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1
THE HONG KONG INSTITUTE OF CHARTERED SECRETARIES
THE INSTITUTE OF CHARTERED SECRETARIES AND
ADMINISTRATORS
International Qualifying Scheme Examination
HONG KONG TAXATION
MAY 2013
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
2
SECTION A
1. Timely Limited carries on a watch trading and distribution business in Hong Kong. Presented
below is information extracted from the company’s financial statements for the accounting
year ended 31 March 2013, which indicated net income of $7,123,000 after taking into
account the following items:
Note $ Income: Dividend income 33,000 Interest income 1 74,700 Profit on disposal of fixed assets 121,000 Compensation 2 100,000 Expenses: Bad debts 3 79,200 Depreciation 321,500 Donations 4 148,800 Interest 5 963,000 Legal and professional fees 6 130,400 Repairs and maintenance 7 142,600
Notes to the accounts:
$
1. Interest income: 27,000
Interest on deposits placed with DBS Bank in Hong Kong 44,000
Interest on a loan advanced to a director* 3,700
Interest on overdue trade debts 74,700
* The company has advanced a low-interest rate loan to a director to finance
his acquisition of a residential property in Taiwan. The funds were remitted
to his bank account in Taiwan.
2. One of the company’s distributors has terminated the distribution contract
with the company and paid compensation of $100,000 as liquidated
damages pursuant to the contract.
3. Bad debts:
Increase in allowance for doubtful accounts computed at various
percentages of trade debts outstanding based on their aging
26,000
Writing off of trade debts for which recovery action taken in vain 113,200
Partial recovery of a loan advanced to a distributor (written off as
bad in 2010)
(60,000)
79,200
3
4. Donations:
Cash donated to Red Cross Hong Kong 50,000
Purchase of a commemorative banknote (the proceeds of which
were to be donated to an approved charity in Hong Kong)
88,800
Purchase of raffle tickets issued by Tung Wah Group of Hospitals 10,000
148,800
5. Interest:
Bank interest paid to DBS Bank (banking facilities being secured
by the deposits placed with the same bank, see note 1 above)
163,000
Debenture interest* 800,000
963,000
* The debentures were listed on a recognised stock exchange. Throughout
the year, 20% of the debentures were held by Affluent Limited, a fellow
subsidiary carrying on a trading business in Taiwan.
6. Legal and professional fees:
Annual retainer fee for general legal consultation 30,000
Legal fees for recovery of a loan to a distributor (see note 3 above) 5,000
Fine for illegal parking 2,000
Other (allowable) 93,400
130,400
7. Repairs and maintenance:
Replacement of carpet 42,000
Renovation of showroom* 55,000
Repair of office equipment 16,000
Other (allowable) 29,600
142,600
* The whole amount incurred has been charged to the income statement.
Additional note:
Total depreciation allowance for profits tax purposes for the year is $579,000.
Additional information:
Timely Limited is going to introduce a new series of watches in the Hong Kong market
bearing the trademark “SCLOCK” which is owned by TM Limited, an unrelated company
carrying on business in Country A. TM Limited has registered the trademark in many
jurisdictions including Hong Kong. The management has negotiated with TM Limited and
the following alternatives are open to both parties:
4
(1) Timely Limited licenses the right to use “SCLOCK” in Hong Kong from TM
Limited at a royalty computed at 2% of the value of sales in Hong Kong.
(2) Timely Limited acquires the trademark registered in Hong Kong from TM
Limited for a consideration of $4 million.
(3) Timely Limited sets up a subsidiary company in a low tax jurisdiction and
arranges for the subsidiary to acquire and hold the registered trademark,
which in turn will be licensed to Timely Limited at a royalty computed at 10%
of the value of sales in Hong Kong.
The board of directors will discuss the available options in the coming meeting and has
instructed the financial controller to advise on the tax implications of these options.
REQUIRED:
1. (a) Prepare the Hong Kong profits tax computation for Timely Limited for the year of
assessment 2012/13. Ignore provisional tax and any one-off tax waiver.
Ans (a) Timely Limited
Profits tax computation
Year of assessment 2012/13
Basis period: Year ended 31 March 2013 (Section 18B(1))
$ $
Profit per accounts 7,123,000
Add: Depreciation 321,500
Donations 148,800
Debenture interest ($800,000 x 20%) 160,000
Increase in general allowance for doubtful debts
26,000
Renovation of showroom ($55,000 x 4/5) 44,000
Legal fee to recover a loan 5,000
Fine 2,000 707,300
7,830,300
Less: Dividend (33,000)
Interest on a loan to a director (44,000)
Profit on disposal of fixed assets (121,000)
Recovery of a loan (60,000) (258,000)
7,572,300
Less: Depreciation allowance (579,000)
6,993,300
Less: Approved charitable donation (50,000)
Assessable profit 6,943,300
Profits tax payable at 16.5% 1,145,644
5
1. (b) Analyse the proper tax treatments for all items given in notes 1 to 7 above in your
computation in part (a) above.
Ans (b) Interest income
Interest income received or accrued to a corporation is taxable under section
15(1)(f) if the person carries on a business in Hong Kong and the interest income is
arising from Hong Kong
Timely Limited carries on business in Hong Kong
Interest on deposits placed with DBS Bank is sourced in Hong Kong and chargeable
to profits tax
Income cannot be exempt from profits tax as the deposits were used to secure the
bank borrowings on which interest expenses are deductible
For the loan advanced to a director, the funds were first made available to the lender
outside Hong Kong and hence under section 15(1)(f) the interest income is not
taxable
Interest on overdue trade debts is considered part and parcel of the original sales
transaction; it is also taxable if the sales income is chargeable to tax
Compensation income
If the distribution contract is only one of many similar contracts of the company and
its cancellation will not affect the entire operating structure of company, the
compensation is a revenue receipt and taxable
Bad debts expenses
Bad debts incurred are deductible under section 16(1)(d) if the trade debts are
proved to have become bad, or are estimated to the satisfaction of the assessor to
have become bad during the basis period, and they have been included as taxable
trading receipts
Where recovery action has been taken on trade debts in vain, the write-off of bad
debts is deductible
Allowance for doubtful accounts which is estimated based on a certain percentage
of trade debts outstanding is not regarded as “incurred” and cannot be deducted
Since the loan advanced to a distributor was not money lent in the ordinary course of
a money-lending business carried on by Timely Limited, the write-off of the loan
could not be deducted in the year 2010; the subsequent recovery of the loan is not
taxable
6
Donations
For a donation to be deducted under section 16D, it must be made to approved
institution and in money, and no advantage of a material character shall be received
in return
The cash donation to the Red Cross is deductible
The cost of purchasing a commemorative banknote cannot be deducted because
advantage of a material character has been received
The same applies to the raffle tickets even though the donee is an approved
charitable institution
Interest
To be deductible, under section 16(1)(a) interest expenses must be incurred in the
production of chargeable profits
Interest paid to DBS Bank is interest on money borrowed from a financial institution
and satisfies the condition under section 16(2)(d)
Although the borrowing was secured by bank deposits, interest income on the
deposits is taxable in Hong Kong; hence, the restriction under section 16(2A) does
not apply
For the debenture interest, the debentures were listed on a recognised stock
exchange and the condition under section 16(2)(f) is satisfied
20% of the debentures were held by Affluent Limited (the fellow subsidiary in
Taiwan); the debenture interest received by the fellow subsidiary is not chargeable
to profits tax in Hong Kong because the subsidiary does not carry on a business in
Hong Kong and the interest was sourced outside Hong Kong; the “market maker”
exclusion under section 16(2G) and 16(2H) apparently is not applicable to Affluent
Limited
Under the interest flow-back test (section 16(2C)), interest which has flowed back to
a connected person shall not be deducted ($800,000 x 20% = $160,000)
Legal and professional fees
The annual retainer fee was incurred in the normal course of business with a view
to earn profit, and is deductible
The loan advanced to a distributor was not made in the ordinary course of business
of Timely Limited; the cost of recovery of the loan is not deductible
Breaking the law is not a normal business transaction and the fine is not deductible
7
Repairs and maintenance
Carpet is an “implement, utensil or article” and the cost of replacement can be
deducted under section 16(1)(f)
The cost of renovating the showroom can be deducted by 5 yearly installments
under section 16F, i.e. $55,000 x 1/5 = $11,000 for the year of assessment 2012/13
Expenditure incurred in the repair of any item of plant or machinery employed in the
production of profits can be deducted under section 16(1)(e)
1. (c) In respect of the trademark “SCLOCK”, advise the board of directors on the Hong
Kong profits tax implications arising from all the three options available from the
perspectives of TM Limited, Timely Limited and the proposed subsidiary in option
(3). You may also need to alert the board if any anti-tax avoidance provisions
under the Inland Revenue Ordinance are potentially applicable.
Ans (c) Option 1 – Licensing the use of trademark
Royalty paid to TM Limited for using the trademark in Hong Kong can be deductible
under section 16(1) as the expense is incurred in the production of assessable
profits, i.e. for selling the watch bearing the trademark in Hong Kong
A sum paid for the use or right to use a trademark in Hong Kong is deemed to be a
taxable trading receipt under section 15(1)(b); TM Limited would be chargeable to
profits tax for the royalty received from Timely Limited
The assessable profit is deemed under section 21A to be 30% of the gross receipt
as Timely Limited and TM Limited are not associates
Timely Limited is obliged under section 20B to report, withhold and pay the tax on
behalf of TM Limited
Option 2 – Acquisition of the trademark by Timely Limited
If Timely Limited acquires the registered trademark directly in its own name, the
acquisition cost can be deducted over five years of assessment under section
16EA(2) and (3), provided that the trademark is used for producing chargeable
profits and it has not been sold at the end of the basis period for that year of
assessment
There is no payment of royalty under this option, and the issue of the deductibility
and taxability of the royalty no longer exists
8
Option 3 – Acquisition of the trademark by a newly set up subsidiary
If a new subsidiary is set up to acquire the trademark and the right to use the
trademark is licensed to Timely Limited, it may deduct the royalty payment as in the
Option 1 above
While the subsidiary is not carrying on business in Hong Kong, section 15(1)(b) will
be applied to deem the royalty as taxable trading receipt
Since the two companies are associates, the deemed assessable profits will be 30%
of the royalty payment only if the trademark has not been at any time owned partly or
wholly by any person carrying on a business in Hong Kong – this is a matter of fact
to be ascertained; otherwise, the whole amount of royalty payable will be deemed as
assessable profit
Anti-avoidance provisions
Option 3 may result in tax benefits as the expense may be fully deductible to Timely
Limited, but not fully taxable to the subsidiary
Furthermore, the rate of royalty to be charged by the trademark holding subsidiary is
appreciably higher than that charged by an unrelated party (TM Limited); this
coupled with the fact that the subsidiary will be established in a low tax jurisdiction
may suggest that the arrangement is tax-motivated by siphoning Hong Kong profits
to an offshore company
Under section 20, 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
The high percentage of royalty charged by the overseas subsidiary will substantially
reduce the profits of Timely Limited; in such circumstances, the subsidiary will be
liable to Hong Kong profits tax and being assessed on the deemed profits, and the
assessment could be raised in the name of Timely Limited as its agent
9
Section 61A could also apply if a transaction is entered into for the sole or dominant
purpose of obtaining a tax benefit; the assistant commissioner may disregard the
royalty payment computed at 10% on sales and substitute it by an arm’s length price
(e.g. 2%) in ascertaining the profits of Timely Limited
Section 61 can also be applied by an assessor to deny an excessive deduction claim
of royalty payment if the transaction is regarded as artificial or fictitious
Alternatively, the assessor may refuse to allow the excessive royalty paid by Timely
Limited under section 16(1)
10
SECTION B
2. Dickson Leung joined Trendy Garment Limited (TGL), a company carrying on garment
manufacturing and trading business in Hong Kong, as a production manager on 1 April
2012. He is responsible for overseeing the company’s manufacturing operations in
Shantou in Guangdong Province. Dickson normally comes back to Hong Kong every
Saturday and returns to the Mainland factory on the following Monday. On the first
Monday of every month, he attends a production meeting in Hong Kong. Apart from this,
he is not required to perform any regular duties in Hong Kong.
Dickson provides you with the following notes for the year ended 31 March 2013:
1. He received a monthly salary of $35,000.
2. He received a meal allowance of $2,000 per month.
3. He was provided with a flat in Shantou which was leased by TGL at a monthly rent
of $1,500. He has the exclusive right to occupy the flat without the payment of any
rent.
4. He joined TGL’s medical insurance scheme and received a refund from the
insurance company of $6,500. TGL has paid an insurance premium of $2,000 in
respect of his cover.
5. He was awarded 30,000 shares in the holding company of TGL on 1 July 2012.
However these shares will only be registered in his name one year from the date of
award if he is still employed by TGL during that year. He received dividend income
of $3,600 on 10 January 2013 from these shares. The shares were quoted on the
Stock Exchange of Hong Kong at $5.00 and $5.20 on 1 July 2012 and 31 March
2013 respectively.
6. He completed a degree course in textile studies offered by a Hong Kong university
during year and TGL refunded him $17,000 of the course fee he paid during the
year. He also received a gift voucher of $3,000 from TGL in appreciation of his
completion of the study.
7. He joined TGL’s MPF scheme and has contributed $3,000 per month to the
scheme.
Dickson is single and is a Hong Kong permanent resident. When he returns to Hong
Kong during the weekend, he stays in his parents’ self-owned property in Lam Tin. His
parents were aged 53 and 56 during the year ended 31 March 2013. Dickson has paid
$6,000 per month to his parents in support of their living expenses.
Dickson wonders if he is required to pay salaries tax in Hong Kong for this employment
as he has performed all his services outside Hong Kong. He reckons that he may need
to pay tax in the Mainland but would like to explore whether any tax relief would be
available to him as a Hong Kong resident. You are informed that he has not yet paid any
tax in the Mainland so far.
11
REQUIRED:
2. (a) Advise Dickson of his Hong Kong salaries tax position and whether or not
he is entitled to any tax relief in the Mainland as a Hong Kong resident.
Ans (a) As Dickson’s employer (TGL) is resident in Hong Kong, it is highly likely that
the IRD would regard his employment as sourced in Hong Kong
All income from a Hong Kong sourced employment will be chargeable to tax
under section 8(1)(a) unless no service is rendered in Hong Kong or services
are rendered in Hong Kong during visits of not more than 60 days
Although Dickson is not required to perform any regular duties in Hong Kong,
he has attended production meetings in Hong Kong every month and it could
not be said that he has not rendered any services in Hong Kong; the
exemption under section 8(1A)(b) does not apply to him
As Dickson has spent more than 60 days in Hong Kong during the year, the
60-day exemption rule does not apply; whether he is a “visitor” for tax
purposes is unimportant
However, if a taxpayer has rendered services outside Hong Kong and has paid
tax of substantially the nature as Hong Kong salaries tax, he could exclude the
income already subject to tax elsewhere by virtue of section 8(1A)(c)
Furthermore, as Hong Kong has entered into double taxation arrangement
with Mainland China (DTA), tax payable in the Mainland could be allowed as a
credit against the Hong Kong salaries tax payable under section 50
Under the said DTA, a Hong Kong resident will be exempt from 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
It is unlikely that Dickson could be exempt from income tax in the Mainland as,
inter alia, he would have spent more than 183 days in the Mainland
12
2. (b) Assuming that Dickson is liable to pay salaries tax in Hong Kong, calculate
his tax liability for the year of assessment 2012/13. Ignore provisional tax
and any one-off tax waiver.
Ans (b) Dickson Leung
Salaries tax computation
Year of assessment 2012/13
$ $
Salary ($35,000 x 12) 420,000
Meal allowance ($2,000 x 12) 24,000
Dividend income 3,600
Rental value 44,760
492,360
Less: Contribution to MPF scheme (14,500)
477,860
Less: Personal allowances
Basic allowance 120,000)
Dependent parent allowance - aged 56 (19,000) (139,000)
Net chargeable income 338,860
Salaries tax at progressive rates 45,606
2. (c) Assuming that Dickson is liable to pay salaries tax in Hong Kong, advise
him of the tax treatments for the information given in notes 3, 4, 5 and 6.
Ans (c) Under section 9(2), rent-free accommodation provided by the employer is
assessable at 10% of the income from the employer after deducting outgoings,
expenses and depreciation allowances
The rental value is assessable as Dickson has the exclusive right to occupy
the property as his place of residence; the fact that it is located outside Hong
Kong is irrelevant
The medical refund from the insurance company is not assessable as it is
only paid due to the contractual entitlement of the employee as a beneficiary
under the insurance policy, and not an income arising from employment
The insurance premium paid by the employer is also not assessable as the
payment is a discharge of the employer’s sole and primary liability for which no
person was surety – section 9(1)(a)(iv)
13
Shares awarded to an employee by virtue of his employment are taxable
perquisites under section 9(1)(a), forming part of his employment income
According to DIPN No. 38, the 30,000 shares awarded to Dickson will not be
assessed to tax until the fulfillment of the specified condition on 1 July 2013
when the shares will be vested in him (the back-end approach)
The market value at the time of fulfillment of the condition will be used for
valuation purposes
Dividend income received during the vesting period is regarded as
employment income and is taxable
The textile studies course offered by a local university qualifies as a
self-education expense, being a course undertaken to gain or maintain
qualifications for use in employment
As the course fee is reimbursed by the employer, no further deduction is made
in the tax computation – section 12(6)(b)
(Alternatively, the reimbursement is chargeable to tax while Dickson could
claim a deduction of $17,000)
The gift voucher is not assessable as it is given in appreciation of Dickson’s
personal success and is not for services rendered
14
3. Fortune Limited wholly owns Treasure Limited and holds 85% interest in Wealth
Limited. All the companies were incorporated in Hong Kong. Fortune Limited has
100,000 authorised shares of $1 each, of which only 50,000 shares were issued and
held by Kelvin Kwan.
On 15 September 2012, Treasure Limited transferred a residential property in North
Point to Wealth Limited at a consideration of $9 million to be used as a director’s
quarters. As both companies are in the same group, the assignment deed has not been
submitted for stamping.
In January 2013, Treasure Limited leased a shop unit to a third party for a term of two
years commencing on 1 February 2013, with a renewal option for another two years.
The monthly rent was $50,000. The tenant was required to pay a rental deposit of
$100,000 and a non-refundable premium of $150,000. Treasure Limited allowed the
tenant a rent-free period of one month for carrying out renovations.
On 5 March 2013, Treasure Limited exchanged a piece of land in Sha Tin with a third
party, Lily Limited. The consideration stated in the deed of exchange was $5 million
payable by Treasure Limited to Lily Limited. The market values of the two pieces of land
exchanged were $7 million and $13 million respectively.
Kelvin is going to marry his fiancée, Christina, next month. Kelvin has decided to
transfer his 10% interest in Fortune Limited to Christina for a consideration of $10. The
accountant has informed Kelvin that the fair market value of the company is $150
million. He wishes to transfer the shareholding in the most cost effective manner.
REQUIRED:
3. (a) Analyse the Hong Kong stamp duty implications arising from all the
completed transactions given above. Compute the stamp duty payable
where applicable.
Ans (a) Conveyance 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; assuming that the stated consideration represents the fair market
value, stamp duty is payable on the assignment deed at:
$9 million x 3.75% = $337,500
15
Exemption from stamp duty under section 45 only applies to a transfer between
associated bodies corporate, including the situation where a third body
corporate is the beneficial owner of not less than 90% of the issued share
capital of two companies
Treasure Limited and Wealth Limited are not associated bodies corporate as
Fortune Limited holds less than 90% interest in Wealth Limited
The instrument must be stamped within 30 days after execution
Late stamping is subject to a penalty at 10 times of the amount of stamp duty
payable if the delay is more than two months
However, the Collector may remit the whole or any part of the penalty in a
voluntary disclosure case; the following formula will be adopted in calculating
the reduced penalty, subject to a minimum of $500:
14% x Stamp duty payable x (No. of days of delay / 365 days)
An agreement for the lease of immovable property is subject to stamp duty
under Head 1(2)
Stamp duty payable is:
Rent portion: $50,000 x 23 /24 x 12 x 0.5% = $2,875
Premium: $150,000 x 4.25% = $6,375
If the lease is executed in duplicate, the duplicate copy is stamped at $5 under
Head 4
The deed of exchange falls into the charge under Head 1(1) because it
concerns immovable property in Hong Kong
Under section 25(7), only the equality money will be subject to stamp duty;
equality money is the higher of the amount payable by one owner to the other
owner or the difference in the value of the two properties
Stamp duty payable is $6 million x 3% = $180,000
16
3. (b) Advise the possible ways that Kelvin can transfer part of his shareholding in
Fortune Limited to Christina, and recommend the cost effective ways from
the stamp duty perspective.
Ans (b) Kelvin may transfer 5,000 issued shares in Fortune Limited to Christina in order
to transfer 10% of his shareholding
Transfer of shares in a Hong Kong company is subject to stamp duty under
Head 2(3), which applies to voluntary disposition inter vivos
The instrument of transfer is chargeable with ad valorem stamp duty at the rate
of 0.2% of the value of the shares transferred plus a fixed duty of $5, i.e. $150
million x 10% x 0.2% + $5 = $30,005
Under section 27(4), no stamp duty will be payable if marriage is the
consideration; Kelvin may take advantage of this provision to obtain exemption
from payment of stamp duty for the transfer of shares
The instrument must be submitted for adjudication by the Collector under
section 13
Alternatively, issue of new shares does not attract stamp duty as there is no
transfer of Hong Kong stock; Fortune Limited may allot new shares to Christina
to dilute Kelvin’s shareholding to 90% of the company’s issued shares
Stamp duty could be minimised or avoided by the latter two ways
17
4. Alex Wang and his brother, Brandon, acquired a residential property located in Tseng
Kwan O as joint tenants in February 2012 for a consideration of $7 million. The
acquisition was partly financed by a mortgage loan from Hang Seng Bank. The brothers
let out the property to Ricky Lai on the following terms:
1. Lease term: 2 years from 1 April 2012, renewable for another one year
2. Rental deposit: $30,000 to cover any cost of repairs or loss of revenue due to default
by the tenant
3. Lease premium: $60,000
4. Monthly rent: $15,000 payable on the 1st day of each month
5. Rates and government rent: $2,700 and $1,620 per quarter respectively payable by
the owner (ignore any rates concession)
6. Building management fee: $1,100 per month payable by the tenant to the building
management office
Starting from January 2013, Ricky has delayed the payment of rent. As of 31 March
2013, rent for February and March 2013 was still outstanding.
During the year, Alex and Brandon have paid loan interest of $140,000 and repair
expenses of $8,500 in respect of the property.
Alex is single. He works as a part-time lecturer with a local tertiary institution and
received a salary of $204,000 for the year ended 31 March 2013. He also runs a
consultancy business in Hong Kong under the name of Alex Business Solutions
Company (ABSC). During the year ended 31 March 2013, ABSC has made a profit of
$530,000 which is after the deduction of his mandatory contribution to the MPF scheme
of $14,500 as a self-employed person, and his medical insurance premium of $3,000.
He is also a partner of a partnership business carried on with his friends. His share of
partnership loss is $75,000 for the year of assessment 2012/13.
Brandon is married and has a son aged 5. Brandon is a resident of Mainland China who
visits Hong Kong regularly and generally spends around a week in Hong Kong every
month. Apart from the rental income, Brandon has no other source of income in Hong
Kong.
18
REQUIRED:
4. (a) Calculate the Hong Kong property tax payable for the year of assessment
2012/13. Ignore provisional tax.
Ans (a) Property tax computation
Year of assessment 2012/13
$
Rent ($15,000 x 12) 180,000
Lease premium ($60,000 x 12/24) 30,000
Assessable value 210,000
Less: Rates ($2,700 x 4) (10,800)
199,200
Less: 20% statutory deduction (39,840)
Net assessable value 159,360
Property tax payable at 15% 23,904
Credit for non-inclusion of the following items:
Bad debt
Government rent
Loan interest
Repair expense
4. (b) Advise whether or not Alex and Brandon are eligible to elect for personal
assessment for the year of assessment 2012/13, and the procedures for the
election.
Ans (b) To be eligible for personal assessment, an individual must be of or above the
age of 18, or under the age of 18 with both parents dead; and who, or whose
spouse, is either a permanent resident or a temporary resident
“Temporary resident” means an individual who stays in Hong Kong for more
than 180 days during the year of assessment in which election is made; or stays
in Hong Kong for more than 300 days in two consecutive years, one of which is
the year of assessment in which the election is made
“Permanent resident” means an individual who ordinarily resides in Hong Kong
It appears that Alex is ordinarily resident in Hong Kong (with a part-time
employment and a sole-proprietorship business carrying on in Hong Kong) and
he will be eligible to be assessed under personal assessment
19
As Brandon is a resident in the Mainland, maintains no place of abode in Hong
Kong and only visits Hong Kong for about a week every month (roughly 84 days
per year and 168 days in two consecutive years), he is unlikely to meet the
criteria of permanent resident nor temporary resident in Hong Kong
Hence, Brandon is not eligible for electing personal assessment unless his wife
is a temporary or permanent resident of Hong Kong
The election must be made in writing and lodged with the Commissioner of
Inland Revenue not later than two years after the end of the year of assessment
concerned or one month after an assessment forming part of the total income
for the year of assessment is final and conclusive; or further period as the
Commissioner may allow; whichever is the later
4. (c) Assuming that Alex is eligible to be assessed under personal assessment,
calculate his tax liability under personal assessment for the year of
assessment 2012/13. Ignore any one-off tax waiver.
Ans (c) Alex Wang
Personal assessment
Year of assessment 2012/13
$
Net assessable value ($159,360 x 50%) 79,680
Assessable income 204,000
Assessable profit ($530,000 + $3,000) 533,000
Total income 816,680
Less: Interest expense (70,000)
746,680
Less: Share of partnership loss (75,000)
671,680
Less: Basic allowance (120,000)
Net chargeable income 551,680
Tax charged under personal assessment 81,785
20
5. Crunchy Snack Limited (CSL) carries on a food manufacturing business in Hong Kong.
In December 2008, it acquired a piece of land for $40 million in Yuen Long and signed a
contract to construct a five-storey building to house its manufacturing operation there.
The construction cost of $20 million is payable as follows:
On signing the contract $8 million
Progress payment $8 million (paid on 5 August 2009)
Upon completion of contract $4 million (paid on 10 April 2010)
The building was immediately put into use by CSL upon its completion in April 2010.
Apart from 50% of the gross area on the ground floor which was used as an office, all
other areas were used as a workshop and warehouse for storage of raw materials and
finished products.
In May 2012, CSL sold the whole building to Healthy Nutrition Limited (HNL) for a
consideration of $72 million (including land and building cost). HNL used the third floor
and fourth floor of the building as a laboratory for research and development, and the
rest of the floors for the production of nutrition products.
HNL has imported a testing machine (30% depreciation rate) from Germany for product
development. It was acquired from a local supplier on hire purchase terms with details
as follows:
List price: $1,200,000
Down payment: $200,000 (paid in June 2012)
Monthly instalment: $90,000 for 12 months commencing on 15 July 2012)
HNL also paid freight and installation expenses of $30,000 and $10,000 respectively in
respect of the machine in June 2012.
Movement of other assets of HNL during the year ended 31 March 2013 are presented
below:
1. New additions include:
Furniture and fixtures $130,000
Motor vehicles $360,000
Production machines $415,000
2. Old furniture was scrapped for $5,000.
21
3. A director donated three air-conditioners to the company in December 2012; he had
bought these at a cost of $18,000 in November 2010. The second-hand value of
these air-conditioners was $4,000.
The tax written down values of the pooling system as of 31 March 2012 are:
20% pool (including air-conditioners, furniture and fixtures): $201,000
30% pool (including motor vehicles): $105,000
Both companies end their accounts on 31 March annually.
REQUIRED:
5. (a) Analyse the tax treatments of the building in Yuen Long for both CSL and
HNL for all the relevant years in the question.
Ans (a) An industrial building is defined in section 40(1) to include a building used for
the purposes of a trade which consists of the manufacturing of goods or
materials or the subjection of goods or materials to any process
It also includes a building used for the purposes of research and development
related to any trade, profession or business
An industrial building does not include any building used as an office unless
the non-qualifying use is not more than 10% of the total capital expenditure
which has been incurred on the construction of the whole building
An allowance is granted on the capital expenditure incurred on the
construction of the industrial building only and hence the land cost does not
qualify for the allowance
CSL carries on a food manufacturing business in the Yuen Long building
which is a qualifying trade for the purposes of an industrial building allowance;
the area used as an office does not exceed 10% of the overall capital
expenditure incurred and can be ignored
CSL is entitled to claim an initial allowance at 20% of the cost of construction
incurred during the basis period
CSL is also entitled to claim an annual allowance at 4% of the qualifying
expenditure as long as it holds the relevant interest and the building is used for
the qualifying trade at the end of the basis period
22
Upon disposal of the building, a balance allowance or balancing charge will
arise, but any balancing charge should be restricted to the initial and annual
allowances previously granted to CSL
HNL used the building for research and development purposes as well as for
the production of nutrition products; hence it also qualifies to claim industrial
building allowances based on the residue of expenditure after sale
5. (b) Calculate the depreciation allowances applicable to CSL and HNL for all the
relevant years of assessment up to and including the year of assessment
2012/13.
Ans (b) Industrial building allowance
Crunchy Snack Limited $
Qualifying expenditure 20,000,000
Less: Initial allowance for 2008/09 ($8m x 20%) (1,600,000)
18,400,000
Less: Initial allowance for 2009/10 ($8m x 20%) (1,600,000)
16,800,000
Less: Initial allowance for 2010/11 ($4m x 20%) (800,000)
Annual allowance for 2010/11 ($20m x 4%) (800,000)
15,200,000
Less: Annual allowance for 2011/12 (800,000)
Residue before sale 14,400,000
Less: Sales proceeds ($72m x 20m / 60m) (24,000,000)
(9,600,000)
Balancing charge (for 2012/13) restricted to 5,600,000
Healthy Nutrition Limited
Residue before sale 14,400,000
Add: Balancing charge 5,600,000
Residue after sale 20,000,000
Year of first use of building 2010/11
25th year after year of first use 2035/36
Year in which sale has taken place 2012/13
No. of years from year of sale to the 25th year 24
Annual allowance for 2012/13 ($20m / 24) $833,333
23
Year of assessment 2012/13
Depreciation allowances on plant and machinery
20% Pool 30% Pool
$ $
W.D.V. b/f 201,000 105,000
Add: Motor vehicles 360,000
Less: Initial allowance (60%) (216,000)
Furniture and fixtures 130,000
Less: Initial allowance (60%) (78,000)
Air-conditioners brought-in* 11,520 _________-
264,520 249,000
Less: Sale proceeds of furniture (5,000) _________-
259,520 249,000
Less: Annual allowance (51,904) (74,700)
W.D.V. c/f 207,616 174,300
* $18,000 x 0.8 x 0.8
Testing machine under hire-purchase
Cost ($1,200,000 + $30,000 + $10,000) 1,240,000
Less: Initial allowance
($240,000 + $1,000,000 x 9/12) x 60% (594,000)
646,000
Less: Annual allowance (30%) (193,800)
W.D.V. c/f 452,200
Production machines ($415,000) qualify for a deduction as prescribed fixed assets
under section 16G
24
6. The statement of income and expenditures of My Doggy Club for the two years ended
31 December 2012 and 2011 were as follows:
2012 2011
Income $ $
Annual subscriptions 50,000 35,000
Sales of food and accessories 153,000 112,000
Grooming and bathing receipts 84,200 57,000
Donations - 80,000
Rental income 48,000 42,000
335,200 326,000
Expenditure
Administrative expenses 177,000 161,500
Cost of food and accessories 98,000 76,000
Supplies 23,000 17,500
298,000 255,000
Surplus for the year 37,200 71,000
The following additional information is available:
1. Apart from annual subscriptions, members were required to pay an entrance fee on
admission to the club, and this fee is credited to the accumulated fund account
directly. The entrance fees received were $9,000 and $12,000 for 2012 and 2011
respectively. All members have voting rights at the general meeting.
2. The club sells food and accessories to both members and non-members. It is
estimated that one half of the sales are from members. However, all grooming and
bathing receipts are from members only.
3. The donation was received from a supplier of dog foods.
4. The club owns premises and has leased out part of the unused space to a third
party, which operates a coffee bar.
REQUIRED:
6. (a) Advise the Hong Kong tax position of My Doggy Club for the years of
assessment concerned. Where applicable, compute the Hong Kong profits
tax and/or property tax payable by the club. Ignore depreciation
allowances, provisional tax and any one-off tax waiver.
25
Ans (a) For a club, section 24(1) provides that if not less than one 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 and the whole of its income
from both members and others (including entrance fees and subscriptions)
shall be considered as business receipts and chargeable to profits tax
A club is liable to property tax in respect of rental income from non-voting
members and non-members no matter whether it is subject to profits tax or
not; however, if it is subject to profits tax, it may apply for exemption under
property tax under section 5(2)(a) or if property tax has been paid, setting off
the property tax paid against profits tax under section 25
2012/13 2011/12
Receipts from voting members $ $
Subscriptions 50,000 35,000
Entrance fee 9,000 12,000
Sales of foods and accessories 76,500 56,000
Grooming and bathing receipts 84,200 57,000
219,700 160,000
Receipts from non-voting members
Sales of foods and accessories 76,500 56,000
Donation - 80,000
Rental income 48,000 42,000
124,500 178,000
Total gross receipts 344,200 338,000
% of receipts from members 63.8% 47.3%
For the year of assessment 2012/13, the club derived more than 50% of its
receipts from voting members and hence is deemed as not carrying on
business and is not liable for profits tax; however, the rental income will still
be subject to property tax
For the year of assessment 2011/12, the club received less than 50% of its
income from voting members; hence profits tax is payable for this year
As the club is subject to both property tax and profits tax in 2011/12, it could
offset the property tax paid against the profits tax payable for the year under
section 25
26
2012/13 2011/12
Property tax computation $ $
Rent 48,000 42,000
Less: 20% statutory deduction (9,600) (8,400)
Net assessable value 38,400 33,600
Property tax at 15% 5,760 5,040
Profits tax computation
Surplus for the year 71,000
Entrance fee 12,000
Assessable profits 83,000
Profits tax at 15% 12,450
Less: Property tax paid set-off (5,040)
Profits tax payable 7,410
6. (b) Johnny Chan carries on a decoration business in Hong Kong. He was recently
investigated by the Inland Revenue Department (IRD) for having omitted certain
income and over-claimed deduction of expenses, resulting in an understatement
of profits for the past few years. As most of the transactions were paid in cash
and Johnny has not kept all his receipts, he used to estimate his profits for
reporting to the IRD, which he believed to be a usual practice. He found it
difficult to reckon the actual profits due to the lapse of time and insufficient
records.
REQUIRED:
Advise Johnny on the distinction between tax avoidance and tax evasion,
and the possible methods which may be used by the IRD to quantify the
understatement of profits.
Ans (b) Tax avoidance refers to the legitimate minimisation of tax payable within the
framework of the Inland Revenue Ordinance
Legal means are employed by a taxpayer to reduce his tax liability by making
use of the characteristics of the Hong Kong tax system, such as the territorial
source principle, generous deduction for specified items, etc.
Tax avoidance normally will not attract any penalty when the tax plan fails
unless there is concealment of facts; the taxpayer is required to pay the tax
as if such arrangements have not been implemented
27
Tax evasion refers to the failure on the part of the taxpayer to supply full and
correct information relevant to the assessment of tax because of deliberate
attempt or negligence
Illegal means are used to reduce the tax liability which usually involve
omitting or understating income or over-reporting of expenses in the returns
Tax evasion is an offence punishable by a fine and/or imprisonment
A direct method cannot be used to quantify the income or profits understated
when the taxpayer’s records are incomplete or not reliable
Depending on circumstances of individual cases, indirect methods such as
the assets betterment statement method, bank deposits method, business
economics (percentage computation) method and projection method may be
employed to quantify the profits
Under the assets betterment statement method, all expenditures of a
non-allowable nature are added to the taxpayer’s yearly asset increase (i.e.
the excess of net assets in any one year over the preceding year), from which
receipts of capital nature or otherwise not assessable are to be deducted to
arrive at the betterment profits
Under the bank deposit method, it is assumed that moneys deposited in the
taxpayer’s bank accounts are surplus funds received from customers; the
total deposits plus moneys withdrawn for the taxpayer’s private use would
represent the total business receipts
The percentage computation method involves the application of percentages
or ratios considered typical of the business operations under investigation to
particular known amounts, e.g. sales to determine the assessable profits
Under the projection method, the IRD would examine the accounting records,
bank statements, etc. in detail for one year to ascertain the profit after
investigation; the net profit ratio for that year will be used to estimate the
assessable profits for other years
END
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