THE TAXATION INSTITUTE OF HONG KONG CERTIFIED TAX ADVISER QUALIFYING EXAMINATION 204 PAPER 2 HONG KONG TAX SUGGESTED ANSWERS Page of 4
Answer (a) Dominance Trading Limited Profits Tax Assessment Year of Assessment 203/204 Basis Period: 3 March 204 $ $ Profits per account 2,222,000 Add: Refurbishing expenses 460,000 Profits tax paid 284,000 Property tax paid 26,000 Interest expense 54,000 Depreciation 620,000 Professional fee for tax objection case 22,000 Donations 20,000,676,000 3,898,000 Less: Interest income (exempt from payment of profits tax) 3,000 Interest income (exempt from profits tax) 4,000 Dividends income 76,000 Costs of refurbishment of the office (/5 x $300,000) 60,000 Cost of purchase of computer 35,000 Decrease in general provision for bad debts 2,000 Advertisement expense (payment to Po Leung Kuk) 0,000 220,000 3, 678,000 Less: Commercial building allowances 297,600 Depreciation allowances 43,66 440,766 3,237,234 Less: Cash donations to approved charity 78,000 Assessable Profits 3,059,234 Profits tax payable at 6.5% 504,733 Less: Tax rebate (maximum $0,000) 0,000 494,773 Less: 203/204 provisional property tax 26,000 468,733 Page 2 of 4
Commercial building allowances $ $ Office Deemed cost of building (2,000,000*2/5) 4,800,000 Less: rebuilding allowances under s.36 2% for 6 years (992/993 to 997/998) 576,000 Deemed capital expenditure under s.33a 4,224,000 Annual Allowance starting 998/999 (4%) 68,960 Directors' quarters Deemed cost of building (7,640,000*2/5) 3,056,000 Annual Allowance starting 2006/2007 (4%) 22,240 Costs of refurbishment of the director's quarters 60,000 Annual Allowance starting 203/204 (4%) 6,400 Total Commercial Building Allowances 297,600 Depreciation Allowance Schedule 20% Pool 30% Pool Allowances WDV brought forward 22,000 7,200 Used car brought into HK 48,020 2 business (Original cost less notional A.A., see note) Office equipment 30,000 9,220 Less: Initial allowance 8,000 2,000 8,000 34,000 Less: Disposal (restricted to cost) 4,000 30,000 Less: Annual allowance 6,000 35,766 4,766 + Written down value c/f 24,000 83,454 Motor car under hire purchase Cash price 80,000 Down payment 30,000 Total capital payment Page 3 of 4
(8 instalments of $5,000 each) 40,000 70,000 Less: Initial allowance (60% x 70,000) 42,000 42,000 2 38,000 Less: Annual allowance 4,400 4,400 Written down value c/f 96,600 Total depreciation allowances 43,66 Note: Original cost of the car transfer from Macau 200,000 Less: Notional A.A. (2009/200) 60,000 40,000 Less: Notional A.A. (200/20) 42,000 98,000 Less: Notional A.A. (20/202) 29,400 68,600 Less: Notional A.A. (202/203) 20,580 Reduced value pooled 48,020 Answer (b) (iii) Expenditure on business trips are deductible under s.6(). Expenditure on directors private overseas trips are deductible as a part of the directors remuneration under s.6(). (iv) (vi) Refurbishment expenses of $300,000 are deductible under s.6f over 5 years of assessment commencing the year of assessment 203/204. S.6F does not apply to building used for domestic purpose. Hence the refurbishment expenses on the director s quarters are not deductible under s.6f. Nevertheless, the company is entitled to commercial building allowance for annual allowance of 4% on $60,000. Property tax is not deductible under section 6() as it is an income tax, and not an expense incurred in the production of assessable profits. Profits tax is not deductible under section 6() as it is an income tax, and not an expense incurred in the production of assessable profits. Salaries tax paid for a director is deductible as it is treated as a part of directors Page 4 of 4
remuneration, and it is incurred in the production of assessable profits. The 203/204 property tax may be set off against profits tax payable under section 25. (viii) The loss on foreign exchange in relation to the trading activities, that is settlement of customers accounts, is deductible. The exchange gain from settlement of the loan used to finance the trading stock is taxable. (ix) (x) (xi) Expenditures on repair to assets that are usable at the time of purchase are revenue in nature and deductible. The interest expense was not deductible. Although it satisfies s.6(2)(d), yet it does not satisfy s.6(2a) as the security is a deposit of the managing director of the company. Donations must be in cash and without consideration. Donation of stock to St. Andrew Church is not deductible as it is not cash donation. The payment to Po Leung Kuk for a complimentary advertisement can be regarded as advertising expense and deductible in full. (6) Page 5 of 4
Answer 2 Mr. Duncan Salaries Tax Computation Year of Assessment 203/204 $ $ Salary (80,000 x 2) ( mark) 960,000 Reimbursement of Club joining fees ( mark) 00,000 Medical insurance ( mark) 0 Holiday journey ( mark) 40,000 Total income,00,000 Assessable income (,00,000 x 292 / 365) ( mark) 880,000 Rental value at (0% of $880,000) ( + marks) 88,000 Less: Rent contribution (4,000 x 2) ( mark) 48,000 40,000 Sub total 920,000 Share option gain [25,000 x ($50 $30) $,000] x 292/365 (3 + marks) 399,200 Net assessable income,39,200 Less: Married person s allowance ( mark) 240,000 Child allowance ( mark) 70,000 Additional child allowance ( mark) 70,000 380,000 Net chargeable income 939,200 Progressive rate ( mark) 40,000 @ 2% 800 40,000 @ 7% 2,800 40,000 @ 2% 4,800 89,200 @ 7% 39,264 47,664 Less: Tax rebate ( mark) 0,000 37,664 Standard rate tax is $,39,200 x 5% = $97,880 ( mark) which is higher than $47,664. ( mark) (Total marks 6) Page 6 of 4
Answer 3(a) Mr. Parker Property Tax Computation Year of Assessment 203/204 Premium ($450,000 x / 36) $37,500 Rent ($40,000 x ) 440,000 577,500 Less: Rates paid by the owner ($0,000 x 3 2/3) 36,667 540,833 Less: Statutory deduction ($540,833 x 20%) 08,67 Net Assessable Value $432,666 Property Tax ($432,666 x 5%) $64,900 No deduction for government rent No deduction for interest expenses (4) Answer 3(b) Loan interest incurred in the purchase of a property for production of income chargeable to property tax is not deductible under property tax, but if Mr. Parker elects for personal assessment, the interest that he paid for the acquisition of the property producing rental income is deductible under personal assessment. The limit of the deduction of interest is restricted to the net assessable value of the property. Under property tax, Mr. Parker is not entitled to personal allowance. If he elects for personal assessment, he is entitled to claim personal allowance and this may reduce his tax liability in Hong Kong. (3) Answer 3(c) If an individual is a permanent resident or a temporary resident of Hong Kong, he is entitled to elect for personal assessment. A permanent resident is an individual who ordinarily resides in Hong Kong. Page 7 of 4
A temporary resident is an individual who stays in Hong Kong for: more than 80 days in the year of election for personal assessment or more than 300 days in two consecutive years of assessment and one of which is the year of election for personal assessment. Based on the above principle, if Mr. Parker falls within one of the two above conditions, he will be entitled for election for personal assessment. If not, he is not entitled for personal assessment. (4) Answer 3(d) The time for election of personal assessment is the later of the following: within two years from the end of the year of assessment in which the election is made, or within one month after the assessment of the income to be assessed under personal assessment is final and conclusive. Thus, Mr. Parker may elect for personal assessment for 203/204 on or before 3 March 206. (2) Answer 3(e) Stamp duty for the lease is calculated as follows: $450,000 x 4.25% = $ 9,25 $40,000 x 2 x % = $ 2,400 Total $ 2,525 The time for stamping is within 30 days after execution of the instrument. (3) Page 8 of 4
Answer 4(a) The source of royalty income derived by a Hong Kong company from the licence of a video is determined under section 4 of the Inland Revenue Ordinance (IRO). In this situation, as the film of The Stone Monkey is not originally owned by TEL, but licensed from an overseas owner, the source of royalty income is determined by operations test at the place where the acquisition and grant to use of intellectual property is effected according to DIPN 49. If either one is in Hong Kong, the royalty income is fully chargeable to profits tax. In this case, TEL did not acquire the proprietary right in the film, but licensed the right for broadcasting from Mainland production film company. As the acquisition and grant to use of film was in Hong Kong, the royalty income of $,000,000 is chargeable to Hong Kong profits tax. (Lam Soon Trademark Limited v CIR) (4) Answer 4(b) As the facts given in the question, PFP, the PRC film production company, does not have any office or permanent establishment in Hong Kong. It does not carry on any business in Hong Kong, and it is not chargeable with Hong Kong profits tax under section 4 of the Inland Revenue Ordinance (IRO). Nevertheless, it may be chargeable to profits tax under deeming provision section 5(). However, section 5()(a) is not applicable in this situation as the intellectual property, i.e. the content of the broadcast of the film, was used in Taiwan, i.e. outside Hong Kong. Section 5()(ba) refers to the trademark, copyright and patent used outside Hong Kong may be chargeable to profits tax if the royalty expense is a deductible expense of the payer. In this case, the royalty income received by TEL from the Taiwan TV stations company is chargeable to Hong Kong profits tax as the acquisition and grant to use took place in Hong Kong (please refer to answer (a) above). Therefore royalty paid by TEL is deductible as it is incurred in the production of chargeable profits. The next issue is whether section 5()(ba) applies to film and video as the wordings in section 5()(ba) do not mention anything about film and video. It was decided in the Turner Entertainment Networks Asia, Inc for Muse Communication Co Ltd v. CIR (202) that copyright subsists in film and video. Thus, section 5()(ba) also applies to Page 9 of 4
film and video. As a result, PEP, the PRC film production company, is chargeable to profits tax on the royalty income received from TEL under section 5()(ba). Answer 4(c) Under section 2A, the assessable profits of a non-resident equals to 00% of the royalty income received if the payer and the recipient are associated and the intellectual property was once owned by a person carrying on a business/profession in Hong Kong. For other cases, the assessable profits would be equal to 30% of the royalty income received. As TEL has no relationship with the PEP, and the video was not owned in Hong Kong, the assessable profits of the PRC production film company are chargeable to profits tax with its assessable profits computed according to 30% of the royalty income received from TEL. The assessable profit is $400,000 x 30% = $20,000. The profits tax payable is $20,000 x 6.5% = $9,800. TEL is required to withhold the profits tax of $9,800 and remit the tax to Hong Kong Inland Revenue Department. TEL is also required to complete a non-resident profits tax return (BIR54) on behalf of the Mainland China production film company. Answer 4(d) (5) TEL carries on a business in Hong Kong, and it is chargeable to profits tax under section 4. If the film is produced in Hong Kong, the income received from overseas distributors for broadcasting the film outside Hong Kong is chargeable to profits tax under development test. It does not matter where the intellectual property is used (in Hong Kong or outside Hong Kong). (HK-TVBI case) Thus, the royalty income of $,500,000 received for the film The Lovely Side of Hong Kong is fully chargeable to Hong Kong profits tax. (3) Page 0 of 4
Answer 5 (a) Company Y Company Y as the seller of Property Q, and the profits from the sale may amount to a trading profit which is chargeable to profits tax or a capital gain exempt from profits tax. In view of the short period of ownership, it is possible that the IRD would challenge that the gain is of a trading nature, and the profit is chargeable to profits tax. As Property Q is used as an office, and Company Y would likely claim commercial building allowance (CBA) in respect of the property. Clawback of balancing charge is taxable, but the amount of balancing charge is limited to the CBA granted previously. Company Z Regarding Company Z as a buyer for a second hand building, it would be entitled to CBA as a fraction of the residue of expenditure after sale divided by the number of years from the year of assessment that Company Y was entitled to CBA up to the 25 th year after the building was first in use. (3) Answer 5 (b) This involves the transfer of an office property. The sales and purchase agreement is not chargeable with any stamp duty. The conveyance is chargeable with ad valorem stamp duty at the rate of 3.75% on the higher of the stated consideration or market value at the date of execution of the instrument. If the transferor and the transferee fall within the definition of associated corporations under section 45 of the Stamp Duty Ordinance as follows: The transfer by the transferor to the transferee is of shareholdings of 90% or above; or A third corporation holds 90% or more of the shares in the transferor or the transferee; Page of 4
then the transfer is exempt from stamp duty. Exemption of stamp duty is granted upon adjudication. Applying the above principle and based on the facts given in the question, Company Y and Company Z are not associated companies with Company X as Company X holds 85% of Company Y. Although Mr. Wong holds all the shares in Company Y and Company Z through Company X, yet this is not relevant as Mr. Wong is not a corporation. Thus, no exemption under section 45 Answer 5 (c) (5) As there is no exemption of stamp duty under section 45 for the transfer of Property Q from Company Y to Company Z, the group may consider the transfer of Property Q with a transfer of Property P from Company Z and Company Y through the execution of a deed of exchange where the two companies exchange Property P and Property Q between themselves. In this way, the transfer is stamped at the equality money which is the difference between the market value of the two properties. As a result, the stamp duty charged on $2,000,000 ($2,000,000 - $0,000,000), the stamp duty payable is $00. (3) Answer 5 (d) Company Z An expense is deductible under profits tax if it is to the extent incurred in the production of assessable profit under section 6() and not a capital expense under section 7()(c) of the Inland Revenue Ordinance (IRO). An expense is of capital nature if it is a once and for all payment and an enduring benefit or a capital asset is acquired with the payment. Page 2 of 4
In this case, Company Z pays a lump sum of $0,000,000 to Company Y for the assignment of receipt of rental income, the payment is of capital nature, and not deductible. Company Y Section 4 governs the charge of profits tax. If a receipt is from a sale of a capital asset, the income is exempt from profits tax. In this case, the receipt represents a sale of a right which is a capital asset, and supposedly should not to be chargeable to profits tax under section 4. However, sections 5()(m) and 5A deem the receipt is a trading receipt and chargeable to profits tax. Thus, the receipt is taxable in the hand of Company Y. (5) Answer 6 Obligations with profits tax return A company which carries on a business in Hong Kong is required to submit profits tax return to Inland Revenue Department (IRD) as follows: (a) to complete and return a profits tax return to IRD within a stipulated period upon receipt of the tax return under section 5() of the Inland Revenue Ordinance (IRO): or (b) to inform IRD of its chargeability to tax within four months after the end of the basis period of the year of assessment concerned under section 5(2). If a company fails to comply with the aforesaid obligation, it may be liable to the following penalty: (i) a level three fine (maximum $0,000) and a penalty of not more than three times of the tax so undercharged as a result of the failure of complying with the obligation. under section 80(2): or (ii) a penalty in the form of additional tax (not more than three times of that undercharged) under section 82A. In Goto Restaurant Limited s case, if the company does not receive its 203/204 profits tax return by 3 July 204, it has to notify IRD of its chargeability to profits tax. If not, the Page 3 of 4
company is in breach of section 5(2), and is liable to penalty under sections 80(2) or 82A. Obligations with employer s return The company is vested with employer s obligations as follows: (a) filing employer s returns for reporting its employees annual income under section 52(2); (b) filing employer s return for staff newly employed within three months after the date of commencement of employment under section 52(4): (c) filing employer s return for staff leaving the company not later than one month before the date of cessation of employment under section 52(5). If a business fails to comply with the aforesaid obligations, the company is chargeable to a level three fine (maximum $0,000) under section 80(). Business Records Section 5C requires that if a person carries on a business, he has to keep sufficient business records to ascertain its assessable profit for at least 7 years after the completion of a transaction. The business records must be in Chinese or English language. In Goto Restaurant Limite s case, if it keeps business records in Japanese only, it is in breach of section 5C, and may be subject to a fine of level 6 (with a maximum fine of $00,000). (6) ****END**** Page 4 of 4