Paper P6 (HKG) Advanced Taxation (Hong Kong) Friday 7 December Professional Level Options Module

Transcription

1 Professional Level Options Module Advanced Taxation (Hong Kong) Friday 7 December 2012 Time allowed Reading and planning: Writing: 15 minutes 3 hours This 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 paper until instructed by the supervisor. During reading and planning time only the question paper may be annotated. You must NOT write in your answer booklet 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. TAX RATES AND ALLOWANCES The following 2011/12 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% On the remainder 17% Standard rate 15% Allowances $ Basic allowance 108,000 Married person s allowance 216,000 Single parent allowance 108,000 Child allowance 1st to 9th child (each) 60,000 Child allowance additional allowance in the year of birth (each) 60,000 Dependent parent/grandparent allowance basic 18,000/36,000 additional 18,000/36,000 Dependent brother/sister allowance 30,000 Disabled dependant allowance 60,000 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 Share transfers 0 2% + $5 Conveyances (ignoring marginal reliefs) Not exceeding $2,000,000 $100 Not exceeding $3,000, % Not exceeding $4,000, % Not exceeding $6,000,000 3% Not exceeding $20,000, % Exceeding $20,000, % Leases (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% Not exceeding three years 0 5% Exceeding three years 1% (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 Assume today s date is 2 December Organic World Inc (the Parent), a company incorporated in the US, has since September 2006 wholly-owned a subsidiary in Hong Kong, Green HK Ltd (Green-HK). Green-HK operates a retail store in Hong Kong and imports organic goods from the Parent and sells the goods in the store. It closes its accounts on 31 December. Starting from January 2010, the Parent also has another wholly-owned subsidiary in China, Green China Ltd (Green-China), which operates a similar retail store in Mainland China but not in Hong Kong. Green-China has been performing very well in these two years, showing continuous increases in profitability, but Green-HK s business has been declining significantly. The Chief Executive Officer (CEO) of Green-HK called a meeting at which the following was discussed: (1) The following extract of management accounts as at 30 November 2011 was presented: Assets: $ Liabilities: $ Land and store building (cost) 10,000,000 Trade creditors 3,000,000 Depreciation (2,000,000) Amount due to parent 15,000,000 Equipment 4,000,000 Capital account (6,000,000) Depreciation (3,000,000) Trading stock 2,000,000 Trade debtors 1,000,000 12,000,000 12,000,000 (2) The Parent decided to cease the business in Hong Kong with effect from 1 January Before the store is closed on 31 December 2011, all the assets and liabilities of Green-HK would need to be cleared according to the following proposal: (i) (ii) The land and store building would be sold to a potential purchaser, and the offer is still under negotiation. The tentative sale consideration is $12,000,000 comprising $11,000,000 for the land and $1,000,000 for the store building. The purchaser has counter-offered that if Green-HK were to demolish the building and sell the land site only, a higher offer might be considered. Based on Green-HK s tax records, the land and building were acquired in July 2006 directly from the property developer at $10,000,000, 50% of which was attributed to the building. The CEO is wondering how the different modes of sale would impact the tax position of Green-HK. Moreover, the CEO is interested to know how much annual depreciation allowance the purchaser, who makes up his accounts to 31 March, might be entitled to claim if he continued to use the store as it is. All the store equipment would be donated to a charitable organisation in Hong Kong. Any remaining minor furniture and fixtures not accepted by the charity would be scrapped. The CEO is wondering if the net book value of the equipment would be eligible for a tax deduction as a charitable donation, and whether it would be better if the equipment was sold first and then the sale money was donated to the charity. (iii) To clear the trading stock on hand, Green-HK would sell it to Green-China at a price to be mutually agreed. Discussions with Green-China so far indicate that the deal would not be made unless the price was fixed at 30% below the usual market price. Although this is not desirable to Green-HK, it was expected that the Parent would consent to this deal. The CEO is concerned about the impact of the deal on Green-HK, especially in the light of the recent development of the transfer pricing principle in Hong Kong. (iv) The amount due to the Parent of $15,000,000 would be waived by the Parent since Green-HK would not be likely to have the ability to pay. Green-HK s records indicated that most of the amount represents the purchase cost of goods imported from the Parent for sale in the store in previous years but which remained unsettled. (3) All staff members would be made redundant. On top of the statutory amount of redundancy payment, Green-HK was considering paying an additional gratuity representing two months salary. Before making the decision, the CEO wants to assess whether these payments would be tax deductible to Green-HK. 4

5 (4) Based on the tax records, Green-HK has brought forward tax losses of around $2,000,000 from 2010/11. The tax written down values for the plant and machinery pools are insignificant. As the tax advisor to Green HK Ltd (Green-HK), prepare a report for the Chief Executive Officer (CEO) addressing the tax issues raised in the meeting as follows, providing supporting calculations where appropriate. (a) (c) (d) Sale of land and store building (per item (2)(i) of the meeting notes): (i) The tax implication to Green-HK arising from the sale of the land and store building, including a computation of the applicable depreciation allowance for each year of ownership and in the year of disposal; (ii) The impact of the potential purchaser s counter-offer on the tax position of Green-HK; (iii) The annual depreciation allowance that might be available to the purchaser upon his acquisition of the land and store building, assuming that the store continued to be used as it was. (3 marks) Donation of equipment (per item (2)(ii) of the meeting notes): (i) Whether, and if so how, the donation would qualify as a tax deduction for Green-HK; (ii) Whether, and if so how, the alternative suggested by the CEO would help Green-HK get the tax deduction. (3 marks) Sale of trading stock (per item (2)(iii) of the meeting notes): (i) (ii) The tax implication to Green-HK arising from the sale of trading stock to Green China Ltd (Green-China) at the price suggested by Green-China; Note: You are not required to discuss the transfer pricing implications in this part. The impact of the current development of transfer pricing principles in Hong Kong on the suggested sale transaction. (5 marks) Waiver of inter-company balance by Organic Worldwide Inc (the Parent) (per item (2)(iv) of the meeting notes): Whether, and if so to what extent, the waiver would be tax effective for Green-HK. If you consider it not tax effective, give suggestions. (e) Redundancy payment and additional gratuity (per item (3) of the meeting notes): Whether, and if so how, the redundancy payment and additional gratuity would be tax deductible to Green-HK. If applicable, give an alternative suggestion. Professional marks will be awarded in question 1 for the appropriateness of the format and presentation of the report and the effectiveness with which its advice is communicated. (39 marks) 5 [P.T.O.

6 2 Antony and Rebecca are a married couple who are seeking professional tax advice on their tax positions. The following information relates to their affairs for the year ended 31 March 2012: (1) Antony was previously employed by Mix and Match Ltd, a Hong Kong-listed company. On 1 March 2011, he was offered a lump sum payment of $300,000 to join Modern Home Ltd (MHL), an interior decoration firm resident in Hong Kong, as head designer. On 1 April 2011 he accepted the offer, received the payment and started working for MHL. (2) His salary with MHL is $100,000 per month. Antony contributed 5% of his total salary to MHL s Mandatory Provident Fund Scheme; MHL contributed 10% to the Scheme. (3) Antony received a housing allowance of $30,000 per month. However, he only spent $25,000 per month on rent, government rates and management fees associated with his rented flat. His employment contract states that his rental allowance is designed to enable him to afford accommodation in Hong Kong, and that it may be applied by him towards rent or a home purchase. MHL requires Antony to provide a copy of his lease and monthly rental receipts, but has never queried the fact that he does not spend the whole of his housing allowance on accommodation. (4) MHL provided Antony with a new car (cost $500,000) which he could, and did, use for private (50%) as well as business (50%) purposes. MHL also provided him with a petrol station card taken out in the name of MHL. Antony charged all his expenditure on petrol, totalling $48,000, to this card. (5) MHL paid a club membership for Antony at the Hong Kong Designers Club. The annual membership fee was $32,000 and the membership was in Antony s name. Antony regularly used the club for entertaining MHL s clients. His total entertainment expenditure at the club was $38,000, of which MHL reimbursed him $28,000 upon production of vouchers showing client entertainment and promotion. (6) Antony received a share option in the year of assessment 2009/10 while he was working for Mix and Match Ltd. Under the terms of his share option, Mix and Match Ltd would either pay him the cash value of his option or provide him with shares. Antony could not insist on receiving shares. The option became exercisable in the year of assessment 2011/12. When Antony exercised his option, Mix and Match Ltd exercised its right to pay cash instead of providing shares; and Antony received $100,000. (7) After work hours, Antony devoted his time to writing numerous articles on interior design for magazines and newspapers. From this activity, he earned $90,000 in the year 2011/12. (8) Antony earned $15,000 in royalties in 2011/12 from a book on interior design that he had written the previous year. The publisher who paid him the royalties is based in Singapore, and the book was published and sold only in Singapore. (9) Rebecca is a housewife. In her spare time, she sells home products to friends on behalf of a Taiwan company. For this purpose, the company sends her a stock of products each month, and Rebecca arranges home parties to which she invites friends and demonstrates the products. She earns a commission of 20% of the gross sales proceeds of the goods she sells on behalf of the company. In the year of assessment 2011/12, Rebecca earned commissions totalling $80,000. (a) Advise Antony and Rebecca of their respective tax positions for the year of assessment 2011/12. Support your advice with a computation of Antony s salaries tax liability. (25 marks) Advise Rebecca of the compliance obligations, if any, imposed on her under the Inland Revenue Ordinance in respect of her sale of home products on behalf of the Taiwan company. (29 marks) 6

7 Section B TWO questions ONLY to be attempted 3 (a) Below is the group structure of P Ltd and its subsidiaries: P Ltd Third party 100% 100% 90% Issue shares 10% To be liquidated A Ltd Transfer shares B Ltd Assets Bank loan 100m (70m) Net assets $30m 100% C Ltd $30m 100% 100% Commercial property Current structure Proposed restructuring Under the current structure, P Ltd owns all the shares in A Ltd and B Ltd. A Ltd, in turn, owns all the shares in C Ltd. P Ltd is incorporated in Bermuda. A Ltd, B Ltd and C Ltd are all incorporated in Hong Kong. C Ltd owns a commercial property in Hong Kong, which is mortgaged in favour of the Citibank for an amount of $70 million. It is proposed to restructure the group in January 2013 as follows: Step 1: Step 2: Step 3: A Ltd will transfer 100% of the shares in C Ltd to B Ltd. The consideration will be $30 million payable to A Ltd, plus another $70 million payable direct to the Citibank on behalf of C Ltd. B Ltd will issue shares equivalent to 10% of its total new shareholdings to an unrelated third party for $4 million. The amount so raised will not be used in Step 1. A Ltd will then be liquidated. Explain the stamp duty implications arising from the transfer of the shares in C Ltd (Step 1). Clearly identify any available exemptions and analyse the extent to which these exemptions may be affected by Steps 2 and 3 in the restructuring proposal. (11 marks) After the restructuring, C Ltd will lease the commercial property to B Ltd for four years. Under the lease agreement, B Ltd will pay C Ltd $50,000 per month plus 3% of B Ltd s gross turnover each month from the business conducted in the property. The market rental of the property is $80,000 per month. Explain the stamp duty implications of this leasing arrangement. (5 marks) (16 marks) 7 [P.T.O.

8 4 Home Design Inc (HDI) is a US corporation which is engaged in the business of purchasing furniture from factories in Mainland China and reselling them to customers around Asia, including Hong Kong. HDI has engaged the services of an unrelated buying agent in Hong Kong, Buyer Ltd, to deal with suppliers on its behalf. Buyer Ltd is responsible for negotiating terms (as dictated by HDI) and placing purchase orders with suppliers representatives in Hong Kong, performing quality control services, and arranging shipment of the furniture either to HDI in the USA or directly to customers outside the USA according to the directions given by HDI. In addition, Buyer Ltd maintains a showroom in Hong Kong, which potential customers visit from time to time to view samples. If buyers wish to place orders during such visits, they complete a purchase order form which Buyer Ltd faxes to HDI s office in the USA. HDI then follows up with customers out of its office in the USA. Buyer Ltd does not negotiate the terms of such sales. About 20% of all sales are made to customers in Hong Kong. (a) Based on the Departmental Interpretation and Practice Note No. 21 entitled Locality of Profits, explain the practice adopted by the Commissioner of Inland Revenue for determining the source of trading profits. Discuss whether Home Design Inc s profits from the trading transactions should be subject to, or exempt from, profits tax. If you consider that the profits are subject to profits tax, advise how Home Design Inc could restructure its activities to ensure that the profits would be exempt from tax. (12 marks) (16 marks) 8

9 5 Auto Ltd is a company incorporated and carrying on business in Hong Kong. Despite continuous profitability since the commencement of its business, in the last year Auto Ltd has experienced a tremendous market downturn and incurred significant accounting losses. The sole shareholder of Auto Ltd, Mr Tan, is a non-hong Kong resident. He understands that under his tax jurisdiction, tax losses incurred by a corporation can be carried back and applied to offset a corporation s profits in the preceding year. Moreover, tax losses of a corporation resident in his tax jurisdiction can be transferred to another profitable corporation within the same group. (a) Based on the Inland Revenue Ordinance, state the general rules governing the treatment of tax losses for corporations carrying on businesses in Hong Kong, assuming the corporations are not involved in any partnership. Mr Tan is considering disposing of the shares in Auto Ltd in order to capitalise the tax benefit arising from the tax losses carried forward by Auto Ltd. Advise Mr Tan on the Hong Kong tax implications arising from the share disposal for the ability of Auto Ltd to carry forward its tax losses. (6 marks) (c) If he does not sell the shares in Auto Ltd, Mr Tan intends to make a loan to Auto Ltd with interest in order to finance the company s future operations. Advise Mr Tan on the Hong Kong tax implications to Auto Ltd in respect of the interest incurred on this loan as currently proposed and, if appropriate, suggest a structure which will ensure that the loan interest will be deductible. Note: You may assume that Mr Tan is not carrying on a money lending business when and by virtue of making the loan. (6 marks) (16 marks) End of Question Paper 9