Institute of Chartered Secretaries (HKICS) and a member of the Hong Kong Certified Public Accountants (HKICPA). During the year, he paid annual subscription fees of $2,460 and $2,600 respectively to these two professional bodies. 9. To comply with his continuing professional development requirements, he attended various seminars and workshops orgainised by HKICS and HKICPA and paid fees totalling $3,000 and $2,700 to these two bodies respectively during the year. 10. In June 2013, Jason obtained a refund of $10,000 from the Continuing Education Fund for a China taxation course taken in He has claimed, and was allowed, a deduction for the full amount of the tuition fee of $13,000 paid by him in the year of assessment 2012/ Jason was divorced in He has a son with his ex-wife, Jacqueline. His son, aged 10 during the year, lives with Jacqueline. Jason paid $10,000 per month to Jacqueline towards the maintenance of his son. Jason s father, aged 65, was residing in a registered elderly care home. During the year, Jason paid $60,000 for his father s residential expenses. REQUIRED: 2. (a) Calculate the Hong Kong salaries tax liability of Jason Lee for the year of assessment 2013/14. You may assume that Jason would avail himself of whatever deductions or reliefs are available. Ignore provisional tax. (12 marks) Ans (a) Jason Lee Salaries tax computation Year of assessment 2013/14 $ $ Salary ($55,000 x 12) 660,000 Bonus 70,000 Refund of car expenses ($34,000 x 50%) 17,000 Holiday journey ($7,500 x 2/5) 3,000 Rental value 74,060 13

14 {[($660,000 + $70,000 + $17,000 + $3,000) ($6,800 + $2,600)] x 10%} Less: Rent suffered ($5,000 x 12) (60,000) 14,060 Share option gain 80,000 Exercise [($14 - $5) x 10,000-10,000] Assignment ($60,000 - $10,000) 50, ,000 Assessable income 894,060 Less: Car expenses ($34,000 x 20%) (6,800) Subscription to HKICPA (2,600) Self-education expenses (5,700) (15,100) Net assessable income 878,960 Less: Elderly residential car expense (60,000) Contribution to MPF scheme (15,000) (75,000) 803,960 Less: Personal allowances Basic allowance (120,000) Child allowance (70,000) (190,000) Net chargeable income 613,960 Salaries tax at progressive rates 92,373 Non-inclusion of medical refund 2. (b) Analyse the proper tax treatment for the information given in notes 7, 8, 9, 10 and 11. (8 marks) (Total: 20 marks) Ans (b) A holiday journey provided by the employer is taxable; the liability test under section 9(1)(a)(iv) does not operate to exclude this benefit even it is the employer s sole or primary liability to make the payment If a holiday was merely incidental to a business trip the IRD will refrain from taxing the benefit, but where the expenses are distinct and separable (e.g. accommodation costs for the extra nights spent on holiday), such expenses will be assessed The cost of air tickets will not be assessable because the trip to Japan was mainly for business purposes and the cost of the air ticket would have to be incurred irrespective of the holiday element Subscription to professional bodies is strictly speaking not deductible under 14

15 salaries tax because the expense is not incurred in the production of assessable income In practice, a deduction can be allowed where the holding of a professional qualification is a prerequisite of the employment and where the retention of membership and the keeping abreast of current developments in the particular profession are of regular use and benefit in the performance of the duties. Such a deduction is restricted to the subscription to one professional association only; hence the subscription to HKICPA will be claimed as the deduction will be higher Self-education expenses in connection with a prescribed course of education can be deducted under section 12(1)(e); a prescribed course of education includes a training or development course provided by a professional association The course of education undertaken must be for gaining or maintaining qualifications for use in any employment Fees for seminars and workshops offered by HKICS and HKICPA of $5,700 in total can be deducted in the year in which the expenses were paid Tuition fees that have been reimbursed or are reimbursable by an employer or any other person are not allowable (section 12(6)(b)); hence, the amount of $10,000 refunded by the Continuing Education Fund should be disallowed Since Jason claimed a deduction of $13,000 in respect of the tuition fee in the year of assessment 2012/13, he must inform the IRD in writing about the reimbursement of $10,000 as soon as he receives it; an additional salaries tax assessment for the year of assessment 2012/13 will be issued to adjust the amount of self-education expenses previously granted A basic allowance is granted to all taxpayers under salaries tax; Jason cannot claim the married persons allowance as he was divorced in 2012 Jason cannot claim a single parent allowance as he did not have the sole or predominate care of his child, who was living with the mother 15

16 Jason is eligible to claim child allowance in respect of his son as the son was aged below 18 and was maintained by Jason; apportionment of child allowance is possible if Jacqueline also claims that she has made a contribution towards the maintenance and education of their son Jason can deduct elderly residential care expenses in respect of his father as he was aged 60 or more and residing in a registered care home; the deduction can be up to $76,000 per annum 16

17 3. You are given the following information on several cases, each of which are independent from one another: (a) Merryland Limited (ML) owns a 100% interest in Cheerfuland Limited (CL) and a 90% interest in Happyland Limited (HL). All these companies were incorporated in Hong Kong. On 20 May 2014, HL transferred an office building in Sheung Wan to CL at its market value of $120 million. This transaction was entered into as part of the arrangement for listing the shares of CL on the Hong Kong stock exchange next year. It is expected that 25% of the shares in CL will be offered for sale to the general public. (b) Wellock Properties Limited let out a unit in a shopping arcade for a term of three years with a renewal option of another two years. The monthly rent includes a fixed sum of $80,000 and a variable amount computed at 3% of the monthly turnover of the business carried on in that unit. The total monthly rent is capped at $120,000. In addition, the tenant was required to pay a lump sum premium of $100,000 and rental deposit of $160,000 at the time of signing the tenancy agreement, which was executed in duplicate. (c) Terry Lau is looking for a residential property for investment purposes. He has a choice of two flats on the same floor of a building, Flat A and Flat B, located in Tsang Kwan O. Both properties were owned by Jenny Wong who asked for a selling price of $8 million. Jenny acquired Flat A from the property developer on 5 August 2010, and Flat B from Louis Ching on 10 September Terry is indifferent as to which flat he should buy because they have comparable views and floor area, and the same investment potential. He wonders if there is any difference in the stamp duty payable on the acquisition of these two properties. Assume that today is 3 June 2014 and the relevant agreement will be executed in the next couple of days. Terry currently owns three other residential properties in Hong Kong. (d) Vincent Wu is in bad health and he has decided to transfer a residential property in Causeway Bay to his son, Simon, who is 15 years old. Vincent asked his good friend, Kelvin Cheung, to hold the property in trust for Simon until he reaches the age of 21. Accordingly, Vincent executed a deed assigning the property to Kelvin for zero consideration on 15 February The market value of the property was $15 million on that day. At the same time, Kelvin signed a declaration of trust undertaking to 17

18 transfer the property to Simon on his 21 st birthday. REQUIRED: Analyse the Hong Kong stamp duty implications arising from all the cases given above. Compute the stamp duty payable where applicable. (Total: 20 marks) Ans (a) Conveyance of immovable property in Hong Kong is chargeable to stamp duty under Head 1(1) Exemption from stamp duty under section 45 applies to a transfer between associated bodies corporate, including the situation where a third body corporate is the beneficial owner of not less than 90% of the issued share capital of two companies CL and HL are associated bodies corporate because ML holds not less than a 90% interest in CL and HL However, section 45(4)(c) provides that the exemption will not apply if the instrument was made in pursuance of or in connection with an arrangement under which the transferor and transferee were to cease to be associated by reason of a change in the percentage of the issued share capital of the transferee in the beneficial ownership of the transferor or a third body corporate CL will be listed on the stock exchange next year and 25% of its shares will be offered for sale to the public; hence, ML s beneficial interest in CL will be reduced to 75% The transfer of the property from HL to CL was part of the arrangement of listing CL s shares on the stock exchange No exemption is therefore available and stamp duty is payable on the assignment deed at: $120 million x 8.5% = $10.2 million The instrument must be stamped within 30 days after execution Ans (b) An agreement for the lease of immovable property 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 The rate for a lease of more than one year but not more than three years is 0.5%; the renewal option is not included Stamp duty payable is: 18

19 Rent portion: $120,000 x 12 x 0.5% = $7,200 Premium:$100,000 x 4.25% = $4,250 The duplicate copy of the tenancy agreement is stamped at $5 under Head 4 The tenancy agreement is to be stamped with 30 days Ans (c) For residential property, the sale and purchase agreement is subject to ad valorem stamp duty under Head 1(1A) based on the higher of the stated consideration or the market value of the property New stamp duty rates specified in Scale 1 apply as Terry owns other residential properties in Hong Kong at the time of acquisition For either unit, stamp duty payable on the sale and purchase agreement would be $8,000,000 x 7.5% = $600,000 If the sale and purchase agreement is duly stamped, the assignment deed is subject to stamp duty of HK$100 under Head 1(1) Special stamp duty (SSD) was introduced on 20 November 2010; Flat A was acquired by Jenny before that day and the disposal of this flat will not give rise to any SSD Flat B was acquired by Jenny between the period from 20 November 2010 to 26 October 2012; as it will be resold within 24 months of acquisition, SSD will be imposed The holding period by the vendor is more than 12 months but not more than 24 months; SSD payable is $8 million x 5% = $400,000 The buyer and seller will be jointly and severally liable for the payment of the SSD; Terry may avoid the SSD if he acquires Flat A Stamp duty is to be paid within 30 days after the execution of the instrument Ans (d) When Vincent conveys the property to Kelvin, the assignment will be chargeable to stamp duty under Head 1(1) as voluntary disposition under section 27 Stamp duty payable is $15m x 7.5% = $1,125,000 The assignment must be stamped within 30 days after the date of assignment The declaration of trust executed by Kelvin is not subject to any stamp duty, but it should be submitted to the Collector for adjudication to the effect that the instrument is exempt from stamp duty When the flat is conveyed to Simon when he reaches the age of 21, the assignment will not be chargeable to stamp duty because there is no change of beneficial interest under section 27(5) Again, the assignment has to be submitted to the Collector for adjudication as being exempt from stamp duty 19

20 4. Jonathan Wong purchased a commercial unit in Kwai Chung from the property developer for investment purposes for consideration of $7 million (including land cost of $4 million). He let out the unit to Darson Limited on the following terms: 1. Lease term: 3 years from 1 April 2013, with one-month rent-free period 2. Rental deposit: $60, Lease premium: $90, Monthly rent: $20,000 payable on the 1 st day of each month 5. Rates and government rent: $3,000 and $1,800 per quarter respectively payable by the owner (ignore any rates concession) 6. Building management fee: $2,700 per month payable by the tenant to the building management office 7. Others: The tenant is required to re-instate the property to its original condition at the end of the lease; otherwise, the relevant cost incurred by the landlord will be deducted from the rental deposit. Darson Limited carries on a chemicals manufacturing business in Hong Kong. The property leased by the company from Jonathan was used as a laboratory for scientific research and product development. In April 2013, Darson Limited incurred $200,000 on leasehold improvements to make the property fit for use as a laboratory. As the company is required to re-instate the property to its original condition by the end of the lease term, the estimated re-instatement cost of $40,000 was accrued in the accounts pursuant to the accounting standard. The following information was extracted from the fixed assets register of Darson Limited for the year ended 31 March 2014: 1. New furniture and fixtures acquired: $110, Production machinery acquired: $145, Office equipment acquired: $84, Old office equipment was scrapped for $8,000 The tax written down values of the pooling system as of 31 March 2013 are: 20

21 20% pool (including office equipment, furniture and fixtures): $165,000 30% pool (including motor vehicles): $271,000 Darson Limited has also acquired a testing machine (ranking for 30% depreciation rate) under hire-purchase. The cost of the equipment was $500,000. Darson Limited made a down payment of $150,000 in December 2012, and the balance was payable by 10 equal monthly instalments interest-free. Five instalments have been paid from January 2013 to May The testing machine was found to be unsuitable and it was returned to the vendor in June 2013 without extra charge. REQUIRED: 4. (a) Calculate the Hong Kong property tax payable by Jonathan for the year of assessment 2013/14. Ignore provisional tax. (5 marks) Ans (a) Property tax computation Year of assessment 2013/14 Rent ($20,000 x 11) 220,000 Lease premium ($90,000 x 12/36) 30,000 Assessable value 250,000 Less: Rates ($3,000 x 4) (12,000) 238,000 Less: 20% statutory deduction (47,600) Net assessable value 190,400 Property tax payable at 15% 28, (b) Analyse whether or not depreciation allowances in respect of the Kwai Chung property are available to Jonathan and Darson Limited, and if so, calculate the relevant allowance or deduction for the year of assessment 2013/14. (6 marks) Ans (b) Depreciation allowance on a building or structure is only available under profits tax where it is used for producing chargeable profits; Jonathan is subject to property tax on the rental income and hence no allowance on the building will be available to him 21

22 Darson Limited, as tenant, has no relevant interest in the building and is not eligible for any depreciation allowance on the building However, Darson Limited has incurred capital expenditure on leasehold improvement; it has a relevant interest in the leasehold improvement and is entitled to claim an allowance based on expenditure of $200,000 The subject property was used for the purposes of research and development related to the chemicals manufacturing business, and therefore qualifies as an industrial building The initial allowance for the year of assessment 2013/14 is $200,000 x 20% = $40,000 The annual allowance is $200,000 x 4% = $8,000 The estimated reinstatement cost does not qualify for industrial building allowance; it is a provision and no actual expenditure has been incurred The actual amount of reinstatement cost is not deductible under section 17(1)(c) because the lease is a capital asset; the reinstatement cost when incurred is regarded as part of the capital cost of acquiring the lease 4. (c) Calculate the depreciation allowances and deduction available to Darson Limited in respect of its fixed assets based on the information given above. (9 marks) (Total: 20 marks) Ans (c) Depreciation allowances on plant and machinery (pooling system) 20% pool 30% pool $ $ W.D.V. b/f 165, ,000 Add: Furniture and fixtures 110,000 Less: Initial allowance (60%) (66,000) Office equipment 84,000 Less: Initial allowance (60%) (50,400) - 242, ,000 Less: Sale proceeds of equipment (8,000) - 234, ,000 Less: Annual allowance (46,920) (81,300) W.D.V. c/f 187, ,700 Test machine under hire-purchase Cost 500,000 Less: Initial allowance (2012/13) 22

23 ($150,000 + $350,000 x 3/10) x 60% (153,000) 347,000 Less: Annual allowance (30%) (104,100) 242,900 Less: Initial allowance (2013/14) ($350,000 x 2/10) x 60% (42,000) 200,900 Total allowances granted 299,100 Total capital expenditure incurred 325,000 Concessional balancing allowance for 2013/14 25,900 Production machinery qualifies for deduction as prescribed fixed assets under section 16G. 23

24 5. Creation Limited commenced a jewellery retailing business in Hong Kong on 1 January It made up its first set of accounts to 31 March 2014, and the profits after making necessary adjustments according to the Inland Revenue Ordinance for these 15 months was $3,300,000. The company has not received any tax return nor has it exchanged any correspondence with the Inland Revenue Department (IRD) so far. The company would like to start a new business selling jewellery to customers in European markets. A new subsidiary would be set up for this purpose. Instead of incorporating a new company, the accounting manager of Creation Limited suggested that it may acquire an existing company, Union Limited, which has been engaged in the garment trading business in Hong Kong for years. However, this company has suffered substantial losses in the past two years and its shareholders are contemplating selling the business at a low price. The tax loss of Union Limited has been agreed with the IRD to be $8,400,000. The accounting manager has said that it would be worth acquiring the company to take advantage of the tax loss. REQUIRED: 5. (a) Determine the basis period(s) and taxable profits of Creation Limited for the relevant year(s) of assessment, and explain the basis in arriving at your answers. (5 marks) Ans (a) Where a person commences a business in Hong Kong and makes up the first accounts to a day other than 31 March, if the first accounts are for a period in excess of a year and are made up to a day within a year of assessment following that in which the commencement occurred, the basis period is to be computed on such basis as the Commissioner thinks fits: section 18C(1)(b) Normally, for the year of commencement, the IRD will choose the period from the date of commencement to the corresponding accounting date in the year of commencement For the year of assessment 2012/13 (year of commencement), the basi s period will be from 1 January 2013 to 31 March 2013 Assuming that there is no tax adjustment to the figure given, the profit assessable in the year of assessment 2012/13 is $3,300,000 x 3/15 = $660,000 24

25 For the year of assessment 2013/14, the basis period will be from 1 April 2013 to 31 March 2014: section 18B(1) The profit to be assessed in the year of assessment 2013/14 is $3,300,000 x 12/15 = $2,640, (b) Advise Creation Limited of its compliance obligations as a taxpayer (other than those as an employer) under the Inland Revenue Ordinance. If the company has violated any relevant provision under the Ordinance, explain the possible penalties. (7 marks) Ans (b) Every person chargeable to tax shall inform the Commissioner in writing that he is so chargeable not later than four months after the end of the basis period for that year of assessment: section 51(2) Creation Limited is chargeable to profits tax for the year of 2012/13 and 2013/14; it should inform the IRD not later than 31 July 2014 for the year of assessment 2013/14 unless it has already received its profits tax return Failure to notify the chargeability is an offence under section 80(2) and liable to a fine at level 3 ($10,000) and a further fine of treble the amount of tax which has been uncharged If a profits tax return is issued by the IRD, the company is required to submit the completed return within the period specified in the return under section 51(1) The company is also required to answer queries raised by the IRD or supply any information as requested within the specified time period If it changes its address, it should inform the Commissioner in writing of the particular of the change within one month under section 51(8) If it ceases to carry on the business, it must inform the Commissioner in writing within one month of such cessation The company is required to keep sufficient records in English or Chinese to enable the assessable profits to be readily ascertained and to retain such records for not less than seven years after the completion of the transaction 5. (c) Comment on the suggestion proposed by the accounting manager. (8 marks) (Total: 20 marks) 25

26 Ans (c) It appears that the accounting manager s proposal is to make use of the tax losses sustained in Union Limited A company s tax loss can be carried forward indefinitely and set-off against future profits made by the company under section 19C(4); the possible tax benefit in the case of Union Limited could be $8,400,000 x 16.5% = $1,386,000 Section 61B applies to disallow the set-off of any loss if a change in the shareholding of a loss-making company has been effected and the Commissioner is satisfied that as a direct or indirect result of the change, profits have been received by or accrued to the company during any year of assessment, and the "sole or dominant" purpose of the change in shareholding was for the purpose of utilisation of the tax loss In deciding whether profits have been received as a result of the change of shareholding, the flow of profits before and after the change will be examined, having particular regard to matters such as the nature and conduct of the company s business, income and expenditure patterns, management and control, and the background of the party to whom shares were transferred In considering the purpose of the change, the continuity of business, level of ownership and any major changes in the nature and conduct of business could be relevant factors There is no indication that Creation Limited has any intention to continue or improve the existing business of Union Limited Union Limited used to carry on a garment trading business in Hong Kong, however a jewellery trading business will be started by the company after its acquisition by Creation Limited. It appears that there is no commercial justification for the acquisition of the business (e.g. utilisation of the sales network or connection established by the company) apart from the utilisation of the tax loss, which is the sole or dominant purpose of the acquisition It is likely that section 61B will be applied to disallow the set-off of any loss against future profit from the jewellery business An arrangement is available for Creation Limited to obtain an advance ruling on the acquisition proposal in respect of the treatment of the losses brought forward Creation Limited should also be aware of the possibility of a challenge by the IRD on the basis of other general anti-avoidance provisions such as section 61A Creation Limited cannot utilise the tax loss directly because group loss relief is not available under the Hong Kong tax regime 26

27 6. Steven Chan is carrying on a partnership business with Johnson Yeung providing technology consultancy services. They share any profit or loss equally. For the year ended 31 March 2014, the partnership has a loss of $279,000, which is arrived at after deducting the following payments: Salary for Steven $300,000 Salary for Johnson $300,000 Contribution to MPF scheme for Steven $30,000 Contribution to MPF scheme for Johnson $30,000 Termination payment to a staff member* $170,000 (* the sum was paid for the staff member agreeing not to join any existing clients of the company for two years) Steven is married and his wife, Teresa, is expecting a baby at the end of this year. Steven has decided to seek a full-time job which could provide him a stable income. The partnership business will then be mainly taken care of by Johnson, while Steven would help during the weekends only. Teresa works as a secretary and her salary for the year ended 31 March 2014 was $150,000. She will resign from her job in September Teresa owns a residential property in Hong Kong which she inherited from her father a few years ago. She received rental income of $120,000 from this property during the year ended 31 March Steven and Teresa currently live in a property in Tai Po which is owned by Steven s mother. They have decided to buy a larger flat in their joint names. Over the years, they have saved sufficient funds for the down payment, but they have to borrow funds to pay for the balance of the purchase consideration. Steven has recently received an offer for a systems analyst position in a local company. The company can be flexible in structuring his remuneration package. For the housing benefit, Steven can choose from one of the following options: 1. He could receive a monthly housing allowance, which he could use to rent a property or to repay his home loan. He would not be required to account for the use of the money. 2. He could borrow a low-interest loan from the company for the acquisition of his dwelling. The interest rate is fixed at 2% per annum. The loan would be unsecured, but Steven and his wife would be required to execute a personal guarantee for the repayment of the loan. 3. He could borrow a mortgage loan from any bank in Hong Kong for the 27

28 purchase of his dwelling. The company would subsidise any interest payment which in excess of 2% per annum by paying this in cash upon the submission of a bank advice. Steven reckons that these options are more or less the same to him in monetary term, excluding any potential differences in tax which he is not familiar with. Steven and Teresa have elected to be assessed under personal assessment for the year of assessment 2013/14. REQUIRED: 6. (a) Compute the Hong Kong profits tax payable by the partnership business, and the tax payable by Steven and Teresa under personal assessment for the year of assessment 2013/14. Show all your workings, including the allocation of profit or loss between the partners. (13 marks) Ans (a) Steven and Teresa Personal assessment Year of assessment 2013/14 Steven Teresa Total $ $ $ Net assessable value ($120,000 x 0.8) - 96,000 96,000 Net assessable income - 150, ,000 Assessable profit 260, ,500 Total income 260, , ,500 Less: Married person's allowance (240,000) Net chargeable income 266,500 Tax at progressive rates 33,305 Steven and Johnson's partnership business Profits tax computation Year of assessment 2013/14 $ Accounting loss (279,000) Add: Salary for Steven 300,000 Salary for Johnson 300,000 MPF contribution - Steven 15,000 MPF contribution - Johnson 15,000 Termination payment 170,000 Assessable profit 521,000 Allocation of profit or loss 28

29 Steven Johnson Total Salary 300, , ,000 MPF contribution 15,000 15,000 30,000 Balance to be shared (1:1) (54,500) (54,500) (109,000) Less: Transfer to personal assessment 260, , ,000 (260,500) - (260,500) - 260, ,500 Tax 39, (b) Advise Steven of the salaries tax implications arising from the three options for housing benefit available to him. (7 marks) 29 (Total: 20 marks) Ans (b) While a rent refund is not taxable under section 9(1A)(a), housing allowance which can be used in whatever manner the employee likes is a cash allowance, which is fully taxable Steven is not required to account for the use of the money, and he is also not renting a property; the housing allowance cannot be a rent refund and is taxable, even though it is used for home loan repayment On the other hand, if the specified conditions are fulfilled, he and his wife could claim a deduction of home loan interest paid up to $100,000 per annum for a maximum of 15 years For the second option, he will enjoy the benefit of paying a reduced amount of interest; however, the benefit is not taxable The benefit does not discharge any personal liability of Steven; the loan is made between Steven and the employer. It will be the sole or primary liability of the employer to provide the benefit and the benefit cannot be converted into money: section 9(1)(a)(iv) and 9(2A) Steven cannot claim a home loan interest deduction under this option because the loan is not secured by a mortgage or charge over the dwelling or any other property in Hong Kong For the third option, as Steven will borrow the loan directly from the bank, he has the personal liability to pay interest at the market rate. The subsidy of the interest differential by the employer represents a discharge of his personal liability, and this is taxable However, he can deduct home loan interest for the interest paid if the relevant conditions are fulfilled END