THE HONG KONG INSTITUTE OF CHARTERED SECRETARIES THE INSTITUTE OF CHARTERED SECRETARIES AND ADMINISTRATORS International Qualifying Scheme Examination HONG KONG TAXATION MAY 2013 Time allowed 3 hours Section A Compulsory case study Section B 5 long questions (attempt any 3) DO NOT OPEN THIS PAPER UNTIL INSTRUCTED TO DO SO BY THE INVIGILATOR Important Note: Candidates are allowed 15 minutes reading time to read through the question paper before the commencement of the examination between 1:45p.m.-2:00p.m. During the reading time, all candidates must be silent and must not write or mark anything on their question papers or answer books. Candidates must close all their reference books, notes or other unauthorised materials and put these under their chairs. If any candidates write or make any marks during the reading time, or if they speak or in any other way communicate with anyone either in or outside the examination hall during this period or read any unauthorised materials, they will be disqualified from continuing this examination paper. Once candidates have opened the question paper, they are not allowed to leave the examination hall until 2:30p.m. Page 1 of 16
THIS IS A BLANK PAGE Page 2 of 16
SUBJECT NO 16M HONG KONG TAXATION MAY 2013 The examination paper is divided into TWO Sections. Section A is a case study with compulsory questions which carries 40 marks. Candidates should attempt THREE questions from Section B, all of which carry 20 marks each. You should allow yourself approximately 70 minutes in total to answer the questions in Section A, and 35 minutes for each of the questions attempted in Section B. Unless otherwise stated, $ denotes Hong Kong dollars. Tuesday afternoon 28 May 2013 Time allowed: 3 hours SECTION A (Compulsory answer ALL questions in this section) 1. Timely Limited carries on a watch trading and distribution business in Hong Kong. Presented below is information extracted from the company s financial statements for the accounting year ended 31 March 2013, which indicated net income of $7,123,000 after taking into account the following items: Note $ Income: Dividend income 33,000 Interest income 1 74,700 Profit on disposal of fixed assets 121,000 Compensation 2 100,000 Expenses: Bad debts 3 79,200 Depreciation 321,500 Donations 4 148,800 Interest 5 963,000 Legal and professional fees 6 130,400 Repairs and maintenance 7 142,600 Page 3 of 16
Notes to the accounts: $ 1. Interest income: Interest on deposits placed with DBS Bank in Hong Kong 27,000 Interest on a loan advanced to a director* 44,000 Interest on overdue trade debts 3,700 74,700 * The company has advanced a low-interest rate loan to a director to finance his acquisition of a residential property in Taiwan. The funds were remitted to his bank account in Taiwan. 2. One of the company s distributors has terminated the distribution contract with the company and paid compensation of $100,000 as liquidated damages pursuant to the contract. 3. Bad debts: Increase in allowance for doubtful accounts computed at various percentages of trade debts outstanding based on their aging 26,000 Writing off of trade debts for which recovery action taken in vain 113,200 Partial recovery of a loan advanced to a distributor (written off as bad in 2010) (60,000) 79,200 4. Donations: Cash donated to Red Cross Hong Kong 50,000 Purchase of a commemorative banknote (the proceeds of which were to be donated to an approved charity in Hong Kong) 88,800 Purchase of raffle tickets issued by Tung Wah Group of Hospitals 10,000 148,800 5. Interest: Bank interest paid to DBS Bank (banking facilities being secured by the deposits placed with the same bank, see note 1 above) 163,000 Debenture interest* 800,000 963,000 * The debentures were listed on a recognised stock exchange. Throughout the year, 20% of the debentures were held by Affluent Limited, a fellow subsidiary carrying on a trading business in Taiwan. 6. Legal and professional fees: Annual retainer fee for general legal consultation 30,000 Legal fees for recovery of a loan to a distributor (see note 3 above) 5,000 Fine for illegal parking 2,000 Other (allowable) 93,400 130,400 7. Repairs and maintenance: Replacement of carpet 42,000 Renovation of showroom* 55,000 Repair of office equipment 16,000 Other (allowable) 29,600 142,600 * The whole amount incurred has been charged to the income statement. Page 4 of 16
Additional note: Total depreciation allowance for profits tax purposes for the year is $579,000. Additional information: Timely Limited is going to introduce a new series of watches in the Hong Kong market bearing the trademark SCLOCK which is owned by TM Limited, an unrelated company carrying on business in Country A. TM Limited has registered the trademark in many jurisdictions including Hong Kong. The management has negotiated with TM Limited and the following alternatives are open to both parties: (1) Timely Limited licenses the right to use SCLOCK in Hong Kong from TM Limited at a royalty computed at 2% of the value of sales in Hong Kong. (2) Timely Limited acquires the trademark registered in Hong Kong from TM Limited for a consideration of $4 million. (3) Timely Limited sets up a subsidiary company in a low tax jurisdiction and arranges for the subsidiary to acquire and hold the registered trademark, which in turn will be licensed to Timely Limited at a royalty computed at 10% of the value of sales in Hong Kong. The board of directors will discuss the available options in the coming meeting and has instructed the financial controller to advise on the tax implications of these options. REQUIRED: (a) (b) (c) Prepare the Hong Kong profits tax computation for Timely Limited for the year of assessment 2012/13. Ignore provisional tax and any one-off tax waiver. (12 marks) Analyse the proper tax treatments for all items given in notes 1 to 7 above in your computation in part (a) above. (16 marks) In respect of the trademark SCLOCK, advise the board of directors on the Hong Kong profits tax implications arising from all the three options available from the perspectives of TM Limited, Timely Limited and the proposed subsidiary in option (3). You may also need to alert the board if any anti-tax avoidance provisions under the Inland Revenue Ordinance are potentially applicable. (12 marks) (Total: 40 marks) Page 5 of 16
SECTION B (Answer THREE questions from this section) 2. Dickson Leung joined Trendy Garment Limited (TGL), a company carrying on garment manufacturing and trading business in Hong Kong, as a production manager on 1 April 2012. He is responsible for overseeing the company s manufacturing operations in Shantou in Guangdong Province. Dickson normally comes back to Hong Kong every Saturday and returns to the Mainland factory on the following Monday. On the first Monday of every month, he attends a production meeting in Hong Kong. Apart from this, he is not required to perform any regular duties in Hong Kong. Dickson provides you with the following notes for the year ended 31 March 2013: 1. He received a monthly salary of $35,000. 2. He received a meal allowance of $2,000 per month. 3. He was provided with a flat in Shantou which was leased by TGL at a monthly rent of $1,500. He has the exclusive right to occupy the flat without the payment of any rent. 4. He joined TGL s medical insurance scheme and received a refund from the insurance company of $6,500. TGL has paid an insurance premium of $2,000 in respect of his cover. 5. He was awarded 30,000 shares in the holding company of TGL on 1 July 2012. However these shares will only be registered in his name one year from the date of award if he is still employed by TGL during that year. He received dividend income of $3,600 on 10 January 2013 from these shares. The shares were quoted on the Stock Exchange of Hong Kong at $5.00 and $5.20 on 1 July 2012 and 31 March 2013 respectively. 6. He completed a degree course in textile studies offered by a Hong Kong university during year and TGL refunded him $17,000 of the course fee he paid during the year. He also received a gift voucher of $3,000 from TGL in appreciation of his completion of the study. 7. He joined TGL s MPF scheme and has contributed $3,000 per month to the scheme. Dickson is single and is a Hong Kong permanent resident. When he returns to Hong Kong during the weekend, he stays in his parents self-owned property in Lam Tin. His parents were aged 53 and 56 during the year ended 31 March 2013. Dickson has paid $6,000 per month to his parents in support of their living expenses. Dickson wonders if he is required to pay salaries tax in Hong Kong for this employment as he has performed all his services outside Hong Kong. He reckons that he may need to pay tax in the Mainland but would like to explore whether any tax relief would be available to him as a Hong Kong resident. You are informed that he has not yet paid any tax in the Mainland so far. Page 6 of 16
REQUIRED: (a) (b) (c) Advise Dickson of his Hong Kong salaries tax position and whether or not he is entitled to any tax relief in the Mainland as a Hong Kong resident. (7 marks) Assuming that Dickson is liable to pay salaries tax in Hong Kong, calculate his tax liability for the year of assessment 2012/13. Ignore provisional tax and any one-off tax waiver. (6 marks) Assuming that Dickson is liable to pay salaries tax in Hong Kong, advise him of the tax treatments for the information given in notes 3, 4, 5 and 6. (7 marks) (Total: 20 marks) Page 7 of 16
3. Fortune Limited wholly owns Treasure Limited and holds 85% interest in Wealth Limited. All the companies were incorporated in Hong Kong. Fortune Limited has 100,000 authorised shares of $1 each, of which only 50,000 shares were issued and held by Kelvin Kwan. On 15 September 2012, Treasure Limited transferred a residential property in North Point to Wealth Limited at a consideration of $9 million to be used as a director s quarters. As both companies are in the same group, the assignment deed has not been submitted for stamping. In January 2013, Treasure Limited leased a shop unit to a third party for a term of two years commencing on 1 February 2013, with a renewal option for another two years. The monthly rent was $50,000. The tenant was required to pay a rental deposit of $100,000 and a non-refundable premium of $150,000. Treasure Limited allowed the tenant a rent-free period of one month for carrying out renovations. On 5 March 2013, Treasure Limited exchanged a piece of land in Sha Tin with a third party, Lily Limited. The consideration stated in the deed of exchange was $5 million payable by Treasure Limited to Lily Limited. The market values of the two pieces of land exchanged were $7 million and $13 million respectively. Kelvin is going to marry his fiancée, Christina, next month. Kelvin has decided to transfer his 10% interest in Fortune Limited to Christina for a consideration of $10. The accountant has informed Kelvin that the fair market value of the company is $150 million. He wishes to transfer the shareholding in the most cost effective manner. REQUIRED: (a) (b) Analyse the Hong Kong stamp duty implications arising from all the completed transactions given above. Compute the stamp duty payable where applicable. (13 marks) Advise the possible ways that Kelvin can transfer part of his shareholding in Fortune Limited to Christina, and recommend the cost effective ways from the stamp duty perspective. (7 marks) (Total: 20 marks) Page 8 of 16
4. Alex Wang and his brother, Brandon, acquired a residential property located in Tseng Kwan O as joint tenants in February 2012 for a consideration of $7 million. The acquisition was partly financed by a mortgage loan from Hang Seng Bank. The brothers let out the property to Ricky Lai on the following terms: 1. Lease term: 2 years from 1 April 2012, renewable for another one year 2. Rental deposit: $30,000 to cover any cost of repairs or loss of revenue due to default by the tenant 3. Lease premium: $60,000 4. Monthly rent: $15,000 payable on the 1 st day of each month 5. Rates and government rent: $2,700 and $1,620 per quarter respectively payable by the owner (ignore any rates concession) 6. Building management fee: $1,100 per month payable by the tenant to the building management office Starting from January 2013, Ricky has delayed the payment of rent. As of 31 March 2013, rent for February and March 2013 was still outstanding. During the year, Alex and Brandon have paid loan interest of $140,000 and repair expenses of $8,500 in respect of the property. Alex is single. He works as a part-time lecturer with a local tertiary institution and received a salary of $204,000 for the year ended 31 March 2013. He also runs a consultancy business in Hong Kong under the name of Alex Business Solutions Company (ABSC). During the year ended 31 March 2013, ABSC has made a profit of $530,000 which is after the deduction of his mandatory contribution to the MPF scheme of $14,500 as a self-employed person, and his medical insurance premium of $3,000. He is also a partner of a partnership business carried on with his friends. His share of partnership loss is $75,000 for the year of assessment 2012/13. Brandon is married and has a son aged 5. Brandon is a resident of Mainland China who visits Hong Kong regularly and generally spends around a week in Hong Kong every month. Apart from the rental income, Brandon has no other source of income in Hong Kong. REQUIRED: (a) (b) (c) Calculate the Hong Kong property tax payable for the year of assessment 2012/13. Ignore provisional tax. (6 marks) Advise whether or not Alex and Brandon are eligible to elect for personal assessment for the year of assessment 2012/13, and the procedures for the election. (7 marks) Assuming that Alex is eligible to be assessed under personal assessment, calculate his tax liability under personal assessment for the year of assessment 2012/13. Ignore any one-off tax waiver. (7 marks) (Total: 20 marks) Page 9 of 16
5. Crunchy Snack Limited (CSL) carries on a food manufacturing business in Hong Kong. In December 2008, it acquired a piece of land for $40 million in Yuen Long and signed a contract to construct a five-storey building to house its manufacturing operation there. The construction cost of $20 million is payable as follows: On signing the contract $8 million Progress payment $8 million (paid on 5 August 2009) Upon completion of contract $4 million (paid on 10 April 2010) The building was immediately put into use by CSL upon its completion in April 2010. Apart from 50% of the gross area on the ground floor which was used as an office, all other areas were used as a workshop and warehouse for storage of raw materials and finished products. In May 2012, CSL sold the whole building to Healthy Nutrition Limited (HNL) for a consideration of $72 million (including land and building cost). HNL used the third floor and fourth floor of the building as a laboratory for research and development, and the rest of the floors for the production of nutrition products. HNL has imported a testing machine (30% depreciation rate) from Germany for product development. It was acquired from a local supplier on hire purchase terms with details as follows: List price: $1,200,000 Down payment: $200,000 (paid in June 2012) Monthly instalment: $90,000 for 12 months commencing on 15 July 2012) HNL also paid freight and installation expenses of $30,000 and $10,000 respectively in respect of the machine in June 2012. Movement of other assets of HNL during the year ended 31 March 2013 are presented below: 1. New additions include: Furniture and fixtures $130,000 Motor vehicles $360,000 Production machines $415,000 2. Old furniture was scrapped for $5,000. 3. A director donated three air-conditioners to the company in December 2012; he had bought these at a cost of $18,000 in November 2010. The secondhand value of these air-conditioners was $4,000. The tax written down values of the pooling system as of 31 March 2012 are: 20% pool (including air-conditioners, furniture and fixtures): $201,000 30% pool (including motor vehicles): $105,000 Both companies end their accounts on 31 March annually. Page 10 of 16
REQUIRED: (a) (b) Analyse the tax treatments of the building in Yuen Long for both CSL and HNL for all the relevant years in the question. (5 marks) Calculate the depreciation allowances applicable to CSL and HNL for all the relevant years of assessment up to and including the year of assessment 2012/13. (15 marks) (Total: 20 marks) Page 11 of 16
6. (a) The statement of income and expenditures of My Doggy Club for the two years ended 31 December 2012 and 2011 were as follows: 2012 2011 Income $ $ Annual subscriptions 50,000 35,000 Sales of food and accessories 153,000 112,000 Grooming and bathing receipts 84,200 57,000 Donations - 80,000 Rental income 48,000 42,000 335,200 326,000 Expenditure Administrative expenses 177,000 161,500 Cost of food and accessories 98,000 76,000 Supplies 23,000 17,500 298,000 255,000 Surplus for the year 37,200 71,000 The following additional information is available: 1. Apart from annual subscriptions, members were required to pay an entrance fee on admission to the club, and this fee is credited to the accumulated fund account directly. The entrance fees received were $9,000 and $12,000 for 2012 and 2011 respectively. All members have voting rights at the general meeting. 2. The club sells food and accessories to both members and non-members. It is estimated that one half of the sales are from members. However, all grooming and bathing receipts are from members only. 3. The donation was received from a supplier of dog foods. 4. The club owns premises and has leased out part of the unused space to a third party, which operates a coffee bar. REQUIRED: Advise the Hong Kong tax position of My Doggy Club for the years of assessment concerned. Where applicable, compute the Hong Kong profits tax and/or property tax payable by the club. Ignore depreciation allowances, provisional tax and any one-off tax waiver. (12 marks) Page 12 of 16
(b) Johnny Chan carries on a decoration business in Hong Kong. He was recently investigated by the Inland Revenue Department (IRD) for having omitted certain income and over-claimed deduction of expenses, resulting in an understatement of profits for the past few years. As most of the transactions were paid in cash and Johnny has not kept all his receipts, he used to estimate his profits for reporting to the IRD, which he believed to be a usual practice. He found it difficult to reckon the actual profits due to the lapse of time and insufficient records. REQUIRED: Advise Johnny on the distinction between tax avoidance and tax evasion, and the possible methods which may be used by the IRD to quantify the understatement of profits. (8 marks) End of Examination Paper (Total: 20 marks) Page 13 of 16
Tax Rates and Allowances Personal Allowances 2012/13 $ Basic 120,000 Married Person 240,000 Child (each, up to the 9 th ) year of birth 126,000 other years 63,000 Dependent Brother or Dependent Sister Allowance 33,000 Dependent Parent Aged 60 or more 38,000 Aged between 55 and 59 19,000 Additional Dependent Parent Aged 60 or more 38,000 Aged between 55 and 59 19,000 Dependent Grandparent Aged 60 or more 38,000 Aged between 55 and 59 19,000 Additional Dependent Grandparent Aged 60 or more 38,000 Aged between 55 and 59 19,000 Single Parent Allowance 120,000 Disabled Dependant Allowance 66,000 Salaries Tax and Personal Assessment Tax Rates 2012/13 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 Rate (2008/09 onwards) 15.0% Depreciation Allowances Plant and Machinery Initial Allowance 60% Annual Allowance 10%, 20% or 30% (as specified in question) Industrial Building Initial Allowance 20% Annual Allowance 4% Commercial Building Annual Allowance 4% Page 14 of 16
Stamp Duty Payable (from 1 April 2010) Head 1(1) $1 - $2,000,000 $100 Head 1(1AA) $2,000,001 - $2,351,760 $100 + 10% of value above $2,000,000 Head 1(1A) $2,351,760 - $3,000,000 1.5% of consideration and $3,000,001 - $3,290,320 $45,000 + 10% of value above $3,000,000 Head 1(1B) $3,290,321 - $4,000,000 2.25% of consideration $4,000,001 - $4,428,570 $90,000 + 10% of value above $4,000,000 $4,428,571 - $6,000,000 3% of consideration $6,000,001 - $6,720,000 $180,000 + 10% of value above $6,000,000 $6,720,001 - $20,000,000 3.75% of consideration $20,000,000 - $21,739,120 $750,000 + 10% of value above $20,000,000 Above $21,739,120 4.25% 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) $5 + 0.2% of value Head 2(4) $5 Head 3(1) 3% of market value Head 3(2) $5 Head 4 $5 (maximum) Page 15 of 16
THIS IS A BLANK PAGE Page 16 of 16