Qualification Programme Examination Panelists Report Module D Taxation (December 2015 Session) (The main purpose of the following report is to summarise candidates common weaknesses and make recommendations to help future candidates improve their performance in the examination.) (I) Section A Case Questions General Comments The case study covered topics on transfer pricing, alternative bond scheme ( ABS ), director s fee, tax administration and stamp duty. The overall performance in this section was not good. Putting aside the topic on ABS which is a new topic with its relevant provisions effective in July 2013, the performance of the candidates on transfer pricing and director s fee was not satisfactory. The questions on both topics required analytical skills. A number of candidates misread the facts of the case. Some of the candidates just copied the provisions of the Inland Revenue Ordinance ( the IRO ) or Departmental Interpretation and Practice Notes ( DIPN ) without applying them to the facts of the case. Some candidates even came to a conclusion without giving the reasons. As to the questions on ABS, well-prepared candidates had good results. Most of the candidates, however, were not cognizant of the topic. Candidates are urged to keep abreast of the latest development of taxation in Hong Kong. Specific Comments Question 1(a) 7 Marks This question required candidates to suggest, with reference to the transfer pricing methods recognised in OECD Transfer Pricing Guidelines as discussed in DIPN No. 46, the most appropriate method in establishing an arm s length price in respect of the selling of the 500,000 shares in Saffron Limited ( the Shares ) by ABC Toys Limited ( the Company ) to ABC (Investments) Limited. The performance of the candidates was not satisfactory. This question required candidates to suggest a method. Many candidates, however, copied materials on the arm s length principle, s.16(1), s.17(1)(b), s.61 or s.61a of the IRO which were completely irrelevant. Besides, although most of the candidates managed to identify the comparable uncontrolled price ( the CUP ) method as the most appropriate method, some of them gave no elaboration on the method while some of them were unable to explain internal comparable uncontrolled price and external comparable uncontrolled price. Further, some candidates mixed up the CUP method with the resale price method. Module D (December 2015 Session) Page 1 of 6
Question 1(b) 10 Marks Following Question 1(a), Question 1(b) required candidates to elaborate the reasons why the other transfer pricing methods as discussed in DIPN No. 46 were not the most appropriate method. The performance of the candidates was not satisfactory either. Most of the candidates were able to name the cost plus method, resale price method, transactional net margin method and profit split method. That said, some of them were unable to distinguish the methods. Many candidates were unable to point out that the cost plus method was mostly used in the case of manufacturers while the resale price method was mostly used for distributors. It seems that candidates do not have an adequate understanding of the methodologies. Question 2 4 Marks This question required candidates to elaborate as to the expenses that were allowable for deduction to the Company in the ABS accepted by the Commissioner of Inland Revenue. The performance of the candidates was poor. First, some of the candidates were not aware that the issue in dispute was an ABS notwithstanding that it was categorically set out in the question. It appears that most of them were not aware that the arrangement entered into between ABC (Financing) Limited and the Company (i.e. Arrangement B) was a qualified investment arrangement. Second, most of the candidates were not aware that a special tax treatment should be applied to ABS. As such, they incorrectly applied s.16(1) or s.16(1)(b) in considering the deduction of the rental expense paid by the Company, not to mention that only a few candidates were able to point out that the selling of the property by the Company to ABC (Financing) Limited was to be disregarded under s.22(3)(a) of Schedule 17A of the IRO. Third, some candidates elaborated on the deduction of the interest expenses paid by ABC (Financing) Limited to the third party investors (i.e. the bond holders) instead of the allowable deduction available to the Company. The former had not been requested in the question. Question 3 5 Marks This question required candidates to elaborate as to the stamp duty liability of the Company and ABC (Financing) Limited in the ABS. The performance of the candidates was not good. As in Question 2, most of the candidates were not aware that the issue in dispute was an ABS. Such being the case, they incorrectly referred to s.45 relief of the Stamp Duty Ordinance ( the SDO ). For those who were able to point out the stamp duty relief under s.47f(1) of the SDO, most of them did not elaborate on the relief they just plainly stated that the instruments involved in the transactions were not chargeable to stamp duty without any elaboration. Module D (December 2015 Session) Page 2 of 6
Question 4(a) 15 Marks This question required candidates to analyse with reference to the relevant legal principles, whether, and if so, how the director s fee derived by the taxpayer from the Company was chargeable to salaries tax with particular analysis on s.8(1a)(b) and s.8(1a)(c) of the IRO. The performance of the candidates was not good. S.8(1)(a) of the IRO provides that income arising in or derived from Hong Kong from any office or employment of profit is chargeable to tax. In the present case, it was categorically set out that the taxpayer had not been involved in the daily management of the Company since his migration and that he received a director s fee. Only a few candidates managed to point out that the income in dispute was an income from an office. Most of the candidates were unable to distinguish the difference between income from an employment and income from an office. As they were not sure whether the issue in dispute was income from an employment or from an office, they addressed the issue either from the perspective of income from an employment only or from the perspective of income from an employment and income from an office concurrently. The former lost their direction whereas the latter lost their precious time as they had to address two types of income. S.8(1)(a) of the IRO is the basic charging section of salaries tax. Candidates are urged to have a thorough understanding of it. Besides, most of the candidates were not aware that the extended charge and the exclusion provisions in s.8(1a) are only applicable to cases of employment income which was categorically provided in the provision of the IRO. Candidates should have been aware of it. That aside, some candidates misread the facts of the case. They thought the taxpayer had entered into an employment contract with the Company in Hong Kong which in fact had not been mentioned in the question. There was no mention of any employment contract in any part of the question. Question 4(b) 6 Marks This question required candidates to analyse the taxpayer s eligibility in having his income assessed under personal assessment and calculate, to his best advantage, his Hong Kong tax liability. It was a simple and straightforward question. Nevertheless, the performance of the candidates in this question was no better than that in Question 4(a). First, some of the candidates did not know the requirements in s.41 of the IRO. They concluded that the taxpayer was not eligible to have his income assessed under personal assessment because he stayed in Hong Kong for a period of less than 60 days or 183 days. Both numbers of days are not mentioned in s.41. Second, some candidates were unable to explain why the taxpayer was not a permanent resident. They only said that he was not a permanent resident. Some candidates just reached the conclusion that the taxpayer was not eligible without giving a reason. Third, some candidates arrived at the correct conclusion that the taxpayer was not eligible to have his income assessed under personal assessment, but surprisingly, they computed the taxpayer s tax liability under personal assessment. Module D (December 2015 Session) Page 3 of 6
Question 5 3 Marks This question required candidates to analyse whether the taxpayer would be successful in his application for revising his salaries tax assessment for the year of assessment 2006/07. It was another simple and straightforward question. The performance of the candidates was fair. Although most of them were able to apply s.70a of the IRO, only some of them managed to consider s.64(1) and analyse whether it was applicable. Further, only a few candidates managed to turn to proviso to s.79 of the IRO which provides that nothing in that section shall operate to extend the time limit for objection or repayment specified in other sections of the IRO. Candidates are urged to consider all relevant provisions in the cases before them. (II) Section B Essay/Short Questions General Comments The questions in this section covered extensive contexts aimed at examining the candidates ability in mastering the technicalities in practising taxation. Questions had been set out from different perspectives, including the computation and identification of statutory depreciation allowances and specific deductions, analysis of the taxability of a lump sum receipt from the perspective of salaries tax, evaluation of anti-avoidance exposures on a specific arrangement, and a generic inquiry regarding PRC tax and ethical considerations in the course of providing tax consulting services. The overall performance in this section was quite unsatisfactory. Other than a fair result in Question 7 regarding the issues related to PRC tax and ethical considerations, the candidates performance in this section was considerably below expectations. Specific Comments Question 6 15 Marks This question required candidates to compute the allowable deduction and capital allowances of the entity as provided therein. The performance in this question was below expectations. Candidates generally were not able to compute commercial building allowance and balancing allowance. Some candidates wrongly computed the depreciation allowance of the hire-purchase asset under the pooling system. Some other candidates spent a lot of time in explaining the relevant provisions, which was not required in the question. Question 7(a) 5 Marks This question required candidates to discuss the PRC Individual Income Tax implications for a non-prc tax resident. The performance in this question was fair. Some candidates discussed in great detail the mechanism of the tax treaty, which was not relevant in the question. Some other candidates mentioned PRC Business Tax and Corporate Income Tax, which were also beyond the scope of this question. Module D (December 2015 Session) Page 4 of 6
Question 7(b) 5 Marks This question required candidates to discuss the ethical principles of a tax representative in providing tax consultancy services. The performance in this question was satisfactory. Candidates were generally able to identify the respective fundamental principles. Question 8(a) 4 Marks This question required candidates to put forward the arguments that the lump sum amount received by the recipient as provided in the question was chargeable to salaries tax. The performance in this question was considerably below expectations. Candidates generally could not comprehensively put forward concrete arguments justifying the taxability of the amount. Instead, some candidates wrongly analyzed the issue from the perspective of service companies and anti-avoidance provisions. In this connection, many candidates could only obtain very low marks. Question 8(b) 4 Marks In contrast to Question 8(a), this question required the candidates to put forward the arguments that the subject amount received by the recipient was not chargeable to salaries tax. The performance in this question was below expectations. Candidates were generally only able to provide some simple arguments substantiating the nontaxable standpoint. The discussion and analysis of the candidates were not comprehensive enough to reach a satisfactory performance. Question 8(c) 3 Marks This question required candidates to identify and elaborate relevant information from practical perspective in order to ascertain the taxability of the amount in the contexts of the IRO. The performance in this question was again not satisfactory. Candidates generally did not give comprehensive consideration to identifying possible and feasible information facilitating the assessment. In this regard, many candidates could only obtain very low marks or even no mark. Question 9(a) 6 Marks This question required candidates to discuss the taxability of the incomes derived by respective persons, and the possible options available for reducing tax liabilities. The performance in this question was also considerably below expectations. Although the majority of the candidates could identify the types of tax to be imposed on the relevant income depicted in the question, and were able to identify the election of personal assessment in order to reduce the tax liability, candidates generally could only provide a very brief and short answer without going into any detailed and comprehensive analysis from different perspectives. Module D (December 2015 Session) Page 5 of 6
Question 9(b) 8 Marks This question required candidates to assess the tax exposure from an anti-avoidance perspective with respect to the proposed arrangement. The performance in this question was again not satisfactory. Many candidates wrongly discussed the issue in some other irrelevant contexts. Only some candidates mentioned the general anti-avoidance provisions in their answers, but their discussions were not comprehensive, and did not apply the provisions to the arrangement as described in the question. (III) Conclusion and Recommendation Candidates are expected to be cognizant of the provisions of the ordinances and the legal principles handed down from precedent. They should acquire a thorough understanding of the basic charging sections of the IRO. That aside, candidates have been repeatedly urged to carefully read the facts set out in the questions and the requirements of the questions. Interpreting the facts in the questions incorrectly will only lead to taking a wrong direction in answering the questions. Candidates are also reminded to improve their ability in applying relevant tax rules and principles to the facts in the questions instead of merely copying provisions in the IRO or paragraphs in the DIPNs without application. Indeed, there are no hard and fast rules other than adequate preparation prior to the examination. Candidates should also practice computations from different perspectives in order to familiarize themselves with the contexts and template generically found in the questions. As emphasized previously, candidates should think carefully before writing down the answer. Performance of the examination is subject to the quality instead of quantity of the answers. Module D (December 2015 Session) Page 6 of 6