THE HONG KONG INSTITUTE OF CHARTERED SECRETARIES
THE INSTITUTE OF CHARTERED SECRETARIES AND
ADMINISTRATORS
International Qualifying Scheme Examination
HONG KONG TAXATION
JUNE 2012
Suggested Answer
The suggested answers are published for the purpose of assisting students in their
understanding of the possible principles, analysis or arguments that may be identified
in each question
1
SECTION A
1.
David Chow is employed as the marketing manager of Elegance Fashion Ltd (Elegance
HK), a company carrying on business in Hong Kong. Elegance HK is listed on the Hong
Kong Stock Exchange and has a wholly-owned subsidiary in the Mainland China,
Elegance Garment Factory Ltd (Elegance China), which manufactures the products for
Elegance HK. David is also one of the directors of Elegance China. He has approached
you for advice and has provided you with the following information relating to the year
ending on 31 March 2012:
Employment / Office
1.
His salary from Elegance HK was $360,000 for the year. He also received
commission income of $220,000.
2.
He received a director’s fee of $100,000 from Elegance China. He normally attends
board meetings in Mainland China. When he cannot make the meetings in person,
he uses video-conferencing from the Hong Kong office. He has paid income tax in
the Mainland of $12,000 equivalent in respect of his director’s fee.
3.
Apart from his duties as a director, he is also required to travel to Mainland China
regularly to ensure that the quality of the products meets the customers’
requirements, and to visit the production facilities with prospective and existing
customers. He roughly spends about 100 days per year in the Mainland.
4.
He rented a car from a motor car company at a monthly rent of $3,000 and paid
petrol costs amounting to $42,000 for the year. He obtained the full refund of car
rental and petrol costs from Elegance HK. The Inland Revenue Department agreed
that 50% of the car was used for employment purposes.
5.
He is enrolled in Elegance HK’s medical insurance scheme. Elegance HK paid
insurance premium of $2,100 for his medical cover. During the year, David has
claimed medical reimbursement of $4,500 from the insurance company.
6.
On 10 January 2012, he was granted a share option to subscribe for 50,000 shares
in Elegance HK at $1 each by Elegance HK. He paid $5,000 for the option. He
assigned his option right for 30,000 shares to his colleague for $150,000 on 2
February 2012. On 15 March 2012, he exercised the option to subscribe for the
remaining 20,000 shares. He disposed of all these shares in the market on 31
March 2012. The market value per share on respective dates was as follows:
10 January 2012
2 February 2012
15 March 2012
31 March 2012
$5
$7
$9
$8
2
7.
He joined the company’s recognised occupational retirement scheme and has
made a contribution of $18,000 to the scheme during the year.
8.
He enrolled in a diploma course in marketing offered by a local university. He paid a
tuition fee of $50,000 in August 2011. He completed the course in January 2012
and obtained a refund of $10,000 from the Continuing Education Fund.
Property
9.
David is the sole owner of a residential property in Shatin which was transferred to
him by his parents in 2010. David let out the property on the following terms:
(i) Lease term: Two years from 1 July 2010.
(ii) Rent: $8,000 per month.
(iii) Rental deposit: $16,000 payable at the start of the lease.
(iv) Lease premium: $24,000 payable at the start of the lease.
(v) Rates and government rent: $1,500 and $900 payable per quarter by the owner
(ignore any rates concession).
(vi) Building management fee: $850 payable by the tenant to the building
management office.
10. David and his family members live in a property in Tai Po, which was jointly owned
by David and his wife, Katherine Wong, in equal share and was the first property in
Hong Kong acquired by them five years ago. They financed the purchase of the
property by a bank loan secured by a mortgage over that property. Interest
expense of $138,000 was paid during the year.
Dependents
11. David is married and his wife, Katherine Wong, is a housewife. Katherine worked as
a part-time tutor for the Open University of Hong Kong and earned remuneration of
$60,000 for the year. She has made a mandatory contribution to the MPF scheme
of $3,000. Katherine is a Christian and she has donated all her net salary of
$57,000 to a church which is an approved charitable institution.
12. David and Katherine have a baby, born on 10 February 2012.
13. David’s parents, aged 70 and 75 during the year, have been living in an elderly
residential care home in Shenzhen, Guangdong Province, since April 2010. David
visits them once every month and paid their residential care fee of $120,000 for the
year ended 31 March 2012.
14. Katherine’s parents, aged 50 and 58 during the year, reside in Hong Kong.
Katherine is their only child and she supported their living by giving them $5,000 per
month towards their maintenance.
3
REQUIRED:
1.
(a)
Ans (a)
Prepare the Hong Kong salaries tax computation for David and
Katherine for the year of assessment 2011/12, using the most
advantageous method and assuming that they would claim whatever
deduction and allowance applicable to them.
Provide brief
explanations for when an item is not included in the computation you
prepared. Ignore provisional tax and one-off tax reductions.
Mr. and Mrs. Chow
Salaries tax computation - joint assessment
Year of Assessment 2011/12
Salary
Commission
Refund of car rental ($3,000 x 12)
Refund of petrol costs
Share option
- exercise [($9-$1) x 20,000 - $2,000]
- assignment ($150,000 - $3,000)
Assessable income
Less:
Allowable outgoings agreed by the
assessor ($18,000 + $21,000)
Less:
Self-education expense
$10,000)
Net assessable income
($50,000
Mr. Chow
$
360,000
220,000
36,000
42,000
158,000
147,000
963,000
Mrs. Chow
$
60,000
60,000
39,000
924,000
-
Joint net assessable income
Less:
Concessionary deductions
Approved charitable donation
Home loan interest ($50,000 + $50,000)
Contribution to recognised retirement
scheme ($12,000 + $3,000)
Personal allowances
Married person's allowance
Child allowance
Child allowance - additional
Dependent parent allowance
Net chargeable income
40,000
884,000
60,000
944,000
57,000
100,000
15,000
172,000
772,000
Less:
Tax at progressive rates
216,000
60,000
60,000
18,000
354,000
418,000
59,060
Tax at standard rate (15%)
115,800
Tax payable (ignore tax reduction of $12,000
proposed in the 2012/13 budget)
4
59,060
Explanation on non-inclusion of:
Insurance premium / insurance refund
The insurance premium paid by Elegance HK is not taxable as the employer
is discharging its sole and primary liability for which no person was surety.
The medical refund received by David is not taxable as it arises from the
insurance policy in his capacity as a beneficiary rather than from his
employment.
Elderly residential care expense
For the deduction of elderly residential care expense, the care home must be
licenced/registered under the applicable Ordinances in Hong Kong (section
26D(5)). The care home in Shenzhen is unlikely to be registered in this
context.
David’s office income (non-HK source – see (c) (ii) below)
Explanation on using joint assessment in computation instead of separate
assessment:
Since Katherine’s net assessable income is less than the aggregate amount
of concessionary deduction and basic allowance, it may be advantageous for
the couple to elect under section 10(2)(a) to be jointly assessed, so that the
excessive amount of deductions could be utilised by David.
1.
(b)
Ans (b)
Calculate the Hong Kong property tax payable by David for the year of
assessment 2011/12. Ignore provisional tax.
Property tax Computation
Year of assessment 2011/12
Rent ($8,000 x 12)
Lease premium ($24,000 x 12/24)
Assessable value
Less:
Rates ($1,500 x 4)
$
96,000
12,000
108,000
(6,000)
102,000
Less:
20% statutory deduction
Net assessable value
(20,400)
81,600
Tax payable at 15%
12,240
5
1.
(c)
Advise David on the following issues, with reference to the Inland
Revenue Ordinance and the Avoidance of Double Taxation Arrangement
signed between Hong Kong SAR and Mainland China where
appropriate:
(i)
whether David is liable to pay PRC income tax in the Mainland in
respect of his employment income from Elegance HK for services
rendered during visit to the Mainland;
(ii) whether his director’s fee received from Elegance China is taxable
in Hong Kong assuming he is liable to pay PRC tax on his director’s
fee;
(iii) whether he could deduct any PRC tax paid in his Hong Kong
salaries tax computation; and
(iv) whether it would be advantageous for David and Katherine to be
assessed under personal assessment for the year of assessment
2011/12.
Computation of the tax payable under personal
assessment is NOT required.
Ans (c)
(i) Pursuant to Article 14 of the Arrangement for the Avoidance of Double
Taxation and the Prevention of Fiscal Evasion with respect to Taxes on
Income (the Arrangement) signed on 21 August 2006, a Hong Kong
resident will be exempt from individual income tax in the Mainland if:
- he is present in the Mainland for not more than 183 days in any
12-month period commencing or ending in the taxable year concerned;
- his remuneration is not paid by a Mainland employer; and
- his remuneration is not borne by a permanent establishment in the
Mainland.
Given that David only spent around 100 days per year in the Mainland
and that his salary was paid by the Hong Kong company and not borne by
the Mainland subsidiary, he should be exempt from tax in the Mainland in
respect of his salary income from employment.
(ii) For directorship, the source of office is the place where the company is
centrally managed and controlled (McMillan v Guest). Normally, the
company is centrally managed and controlled in the place where the
directors’ meetings are held and decisions are made.
David is a director of Elegance Garment Factory Ltd, a company carrying
on manufacturing business in Mainland China. The directors’ meetings
were held in Mainland China. Hence, the office is sourced outside Hong
Kong and income from it is not chargeable to Hong Kong salaries tax
under section 8(1)(a).
6
(iii) As the director’s fee is not taxable in Hong Kong (see (ii) above) and
David’s income from Elegance HK is not subject to tax in the Mainland,
the issue of double taxation does not arise. No tax credit or deduction of
tax paid would be applicable in computing his Hong Kong salaries tax.
(iv) Property tax is charged at the standard rate of 15% on the net assessable
value of the Shatin property. David and Katherine would have fully utilized
all concessionary deductions and personal allowances under salaries tax
already. There is no extra deduction (e.g. interest expenses, unutilized
donation, etc.) available under personal assessment. If they are
assessed under personal assessment, the net assessable value
aggregated to the total income would be charged at the higher
progressive tax rate of 17%. Hence, it would not be advantageous for the
couple to be assessed under personal assessment.
1
(d)
Analyse the salaries tax implications of the motor car expenses incurred
by David and the refund received from his employer (see note 4), and
recommend ways in which the benefit could be provided to him in a
more tax efficient manner.
1
(d)
For an expense to be deductible under salaries tax, it must not be domestic,
private or capital in nature and must be wholly, exclusively and necessarily
incurred in the production of the assessable income (section 12(1)(a)). In
practice, the Inland Revenue Department (IRD) allows the apportionment of
an expense if it is separable and identifiable. Hence, David would be able to
claim deduction of 50% of the car rental and petrol costs as agreed by the
IRD (see part (a)).
While the full refund of the car rental and petrol costs from the employer is
taxable, he is able to claim 50% of the expense incurred as deduction under
salaries tax. Effectively, he is subject to tax on 50% of the refund.
On the other hand, any benefit received by an employee could be non-taxable
by virtue of section 9(1)(a)(iv) if the employer is discharging its sole and
primary liability for which no one was surety, and that the benefit is not
convertible into money.
Hence, Elegance HK may enter into a contract with the motor car company
directly for the renting of car and provide this for David’s use instead of
refunding the rental payment. It may also provide a fuel card registered in the
company’s name and allow David to charge all fuel expenses to the card. In
these ways, the employer would be discharging its sole and primary liability.
The whole benefit received, including the portion related to David’s personal
and private use, would not be taxable.
7
SECTION B
2.
Greenwich Ltd carries on a trading business in Hong Kong. The company has earned
net income of $2,700,000 for the year ending on 31 March 2012, which was arrived at
after charging and crediting, inter alia, the following items:
Note
Income:
Rental income
Interest income
Dividend income
Expenses:
Bad debts
Depreciation expenses
Interest expenses
Legal and professional fee
Repairs and maintenance
Taxation
$
1
2
360,000
16,000
27,000
3
33,000
210,000
269,500
134,200
97,000
654,200
4
5
6
7
Notes:
1.
The company owns an office premises in Quarry Bay which was let at a monthly
rent of $30,000. Property tax on the rental income has been paid (see note 7).
2.
Interest income:
Interest on long-term qualifying debt instruments
Interest on time deposits placed with HSBC in Hong Kong*
$
5,000
11,000
* The deposits were used to guarantee the bank overdraft facility (see note 4 below)
3.
4.
5.
Bad debts expenses:
Increase in general allowance (at 2% on trade debts outstanding)
Increase in specific allowance (legal action in progress)
Recovering of trade debts written off in 2010
Interest expenses:
Overdraft interest to Hang Seng Bank (secured by time deposits)
Loan interest to Bank of Asia (secured by a mortgage over the
director’s quarters)
Surcharge for late payment of tax
Legal and professional fees:
Audit fee
Recovery of trade debts
Others (allowable)
43,000
20,000
(30,000)
165,500
72,000
32,000
80,000
7,000
47,200
8
6.
Repairs and maintenance:
Replacement of carpet
Renovation of showroom
Maintenance of office equipment
Replacement of a LCD television
7.
Taxation:
Property tax paid for 2011/12
Profits tax paid and provision for 2011/12
8.
$
24,000
50,000
15,000
8,000
43,200
611,000
Total depreciation allowances for the year have been agreed with the assessor
to be $423,000.
REQUIRED:
2.
Ans
(a) Prepare the Hong Kong profits tax computation for Greenwich Ltd for
the year of assessment 2011/12. Ignore provisional tax and one-off tax
reductions.
(a)
Greenwich Ltd
Profits tax computation
Year of assessment 2011/12
Basis period: Year ended 31 March 2012 (section 18B(1))
$
$
Profit per accounts
2,700,000
Add: Depreciation
210,000
Increase in allowance for doubtful
debts
43,000
Surcharge for tax payment
32,000
Replacement of LCD projector
8,000
Renovation of showroom
($50,000 x 4/5)
40,000
Taxation expenses
654,200
987,200
3,687,200
Less: Dividend
(27,000)
Interest on qualifying debt instruments
(5,000)
(32,000)
3,655,200
Less: Depreciation allowance
(423,000)
Assessable profit
3,232,200
Profits tax payable at 16.5%
Less: Property tax paid
533,313
(43,200)
490,113
9
2.
(b) Analyse the proper tax treatments for the following:
(i)
(ii)
(iii)
(iv)
Ans (b) (i)
rental income and property tax paid [notes (1) and (7)];
interest income [note (2)];
interest expenses [note (4)]; and
repairs and maintenance [note (6)].
Rental income and property tax paid [note (1) and (7)]
Under section 2, ‘business’ is defined to include letting and sub-letting
by a corporation and hence the rental income from property letting is
subject to profits tax. At the same time, under section 5(2)(a) property
tax can be exempt if the property is owned by a corporation carrying on
business in Hong Kong and the property is used for business purposes
or the rental income is subject to profits tax. If no exemption is made,
property tax paid could be offset against the profits tax payable under
section 25.
As Greenwich Ltd has paid property tax for the year of assessment
2011/12, tax paid could be offset against the final profits tax payable.
Property tax and profits tax paid or payable are not deductible under
section 17(1)(g).
(ii) Interest income [note (2)]
Interest income from long-term qualifying debt instruments is exempt
under section 26A(1)(h).
Interest income on time deposits placed with HSBC in Hong Kong is
taxable under section 15(1)(f) because Greenwich Ltd is carrying on a
business in Hong Kong and the interest income was sourced in Hong
Kong under the provision of credit test.
The Exemption Order does not apply in this case as the deposits were
used to guarantee the bank overdraft facility and the overdraft interest
is deductible.
(iii) Interest expenses [note (4)]
Bank overdraft interest is deductible because it was incurred in the
production of chargeable profits (section 16(1)(a)) and the money was
borrowed from a financial institution (section 16(2)(d)).
There is no restriction on the deduction of interest expenses under
section 16(2A). Although the overdraft facility was secured by the time
deposits, interest income from the deposits is taxable in Hong Kong.
Furthermore, there is no interest flowing back to a connected person
under section 16(2B).
10
Loan interest is also deductible because section 16(1)(a) and 16(2)(d)
are fulfilled and the deduction is not restricted by section 16(2A) or
16(2B).
Surcharge for late payment of tax is a penalty and not an expense
incurred in the production of chargeable profit. It is therefore
non-deductible.
(iv) Repairs and maintenance [note (6)]
Carpet is an implement, utensil and article as prescribed by Inland
Revenue Rule 2. The cost of its replacement is deductible under
section 16(1)(f).
Capital expenditure on the renovation of a non-domestic building or
structure can be deducted over five years of assessment under section
16F. Hence, only $10,000 out of $50,000 can be deducted for the year
of assessment 2011/12.
The maintenance charge for office equipment is a normal business
expense incurred in the production of chargeable profits, and is
deductible under the general deduction rule of section 16(1).
Replacement of the LCD television is capital expenditure incurred on
plant and machinery. Capital expenditure is not deductible under
section 17(1)(c). Instead the company may claim an initial allowance at
60% on the cost and an annual allowance at 20% on the reducing
value.
11
3.
Vincent Chen is from Taiwan. He was employed by Millions Investment Ltd
(Millions), a company carrying on business in Hong Kong, with effect from 1
April 2010 for a contract term of three years. During the period of his
employment with Millions he lived and worked in Hong Kong. On 31 March
2012, his employment was terminated unilaterally by Millions without notice
and he received the following sums:
(1) $960,000 (Sum A) – equivalent to his salary under the remaining
period of his contract (12 months);
(2) $960,000 (Sum B) – equivalent to one year’s salary;
(3) $500,000 – payment for agreeing not to work for Millions’ major
competitors for one year;
(4) $60,000 – payment in lieu of leave; and
(5) $75,000 – housing allowance for three months.
Vincent negotiated his terms of employment in Taiwan. The employment
contract was signed by him when he reported for duty on 1 April 2010.
Under the employment contract, both parties are required to provide three
months’ notice to the other party for early termination of employment.
Vincent is entitled to the payment of one additional year of salary should the
employment contract be terminated pre-maturely by Millions. His
remuneration was credited to his bank account maintained with Bank of
North Asia in Hong Kong. He was provided with company quarters in
Taikoo Shing rent-free by Millions. After his contract was terminated, his
was asked to move out from the quarters within one week.
Vincent decided that he would go back to Taiwan instead of finding another
job in Hong Kong. He has already paid his Hong Kong salaries tax for the
year of assessment 2010/11 and provisional tax for 2011/12. Hence, he left
Hong Kong on 20 April 2012 without attending to his taxation matters. On
16 May 2012, he received the individual tax return which was redirected to
him by Millions and a week later he received the notice of estimated
assessment for the year of assessment 2011/12 dated 5 May 2012, which
was also redirected to his Taiwan address by Millions. He was shocked to
note that the Inland Revenue Department has assessed all his termination
payments to salaries tax. Furthermore, the salaries tax is due on 10 June
2012.
Today is 29 May 2012.
12
REQUIRED:
Advise Vincent of the following:
3.
(a)
The taxability of the various sums received by him for the termination
of his employment.
Ans (a)
Section 9(1)(a) provides that income from employment includes any wages,
salary, leave pay, fee, commission, bonus, gratuity, perquisite, or
allowance, whether derived from the employer or others. Applying the
general principles, income is taxable if it is derived from the employment, it
is for services rendered or to be rendered, and it represents money or
money’s worth. Genuine compensation payments are not taxable.
In Fuchs, Walter Alfred Heniz v CIR (2011), the Court of Final Appeal
decided that income chargeable to tax is not confined to income earned in
the course of employment but embraces payments made in return for
acting as or being an employee, as a reward for past services, or as an
inducement to enter into employment and provide future services.
Vincent is entitled to three months’ advance notice of termination of his
contract but his employment was terminated unilaterally by Millions without
notice. The payment of Sum A is likely to be a compensation for early
termination and the deprivation of Vincent’s right to receive adequate
notice, although the sum is more generous than that which Vincent is
strictly entitled to (i.e. three months) under the employment contract. The
fact that the payment of Sum A is not specifically provided for in the
contract adds weight to this argument, which could be regarded as a
genuine compensation for the loss of right to receive a proper three-month
notice in accordance with the contract and not payment for services
rendered.
Vincent is entitled to the payment of one additional year of salary should his
employment contract be terminated pre-maturely by Millions. Sum B is
substantial compensation which is enforceable in law if his employment is
terminated early. Following the Fuchs case, this is likely to be an
inducement for Vincent to sign the contract and relocate to work in Hong
Kong for the term of his employment. The sum was made in satisfaction of
the rights which had accrued to the taxpayer under the contract of
employment and is an amount derived from his employment. It is not a sum
paid in consideration of the abrogation of the taxpayer’s right under the
employment contract. In fact, Vincent has surrendered no rights.
Payment for giving up the right to work for the competitors for one year is
compensation for deprivation of rights and is not a payment for past or
future services. The sum of $500,000 is non-taxable.
13
Leave pay is specifically listed as taxable income under section 9(1)(a).
Payment in lieu of leave is arising from employment and is payment for past
service rendered.
The housing allowance is arguably not taxable. Vincent was provided with
the company’s quarters during the period of his contract of employment.
His employment was terminated without prior notice and he was required to
move out from the quarters almost immediately after his contract was
terminated. The three months’ housing allowance can be compensatory in
nature rather than a reward for his services. There is no obligation on the
part of the employer to let Vincent have a housing allowance when he was
no longer employed by the company. The sum can be viewed as a
compensation for Vincent’s loss of the accommodation due to the
termination of contract (see BR116/77).
3.
(b) His obligations as an employee under the Inland Revenue Ordinance
in relation to the information provided above. You should include the
deadlines for him to comply with the Ordinance.
Ans (b) Vincent’s obligations under the Inland Revenue Ordinance include:

To notify the Commissioner of Inland Revenue of his cessation to
derive employment income from Hong Kong within one month of such
cessation – section 51(6). The deadline in Vincent’s case is 30 April
2012.

To notify the Commissioner of Inland Revenue of his departure from
Hong Kong not later than one month before the expected date of
departure – section 51(7). The deadline for Vincent is, theoretically
speaking, 20 March 2012. However, the Commissioner may accept
shorter notice as he may deem reasonable.

To notify the Commissioner of Inland Revenue of the change of his
address within one month of the change – section 51(8).

To furnish the IRD with his tax return within the reasonable time stated
in the notice – section 51(1).
14
3.
(c)
Ans (c)
The proper courses of action that he should take.
Even though Vincent has paid provisional salaries tax for the year of
assessment 2011/12 already, he is still required to submit his tax return for
the same year. In particular, he has received substantial taxable
termination payments for the year which obviously have not been taken into
consideration in computing his provisional salaries tax.
As some of the termination payments should be non-taxable, Vincent
should be advised to lodge an objection in writing, stating precisely the
grounds of objection, which should be received by the Commissioner within
one month after the date of the notice of assessment, i.e. 5 June 2012
(section 64(1)).
Today is 29 May 2012. There is a risk that the objection may be received by
the Commissioner after 5 June 2012. A late objection could be accepted if
the Commissioner is satisfied that it is owing to absence from Hong Kong,
sickness and other reasonable cause. Vincent may state the relevant facts
in the objection letter for the consideration by the Commissioner.
Notwithstanding any objection or appeal, tax must be paid on or before the
date specified in the notice under section 71(1). As the salaries tax is due
soon, Vincent may request the Commissioner to holdover the payment of
tax pending the determination of the objection under section 71(2). The
Commissioner has the discretion whether or not to grant a holdover order,
either with or without condition. Vincent should note that if the
Commissioner grants an unconditional holdover but the tax held over is
subsequently payable upon determination, interest shall be payable on the
amount of tax held over.
15
4.
Pineapple Foods Ltd (Pineapple) is wholly owned by Danny Chan. The
company carries on a food processing and canning business in Hong Kong.
It also holds a number of properties for investment purposes. The following
transactions were entered into by the company for the year ended 31
December 2011:
(1) The company acquired a piece of land in Tai Po for $10 million. The
conveyance on sale was signed on 5 January 2011. The company
engaged a contractor to build a two-storey building on that site at a
construction cost of $6 million in May 2011. The building was
completed on 20 December 2011 and immediately used for production.
(2) The company let out a shopping unit in Fanling on the following terms:
Rent:
$20,000 per month plus 3% of the turnover of the
business carried on in that unit. The maximum monthly
rent is not to exceed $60,000.
Deposit:
$100,000 payable upon signing of the agreement.
Lease term: Two years from 1 June 2011.
The tenancy agreements were signed on 20 May 2011 in duplicate.
(3) The company sold a residential property in Tai Wai for $7 million. The
provisional sale and purchase agreement was signed on 10 October
2011. The formal sale and purchase agreement was signed on 20
October 2011, followed by the assignment deed on 20 November 2011.
The property was previously acquired by the company on 15 December
2010 for $5 million.
(4) Pineapple holds 20% interest in Lemon Investment Ltd (Lemon), a
company incorporated in Hong Kong. Pineapple transferred all the
shares in Lemon to Danny on 2 December 2011 at its book value of
$300,000. The fair value of shares transferred is estimated to be
$500,000. The sale and purchase contract was signed in Taiwan when
Danny was on a leisure trip.
REQUIRED:
4
(a) Evaluate the Hong Kong stamp duty implications arising from all the
above transactions. Support your answers with stamp duty
computations where appropriate.
Ans (a)
(1) Conveyance on the sale of immovable property in Hong Kong is
chargeable to stamp duty under Head 1(1). Stamp duty is computed at the
higher of the stated consideration and value of the property. Stamp duty
payable is:
16
$10,000,000 x 3.75% = $375,000
The instrument must be stamped within 30 days after execution.
(2) An agreement for the lease of immovable property is subject to stamp
duty under Head 1(2). Based on the principle of contingency, if the rent
payable is uncertain at the time of execution of the instrument, stamp duty is
chargeable on the maximum of any specified amount. The rate for a lease
term of more than one year but not more than three years is 0.5% of the
average yearly rent. Stamp duty payable is:
$60,000 x 12 x 0.5 = $3,600
As the tenancy agreement is executed in duplicate, the duplicate copy is
stamped at $5 under Head 4. The agreements must be stamped within 30
days after execution.
(3) The provisional sale and purchase agreement of residential property
would be subject to stamp duty under Head 1(1A). However, it was
superseded by the formal sale and purchase agreement within 14 days and
the later became the dutiable instrument. Stamp duty payable is:
$7,000,000 x 3.75% = $262,500
Since the property was acquired by Pineapple on or after 20 November
2010 and was disposed of with 24 months of the date of acquisition, special
stamp duty is payable under Head 1(1B). The rate is 10% as the property
has been held for six months or more but less than 12 months. Special
stamp duty is:
$7,000,000 x 10% = $700,000
If the sale and purchase agreement is duly stamped, the deed of
assignment will be subject to stamp duty of $100 only under Head 1(1).
All instruments must be stamped with 30 days.
(4) As Lemon Investment Ltd is a company incorporated in Hong Kong, the
transfer of its shares must be registered in Hong Kong and must be
stamped under Head 2. The fact that the sale and purchase agreement is
executed outside Hong Kong is irrelevant. A person who effects any sale or
purchase of Hong Kong stock as principal or agent is statutorily required to
make and execute a contract note and cause it to be stamped under section
19(1).
As the consideration for the transfer is inadequate, it will be deemed to be a
transfer operating as a voluntary deposition and the market value of shares
will be substituted. Stamp duty payable under Head 2(3) is:
$500,000 x 0.2% = $1,000
17
A fixed duty of $5 will be payable for the instrument of transfer.
Contract notes and the instrument of transfer should be stamped within 30
days after execution if they are effected outside Hong Kong.
4
(b) For the purposes of Hong Kong profits tax, identify the type of
depreciation allowance available to Pineapple Foods Ltd for
transaction (1). Compute the relevant depreciation allowances for the
year of assessment 2011/12.
Ans (b) Pineapple Foods Ltd carries on a food processing and canning business in
Hong Kong. The newly constructed factory building in Tai Po was used for
its production. Hence, the building was used for one of the qualifying trades,
namely, a trade consisting of the subjection of goods or materials to any
process. Industrial buildings allowances will be available for Pineapple for
the year of assessment 2011/12.
Land cost is not qualifying expenditure. Depreciation allowances can be
claimed on the cost of construction only, as follows:
Initial allowance:
$6 million x 20% = $1,200,000
Annual allowance:
$6 million x 4% = $240,000
18
5.
Rocky Cheung and his friend, Candy Wan, carry on a partnership
business in Hong Kong under the name Rocky Candy & Co. They are
considering converting the business into a corporation and wish to know
the differences in the tax treatment, if any, for the following items if the
business is run in the form of a corporation rather than a partnership:
(1) The business is currently operated from office premises owned by
Rocky. Rocky charges the company a monthly rent of $20,000 which
is below the market rent. The rateable value of the premises is
$360,000. There will not be any change in the amount of rent payable
to Rocky if the business is converted into a corporation.
(2) Rocky and Candy currently work full-time for the business. Each of
them draws a monthly salary of $30,000 from the business which is
considered commensurate with their duties. They would become
employees of the corporation if they were to proceed with the
incorporation.
(3) The business currently makes a contribution to the MPF scheme at
10% of the monthly salary of Rocky and Candy. The same
contribution percentage would be maintained.
(4) Kelvin Cheung, Rocky’s son, works as a part-time accountant for the
business and receives a monthly salary of $5,000.
(5) The business rents a car parking space at a monthly rent of $2,000
for the use by Rocky, who drives to work from home.
(6) Rocky and Candy share any profits and loss equally after deducting
all expenses mentioned above. Up till now, they have distributed
almost all the profits available, and both of them are normally
assessed under personal assessment.
REQUIRED:
Advise Rocky and Candy on the differences, if any, in Hong Kong tax treatments
arising from the incorporation of their partnership business for all the payments
and profits distribution mentioned above.
Ans
(1) Rent paid for a building occupied the purpose of producing
chargeable profits is deductible under section 16(1)(b), but the rent
should not exceed the assessable value of that building when the rent
is paid to a partner of a partnership.
19
For the partnership, total amount of rent paid to Rocky ($240,000 per
annum) will be deductible expense while the same amount is
assessable to Rocky under property tax. The rateable value is
irrelevant.
For a corporation, the rent paid can also be deducted (the same
amount is assessable to Rocky under property tax). Hence, there is
no difference in the tax treatment.
(2) Under section 17(2), no deduction is allowed for salaries or other
remuneration paid to a partner or a partner’s spouse by a partnership.
Therefore, even though Rocky and Candy rendered services to the
partnership for the purpose of producing chargeable profits and their
salaries are not excessive, their salaries are not deductible in
computing the assessable profits.
On the other hand, the salary income received by them is not
chargeable to salaries tax under section 8(2)(k).
If the business is incorporated, it will become a separate legal entity.
Rocky and Candy will become employees of the corporation. Salaries
paid to them will be deductible under section 16(1) as expenses
incurred in the production of chargeable profits. The salaries they
receive will be subject to salaries tax.
(3) Under section 16AA, mandatory contributions to an MPF scheme in
respect of a partner in a partnership as a self-employed person are
deemed to be expenses wholly and exclusively incurred in the
production of chargeable profits and can be deducted up to a
maximum of $12,000 per year. Despite the partnership making
contributions based on 10% of the salaries of Rocky and Candy, only
$12,000 can be deducted for each of them per annum.
If the business is incorporated, Rocky and Candy would become
employees of the corporation. Contributions made for employees can
be deducted up to 15% of the total emoluments of an employee under
section 17(1). Hence, the whole amount of MPF contribution made for
Rocky and Candy can be deducted by the incorporated business.
On the other hand, for Rocky and Candy, any sum withdrawn from
the MPF scheme in respect of voluntary contributions made by the
employer is chargeable to salaries tax unless it is received upon
retirement, death or incapacity. If the sum withdrawn is due to
termination of service, any amount received which is in excess of the
proportionate benefit will also be taxable.
20
(4) Salaries paid to a partner or a partner’s spouse are not deductible
under section 17(2). The restriction does not apply to other relatives.
As long as Kelvin provides accounting services to the business
(services for the purpose of producing chargeable profits), his salary
could be deducted under section 16(1).
It makes no differences whether the business is incorporated or not.
(5) As the parking space is for Rocky’s car which is used by him for
travelling from home to office, it is for private use only and the rental is
not a business expense. A partner’s personal expense cannot be
deducted under profits tax. This would be treated as an appropriation
of profits instead.
If the business is incorporated and Rocky becomes an employee or
director of the company, the rental expense could be regarded as a
fringe benefit provided to the employee/director and is a cost of
employing and retaining the staff. The expense would be deductible
under section 16(1). There should be no salaries tax implication to
Rocky as the benefit is not convertible into cash nor does it represent
a discharge of Rocky’s liability.
(6) Currently, if Rock and Candy elect to be assessed under personal
assessment, their share of partnership profits will be transferred to
and dealt with under personal assessment where they can deduct
concessionary deductions and personal allowances. Any partnership
losses can be set off against other sources of income (e.g. rental
income in the case of Rocky) under personal assessment.
If the business is incorporated, the distribution of profits will be in the
form of the payment of dividends. Dividend income is not taxable in
Hong Kong. However, even if Rocky and Candy have elected for
personal assessment, profits of a corporation cannot be transferred to
personal assessment. Assessable profits will be taxable under the
name of the corporation. If there is any loss, the loss could only be
carried forward and set off against the company’s future profits.
However, any salaries or taxable benefit they obtain from the
corporation will be assessable under salaries tax no matter whether
they elect for personal assessment or not.
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6.
Mountain Ltd carries on a business of trading in electronic appliances in
Hong Kong. Its products are mainly sourced in Mainland China and
Thailand and sold to customers in the US. The company is solely owned by
Patrick Fung who has good personal connections in the industry and is able
to sell fancy products at very good price. Patrick is concerned about the
huge amount of tax bills in Hong Kong. He plans to set up a new company,
River Ltd, in a low tax jurisdiction outside Hong Kong. He will hold all the
shares in River Ltd. Under his plan, Mountain Ltd will firstly sell the goods to
River Ltd at cost plus 5%, which is about sufficient to cover its expenses
incurred in Hong Kong. River Ltd will re-sell the goods to the ultimate
customers at the normal mark-up of 25%. All contract negotiation, shipment
and financing arrangements will continue to be performed by Mountain Ltd’s
staff in Hong Kong.
The following information relating to the assets of Mountain Ltd for the year
ended 31 December 2011 are extracted from the company’s book:
1.
A computer server (annual allowance at 30%) was acquired in June
2011 under a hire-purchase agreement:
-
Cash price: $200,000
Down payment: $20,000 (paid on 20 June 2011)
Instalments: Balance repayable by 12 instalments of $16,000 each
commencing on 20 July 2011
2.
Two sets of desktop computers and printers (annual allowance at 30%)
were acquired for $19,000 during the year.
3.
An electric motor car was purchased in August 2011 for $250,000. An
old motor car (annual allowance at 30%) was sold for $130,000.
4.
New office furniture (annual allowance at 20%) costing $80,000 was
acquired during the year.
5.
Tax written down values as at 1 January 2011 are:
-
20% pool: $185,000
30% pool: $177,000
22
REQUIRED:
6.
(a) Advise Patrick on the feasibility of his proposal. You should include in
your answer a discussion of the relevant anti-avoidance provisions in
the Inland Revenue Ordinance and how they could be applied to the
case.
Ans (a) By selling the goods to the newly set up company, River Ltd, at a reduced
mark-up, it can be foreseen that Mountain Ltd will be earning minimal profits
or even suffering a loss, given that the 5% mark-up will be about just
sufficient to cover all expenses incurred by Mountain Ltd in Hong Kong. After
the proposed change, Mountain Ltd’s taxable profits will be substantially
reduced and this may be subject to challenge by the Inland Revenue
Department (IRD).
Under section 20 of the Inland Revenue Ordinance, where a non-resident
person carries on business with a resident person with whom he is closely
connected, and the course of such business is so arranged that it produces
to the resident person either no profits which are sourced in Hong Kong, or
less than the ordinary profits which might be expected to arise in or derived
from Hong Kong, the business done by the non-resident person in
pursuance of his connection with the resident person is deemed to be
carried on in Hong Kong and the non-resident person will be assessed in
respect of the profits derived in the name of the resident person as if he were
the agent of the non-resident person.
Mountain Ltd and River Ltd are solely owned by Patrick and they are ‘closely
connected’. As the proposed arrangement significantly reduces Mountain
Ltd’s taxable profits, the business to be carried on by the non-resident, River
Ltd, may be deemed to be carrying on in Hong Kong and be chargeable to
Hong Kong profits tax in the name of Mountain Ltd (see Radofin Electronics
(Far East) Ltd).
Furthermore, the general anti-avoidance provisions under section 61 and
section 61A may also operate to defeat the scheme. Under section 61,
where any transaction which reduces the amount of tax payable is artificial
or fictitious, an assessor may disregard the transaction and raise an
assessment accordingly. The profits from selling the goods to ultimate
customers would then be chargeable to tax in the name of Mountain Ltd.
Even though the proposed arrangement may not be ‘fictitious’ for the
purposes of section 61, section 61A could also apply if the transaction has
the effect of conferring a tax benefit on a person and the transaction is
entered into with the sole or dominant purpose of obtaining a tax benefit. In
23
such a case, the assistant commissioner may raise an assessment as if the
transaction had not been entered into or carried out, or in any other manner
that he considers appropriate to counteract the tax benefit.
Given that the profit margin made by Mountain Ltd would be very low
compared with a normal sale to the ultimate customers, the sales is not at
arm-length and this conferred a substantial tax benefit on the taxpayer. ‘Tax
benefit’ means the avoidance or postponement of the liability to pay tax or
the reduction in the amount of tax. Mountain Ltd may need to demonstrate
that the proposed arrangement has genuine commercial purposes other
than the avoidance of tax. Furthermore, as all contract negotiation, shipment
and financing arrangement will continued to be carried out by Mountain Ltd,
this could not justify the low profit margin to be earned by Mountain Ltd in
Hong Kong.
Hence, there is a high risk that Patrick’s proposed arrangement would be
counteracted by the IRD applying anti-avoidance provisions. If he wishes to
implement the proposal, he should ensure that some activities are
undertaken by River Ltd in addition to merely paper work such that the
mark-up can be justified as a reasonable one. Specifically, River Ltd may
consider taking up some functions and risks such as being responsible for
negotiating sale contracts with ultimate customers, storage of goods, and
assuming credit risk, foreign exchange exposure and product liability, etc.
These activities should be conducted outside Hong Kong or River Ltd will be
considered to be carrying business in Hong Kong and subject to profits tax
under section 14.
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6.
(b) Calculate the depreciation allowances which Mountain Ltd is entitled to
for the year of assessment 2011/12. For asset(s) where depreciation
allowance was not claimed by Mountain Ltd, identify the alternate tax
treatment available.
Ans (b) Desktop computers and printers qualify as prescribed fixed assets and the
acquisition costs can be deducted immediately in the year of purchase under
section 16G.
An electric motor car qualifies as an environment-friendly vehicle and the
capital expenditure incurred can be deducted in the year of assessment
2011/12 under section 16I.
Depreciation allowances on other fixed assets are computed as follows:
Pooling system
Year of assessment 2011/12
W.D.V. b/f
Add: New additions
Less: Initial allowance (60%)
Less:
Sale proceeds
Less: Annual allowance
W.D.V. c/f
20% pool 30% pool Allowances
$
$
$
185,000
177,000
80,000
(48,000)
48,000
217,000
177,000
- (130,000)
217,000
47,000
(43,400)
(14,100)
57,500
173,600
32,900
105,500
Computer sever acquired under hire-purchase
Cost
200,000
Less: Initial allowance
($20,000 + $180,000 x 6/12) x 60%
(66,000)
134,000
Less: Annual allowance (30%)
(40,200)
W.D.V. c/f
93,800
66,000
40,200
211,700
END
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