THE TAXATION INSTITUTE OF HONG KONG CERTIFIED TAX ADVISER QUALIFYING EXAMINATION 2010 PAPER 1 HONG KONG TAX SUGGESTED ANSWERS Page 1 of 11
Question 1 Ignore provisional tax (a) ABC Limited Profits Tax Computation Year of Assessment 2009/10 Basis period: Year ended 31.3.2010 $ $ Profit per accounts 1,394,000 Add: Depreciation charge 284,000 Ordinary contribution to retirement scheme 200,000 (limited to 15%) ($800,000 / 20% x (20%-15%) Special contribution to retirement scheme (to be 48,000 claimed over 5 years) ($60,000 x 4 / 5) Donations 1,285,000 Initial purchase of curtains 11,000 Loan to a director written off 65,000 Professional fee for lodging profits tax appeal 39,000 Loan interest to Wonderful Bank 51,000 1,983,000 3,377,000 Add: Proceeds from sale of patent ($650,000 -$150,000) 500,000 3,877,000 Less: Dividends (38,000) Interest on deposits - Wonderful Bank, London (51,000) - (11,700) Wonderful Bank, Hong Kong Exchange gain on USD fixed deposits (20,000) Decrease in general provision for bad debts (68,000) Industrial/commercial building allowances (given) (285,000) Depreciation allowance - Plant & machinery (see calculations below) (269,800) (743,500) 3,133,500 Less: Donation (in cash) (limited to maximum of 35% x $3,133,500) (1,096,725) Assessable profit 2,036,775 Profits tax at 16.5% 336,067 (ignore cents) (curtains are not entitled to depreciation allowance but replacement cost of curtains is fully deductible) Page 2 of 11
Depreciation allowance 20% pool 30% pool Allowance $ $ $ W.D.V. b/f 245,000 367,000 Add: Motor car brought-in 252,000 245,000 619,000 Less: Disposal (60,000) 245,000 559,000 Less: Annual allowance (49,000) (167,700) 216,700 W.D.V. c/f 196,000 391,300 Sewing machine on hire-purchase Cost 100,000 Less: Allowance Total Allowance $ $ $ Initial allowance (10,000+7,500x6) x 60% (33,000) 33,000 67,000 Less: Annual allowance (20,100) 20,100 W.D.V. c/f 46,900 53,100 Total depreciation allowance = $216,700 + $53,100 = $269,800 Used motor car brought-in $ Cost 360,000 Less: Notional allowance - 2008/09 (30%) (108,000) Brought-in value for tax purpose 252,000 (b) Note 2 (Profit from sale of patent) Under S16E of the IRO, the cost of purchase of patent rights for use in Hong Kong the trade, profession or business in the production of profits is allowable as a deduction. The expenditure of HK$500,000 incurred in September 2004 had been allowed as a deduction in 2004/2005. S16E(3) stipulates that the proceeds from the subsequent sale of the patent right will be chargeable to profits tax notwithstanding that the receipt is capital in nature. Hence, apart from the profit of HK$150,000 already reflected in the accounts which is taxable, the remaining balance of the proceeds of HK$500,000 should also be brought into charge and treated as taxable profit in the computation. Page 3 of 11
Note 3 (Interest income) Under S15(1)(f) of the Inland Revenue Ordinance (IRO), sums received by or accrued to a corporation carrying on a trade, profession or business in Hong Kong by way of interest is deemed as taxable receipt if the interest is arising in or derived from Hong Kong. In determining the source of interest income, the provision of credit test is relevant, i.e. one looks at the place where the credit was first made available to the borrower. Applying the provision of credit test, the GBP time deposits placed with Wonderful Bank in London was prima facie sourced outside Hong Kong and the related interest income is not taxable. Regarding the interest income received from the Japanese Yen time deposits placed with Wonderful Bank in Tsimshatsui Branch, the provision of credit was in Hong Kong and therefore such interest income is caught by S15(1)(f). The currency of the deposits is irrelevant. Nevertheless, with effect from 22.6.1998, interest income from deposits placed with financial institutions in Hong Kong is exempt from payment of profits tax under the Exemption from Profits Tax (Interest Income) Order, provided that the deposits are not used to secure bank borrowings on which the interest expense is deductible under S16(2)(d). The deposits have not been used to guarantee any borrowings and accordingly, interest income of $11,700 from Wonderful Bank would be exempt. Taxability of the interest income derived from trade debts is determined by reference to the related trading transactions, as the financing arrangement on the sale of goods on credit is part and parcel of the trading transaction. On the basis that the trading profits derived from the sale of goods to customers are taxable, the interest income derived from the trade debts is also taxable. Note 11 (Interest expenses) Interest payable on money borrowed for the purpose of producing chargeable profits is deductible under S16(1)(a) of the IRO provided that any one condition set out in S16(2) is satisfied, subject to limitations under S16(2A), (2B) and (2C) (with effect from 25 June 2004). In the case of borrowings from a financial institution, the amended S16(2)(d) with effect from 25 June 2004 is relevant. S16(2A) states that amount of interest expenses that can be deductible will be the interest expenses paid as reduced by the tax-exempt interest earned by the GBP time deposits placed with Wonderful Bank in London by the taxpayer (i.e. BEA Limited). In this case, the deduction of interest expenses is reduced by the amount of tax-free interest of HK$51,000 earned from the time deposit and only HK$58,000 ($109,000-$51,000) will be qualified for deduction under profits tax. Therefore, HK$51,000 ($109,000-$58,000) of interest expenses has to be added back in the profits tax computation. Question 2 (a) In Hong Kong (HK), salaries tax is charged on income from an employment, office or pension arising in or derived from HK. In the case of employment income, the court ruled in the Goepfert case that the approach is to look for the place where the income really comes to the employee, that is, where the employment is located. As a consequence of this decision, the Inland Revenue Department (IRD) issued Departmental Interpretation and Practice Note (DIPN) No. 10 and accepts that an employment is located in HK (a HK employment) where the following three factors are present: (i) the contract of employment was negotiated, entered into, and enforceable in HK; (ii) the employer is resident in HK; and (iii) the employee s remuneration is paid to him in HK. Page 4 of 11
If all of the above factors are not in HK, it appears that the place where the contract of employment is enforceable is more important than the other factors, and the place of payment of remuneration is of least importance. If a person is recruited by an employer resident in HK, the enforcement of the employment is in Hong Kong and the employment is unlikely to be located outside HK, even though the contract is negotiated outside HK and his remuneration is partly paid in HK. The IRD reserves the right to look beyond the three factors where the employment is in reality a Hong Kong employment but manipulation exists. Based on the above, Eric s employment should therefore be a HK employment. (b) Eric Man Salaries Tax Computation Year of Assessment 2009/10 $ $ Salary 1,000,000 Holiday journey benefit - air ticket for wife (28,000+2,000)/2-2,000 13,000 - hotel room charges (27,000 x 9/27) 9,000 22,000 Education cost 80,000 Reimbursement of air ticket 9,000 Entertainment allowance 24,000 Private car expenses 8,000 1,143,000 Rental value 10% x 1,143,000 114,300 Less: rent suffered (480,000-420,000) (60,000) 54,300 Share option gain Exercise of share option [12,000 x (40-30-3)] 84,000 Assignment of share option [8,000 x (2-3)] 0 84,000 Assessable income 1,281,300 Less: income earned in China (400,000) 881,300 Less: concessionary deductions charitable donation (limited to maximum = 881,300 x 35% = 308,455) (308,455) MPF contribution (limited to maximum) (12,000) 560,845 Less: Married person s allowance (216,000) Child allowances (for two) (316,000) (100,000) Net chargeable income 244,845 Salaries tax at progressive rates on $244,845 = $8,400 + $(244,845 120,000) x 17% 29,623 (ignore cents) Page 5 of 11
Salaries tax at standard rate @15% on 84,126 $560,845 (ignore cents) Salaries tax liability 29,623 Note: Air ticket for family relocation to Hong Kong and reimbursement of medical expenses are not taxable income items. (c) Explanatory notes for the items: Item(iii) With effect from 1 April 2003, any amount paid by an employer in connection with a holiday journey is taxable under S9(2A)(c), and the benefit is assessed by reference to the cost incurred by the employer (see DIPN No. 41, para. 6). Where a holiday journey benefit is associated with or attributable to a cost paid by an employer, that benefit is taxable notwithstanding that the employer does not incur additional, or incremental, costs for that benefit (see DIPN No. 41, para. 11). In Eric s case, the cost of his wife s ticket is actually borne by Sunlight and is therefore taxable (example 7 in DIPN No. 41). Where a trip is taken partly for business and partly for holiday, if a clearly identifiable part of the journey is taken for holiday purposes, the expenses relating to that part of the journey is taxable. In Eric s case, the extended stay cannot be regarded as being incidental to the business trip and the cost of such extended stay is taxable. Since the expenses relating to such part cannot be readily ascertained, an apportionment based on the holiday-days basis will generally be adopted (see DIPN No. 41, para. 14 and 15). Item(v) The claim for deduction of entertainment expenses cannot be accepted as Eric could not provide evidence and details to prove that the expenses were incurred wholly, exclusively and necessarily in the production of assessable income and such expenses were not private and domestic in nature. Reimbursement of non-allowable expenses is wholly taxable. Item(viii) S9(1)(d) deems any gain realised on the exercise, release or assignment of a share option to be income from employment or office. In the case of an exercise of an option, the gain is equal to the open market value of the shares at the time of exercise less the consideration paid for the option and the amount paid for the shares. In the case of a release or assignment, the gain is simply the amount of any consideration received less the amount paid for the option. Any loss realised on the exercise, release or assignment is ignored. Sale proceeds of shares are irrelevant and the loss from sale of shares is not deductible as it is not incurred in earning the assessable income. Item(ix) S8(1A)(c) states that when Eric performs some of his duties in China, his assessable income earned in the PRC will be excluded from the assessable income if Eric has paid individual income tax ($140,000) in the PRC for the income attributable to his services rendered there. The PRC income tax was comparable to salaries tax in Hong Kong as agreed by the IRD. Question 3 (a) The pooling system does not apply when (i) applying the pooling system is impractical and inequitable (ii) plant and machinery is acquired under a hire purchase agreement Page 6 of 11
(iii) an asset used wholly for the purpose of earning the assessable profits ceased to be so used. (its reducing value which is equal to the estimated open market value must then be excluded from the pool) (iv) an asset is not used wholly for producing profits. (v) the plant and machinery items are prescribed fixed assets (vi) specific environmental protection facilities (from 2008/09) (vii) environment-friendly vehicles (from 2010/11) (b) Computation of depreciation allowance: 10% pool 20% po ol 30% pool Total allowance $ $ $ $ WDV b/f 432,000 320,000 406,000 Cost (note 1-3) 130,000 120,000 1,000,000 Less: IA 60% (78,000) (72,000) (600,000) 750,000 Valued to be pooled in 08/09 (note 4) 42,000 484,000 368,000 848,000 Disposal: Delivery van(15 Jan 09) (108,000) Delivery van (20 Feb 09) (limited to cost) (300,000) 440,000 Less: AA (48,400) (73,600) (132,000) 254,000 WDV c/f 435,600 294,400 308,000 Hire purchase item Total allowance $ $ Cost 40,000 Less: IA (60%) (note 5) (18,000) 18,000 22,000 Less: AA (30%) (6,600) 6,600 WDV c/f 15,400 24,600 Total depreciation allowance for the year of assessment : $(750,000 + 254,000 + 18,000 + 6,600) = $1,028,600 Special deductions for prescribed fixed assets under S16G = $40,000 Notes: (1) Total cost of 10% pool = $130,000 (2) Total cost of 20% pool = $100,000 + 20,000 = $120,000 (3) Total cost of 30% pool = $250,000 + 300,000 + 50,000 + 400,000= $1,000,000 (4) Value to be pooled in 2008/2009 for transfer of motorcycle = $60,000 18,000 (30% of AA on $60,000) = $42,000 (5) Capital repaid during the basis period: $10,000 + $2,000 x 10 = $30,000 Page 7 of 11
Question 4 Mr. and Mrs. Lee Personal Assessment Computation Year of Assessment 2009/10 Mr. Lee Mrs. Lee Total $ $ $ Rent received 207,500 120,000 Less: 20% statutory deduction (41,500) (24,000) Net Assessable Value 166,000 96,000 Assessable Profit 35,000 N il Net Assessable Income 800,000 Nil Total income 201,000 896,000 Less: mortgage loan interest paid (166,000) (95,000) (limited to NAV (for Mr. Lee)) 35,000 801,000 Less: Donations Total claimable by Mr. Lee 35% x ($35,000 + $5,000) = $14,000 (already deducted =$5,000) (9,000) Total claimable by Mrs. Lee (32,000) Amount transferred to Mrs. Lee by Mr. Lee -- (18,000) Note: (32,000-5, 000-9,000 ) 26,000 751,000 Less: Contributions to MPF (maximum = $12,000) (12,000) 739,000 Less: Loss b/f (100,000) Nil (74,000) 739,000 Set-off spouse loss 74,000 (74,000) Net joint total income NIL 665,000 665,000 Less: Married person s allowance (216,000) Child allowance (first 3 children) (150,000) Child allowance (4th child) (50,000) Child allowance (new-born child) (50,000) DPA (Mr. Lee s father) (30,000) ADPA (Mr. Lee s father) (30,000) 59) DPA (Mr. Lee s step-mother)(age (15,000) ADPA (Mr. Lee s (15,000) Page 8 of 11
step-mother)(age 59) Net joint total income after allowances 109,000 Total tax payable under Personal Assessment ($3,600 (first $80,000) + $3,480 ($29,000 x 12%)) 7,080 (lower than the tax amount 15% x $665,000 = $99,750) In 2009/10, there is a 75% tax reduction. = $7,080 - $7,080 x 75% = $7,080 - $5,310 = $1,770 (payable by Mrs. Lee) Personal assessment tax payable by Mrs. Lee Question 5 (A) Purchase of flat in mid-level - An agreement for sale (AFS) of residential immovable property is chargeable under Head 1 (1A) of the Stamp Duty Ordinance. An AFS which is termed provisional or informal is still subject to stamp duty if it amounts to a legally binding contract. - The stamp duty payable is $6,800,000 x 3.75% = $255,000 - Since the provisional AFS was superseded by a formal AFS within 14 days of the provisional AFS, no stamp duty is payable on the provisional AFS. Stamp duty is payable within 30 days from the date of execution of the formal AFS. - Where a conveyance on sale document is executed in conformity with a chargeable AFS which has been stamped, the conveyance on sale document is chargeable with stamp duty of $100 only. Stamp duty is payable within 30 days from the date of execution of the conveyance. (B) (a) Lease agreement - The stamp duty payable is $24,000 x 3.75% + $(20,000 x 12) x 0.5% = $2,100 - Refundable deposit is not chargeable to stamp duty. - The stamp duty is payable within 30 days of execution of the lease agreement. - The stamp duty should be payable by all the parties to the transaction jointly and severally. The Collector of Stamp Revenue may ask any party to the execution of the lease for the payment of the full stamp duty. (b) Mr. Fung s property tax liability for the year of assessment 2008/09 HK$ Rental ($20,000 x 11.5) 230,000 Premium ($24,000 x 12/24) 12,000 Repairs borne by tenant 5,000 247,000 Less: rates ($3,000 x 4) (12,000) 235,000 Less: 20% statutory deduction (47,000) Page 9 of 11
Net assessable value 188,000 Property tax at 15% thereon 28,200 Explanations: 1. As no rental was payable during the rent-free period, there is no taxable consideration for that period 2. Rental deposit of $40,000 is not income to the owner and is not assessable. 3. Initial premium is taxable consideration for the right of use of the property. It is spread over the term of lease, subject to a maximum of three years from the start of the lease. 4. Rates paid by the owner and a statutory allowance of 20% are deductible. 5. Management fee paid by the tenant directly to the management company is not income of the owne and is not assessable. 6. Mortgage loan interest is not specifically deductible under property tax. 7. Agency fee is not specifically deductible under property tax. 8. Repairs borne by the tenant but not reimbursed by the landlord is deemed to be income of the owner and is taxable. Question 6 (A) Section 51C of the Inland Revenue Ordinance requires a person carrying on a business in Hong Kong to keep sufficient records, in English or Chinese, of his income and expenditure for at least seven years after the completion of the transactions, acts or operations to which they relate so as to enable his assessable profits to be readily ascertained. The business records should include: - the books of accounts recording receipts and payments, or income and expenditure. - the underlying documentation necessary to verify the entries in the books of accounts, such as vouchers, bank statements, invoices, receipts or other relevant papers. - a record of the assets and liabilities of the business. - a day-by-day record of all sums of money received and expended by the trade, profession or business together with the supporting details of the receipts or payments. Taxpayers should also keep records relating to all business assets and liabilities at the end of each year, including: - a list of debtors and creditors; and - stocktaking figures. For those who deal in goods, the required business records should also include statements of trading stock held by the person at the end of each accounting period. It is an offence not to keep sufficient business records, and the maximum penalty for failure to comply with S51C is $100,000. An order from the court may be granted to request compliance from the offender within the time specified in the order. (B) Obligations of the owner of a let-out property include: (i). Notification of chargeability: Since Peter Ho is liable to Property Tax, he should inform the Commissioner of Inland Revenue in writing that he is chargeable to tax Page 10 of 11
not later than 4 months after the end of the basis period for that year of assessment unless he has been furnished a tax return. (S51(2)) (ii) Filing tax return: Peter Ho has to file the Property Tax Return or the Composite Tax Return within the time period specified in the return. (S51(1)) (iii) Keeping rental records: Peter Ho, being the owner of a rental property, is required to keep sufficient records of the consideration, in money or money s worth, payable or deemed to be payable to him to enable the assessable value of the property to be readily ascertained and he is also required to retain such records for a period of not less than 7 years. (S51D) Failing to observe these obligations without reasonable excuse is an offence under S80(1) (failure to file a tax return or to keep proper rental records) or S80(2) (failure to notify chargeability). Conviction under S80(1) will lead to a possible fine of $10,000. Offence under S80(2) is subject to a fine of $10,000 and treble the amount of the tax undercharged. Prosecution can also be made under S82 if the taxpayer has a wilful intent to evade tax. The offence under S82 is subject to a fine of $50,000 and treble the amount of the tax undercharged and three-year imprisonment. Alternatively, the Commissioner of Inland Revenue may raise additional (penalty) assessment under S82A up to three times of the tax undercharged. (C) For a club, S24(1) of the Inland Revenue Ordinance lays down a test: If not less than half of the club s gross receipts on the revenue account (including entrance fees and subscriptions) are from its voting members, the club is deemed not to carry on a business. Otherwise, it is deemed to carry on a business. If a club is deemed to carry on a business, all receipts and profits are chargeable to profits tax after necessary adjustments. Entrance fees and subscriptions are included as revenue receipts/income items. If a club is not deemed to carry on a business, it may still be liable to property tax in respect of its rental income from the non-voting members and non-members. ****END**** Page 11 of 11