CERTIFIED TAX ADVISER QUALIFYING EXAMINATION 2010 PAPER 1 HONG KONG TAX THURSDAY, 21 OCTOBER 2010 (MORNING SESSION) Time allowed: Three hours Tax Rates & Allowances are provided for reference and are contained in this question paper from Page 3 to Page 7. Section A ONE compulsory question. This section carries 36 marks. Section B Answer any FOUR out of five questions. Each question carries 16 marks. This section carries a total of 64 marks. Fill in your Seat Number in the box below. Do not open this question paper until instructed by the invigilation personnel. Answers must be written in black or blue ink. This question paper must not be removed from the examination room. Seat Number Page 1 of 19
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TAX RATES AND ALLOWANCES 75% of salaries tax or tax under personal assessment for the year of assessment 2009/10 will be waived, subject to the maximum of $6,000 100% of salaries tax or tax under personal assessment for the year of assessment 2008/09 will be waived, subject to the maximum of $8,000 75% of property tax, profits tax, salaries tax or tax under personal assessment for the year of assessment 2007/08 will be waived, subject to the maximum of $25,000 Personal Allowances (Salaries Tax and Personal Assessment) For 2009/10 and 2008/09 Basic allowance $108,000 Married person s allowance $216,000 Child allowance: first ninth child $50,000 EACH Child allowance additional (for child born during the year) $50,000 EACH Dependent parent/grandparent allowance (aged 60 or above OR is eligible to claim an allowance under the Government s Disability Allowance Scheme) $30,000 EACH Dependent parent/grandparent allowance (aged 55 or above but below 60) $15,000 EACH Additional dependent parent/grandparent allowance (aged 60 or above OR is eligible to claim an allowance under the Government s Disability Allowance Scheme) $30,000 EACH Additional dependent parent/grandparent allowance (aged 55 or above but below 60) $15,000 EACH Single parent allowance $108,000 Disabled dependant allowance $60,000 EACH Dependent brother or dependent sister allowance $30,000 EACH Page 3 of 19
For 2007/08 Basic allowance $100,000 Married person s allowance $200,000 Child allowance: first ninth child $50,000 EACH Child allowance additional (for child born during the year) $50,000 EACH Dependent parent/grandparent allowance (aged 60 or above OR is eligible to claim an allowance under the Government s Disability Allowance Scheme) $30,000 EACH Dependent parent/grandparent allowance (aged 55 or above but below 60) $15,000 EACH Additional dependent parent/grandparent allowance (aged 60 or above OR is eligible to claim an allowance under the Government s Disability Allowance Scheme) $30,000 EACH Additional dependent parent/grandparent allowance (aged 55 or above but below 60) $15,000 EACH Single parent allowance $100,000 Disabled dependant allowance $60,000 EACH Dependent brother or dependent sister allowance $30,000 EACH Deductions (Maximum) (Salaries Tax and Personal Assessment) For 2009/10 and 2008/09 Self education expenses $60,000 Home loan interest $100,000 Elderly residential care expenses $60,000 Contribution to MPF/MPF-exempted retirement scheme $12,000 Approved charitable donations = maximum of 35% of (assessable income LESS allowable expenses LESS depreciation allowances) For 2007/08 Self education expenses $60,000 Home loan interest $100,000 Elderly residential care expenses $60,000 Contribution to MPF/MPF-exempted retirement scheme $12,000 Approved charitable donations = maximum of 25% of (assessable income LESS allowable expenses LESS depreciation allowances) Page 4 of 19
Tax Rates (Property Tax) For 2009/10 and 2008/09 15% For 2007/08 16% Tax Rates (Salaries Tax and Personal Assessment) For 2009/10 and 2008/09 Standard Rate 15% Progressive Rates First $40,000 2% Next $40,000 7% Next $40,000 12% Remainder 17% For 2007/08 Standard Rate 16% Progressive Rates First $35,000 2% Next $35,000 7% Next $35,000 12% Remainder 17% Tax Rates (Profits Tax) For 2009/10 and 2008/09 Corporation 16.5% Unincorporated Business 15.0% For 2007/08 Corporation 17.5% Unincorporated Business 16.0% Page 5 of 19
Depreciation allowance rates From 1998/99 Initial allowance: - Industrial building (unused) 20% - Plant and machinery 60% Annual allowance: Industrial/Commercial building (unused) 4% Plant and machinery: - Furniture, office machine 20% - Motor car, van 30% Stamp Duty Rates Head 1 Head 1(1) and Head 1(1A) Effective from 1 April 2010 Value of consideration Rate of stamp duty $1-$2,000,000 $100 $2,000,001-2,351,760 $100 + 10% x (C - $2,000,000) $2,351,761-3,000,000 1.5% $3,000,001-3,290,320 $45,000 + 10% x (C - $3,000,000) $3,290,321-4,000,000 2.25% $4,000,001-4,428,570 $90,000 + 10% x (C - $4,000,000) $4,428,571-6,000,000 3% $6,000,001-6,720,000 $180,000 + 10% x (C - $6,000,000) $6,720,000-20,000,000 3.75% $20,000,001 - $21,739,120 $750,000 + 10% x (C - $20,000,000) More than $21,739,120 4.25% Note: C = Consideration Effective from 11 am, 28 February 2007 to 31 March 2010 Value of consideration Rate of stamp duty $1-$2,000,000 $100 $2,000,001-2,351,760 $100 + 10% x (C - $2,000,000) $2,351,761-3,000,000 1.5% $3,000,001-3,290,320 $45,000 + 10% x (C - $3,000,000) $3,290,321-4,000,000 2.25% $4,000,001-4,428,570 $90,000 + 10% x (C - $4,000,000) $4,428,571-6,000,000 3% $6,000,001-6,720,000 $180,000 + 10% x (C - $6,000,000) More than $6,720,000 3.75% Note: C = Consideration Page 6 of 19
Head 1(2) (1 April 2001 Present) Premium same as under Head 1(1) Rent: lease with uncertain term 0.25% of annual rent lease with term of less than 1 year 0.25% of total rent lease with term of 1 year to 3 years 0.5% of annual rent lease with term of more than 3 years 1% of annual rent Head 2 (1 April 2001 present) Head 2(1) 0.1% of the consideration Head 2(2) $5 Head 2(3) $5 + 0.2% of the consideration Head 2(4) $5 Head 3 (1 April 2001 present) Head 3(1) 3% of market value Head 3(2) $5 Head 4 (1 April 2001 present) $5 **************** Page 7 of 19
This examination paper contains TWO Sections. Section A contains ONE compulsory question carrying 36 marks. Section B contains five questions and candidates are expected to answer any FOUR of these five questions. Each question carries 16 marks. Maximum score for Section B is 64 marks. ***************************************************** Section A (COMPULSORY) Question 1 (36 Marks) ABC Limited (ABC) has been carrying on a garment manufacturing business in Hong Kong for many years. For the year ended 31 March 2010, ABC s financial statements, as listed below, showed a net profit before taxation of $1,394,000. Note $ INCOME: Gross profits from Hong Kong manufacturing business 18,031,500 Dividends 38,000 Compensation received 1 180,000 Profit on sale of patent 2 150,000 Interest income 3 79,500 Exchange gain 4 55,000 18,534,000 LESS: EXPENSES Salaries and allowances for office staff 4,000,000 Rent and rates 10,000,000 Depreciation charge 284,000 Contributions to recognised retirement scheme for 5 860,000 office staff Donations 6 1,285,000 Repairs and maintenance 7 99,000 Bad debts and provisions 8 244,000 Compensation paid 9 160,000 Legal and professional fees 10 99,000 Interest expenses 11 109,000 17,140,000 Net profit 1,394,000 Page 8 of 19
Notes: 1. A fire occurred in the factory of ABC during one night in June 2009. Some trading stock was destroyed and ABC received $180,000 from the insurance company as compensation for the loss. 2. ABC purchased a patent in September 2004 for the manufacture of a type of quick-to-dry fabric. The purchase cost of the patent was $500,000. Deduction had been claimed by ABC in the profits tax computation for the year of assessment 2004/2005. In July 2009, the patent was sold to another garment manufacturer at a consideration of $650,000. 3. $ Interest on GBP time deposits placed with Wonderful Bank 51,000 in London, United Kingdom (also see Note 11 below) Interest on Japanese Yen time deposits placed with 11,700 Wonderful Bank in Tsimshatsui, Kowloon, Hong Kong Interest charged on customers on overdue account balances 16,800 79,500 4. $ Exchange gain on collection of trade debts 35,000 Exchange gain on conversion of US Dollar fixed deposits 20,000 55,000 5. Contributions to recognised retirement scheme for office staff comprise: $ Ordinary monthly payment to the scheme (representing 20% of the total salaries) 800,000 Special contribution paid to make up shortfall from investment loss 60,000 860,000 (note: staff costs, including retirement benefits and other fringe benefits, were all deductible and have been dealt with in the computation of gross profits from Hong Kong manufacturing business.) Page 9 of 19
6. Donations of cash ($1,245,000) and toys (purchased at $40,000) were made to the Hong Kong Community Chest and Po Leung Kuk in January and February 2010 respectively. 7. $ Repairs and maintenance charges 57,000 Replacement of carpets and blinds 31,000 Initial purchase of curtains 11,000 99,000 8. Bad debts and provisions: $ Decrease in general provisions for trade debts (68,000) Increase in specific provisions for trade debts 79,000 Trade debts written off 207,000 Loan to a director written off 65,000 Recovery of trade debts previously written off (39,000) 244,000 9. ABC paid $160,000 to a customer as compensation for cancelling a trading contract. ABC did not complete that contract because it found another customer who paid a much higher price for the garment products. 10. $ Legal fee for trade debt collection 8,000 Registration of trademark 20,000 Audit fee and professional fee for filing profits tax return 32,000 Professional fee for lodging profits tax appeal 39,000 99,000 11. Loan interest to Wonderful Bank, Tsimshatsui Branch, Kowloon, Hong Kong: $109,000. The above loan interest was paid on a loan borrowed from the Wonderful Bank, Tsimshatsui Branch, Kowloon, Hong Kong. The loan was not wholly and exclusively used to finance the purchase of trading stock or plant and machinery. The loan was secured by the GBP time deposits placed by ABC with Wonderful Bank in London, United Kingdom (see Note 3 above). [The term of the loan came to the end on 31 May 2009 on which date the interest of $109,000 for the 2-month period from 1 April 2009 to 31 May 2009 was fully paid to Wonderful Bank. Thereafter, a related company of ABC provided an interest-free Page 10 of 19
loan to ABC to finance its operation for the period from 1 June 2009 to 31 March 2010.] Additional Information: I. As at 31 March 2009, the tax written down values of the company s plant and machinery were as follows: 20% Pool $245,000 30% Pool $367,000 During the year ended 31 March 2010, ABC (a) purchased a sewing machine (30% pool) on hire-purchase terms. The cash price was $100,000, payable by 12 instalments of $8,000 each month. The first instalment was due on 1 October 2009. An initial deposit of $10,000 was paid upon signing the hire-purchase agreement on 15 September 2009. (b) sold a delivery van (30% pool) for $60,000 in February 2010. This car was acquired at a cost of $180,000 in September 2007. (c) took up a director s own car (30% pool) at nil consideration in March 2010. This car was acquired by the director in April 2008 at a cost of $360,000. II. Industrial and commercial building allowances agreed by the Inland Revenue Department amounted to $285,000 for the year ended 31 March 2010. III. Other items of income and expenses not shown above do not require any adjustments for tax purposes. Required: (a) Compute the Hong Kong profits tax liability of ABC Limited for the year of assessment 2009/10, including the depreciation allowances in respect of plant and machinery that can be claimed by ABC Limited. Ignore provisional tax in your computation. (27 marks) (b) Explain the tax treatments that you have accorded to Notes (2), (3) and (11). (9 marks) (Total: 36 marks) Page 11 of 19
Section B (Answer FOUR questions from this Section) Question 2 (16 Marks) Eric Man has been working in an engineering company in the United States of America (USA), as project manager since 2004. In April 2008, he applied for a job offered by Sunlight (HK) Ltd (Sunlight) to handle a project in Hong Kong for three years. Eric negotiated the terms of employment with Sunlight via email. He signed the contract with Sunlight in January 2009 while he was on holiday in Hong Kong. The contract of employment was enforceable in Hong Kong. The project required research and development to be conducted in the People s Republic of China (PRC) and in Hong Kong. Sunlight provides Eric with housing benefits as detailed in item (ii) below. Sunlight pays 50% of the salary to Eric s bank account in Hong Kong and the remainder to his bank account in the USA. Sunlight also paid $32,000 to purchase air tickets for Eric, his wife and two children to relocate them from the USA to Hong Kong on 1 April 2009. During the year ended 31 March 2010, Eric made the following trips: PRC USA HK 123 days 28 days (27 nights including 9 nights (i.e. 10 days) of annual leave) 214 days Eric has the following income and expenditure for the year to 31 March 2010 (all amounts are denominated in Hong Kong dollar): (i) Salary for the year: $1,000,000. (ii) Eric rented a flat at a yearly rent of $480,000. Sunlight reimbursed him $420,000 as housing allowance upon production of rental receipts. (iii) Eric took an 18-day business trip to the USA, and extended his stay for 10 days to visit his parents in New York City. Sunlight purchased a business class ticket for $28,000 for Eric, but Eric paid the airline company $2,000 to exchange the ticket for two economy class tickets. Eric s wife travelled with him using one of the economy class tickets, and shared the hotel room with him. Sunlight approved the arrangement and paid the hotel room charges for 27 nights totalling $27,000 and Eric agreed that 9 nights of hotel accommodation was for his 10 days of annual leave. No extra charge had to be paid to the employer and the hotel operator by Eric for sharing the hotel room with his wife. Such air-ticket and hotel room arrangements were reported by the employer to the Inland Revenue Department. (iv) Eric sent his younger son for high school study in the USA. Sunlight reimbursed $80,000 to Eric for part of the school fees incurred. Sunlight also reimbursed Eric the cost of the air ticket in respect of his younger son in the amount of $9,000. (v) Sunlight gave Eric a monthly entertainment allowance of $2,000. He spent $8,000 Page 12 of 19
entertaining his clients but he did not keep the vouchers. He pocketed the balance of $16,000. (vi) Sunlight provided Eric with a corporate credit card, which was used by Eric to pay his private car expenses in the amount of $8,000. The credit card statements were settled by Sunlight. (vii) Sunlight operates a group employee medical scheme. During the year, Eric paid $13,000 to his family doctors for medical consultations in respect of him and his family members. He received full reimbursement of these fees from Sunlight s insurance company. (viii)sunlight, for a handling charge of $3 per share, granted Eric an option to acquire 20,000 shares at $30 each in an affiliated company in Hong Kong which was listed on both the Hong Kong Stock Exchange and the New York Stock Exchange. He acquired the option on 3 May 2009. On 1 October 2009, he exercised the option to acquire 12,000 shares. The shares were traded at $40 on that day. Unfortunately, the share price dropped very sharply to $28 in November 2009. On 1 February 2010, he assigned to his colleague, Philip Cheung, the option to acquire the remaining 8,000 shares by receiving $2 per share from Philip Cheung, and sold the 12,000 shares already acquired at $38 per share. (ix) For the income of $400,000 relating to his services rendered in the PRC, Eric has paid individual income tax of $140,000 in the PRC. The Assessor agreed that the income tax system in the PRC was comparable to the salaries tax system in Hong Kong. (x) Eric contributed a total of $24,000 to the Mandatory Provident Fund Scheme in Hong Kong. (xi) Eric is married with two children, aged 20 and 15. His wife is a housewife. Every month Eric remits USD1,000 to his parents in the USA for their daily living. The elder son is with his former wife and he is a full-time university student at Oxford University in the United Kingdom. (xii) On 1 March 2010, Eric donated $400,000 to the Hong Kong Community Chest. Required: (a) State, giving reasons, whether Eric Man s income should be assessed in full to Hong Kong salaries tax for the year of assessment 2009/10. (3 marks) (b) Based on the reasons given in answer (a), compute the salaries tax liability of Eric Man for the year of assessment 2009/10. Ignore provisional salaries tax and the one-off 75% tax reduction for 2009/10. (9 marks) (c) Briefly explain the tax treatments you have accorded to items (iii), (v), (viii) and (ix) above. (4 marks) (Total: 16 marks) Page 13 of 19
Question 3 (16 Marks) Mr. Kong inherited a sole proprietorship transportation business from his father. The transportation business provides delivery services, using a delivery van, to customers in Hong Kong. In order to improve the transportation business, Mr. Kong acquired some new plant and machinery items for use by the business from 1 April 2008 to 31 March 2009. The accounts of the business are made up to 31 March annually. As of 31 March 2008, details of the business s plant and machinery were as follows: Original cost Market value Tax Written Down Value as at 31.3.2008 $ $ $ 10% pool 500,000 480,000 $432,000 20% pool 450,000 300,000 $320,000 30% pool 475,000 250,000 $406,000 The following items of plant and machinery were acquired during the year: (i) 1 April 2008 Purchased the following assets: - A new copier (20% pool) for $20,000 - A new motor car (30% pool) for 250,000 - Air-conditioning plant (10% pool) for $130,000 - Furniture (20% pool) for $100,000 - A new delivery van (30% pool) for $300,000 (ii) 1 May 2008 Purchased two sets of personal computer (30% pool). One set was purchased in cash for $40,000. Another set was purchased on the following hire-purchase terms: Cash price $40,000 Down payment $10,000 Balance by 15 equal monthly instalments of $2,100 each, commencing 1 June 2008 The business had the following transactions in respect of the disposal and transfer to/from the business in respect of its assets during the year ended 31 March 2009: Date Transactions (i) 1 April 2008 Mr. Kong sold his own private car (30% pool) to the business for $50,000. The car was purchased by Mr. Page 14 of 19
Kong on 1 October 2006 at a cost of $70,000. In addition, Mr. Kong also transferred his own private motorcycle (30%) to the business without any consideration. The motorcycle was purchased by Mr. Kong on 1 February 2008 for $60,000. (ii) 15 January 2009 A delivery van (purchased on 15 April 2007 for $368,000) was damaged in an accident. The business received $100,000 as compensation from the insurance company and the damaged delivery van was sold to a used-car dealer for $8,000. (iii) 20 February 2009 The delivery van (purchase on 1 April 2008) was sold for $330,000 and was replaced with a new delivery van (30% pool) at a cost of $400,000. Required: (a) Under what situations would the pooling system not be considered an appropriate method for computing the depreciation allowance for an asset classified as plant and machinery? (5 marks) (b) Compute the total depreciation allowance relating to plant and machinery that can be claimed by Mr. Kong s business for the year of assessment 2008/09. Include in your calculations any balancing adjustments that may need to be computed and list the amount of deductions, if any, for prescribed fixed assets. (11 marks) (Total: 16 marks) Question 4 (16 Marks) Mr. Lee has been a retired civil servant since 2008 when he was aged 55. Being very knowledgeable in gardening, he used to contribute articles to magazines and newspapers on the topics on a freelance basis. During the year of assessment 2009/10, he had the following income and expenses: (i) (ii) (iii) (iv) (v) Rental income of $207,500 from his flat in Sheung Wan; Mortgage loan interest of $180,000 for a loan obtained to finance the purchase of the flat in (i) above; Dividend of $45,000 from shares listed on the Hong Kong Stock Exchange; Fees, net of allowable expenses and $5,000 donation, of $35,000 received for articles written; and Donations totaling $32,000 (including $5,000 mentioned in (iv) above) made to his church (an approved charitable organization). Page 15 of 19
Mr. Lee also had a loss brought forward of $100,000 from previous years under personal assessment. Mrs. Lee is employed as a human resources manager in an accountancy firm. income and expenses accrued to her during the same year: The following (i) Rental income of $120,000 from her flat in North Point; (ii) Mortgage loan interest of $95,000 for a loan obtained to finance the purchase of the flat in (1) above; (iii) Interest from fixed deposit of $18,500; (iv) Salary, bonus and allowance totaling $800,000 (her contribution to Mandatory Provident Fund for the year was $32,000); and (v) Donations totaling $32,000 made to her church (an approved charitable organization). Mr. and Mrs. Lee have 3 children, aged 23, 21, and 17 in 2009/10. Their eldest daughter, Vivian, is pursuing her Ph.D. full-time in the UK. She was married in October 2009. Their second son, Frankie, completed his full-time degree study at the Hong Kong Polytechnic University in June 2009. Since then, he has been employed as an Audit Trainee in a CPA firm. Their third son, Simon, is attending Form 5. In addition, the couple unexpectedly had a new-born baby on 31 March 2010. Mr. Lee s mother died twenty years ago. Mr. Lee s father remarried ten years ago. During 2009/10, Mr. Lee s father, aged 70, and Mr. Lee s step-mother, aged 59, were living together with Mr. and Mrs. Lee. Mr. and Mrs. Lee have NOT yet paid any taxes (i.e. property tax, salaries tax, and profits tax) for the year of assessment 2009/10 and have decided to elect personal assessment for that year. Required: Calculate the tax payable by Mr. and Mrs. Lee under personal assessment for the year of assessment 2009/10. Show all your workings, including the one-off 75% tax reduction for 2009/10. (16 marks) Page 16 of 19
Question 5 (16 Marks) (A) Mr. Fung purchased a property in the Mid-levels on 1 January 2008 from Mr. Yeung. Mr. Fung and Mr. Yeung entered into a legally binding provisional sale and purchase agreement whereby Mr. Fung agreed to purchase the property in the Mid-levels from Mr. Yeung for $6.8 million. Mr. Fung borrowed a mortgage loan of $5.2 million from ABC Bank, Hong Kong Branch, to finance the purchase. On 13 January 2008, Mr. Fung and Mr. Yeung executed a formal sale and purchase agreement in a solicitor s office. On 31 January 2008, the date of completion of the transaction, conveyance of the title of the property from Mr. Fung to Mr. Yeung was effected. Required: Calculate the stamp duty for the stampable documents. Your answer should explain which documents are stampable and the deadline for the payment of stamp duty. (6 marks) (B) The property referred to in (A) above was leased to Miss Kong for two years. of the terms of the lease agreement are as follows: Details (i) Term of lease: Two years from 1 April 2008 (ii) Monthly rental: $20,000, payable in advance on the first day of each month (iii) Rent-free period: Half month from 1 April 2008 (iv) Rental deposit: $40,000, payable on 1 April 2008 (v) Initial premium: $24,000, payable on 1 April 2008 (vi) Rates: $3,000 per quarter, payable by Mr. Fung (vii) Management fee: $2,000 per month, payable by Miss Kong directly to the management company and the management fee is the responsibility of the tenant in the lease agreement (viii) Repairs: For the account of Mr. Fung (ix) Sub-letting: Miss Kong is allowed to sublet a room to her colleague During the year ended 31 March 2009, Mr. Fung incurred the following expenses: (i) Mortgage loan interest of $25,000 per month, payable to Hang Lung Bank in respect of the leased property. (ii) Agency fee of $10,000 paid to property agent for arranging the lease of the property. (iii) In February 2009, a water pipe inside the property burst. As a result, the floor flooded. Miss Kong incurred and paid a repair cost of $5,000. Mr. Fung did not reimburse this amount to Miss Kong. Page 17 of 19
Required: (a) Calculate the stamp duty on the lease agreement which should be payable and explain who is responsible for paying the stamp duty and how the stamp duty is to be split among the responsible parties. (5 marks) (b) Calculate the property tax liability for the year of assessment of 2008/2009 and give explanations for the items which are included and excluded in your computation. (5 marks) (Total: 16 marks) Question 6 (16 Marks) (A) Peter Ho, Managing Director of Water Limited, seeks your advice on record-keeping requirements for corporations incorporated in Hong Kong under the Inland Revenue Ordinance (IRO). Required: Explain to Peter Ho Hong Kong s record-keeping requirements under the IRO, in particular the types of business records required and the penalties for failure to keep proper business records. (6 marks) (B) Peter Ho told you that he is the owner of a property which has been leased for rental income. Required: Explain to Peter Ho his obligations under the IRO as the owner of a rental property, and the possible consequences of failing to observe these obligations. (6 marks) (C) Peter Ho informed you that he is a member of Topfit Health Club, a fitness club established for many years. All members of Topfit Health Club can vote at general meetings of the Club. Required: Explain to Peter Ho the chargeability of a club to profits tax and property tax under the IRO. (4 marks) (Total: 16 marks) END OF QUESTION PAPER Page 18 of 19
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