14. Module D_Essentials by Louis Li

Essentials

Module D Taxation CopyrightÂŠ Kaplan Financial (HK) Limited 2009 All rights reserved. No part of this examination may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system, without prior permission from the publisher.

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ESSENTIALS

CHAPTER - 1

Index

THE TAX SYSTEM IN HONG KONG Chapter Topic

CLP Ref No. 4

Page No. 2

The Tax System in Hong Kong

Hong Kong Stamp Duty

Administration Procedures Revenue Ordinance

Hong Kong Profits Tax

Hong Kong Salaries Tax

Hong Kong Property Tax

Personal Assessment

Non-residents

General Introduction to Tax Planning

10.

Tax Investigation and Field Audit

11.

Tax Compliance and Tax Advisory

12.

Double Taxation Arrangement and Agreements

under

The

Inland

About the system: x Only income ‘arising in or derived from’ sources in Hong Kong is chargeable for tax under the Inland Revenue Ordinance (IRO). x Residence or nationality of person is irrelevant in determining his chargeability for tax x Foreign companies are charged to tax on the same basis and same rates as local companies x Capital gains are outside the scope of charge for tax in Hong Kong x Hong Kong operates under the ‘one country, two systems’ concept and is not subject to Mainland China’s taxation Inland Revenue Ordinance x Scope of charge includes Property tax, Salaries tax and Profits tax x s. 2 of the IRO defines a person as: ‘a corporation, partnership, trustee, whether incorporated or unincorporated, or body of persons’ x Tax is charged on the ‘person’ as follows:

Individual Corporation Partnership Trustee Body of persons

Property Tax 9 9 X 9 9

Salaries Tax 9 X X X X

The tax rates apply as follows: Allowances:

Basic allowance Married person’s allowance Single parent allowance Child allowance – 1st to 9th child (each) - for each child born during the year Basic Dependent parent/grandparent allowance -60 or above -55 to 59 Additional Dependent parent/grandparent allowance -60 or above -55 to 59 Dependent brother/sister allowance Single parent allowance Disabled dependent allowance

QP Module D (Feb 09) – Essentials

Profits Tax 9 9 9 9 9

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2007/08

2008/09

$ 100,000 200,000 100,000 50,000 50,000

$ 108,000 216,000 108,000 50,000 50,000

30,000 15,000

30,000 100,000 60,000

30,000 108,000 60,000

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Deductions: Self-education expenses (maximum) Home loan interest (maximum) Elderly residential care expenses (maximum) Contributions to recognized retirement schemes Charitable donations

Depreciation allowance rates: 40,000 100,000 60,000 12,000 35% limit

60,000 100,000 60,000 12,000 35% limit

Tax Rates: 2007/08 First $35,000 2% Next $35,000 7% Next $35,000 12% Remainder 17%

2008/09 First $40,000 2% Next $40,000 7% Next $40,000 12% Remainder 17%

Standard rate

16%

15%

Profits tax rate for corporations

17·5%

16·5%

Salaries tax rates

Property Tax Property tax is charged on the owner of any land or buildings in Hong Kong at the standard rate (15%) on the net assessable value of such land or buildings. Stamp Duty Immovable Property: conveyance on sale Property consideration/Market value Up to $2,000,000 $2,000,001 - $2,351,760 $2,351,760 - $3,000,000 $3,000,001 - $3,290,320 $3,290,321 - $4,000,000 $4,000,001 - $4,428,570 $4,428,571 - $6,000,000 $6,000,001 - $6,720,000 >$6,720,000

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2008/09 $100 $100 + 10% of the excess over $2,000,000 1.5% $45,000 + 10% of the excess over $3,000,000 2.25% $90,000 + 10% of the excess over $4,000,000 3% $180,000 + 10% of the excess over $6,000,000 3.75%

Initial allowance: Plant and machinery Industrial building Annual allowance:

60% 20%

Electric data and processing equipment Motor vehicle Furniture Air-conditioning plant Industrial building Commercial building

30% 30% 20% 10% 4% 4%

Double Taxation Arrangements x Arrangements may be made with the Government of any territory outside Hong Kong to afford relief from double taxation in relation to income tax or any tax of similar character x Hong Kong has double taxation arrangements with USA, Singapore, Sri Lanka, UK, PRC, the Netherlands, New Zealand, Germany, Norway and Denmark on international shipping income x Hong Kong also has double taxation arrangements with countries including Korea, New Zealand, Canada, the Netherlands, Germany, United Kingdom, Israel, Mauritius, Russian Federation, PRC, Denmark, Sweden, Norway and many other countries in respect of international aviation income x The most important double taxation arrangement is with Mainland of China, The new deal, signed on 21 August 2006 extends the scope of the original arrangement signed in February 1998. It covers both direct income earned by business and individuals as well as indirect income such as dividends, interest and royalties. The new arrangement will take effect with respect to Hong Kong taxes from year of assessment beginning on or after 1 April 2007, and with respect to Mainland taxes from the taxable year beginning on or after 1 January 2007. x Hong Kong also has a comprehensive arrangement for avoidance of double taxation including income tax and withholding taxes with Belgium, Thailand Luxembourg and Vietnam.

Marginal relief is available upon entry into each higher rate band. Hong Kong stock With effect from 1 September 2001, the rate of stamp duty on stock transactions is 0.2% ($2 per $1,000) per transaction. This is payable half by the vendor and half by the purchaser. Hong Kong bearer instrument Duty of 3% of the market value is charged for any Hong Kong bearer instrument issued in respect of any stock. QP Module D (Feb 09) – Essentials

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CHAPTER - 2

2. Agreements for sale of residential property (Head 1(1A)) Stamp duty on agreements for the sale and purchase of residential property was introduced to deter speculations in residential property market.

HONG KONG STAMP DUTY Meaning: Stamp duty is a tax on instruments or documents levied under the Stamp Duty Ordinance (SDO). Scope of Charge: An instrument that falls under one of the following heads of charge, will be stampable, whether or not that instrument was executed in or outside Hong Kong. Head 1 Immovable property in Hong Kong (1) Conveyance on sale (1A) Agreement for sale (2) Lease Head 2 Hong Kong stock (1) Contract note (2) Contract note (Jobbing business) (3) Transfer as voluntary disposition (4) Transfer of any other kind Head 3 Hong Kong bearer instruments Head 4 Duplicates and counterparts Stamp duty may be either fixed or ad valorem. The stamp office is not responsible for document/instrument before stamping.

Agreements to sell immovable property Each purchaser and vendor who enters into an agreement (written or unwritten) for the sale of immovable property (residential and non-residential) is required to execute an agreement for sale.

Non-residential property does not attract stamp duty on agreement for sale and is immovable property which may not be used at any time for residential purposes. Classification of the property as residential or non-residential is by reference to permitted use rather than actual use. ascertaining

the

legality

any

A. Immovable property in Hong Kong (Head 1) Immovable property means: x Land, whether covered by water or not x Any estate, right, interest or easement in or over land; and x Things attached to land or permanently fastened to anything attached to land 1. Conveyance on sale (Head 1(1)) Conveyance is defined to include every instrument and every decree or order of any court whereby any immovable property is transferred to or vested in any person. Head 1(1) applies to the following: x Sale and purchase of immovable property x Gift of immovable property x Foreclosure order relating to immovable property x Exchange of immovable property x Deed of family arrangement by which the beneficiary takes immovable property x Agreement or contract for the sale of any equitable estate or interest in immovable property

Stamp duty payable on residential property transfers is no longer deferred until a conveyance is finally executed. However, from 1 April 1999, payment of stamp duty may be deferred until completion of the purchase.

Stamp duty is chargeable on such instrument evidencing an agreement for the sale of immovable property, provided that the property is residential.

Dutiable Instruments:

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ESSENTIALS

3. Lease (Head 1(2)) The charge under this head only covers lease of immovable property. To constitute a lease, the instrument must give the lessee the right to exclusive possession. If the right is restricted, the instrument is a license and not a lease. License is not chargeable for stamp duty. The stamp duty on lease of immovable property is shared by the lessor and lessee equally. Lease Premium (Head 1(2)(a)) Stamp Office treats advance payment of more than one year’s rent as premium. Duty is levied on the premium at the same rate as the maximum for a conveyance on sale (i.e. 3.75%) Rent (Head 1(2)(b)) Stamp duty is charged on rent with reference to the terms of the lease agreement and the yearly rent/average yearly rent.

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B. Hong Kong stock (Head 2) Hong Kong stock is stock the transfer of which is required to be registered in Hong Kong. 1. Contract note, not jobbing business (Head 2(1)) Contract notes are made and executed for every sale and purchase of Hong Kong stock. These notes have to be stamped at the rate of 0.2% at the higher of the consideration or its value at the date of execution.

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Exemptions and Relief Section 39 40

Exemption/Relief Instruments generally exempted. Instruments specifically exempted.

Instruments executed by the Government and the Housing Authority are exempt from stamp duty. 41

Exemption to Government or public officer

Relief for leases between Government/public officer and another person

Stock borrowing and lending transactions are not chargeable for stamp duty. 2. Contract note, jobbing business (Head 2(2)) Jobbing business is the business carried on by a broker. Contract notes in respect of jobbing business are stamped at HK$5. 3. Transfer of Hong Kong stock operating as a voluntary disposition inter vivos (Head 2(3)) Stamp duty on an instrument of transfer of Hong Kong stock operating as a voluntary disposition inter vivos is at HK$5 and 0.2% of the value of stock. 4. Transfer of any other kind (Head 2(4)) All other instruments of transfer are charged stamp duty at a fixed duty of HK$5. Unit trust schemes are exempt from this duty from 2003/04.

Government/incorporated public officers are exempt from stamp duty. The other party to the instrument is still liable for payment of the full amount chargeable. 43

Relief for leases of consular premises

Leases of consular premises or between Government/incorporated public officer and another person, only 50% of the duty chargeable is payable by the other party. 44

Relief for gifts to exempted institutions

Gifts of immovable property/Hong Kong stock to charitable bodies/public trusts that are exempt under Sec 88 of the IRO, are exempt from stamp duty. 45

Relief for conveyance or transfer between associated bodies corporate

Relief under s. 45 for conveyance of immovable property (Head 1(1)) or transfer of Hong Kong stock (Head 2(1) and 2(3)) between associated bodies only applies when: x

C. Hong Kong Bearer Instruments (Head 3) Hong Kong bearer instruments are bearer instruments issued: x In Hong Kong; or x Elsewhere by or on behalf of a body corporate/unincorporated body of persons established in Hong Kong D. Duplicates and Counterparts (Head 4) Fixed duty of $5 or the original duty, whichever is lesser.

One body corporate is the beneficial owner of not less than 90% of the issued share capital of the other; or A third body corporate is beneficial owner of not less than 90% of the issued share capital of each of the companies.

Relief under s. 45 is NOT available when: x x x

Companies are held by the same individual Lease of immovable property between associated bodies corporate chargeable under Head(1(2)) Associated companies cease to remain associated within two years of transfer

If transferor company is liquidated within two years, s. 45 relief may NOT be revoked if: x x

Transferor company is holding company of transferee company and there is another holding company of the transferor which continues in existence during the two year period; or The transferor and transferee companies are under common control of a holding company and that holding company retains not less than 90% of the shareholdings in the transferee company during the two year period

Anti-avoidance provisions: s. 45 is not applicable in the following cases: x x

QP Module D (Feb 09) – Essentials

If any part of consideration of the transfer was provided / received by an unrelated non-associated person [s.45(4)(a)] the two companies will cease to be associated because of a change in the percentage of the issued share capital of the transferee, within two years of transfer [s.45(4)(c)]

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47A 47B

Relief for transfer of units of Constituent Funds under Mandatory Provident Fund (MPF) Schemes Instruments of transfer relating to indirect allotment or redemption of units under unit trust schemes

Stamp Duty Administration Time Limit for Stamping Instrument Time limit Conveyance on sale of immovable property in HK 30 days after execution Lease of immovable property in HK Contract notes (bought/sold notes) in HK

30 days after execution 2 days after sale/purchase effected in HK or 30 days after sale/purchase effected outside HK

Instrument of transfer of HK stock

Before execution Or 30 days after execution if executed outside HK Before issue 7 days after execution or such longer period as time for stamping the original document would allow

HK bearer instrument Duplicates and counterparts

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Compulsory Adjudication: Adjudication is compulsory in the following cases and no adjudication fee is payable for the following instruments: x Conveyance or transfer operating as a voluntary disposition inter vivos x Instrument conveying or transferring property in contemplation of sale which is treated as a conveyance or transfer operating as a voluntary disposition inter vivos x An instrument exempt under s. 45 x Instrument claims to be specially exempt from stamp duty x A conveyance or contract note to which s. 24(2) applies (i.e. transaction in consideration of debt where the consideration would otherwise exceed the value of the property) x Gifts to exempted institution x Foreclosure orders Appeal against stamp duty Procedure: Any person dissatisfied with the assessment by the Collector of Stamp Revenue after adjudication may: o Within one month from the date of assessment o Subject to any order of the Court o By notice served on the Register of the District Court appeal against the assessment. The District Court will determine the correctness of the assessment. If the person is still dissatisfied, he may make a further appeal to the Court of Appeal

Penalty for late stamping

Stamp Duty Planning

Period late for stamping Penalty Not exceeding 1 month Twice the duty More than 1 month but not exceeding 2 Four times the duty months

The following methods are commonly used to reduce exposure to stamp duty: x Purchasing immovable property in the name of a corporation and then disposing of the shares of the company instead of the immovable property x Transferring shares of a non-HK holding company x Undertaking share allotment instead of share transfer; and x Utilizing s. 45 relief

More than 2 months

Ten times the duty

Adjudication Scope of charge: If a person disagrees with the amount of stamp duty payable or does not know whether an instrument is chargeable for stamp duty or not, he may apply for adjudication. The fee is HK$50.

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ESSENTIALS

Assessments raised under the IRO

CHAPTER - 3 ADMINISTRATION PROCEDURES UNDER THE INLAND REVENUE ORDINANCE Returns Taxpayer’s return x Board of Inland Revenue requires that a return be furnished in respect of: o Property tax, salaries tax or profits tax; or o Property tax, salaries tax and profits tax (i.e. a composite tax return) x Returns may be furnished in either the paper form or electronically (telefiling, ESD Scheme or Electronic Government Forms) Time limit for submission of relevant tax returns is as follows for assessment year 2007/08:

Time limit: Under s. 60(1) of the IRO, an assessor may raise an assessment/additional assessment: x Within the year of assessment x Within six years after the year of assessment; or x Within ten years after the year of assessment if the non-assessment/underassessment is due to willful evasion In the case of a deceased taxpayer, under s. 54(b) of the IRO, no assessment/additional assessment can be raised after: x One year from the date of death; or x One year from the date of filing any affidavit required under the Estate Duty Ordinance whichever is later. Notice of assessment and demand for provisional tax

Type of return Property tax return x Jointly owned property x Property owned by a corporation Tax return – Individuals x Salaries tax x Profits tax – sole proprietor business Profits tax return x Corporation o With Dec year end o With year end date between 1 Jan and 31 Mar o With any other year end dates

Normal time limit for submission One month from date of issue One month from date of issue

With any other year end dates

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The Commissioner issues a Notice of Assessment to the taxpayer with details of amount assessed, tax charged and due date of payment Notice of Assessment may be issued together with a demand of provisional tax that is computed based on the amount of income most recently assessed

Objection: One month from date of issue Three months from date of issue or five months from date of issue for represented cases

15 Aug under block extension 15 Nov under block extension (further extension to 31 Jan may be applied for loss cases) One month from date of issue

Objection is valid when x it is made in writing, x it states precisely the grounds of objection, x it was lodged within 1 month from the date of notice of assessment issued, and x it was accompanied by a valid return or all details left outstanding on a return if the objection is made against estimated assessment raised under S.59(3) Late objection is accepted only if it is due to: x Absence from Hong Kong x Sickness x Other reasonable cause Holdover of tax payment

Business other than a corporation x With Dec year end 15 Aug under block extension x With year end date between 1 15 Nov under block extension (further extension Jan and 31 Mar to 31 Jan may be applied for loss cases) x

One month from date of issue

The Commissioner may holdover the tax in dispute under an objection as follows: x Conditional holdover o Granted in cases considered to be of little merit o Holdover is granted on the condition that the taxpayer purchased a Tax Reserve Certificate or provided a banker’s undertaking o If the tax is subsequently discharged, the Tax Reserve Certificate will be redeemed with interest to the taxpayer

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ESSENTIALS

Unconditional holdover o Granted in cases where the tax in dispute is likely to be discharged o No tax is payable until notice is issued o If the tax is subsequently payable, taxpayer has to also pay interest at a rate specified by the Chief Justice

Holdover of tax payment When Objection or appeal is lodged, CIR may order holding over of tax x

A tax appeal may be made in the following order: x Board of review x Court of first instance x Court of appeal x Court of final appeal

x x

Salaries tax o Entitlement to further allowances under Part V of the IRO o Net chargeable income is likely to be less than 90% of the provisional amount assessed o Cessation of income chargeable to salaries tax o An objection has been lodged against the final assessment upon which provisional assessment is based Profits tax o Assessable profit for the year is likely to be less than 90% of the provisional amount assessed o A loss brought forward has been omitted or is incorrect o Cessation of trade, profession or business o Election for personal assessment has been made which is likely to reduce the tax liability o An objection has been lodged against the final assessment upon which provisional assessment is based

QP Module D (Feb 09) – Essentials

Tax Appeal

Error or Omission Claims (s.70A)

Unconditional hold-over when - Apparent that objection is allowed - Interest is charged if tax becomes payable Conditional hold-over - Requiring taxpayer either (a)To purchase Tax Reserve Certificate or (b)To furnish a banker's undertaking

Holdover of provisional tax payment A taxpayer may apply in writing for partial or complete holdover of provisional tax as follows: x Property tax o Assessable value of the property is likely to be less than 90% of the provisional amount assessed o Cessation of income from property o Election for personal assessment has been made which is likely to reduce the tax liability o An objection has been lodged against the final assessment upon which provisional assessment is based x

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Re-opening of assessment that has become final and conclusive Grounds of claim 1) Error or omission in the return or statement submitted or 2) Arithmetical error or omission in calculation x Time limit 6 years after the end of the Y/A concerned and 6 months after date of notice of assessment issued, whichever is later x No correction for errors or omissions made in accordance with the prevailing practice. Final and conclusive assessments An assessment is final and conclusive under s. 70 in the following cases: x There is no valid objection/appeal within the time limit x The objection has been agreed by the Commissioner x A settlement has been entered into, reduced in a form specified by the Board of review signed by the appellant and Commissioner and endorsed by the Board of review x The appeal has been withdrawn x The appeal has been dismissed x The assessment has been determined on objection or appeal with no further appeal

QP Module D (Feb 09) – Essentials

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Comparison of penalty provisions

Obligations of Taxpayers

(a) To complete returns as requested in the notice (b) Obligation to notify CIR of chargeability to tax (c) Obligation to notify cessation of source of income (d) Obligation to notify CIR if a taxpayer is about to leave Hong Kong (e) Obligation to notify any change of address (f) Obligation to keep record: (i) Business records of not less than 7 years; (ii) Rent records of not less than 7 years (Unless waived by the CIR or the corporation concerned has been dissolved.)

Time Limit Time specified in the Returns (Usually one month) Within 4 months from the end of the year of assessment concerned Within 1 month from date of cessation One month before date of departure Within one month of change

IRO ref s. 51(1)

s. 51(2)

s. 51(6) s. 51(7)

s. 80(1)

Covers most noncompliance offences not involving tax undercharged

s. 80(2) For offences without a reasonable excuse Covers noncompliance offences involving tax undercharged

Civil proceeding

Criminal proceeding

Administrative penalty. No legal proceeding either before or after the additional tax

Taxpayer to prove, on balance of probability

Prosecutor to prove, beyond reasonable doubts

Taxpayer to prove, on balance of probability

Penalty assessed by Court

For offences without a reasonable excuse

s. 51D

Penalty: fine at level 3

Obligation of Employers

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s. 82A

For willful evasion cases

For offences without a reasonable excuse

Covers incorrect return involving tax undercharged

Covers noncompliance offences involving tax undercharged

s. 51(8)

s.51C

Time Limit (a) Returns of remuneration of employees, Time specified in the including directors Returns (Usually one month) (b) Information of all new employees liable or Within 3 months of likely to be liable to Salaries Tax commencement of employment (c) Notification of employees about ceased One month before to be employed cessation (d) Notification of employees about to leave One month before HK for more than 1 month (other than a departure business trip) (e) Retention of money payable to an One month from the date employee who is about to leave HK for of notice under s. 52(6) more than 1 month

s. 82(1)

Penalty: fine at level 3 + 3 times of the tax undercharged

IRO ref s. 52(2)

Penalty assessed by Court Penalty: On summary conviction: fine at level 3 + 3 times of tax undercharged + 6 months imprisonment

Additional tax raised by Commissioner/Deputy Commissioner personally Penalty: additional tax not exceeding 3 times of tax undercharged

On indictment: fine at level 5 + 3 times of tax undercharged + 3 years imprisonment

s. 52(4)

s. 52(5) Appeal to Court

Appeal to Court

s. 52(6)

Appeal to Board of Review

Appeal against additional tax s. 52(7)

x x

Under s. 82B of the IRO, within one month after the Notice of Assessment to additional tax, a taxpayer may lodge an appeal in writing There are 3 grounds of appeal: o There is reasonable excuse o The additional tax exceeds the maximum amount allowed under s. 82A; and o The additional tax is excessive having regard to the circumstances

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CHAPTER - 4

Advance Rulings System x x x

Under s. 88, any person who wishes to ascertain the tax position of a contemplated transaction or arrangement can do so by obtaining an advance ruling The person should make an application to the Commissioner of Inland Revenue in accordance with Part 1 of Schedule 10 of the IRO and pay the prescribed fees The Commissioner may refuse to issue a ruling if the ruling: o Is the subject of a return which has been/due to be dislodged o Is the subject to an objection or appeal o Requires the Commissioner to determine any question of fact o Depends on the Commissioner making an assumption about any future event A ruling made by the Commissioner must state: o The name of the person, provision of the IRO, and the arrangement to which the ruling applies o The period for which the ruling applies o Any material assumptions in respect of a future event or any other matter made The person who has obtained a ruling should disclose in the return: o The existence of the ruling and the reference number o Whether or not the person has relied on the ruling in preparing and providing the return o Any material changes to the arrangement identified in the ruling The Commissioner has the power to withdraw any ruling at any time by notifying the applicant in writing of the withdrawal and the reasons for the withdrawal

Deregistration of a private limited company x x x

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To facilitate deregistration of a company, a written notice by the Commissioner of Inland Revenue stating that he has no objection to the company being deregistered is required Application can be made under s. 88B of the IRO along with payment of prescribed fees The notice of no objection is issued if: o The company has never commenced operation or has already ceased business o The company will not start/resume business in the future o The company has disposed of all trading stock, landed property and securities, if any o The company has no outstanding tax liabilities o The company has no outstanding obligations under the IRO o There are no unanswered enquiries from the IRO o There are no unsettled objections/appeals in respect of assessments already raised

HONG KONG PROFITS TAX Meaning Profits tax is charged to every person (individual, partnership or corporation) carrying on a trade, profession or business in Hong Kong in respect of profits arising/derived from Hong Kong (excluding capital gains). Scope of charge Conditions under s.14 – the charging section, are as follows: x The person must carry on the trade, profession or business in Hong Kong x The profits must be from such trade, profession or business carried on by the person in Hong Kong; and x The profits must be the profits arising in/derived from Hong Kong Rate of Tax The profits tax rate for corporations is fixed at 16.5%. Trade, Profession or Business Trade Under s. 2 of the IRO, ‘trade’ includes every trade and manufacture and every adventure and concern in the nature of trade. The existence of trade is determined by badges of trade, some of which are as follows: Badges of Implications and reference to case law trade Subject matter Asset may be purchased for personal enjoyment, production of of realization income or trading. When neither personal enjoyment nor income could be obtained from the asset, the asset is likely to be acquired for trading purposes. Motive The intention of making a profit is relevant but not decisive. The seller’s intention has to be considered. Buying something with borrowed money is an indication of trading intention, particularly in property transactions. Length of Short period of ownership is likely in trading transactions. ownership Frequency of If a number of similar transactions exist, it is likely that trade is similar being carried on. transactions Supplementary If work is done to enhance value of asset to make it more work done marketable, it is likely that a trade is being carried on. Circumstances Assets realized in a sudden emergency may show that there is responsible for no plan to carry on a trade in respect of the subject matter. realization Business Under s.2 of the IRO, ‘business’ includes: x Agricultural undertaking, poultry and pig rearing x The letting or sub-letting by any corporation x Sub-letting by any other person

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Income from Letting premises Sub-letting premises

Corporation Profits tax Profits tax

Persons other than a corporation Property tax Profits tax

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Cross-border land transportation income

The term profession is not defined in the IRO. The Court of Appeal has stated profession to include the idea of an occupation requiring either pure intellectual skill or manual skill, as in painting and sculpture etc which is controlled by the intellectual skill of the operator.

Section 15(1)(a)

Under s.14 of the IRO, only ‘profits arising in/derived from Hong Kong’ are taxable. The DIPN No. 21 issued by the IRD specifies tax treatments on income as follows: Determining factor Place where the contracts for purchase and sale are effected

x x x

Profit from sale of listed securities

Location of stock exchange where securities are traded

Profit from sale of unlisted securities

Place where the contracts of purchase and sale are effected Place where manufacturing activities are carried out

x x x

Tax treatment Both contracts effected in Hong Kong – fully taxable Both contracts effected outside Hong Kong – exempt Either one contract effected in Hong Kong – as an initial presumption, fully taxable Stock exchange effected outside Hong Kong – exempt Both contracts effected outside Hong Kong – exempt Good manufactured in Hong Kong – fully taxable Goods manufactured partly in Hong Kong – apportionment Services performed outside Hong Kong – exempt

Place where services are performed

Interest earned by Place where the credit is persons other than provided to the borrower financial institutions

Credit provided in Hong Kong – fully taxable

Rental income

Location of the property

Profit from sale of real property Royalties other than those deemed chargeable under s. 15(1)(a) or (b)

Location of the property

On the same basis as trading profits

Property located outside Hong Kong – exempt Property located outside Hong Kong – exempt Contracts effected in Hong Kong – fully taxable

Service fee

Passengers or goods uplifted in Hong Kong – fully taxable

Deemed trading receipts: The following receipts are specifically chargeable for profits tax under s.15:

Source

Manufacturing profit

Sums Specifically Chargeable for Profits Tax

Profession

Income Trading profit

Normally the place of uplift of the passengers or goods

QP Module D (Feb 09) – Essentials

15(1)(b)

15(1)(ba)

15(1)(c)

15(1)(d) 15(1)(f) 15(1)(g) 15(1)(h)

15(1)(i) 15(1)(j) 15(1)(k) 15(1)(l) 15(1)(m) 15A 15(2)

Sums specifically chargeable for profits tax Sums, not otherwise chargeable for profits tax in Hong Kong, received/accrued from the exhibition/use in Hong Kong of any films, tapes, sound recording, or any advertising materials connected with such films, tapes or recording Sums, not otherwise chargeable for profits tax in Hong Kong, received/accrued for use in Hong Kong any patent, design, trademark, copyright material, secret process or formula, or for imparting knowledge directly or indirectly relating to the above for use in Hong Kong Sums, not otherwise chargeable for profits tax, received/accrued for use/right to use outside Hong Kong any patent, design, trademark, copyright material, secret process or formula, or for imparting knowledge directly/indirectly relating to the above for use outside Hong Kong, which are deductible in ascertaining the assessable profits of a person under profits tax Sums received/accrued by way of grants, subsidies or other financial assistance in connection with the carrying on of a trade, profession or business in Hong Kong, other than sums in connection with a capital expenditure made by the person Income from the hire or the right to use movable property in Hong Kong Interest income – corporations Interest income- persons other than a corporation Refund of contributions to a recognized occupational retirement scheme or refund of voluntary contributions to mandatory provident fund scheme Interest income- financial institutions Gain from disposal of certificates of deposit or bills of exchange corporation Gain from disposal of certificates of deposit or bills of exchange – persons other than a corporation Gain from disposal of certificates of deposit or bills of exchange – financial institutions Consideration for the transfer of the right to receive income Transfer of the right to receive income Debts incurred but subsequently released

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ESSENTIALS

Concessionary Trading Receipts chargeable for tax at Half of the Profits Tax Rate Stock Valuation Income derived from qualifying debt instruments and the assessable profits of an insurance company derived from qualifying reinsurance business are only taxed at half of the profits tax rate:

Stock valuation on cessation of trade or business

Section

Under s.15C of the IRO, the trading stock of a trade or business at the date of cessation should be valued as follows:

14A(1)(a) 14A(1)(b) 14B

Concessionary trading receipts chargeable for tax at half of the profits tax rate Sums received/accrued as interest paid/payable on a medium term debt instrument Sums received/accrued as any gain/profit on sale/other disposal or redemption on maturity or presentment of a debt instrument Assessable profits of a corporation, to the extent they are the assessable profits derived from the business of reinsurance of offshore risks as a professional reinsurer

Situation Stock is sold/transferred for valuable consideration and the purchaser will deduct the cost in computing the profit chargeable for tax Other cases

Stock valuation At amount realized or consideration given for the transfer At open market value on date of cessation

Sums Specifically Exempt From Profits Tax

Capital vs Revenue

Section 14 20AC to 20AE 26(a) 26(b) 26A(1)(a) 26A(1)(b)

In general, capital expenditures are not tax deductible pursuant to s.17. However, capital gains (i.e profits arising from the sale of capital assets) are excluded from tax pursuant to s.14 of the IRO.

26A(1)(c) 26A(1)(d) 26A(1)(e) 26A(1)(f) 26A(1)(g) 26A(1)(h) 26A(1)(i) 26A(1A)(a)

Sums specifically exempt from profits tax Profit on sale of a capital asset Assessable profits of offshore funds from specified transactions and has been carried out/arranged by a specified person. Dividends from corporations chargeable for profits tax Profits already charged for profits tax in the name of another person Interest on Tax Reserve Certificates Interest on bonds issued under the Loans Ordinance or Loans (Government Bonds) Ordinance Profit on sale/disposal/redemption on maturity/presentation of bond issued under the Loans Ordinance or Loans (Government Bonds) Ordinance Interest on Exchange Fund debt instrument Profit on sale/disposal/redemption on maturity/presentation of Exchange Fund debt instrument Interest on Hong Kong dollar denominated multilateral agency debt instruments Profit on sale/disposal/redemption on maturity/presentation of Hong Kong multilateral agency debt instrument Interest pad/payable on long-term debt instrument Any gain/profit on sale/disposal/redemption on maturity/presentation of a long-term debt instrument Any sums received/accrued in respect of a specified investment scheme by or to the person as: x An authorized mutual fund corporation x A trustee of an authorized unit trust x A mutual fund corporation established outside Hong Kong which complies with the requirements of a supervisory authority within an acceptable regulatory regime x A trustee of a unit trust established outside Hong Kong which complies with the requirements of a supervisory authority within an acceptable regulatory regime x A person chargeable to profits tax in respect of a similar collective investment scheme which complies with the requirements of a supervisory authority within an acceptable regulatory regime Interest income derived from any deposit placed in Hong Kong with an authorized institution (exemption not applies: deposits of financial institutions used to secure money borrowed with interest expenses allowable under s.16)

QP Module D (Feb 09) – Essentials

Capital receipts and trading receipts In general, trading or business receipts include: x x

Receipts from disposal of trading stock or services in the course of business; and Receipts arising incidentally to the business

Capital receipts are those related to the structure of the business. Capital expenditure and revenue expenditure Capital expenditure is: x x x x x x

Once and for all Usually of a large amount Provides an enduring benefit to the business Influences the profit yielding structure of the business May be fixed within the business in the form of an asset Shown in the balance sheet as assets

Revenue expenditure: x x x x x x

Often recurs Usually of a small amount Provides short-term benefits or temporary influence to the business No or limited effect on the profit yielding structure of the business May circulate within or depart from the business Charged to the Profit and Loss Account/Income Statement as expenses

QP Module D (Feb 09) – Essentials

ESSENTIALS

Tests for the Deductibility of Interest Expense (s.16(1)(a), s16(2) and s16(2A) & (2B) / s16(2C))

Allowable Deductions Deductibility of Interest Expense s. 16(1)(a) ~ Loan Interest and Related Expenditure s. 16(1)(a) allows the deduction of interest paid on money borrowed together with other incidental expenses, such as legal fees, procuration fees, stamp duties, in connection with the borrowing, for the purpose of producing chargeable profit. However, the deductions would only be allowed if further conditions under s.16(2) and the followings restrictive sections are not applied. -

s.16(2A) & s16(2B) [applicable to s.16(2(c), 16(2)(d) and 16(2)(e) cases], s.16(2C) [applicable to s16(2)(f)] cases.

Whether interest incurred in the production of chargeable profits?

Is the interest expense incurred for the purpose of producing chargeable profit (s.16(1)(a)) and satisfies any one of the following conditions: s.16(2)(a –f)?

Not deductible

Yes

Do the following conditions satisfy? s.16(2)(c) and s.16(2A) & (2B) not apply; s.16(2)(d) and s.16(2A) & (2B) not apply; s.16(2)(e) and s.16(2A) & (2B) not apply; s.16(2)(f) and s. 16(2C) not apply. s.16(2)(f) and s. 16(2C) not apply.

Zeta Estates Limited v CIR [CFA: 29 March 2007]

x x x x

Zeta is engaged in the letting and development of properties for sale funds largely locked up in business assets declared dividends of about $400M dividends declared became shareholders’ loans and interest charged thereon

Court of Final Appeal: x x x x

properties developed for sale = working capital @profit earning stage subsequent expenditure incurred for maintaining the profit-earning assets = for the purpose of producing profits taxpayer is obliged to pay dividends declared Æ borrow/sell profit-earning assets the shareholder loan enabled Zeta to discharge dividends declared without disposing the profit-earning assets (maintaining those assets) i.e. looked at the underlying purpose of the loan Æ interest deductible under s.16(1)(a)

Further Conditions under s. 16(2) (a) interest paid by financial institutions; (b) interest paid by a public utility company not exceeding a rate of interest specified by the Financial Secretary; (c) interest paid to a person other than a financial institution or overseas financial institution will be allowed if the lender is liable to Profits Tax on the interest received; (d) interest paid to financial institution or overseas financial institution; (e) interest paid in respect of funds borrowed from a lender, who is not a connected person, to finance wholly and exclusively (i) acquisition of plant and machinery ranking for depreciation allowance; (ii) purchase of trading stock which is used in the production of chargeable profit. (f) Interest is paid by a corporation on debenture listed in Hong Kong/recognised stock exchange, or instruments marketed in Hong Kong/recognised centre, issued by the corporation or its associated corporation;

QP Module D (Feb 09) – Essentials

Interest deduction is reduced by an amount calculated on a reasonable basis

Yes

Background:

Deductible

New subsections and DIPN13A: S16(2A) [secured-loan test]: restriction applies when the borrowing is secured by a deposit or loan made by the borrower or a person associated with the borrower with or to -the lender, a financial institution, an overseas financial institution, or an associate of any of the above, and -interest generated by such deposit or loan is not taxable. Restriction: interest deduction be reduced by an amount calculated on a reasonable basis. S16(2B) [interest flow-back test]: restriction applies when an arrangement in place such that “any sum payable by way of interest on the loan borrowed” is ultimately paid back to the borrower, or its associate, who is not an “excepted person” under s16(2E)(c). “any sum payable by way of interest on the loan borrowed” covers the payment of interest or principal in respect of any other loan, the repayment of which is secured by the payment of interest or repayment of principal of the loan in question. Example: H borrowed a loan of $100M from Bank J. Bank J entered into a loan sub-participation arrangement with company K, which is an associated company of company H. Under the arrangement, company K advanced a loan of $100M to Bank J that the repayment of principal and interest of this loan by Bank J to company K would only be made on the

QP Module D (Feb 09) – Essentials

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condition of the repayment of principal and interest of the bank loan made by company H to Bank J.

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16(1)(d)

Interest paid by Bank J to company K Æ interest on loan borrowed by company H from Bank J, for s16(2B) purposes, and Company K is an associate of company H, if company K is not an excepted person, interest deduction of company H would be denied. 16(1)(e)

S16(2C): -applies in conjunction with s16(2)(f); -restriction same as s.16(2B).

16(1)(f)

Associate 16(1)(g) Per s16(3), an associate include : z For a natural person - Relative and / or partner z For a corporation - Director, Principal Officer (or a person who controls the corporation), or an Associated Corporation

Bad and doubtful debts incurred in any trade, profession or business that have become bad during the said period. Also: x Deductions shall be limited to debts included as trading receipts in ascertaining profits chargeable under profits tax x All sums recovered that were previously allowed shall be treated as part of the profits for that basis period Expenditure incurred in the repair of any premises, plant, machinery, implement, utensil or article employed in the production of such profits Expenditure incurred in replacement of any implement, utensil or article employed in production of such profits, provided no depreciation allowances had been made in respect of such article Sums expenses for the registration of a trademark, design or patent used in the trade, profession or business which produces such profits

Specific Deductions Associated Corporations is z a corporation which has control over the person; or z a corporation which is under the control of the same person Definition of “Excepted Person” (applicable to new restriction on s16(2B), s16(2C))

ss16A to 16K provide for the deduction of the following items which are not generally allowable: Section

Expenditure

Allowable deductions

Treatment of refund/sale proceeds

-a person who is charged to tax in respect of the interest in question; -a person acting as a bare trustee; -a beneficiary of a unit trust to which section 26A(1A)(a)(i) or (ii) applies, where the interest payment is in respect of a specified investment scheme; -a member of a recognised retirement scheme; -a public body; -a body of corporate of which Government owns more than 50% issued share capital; -a FI or overseas FI.

16A

Special payment under a recognized occupational retirement scheme or a mandatory provident fund scheme

20% per year of assessment from the year of assessment in which expenditure was incurred

Refund of contributions, to the extent that the sums were previously allowed as deductions, is taxable

16AA

Mandatory contributions to self-employment cases

Mandatory contributions under the MPF scheme Ordinance which are not otherwise allowable and not exceeding HK$ 12,000

N/A

Other allowable deductions:

16B

Research and Development

General expenditure /expenditure on plant or machinery fully deductible in the year of assessment it is incurred

Sale proceeds of machinery or plant, to the extent not chargeable for profits tax and not exceeding amount of deduction previously allowed, are taxable

Section 16(1)(b)

16(1)(c)

Allowable deductions Rent paid by any tenant of land or buildings occupied for the purpose of producing such profits, not exceeding an amount equal to the assessable value of the land or buildings Tax of the same nature as imposed by this Ordinance, paid elsewhere, by a person other than a corporation who carries on a trade, profession or business in Hong Kong for the year of assessment in respect of profits chargeable for tax under s.15.

QP Module D (Feb 09) – Essentials

Expenditure on buildings /structure qualifies for Industrial Building Allowance 16C

Technical education

QP Module D (Feb 09) – Essentials

Fully deductible in the year of assessment it is incurred

Balancing charges on disposal of industrial building is taxable N/A

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16D

Approved charitable donations

16E

Patent rights, know-how, etc

16F

Expenditure on building refurbishment

16G

Capital expenditure on the provision of a prescribed fixed asset

16H -16K

Environmental protection facility

QP Module D (Feb 09) – Essentials

Deductions not allowable under s.17

Allowable if aggregate is not less than HK$100 and not exceeding 25% of assessable profits (10% for year of assessment prior to 2003/04)

N/A

Fully deductible in the year of assessment it is incurred 20% per year of assessment from date it was incurred Fully deductible in the year of assessment it was incurred

Sale proceeds of patent right, know how etc. are taxable N/A

Cost of machinery fully deductible in the year of purchase s16I(2) Cost of installations deductible equally in five years of assessment s16I(2)&(3)

ESSENTIALS

s.17 of the IRO prohibits deductions of the following items:

Sale proceeds of prescribed fixed asset, to the extent not chargeable to profits tax and not exceeding amount of deduction previously allowed, are taxable Sale proceeds of machinery are taxable limited to amount of deductions already granted. Sale of installations: If unallowed expenditure exceeds the proceeds, the excess is deductible. S16J(3)(a) If proceeds exceed unallowed expenditure, the excess is taxable. S16J(3)(b)

Section 17(1)(a)

Non-allowable deductions Domestic or private expenses, including cost of traveling between residence and place of business and contributions made to MPF scheme as a member of the scheme

17(1)(b)

Any disbursements or expenses not being money expended for the purpose of producing chargeable profits Capital expenditure Cost of improvements Sums recoverable under an insurance or contract of indemnity Rent and expenses for premise which are not used for producing assessable profits Any taxes payable under the IRO except salaries tax paid on behalf of employee

17(1)(c) 17(1)(d) 17(1)(e) 17(1)(f) 17(1)(g) 17(1)(h)

Any sums made by employer in respect of an employee as: x An ordinary annual contribution to a fund duly established under a recognized occupational retirement scheme x An ordinary annual premium in respect of a contract of insurance under a recognized occupational retirement scheme x Regular contributions made to a mandatory fund scheme to the extent that the total payments exceeds 15% of total emoluments of the employee for the periods to which the payments relate

17(1)(i)

Provisions made by the employer in respect of a recognised occupational retirement scheme to the extent that the aggregate of such provisions and any payment under s.17(1)(h) exceeds 15% of total emoluments of an employee for the period of which the provision is made

17(1)(j)

Provisions made by an employer in respect of an unrecognized occupational retirement scheme Sums made by an employer in respect of an employee as: x A contribution under an occupational retirement scheme; or x A premium in respect of a contract of insurance under an occupational retirement scheme; or x A contribution to a mandatory fund scheme where provision for payment of the sum has been made in a prior year of assessment and a deduction has been allowed for that provision

17(1)(k)

17(1)(l)

Contributions made by an employer to the funds of an occupational retirement scheme other than a recognized occupational retirement scheme; or Payments made by an employer for the purposes of the operation of an occupational retirement scheme other than a recognized occupational retirement scheme

17(2)

Salaries or other remuneration, or interest on capital or loans provided by, or contribution made to a MPF scheme in respect of a proprietor’s spouse, a partner or a partner’s spouse

QP Module D (Feb 09) – Essentials

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Depreciation Allowances Depreciation allowances are available for capital expenditure incurred on: x x x

Industrial buildings or structures Commercial buildings or structures (buildings or structures other than an industrial building or structure); and Machinery or plant (other than a prescribed fixed asst or an asset used for research and development purposes)

Capital expenditure on implements, utensils and articles (including betting, crockery and cutlery, kitchen utensils, linen, loose tools, soft furnishings and dental instruments, tubes for X-ray and infra-red machines) is allowable on a replacement basis. Capital expenditures on prescribed fixed assets (e.g. manufacturing equipment, computer) or written down value of prescribed assets brought forward are allowed as deductions under s.16G. The depreciation allowances on fixed assets (other than prescribed fixed assets, implements, utensils and articles, or an asset used for research and development) are as follows: Allowance Initial Allowance Annual Allowance

Balancing Adjustments

Industrial Building

Commercial Building 20% N/A 4% on cost or 4% on cost or computed based on computed based on the residue of the residue of expenditure expenditure Balancing charge or Balancing charge or balancing balancing allowance allowance

Qualifying capital expenditure includes: x Interest paid and any commitment fees incurred in connection with a loan made for the purpose of financing an industrial building or structure; and x Expenditure incurred on ordinary work done in preparation for the laying of foundations, laying of drains, sewers and water mains for a building and excludes: x Expenditure incurred on acquisition of land, or rights in or over land x Expenditure incurred on demolishing the existing building on the land; and x Expenditure incurred on preparation and leveling of the land Commercial Building Allowance (CBA) Commercial building or structure means any building or structure or part of any building or structure used by a person with relevant interest for his trade, profession or business. Allowances are granted to a person who has a relevant interest in a building or structure at the end of the basis period for which the building or structure is in use as a commercial building or structure.

Machinery or plant 60% 10%, 20% or 30% on reducing balance Balancing charge or balancing allowance

Industrial Building Allowance (IBA) An industrial building or structure is any building or structure, which is used: x For the purposes of a trade carried on in a mill, factory or similar premises x For the purposes of a transport, tunnel, dock, water, gas or electricity undertaking or a public telephone or telegraph service x For the purposes of a trade consisting of the manufacture or processing of goods or materials x For the purposes of a trade which consists in the storage: o Of goods or materials which are to be used in the manufacture of other goods and material o Of goods or materials which are to be subjected to any process in the course of a trade; or o Of goods or material on their arrival into Hong Kong x For the purposes of a farming business; or x For the purposes of research and development in relation to any trade, profession or business

QP Module D (Feb 09) – Essentials

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Depreciation allowances on plant and machinery Plant refers to the tools or apparatus with which the business is carried on. Building refers to the environment or a general setting in which the business is carried on. To qualify as plant, the feature needs to perform a vital or specific function for the purposes of the trade, profession or business (i.e. the functional test). In general, depreciation allowances on machinery or plant are computed under the pooling system. Special Classes of Business There are specific provisions applicable to special classes of business as follows: 1. Financial institutions In general, the computation of the assessable profits of a financial institution is the same ass that for other businesses, but special provisions in s. 15(1)(i) and s. 15(1)(l) apply to interest income and gains from disposal/sale of certificates of deposits and bills of exchange derived by financial institutions. Both s. 15(1)(i) and 15(1)(l) refer to income ‘through or from carrying on its business in Hong Kong’ and the place where the credit is provided is ignored.

QP Module D (Feb 09) – Essentials

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The agreed tax treatments (in DIPN No. 21) are as follows: 1.

2. 3. 4.

Types of income Interest from loans a) Offshore loans initiated, negotiated, approved and documented by an associated party outside Hong Kong and funded outside Hong Kong b) Offshore loans initiated etc by the Hong Kong institution and funded by it in/from Hong Kong c) Offshore loans initiated etc by an associated party outside Hong Kong but funded by the Hong Kong institution d) Offshore loans initiated etc by a Hong Kong institution but funded by offshore associates Interest on certificates of deposit (CDs) Acquisition of CDs will be treated in a similar manner as deposit placements Interest from securities other than CDs Treated similarly as interest from loans Participation, commitment fees etc To follow the tax treatment accorded to related loans

ESSENTIALS

s. 23 provides two methods of ascertaining assessable profits of a life insurance business. Tax treatment 100% non-taxable 100% taxable

Method 1 Assessable profits = 5% of premium from life insurance business in HK during basis period for the year of assessment

50% taxable

Premium from life insurance business in HK includes: x all premiums received/receivable in HK from residents and non-residents; and x all premiums received/receivable elsewhere, from HK residents in respect f policies received in HK

100% taxable

Returned premiums or reinsurance premiums relating to those received must be deducted before applying the 5%.

50% taxable

See (1) above

Method 2 When taxpayer elects, part of the adjusted surplus ascertained under s. 23, will be assessable profits of the life insurance business.

See (1) above Adjusted surplus is computed as follows:

Active fee To be determined by reference to the ‘activity test’ Depends on the particular i.e. services performed to earn the fee facts of the case Guarantee/underwriting fees A principal consideration of source is related to Depends on the particular whether or not he risk under the guarantee or facts of the case underwriting is evaluated and is to be borne by the Hong Kong institution

ADD: x x x x

deficit of previous period which is included in the actuarial report non-deductible expenses under s. 16 or 17 charged against life insurance fund other sources of taxable income not already included in life insurance fund appropriations of profits or transfers to reserves which have been charges to life insurance fund, other than transfers to policy holder; and any balancing charges

If accounts are prepared by the bank, the assessable profits shall be computed on the basis of such accounts.

x LESS: x any surplus of previous period retained in life insurance fund x any transfers or appropriations to policy holders not charges against life insurance fund in the actuarial report x deductible expenses under s. 16 not charged against life insurance fund x capital receipts or transfers from reserve; and x depreciation allowances

If no accounts are prepared, or such accounts do not show the true profits, then the following formula should be used to compute assessable profits of the branch:

The adjusted surplus may be related to the company’s life insurance business in HK and overseas. To compute HK sourced profits, apportionment is made as:

Assessable profits = Total HK branch assets x Worldwide profits Total Worldwide assets

Assessable profits = Adjusted surplus ×

Branch of a foreign bank The method to assess the profits of the Hong Kong branch of a bank whose head office is outside Hong Kong is stipulated in Rule 3 of the IRR.

Total premiums from life insurance business

2. Life Insurance Companies Under s. 23 of the IRO, life insurance business refers to business of the following classes: x life and annuity x marriage and birth x linked long term x tontines QP Module D (Feb 09) – Essentials

Premiums from life insurance business in HK

Since, actuarial report may cover more than one year of assessment, apportionment may be required as follows: Premiums from life insurance business in HK in basis Assessable profits = Adjusted surplus ×

QP Module D (Feb 09) – Essentials

Total life insurance premiums in HK covered by the actuarial report

ESSENTIALS

3. Non-life insurance companies

4. Mutual insurance companies

s.23A of the IRO deals with ascertainment of assessable profits of insurance businesses (whether mutual or proprietary) other than life insurance. Under s. 23A(1) the assessable profits of non-life insurance companies are to be ascertained as follows: To calculate gross premiums from insurance business in HK: ADD: x any interest or other income arising/derived from HK x balancing charge; and x reserve for unexpired risks outstanding at the commencement of the period LESS: x returned premiums x corresponding re-insurance premiums x reserve for unexpected risks outstanding at the end of the period x actual losses less recoveries x agency expenses x a fair proportion of the expenses of the head office; and x depreciation allowances Premium from insurance business in HK includes: x all premiums in respect of contracts of insurance, other than life insurance, made in HK; and x all premiums on contracts of insurance, other than life insurance, the proposals for which were made to the corporation in HK Formula to ascertain assessable profits: A=

B×D C

where, A = assessable profits B = assessable profits of non-life insurance business computed under s. 23A(1) C = aggregate of total income earned by/accrued to non-life insurance company during that basis period for that year of assessment D = aggregate of offshore reinsurance income earned by/accrued to non-life insurance company during that basis period for hat year of assessment Under s. 14B, assessable profits of a non-life insurance company derived from business of reinsurance of offshore risks as a professional re insurer, are upon an irrevocable election by the company in writing, chargeable for profits tax at 50% of the tax rate as a concessionary trading receipt. Professional re insurer – company authorized to carry on in/from HK reinsurance business only. Offshore reinsurance income means, sums attributable to/derived from: x premiums from reinsurance of offshore risks x gains or profits from offshore reinsurance investments

QP Module D (Feb 09) – Essentials

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Mutual insurance companies are owned by policy holders who share the profits made by the insurance companies, usually by way of lower premiums or higher bonuses. Under s. 23AA of the IRO, a mutual insurance corporation is deemed to carry on insurance business. The assessable profits should be ascertained in accordance with s. 23 and 23A and charged for tax under s. 14. 5. Ship owners Ship owner includes he owner or the charterer of a ship who carries on a business of chartering (i.e. letting of a shop under a charter party) or operating ships in HK. Three main types of charter party include: x bareboat charter x time charter x voyage charter Under s. 23B of the IRO, a ship owner is deemed to carry on a business of chartering or operating ships in HK if: x the business is normally controlled or managed in HK; or x the person is a company incorporated in HK; or x in any other case, any ship owned by the ship owner calls at any location within the waters of HK For non-resident ship owners, where the call of a ship in HK is casual, and further calls are not likely, the Commissioner may decide that the owner shall not be deemed to be carrying on business in HK. The formula for calculating the assessable profits of a ship owner is the same for resident and non-resident ship owners: Relevant sums Assessable profits = Total shipping profits ×

Total shipping income

However, if Assessor if of the opinion that formula cannot be applied satisfactorily for non-resident, the assessable profits may be computed on the basis of a fair percentage of the relevant sums. Relevant sum refers to sums derived from/attributable to: x carriage of passengers, goods, etc x towage operations x dredging operations; and x charter hire

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6. Hong Kong aircraft owners s. 23C applies to resident aircraft owners. The chargeable person is an aircraft owner (i.e. either the owner or the charterer of an aircraft) who carries on business of chartering (i.e. letting of an aircraft under a charter party) or operating aircraft in HK. Aircraft includes a helicopter. An aircraft owner is deemed to be carrying on a business o chartering or operating aircraft in Hong Kong if: x the business is normally controlled or managed in HK; or x the owner is a company incorporated in HK

ESSENTIALS

Relevant sums include: x any sums derived from/attributable to: o any relevant carriage shipped in HK o any relevant charter hire; and o any charter in respect of the operation of an aircraft flying between aerodromes or airports within HK x half of any sums derived from/attributable to any charter hire in respect of the operation of an aircraft flying between any aerodromes or airport within HK and Macau 8. Clubs and trade associations, etc

Under s. 23C(2), the formula for computing the assessable profits of a resident aircraft owner is: Relevant sums Assessable profits = Total aircraft profits × Total aircraft income

Clubs etc A club refers to an association of persons who gather together or their mutual benefits and is usually in receipt of mutual profits which are not taxable.

Relevant sum includes: x any sums derived from/attributable to: o any relevant carriage shipped in HK o any relevant charter hire; and o any charter in respect of the operation of an aircraft flying between aerodromes or airports within HK x half of any sums derived from/attributable to any charter hire in respect of the operation of an aircraft flying between any aerodromes or airport within HK and Macau

s. 24(1) lays down a test to determine whether the receipts of a club are business receipts and the profits arising therefrom are chargeable for profits tax.

7. Non-resident aircraft owners

Members – those with voting rights Non-members – non-voting members and outsiders

s. 23D deals with owners or charterers of any aircraft that and at any aerodrome or airport within HK, but are not within the definition of HK aircraft owners under s. 23C. Such persons are deemed to be carrying on a business of chartering or operating aircraft in HK and thus liable to HK profits tax. For non-resident aircraft owners, where the landing of an aircraft in HK is casual, and further landings are improbable, the Commissioner may decide that the owner shall not be deemed to be carrying on business in HK.

If not less than half of the club’s gross receipts on the revenue account (including entrance fees and subscriptions) are from voting members, the club is deemed not to carry on a business. However, if the above is less than half, all the club’s receipts (including entrance fees) are deemed to be trading receipts chargeable for profits tax.

If a club is not chargeable for profits tax under s. 14, it may still be subject to other taxes. Trade associations, etc Trade association is a body of persons that is formed for the purpose of furthering the trade interest of its members. Under s. 24(2), the test is:

Pursuant to Article 8 of The Arrangement between the Mainland of China and the HKSAR for Avoidance of Double Taxation on Income, the aviation income of Mainland residents from operations carried on in HK will be exempt from HK profits tax. The formula in computing assessable profits of a non-resident aircraft owner is as follows: Relevant sums

Assessable profits = Total aircraft profits ×

Where more than half the receipts from subscriptions are from persons who claim, that their subscriptions are allowable against deductions against their own business profit under s.16, the association is deemed to be carrying ob a business and the whole of its income (including entrance fees and subscriptions) is subject to profits tax. Subscriptions refer to the recurrent payments and do not include founders’ contributions and entrance fees.

Total aircraft income

QP Module D (Feb 09) – Essentials

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CHAPTER - 5

Employment

HONG KONG SALARIES TAX Scope Under s. 8(1) of the IRO, salaries tax is imposed on a person’s income arising in or derived from Hong Kong from the following sources: x office x employment x pension Under s. 8(1A), income arising in or derived in Hong Kong from any employment is defined as: Section 8(1A)(a) 8(1A)(b)

8(1A)(c)

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Includes all income derived from services rendered in Hong Kong, including leave pay attributable to such services Excludes income derived from services rendered by a person who: Is not employed by the Government or as master or member of the crew of a ship or as commander or member of the crew of an aircraft and Renders outside Hong Kong all services connected with his employment Excludes income derived by a person from services rendered by him in any territory outside Hong Kong where the person is chargeable for and has paid tax of substantially the same nature as, salaries tax in Hong Kong in respect of the income

s. 8(1)(a) is the basis charge of salaries tax and s. 8(1A) is an extended charge on employment income which covers income for services rendered in Hong Kong from a foreign employment.

For an employment to exist, there must be a master and servant relationship between employer and employee. Factors that determine whether a person is in employment include: x Control test o Whether the company can instruct the taxpayer on what to do, how to do and when to do? o Whether the company provides the place of work? o Whether the taxpayer is required to follow the rules and regulations of the company? o Can the taxpayer work for other persons without the company’s approval? o Can the taxpayer be dismissed x Integration test o Does the taxpayer represent to outsiders that he is an employee of the person? o Is the taxpayer part and parcel of the organization of the person? o Has the taxpayer a supervisor and/or subordinates who are employees of the company? x Economic reality test o Does the taxpayer provide his own tools, equipment or assistants? o Does the taxpayer contribute capital, and is that capital at risk? o Whether the taxpayer’s performance of duties can affect his profit or loss? o Does the taxpayer get promoted within the person’s organizational framework o Is the relationship a continuing one or does it exist only to provide result

s. 8(1A)(c) is a unilateral double taxation relief, which applies in the situation where part of a Hong Kong employee’s income has been subject to tax similar to salaries tax in another territory. Under the Double Tax Arrangement between the Mainland and Hong Kong SAR, Hong Kong residents are exempt from PRC individual income tax if they spend no more than 183 days in the PRC during the calendar year and their income is not paid by a PRC party or borne by a permanent establishment or fixed base of their employment in the PRC.

In determining the situs of employment, IRD issued DIP No. 10 (revised) which specifies:

Definition and Source of Income

Pension

Office

Pension refers to an annuity or other recurring periodic payments for consideration of past services. The situs of a pension is the place where the pension is managed and controlled.

Office is a subsisting, permanent, substantive position, which has an existence independent of the person who fills it and which goes on and is filled in succession by successive holders e.g. Company director, Company secretary.

z z

The place where the employment contract is negotiated, concluded and enforceable; The residence of the employer; and The place where the employee’s remuneration is paid.

The location of an office is the place where it legally exists, that means the place where central management and control of the company is located. (i.e. where meetings of Board of Directors are held)

QP Module D (Feb 09) – Essentials

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In Summary:

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Emoluments chargeable for salaries tax The basic principle is that it should be made in consideration of services (past, present or future).

Employment Visit < 60 days in HK or no services rendered in HK

Yes

Exempt

Non-HK employment

Benefits in kind (i.e. a reward in a form other than money) will not be subject to salaries tax if they are: z z

HK employment

z z

Time in time out basis

Not convertible into cash; Provided by the employer in such a way that the employer has a sole and primary liability to pay for that benefit; A settlement of the employer’s liability not guaranteed by any other person; Not benefits specifically chargeable for tax.

Non-HK tax paid?

Items Specifically Chargeable for Salaries Tax No

Yes

Educational benefits s. 9(2A)(b) Taxable in full

Non-HK services exempt

Taxable payments include tuition fees, incidental education expenses such as boarding fees and cost of school outings. Payments after 1 April 2003 for passage in connection with education of employee’s children are also chargeable to tax. However, education benefits through a formally established education trust are exempt from tax.

Pension

Office directors

Location of fund (place of management and control)

Company managed and controlled in HK

Yes

Exempt

Taxable in full

Accommodation benefits A rental value shall be included in assessable income of an employee if his employer /associated company has: x Provided him with a place of residence rent-free s. 9(1)(b) x Provided him a place of residence at rent less than rental value s. 9(1)(c) x Paid or refunded part or all of the rent for his place of residence s. 9(1A)(b)

Share/Stock option gains s. 9 (1)(d) Income from office or employment Under s. 9 of the IRO, income from any office or employment includes wages, salary, leave pay, fee, commission, bonus, gratuity, perquisite, or allowance, whether derived from the employer or others, except ………..

QP Module D (Feb 09) – Essentials

The amount of taxable gain is calculated as follows: Situation Assessable amount Exercise of option Market value at the time of taking up the shares over the cost of the option and shares Option assigned/released Consideration for assignment/release of option less cost of option

QP Module D (Feb 09) – Essentials

ESSENTIALS

Share award benefits

ORSO Accrued benefits attributable to

The IRD issued the revised DIPN 38 in March 2008 to include the tax treatments on share award benefits. Part 2 of the DIPN identifies share award benefits in two categories: “upfront” and “back end”, the characteristics of the two categories can be identified as follows: Upfront approach Back end approach No Yes At the time the award is At the time when the granted conditions are fulfilled, e.g. when vesting period is completed. Valuation Market value as at granting Market value as at the date date when conditions are fulfilled. Discount in valuation Potentially – if there is sale No. restriction of shares after the grant (generally speaking, 5% per year) Distributions such as Not taxable – regarded as Received during the dividends or bonus investment income since vesting period: Taxable, shares the employee is entitled to since the employee is the shares at the time of entitled to the shares only the award at the end of the vesting period. Vesting period Time of Assessment

Benefits Specifically Excluded From Tax

Employee’s contributions

Employer’s contributions

MPF Accrued benefits attributable to Employee’s contribution (mandatory and voluntary)

Employer’s mandatory contributions

Employer’s voluntary contributions

Exempt

Retirement

Exempt

Death

Exempt

Incapacity

Exempt

Termination of service (with or without permanent departure from Hong Kong)

Exempt

Exempt but “proportionate benefit rule” applies

Exempt

Exempt but “proportionate benefit rule” applies

Permanent departure from Hong Kong without terminating service

Exempt

Assessable

Exempt

Assessable

Other cases

Exempt

Assessable

Exempt

Assessable

Receipt of share option rights s. 9(5) Since notional gain on exercise or release of the share option rights is chargeable for tax under s. 9(1)(d), the grant of a right to acquire shares is not subject to salaries tax.

Holiday warrants/passages s. 9(1)(a)(i), (ii) & (iii) Holiday warrants were exempt from tax prior to the year of assessment 2003/04. However, the exemption was repealed with effect from 1 April 2003. Payment (or refund) of rent s. 9(1A)(a) Since accommodation benefits provided by the employer are taxed on the notional rental value of the accommodation, the payment (or refund) of rent by the employer/associated company is not chargeable for tax. Lump sum payment from recognized occupational retirement schemes/ mandatory provident fund s. 8 (2)(c), (cb), (cc) Lump sum payments received from a recognized occupational retirement scheme upon termination of service, death, incapacity or retirement of the employee is exempt from salaries tax.

QP Module D (Feb 09) – Essentials

ESSENTIALS

Allowable Deductions

Approved charitable donations s. 26C

Outgoings and expenses s. 12(1)(a)

Approved charitable donations made by the taxpayer or his/her spouse are allowable under salaries tax if the aggregate amount is: x In cash x Not less than HK$100; and x Not exceeding 35% of (assessable income minus allowable outgoings and expenses minus depreciation allowances); and x Not allowable as a deduction under profits tax

All outgoings and expenses, other than expenses of a domestic/private nature and capital expenditure, wholly, exclusively and necessarily incurred in the production of assessable income are allowed to be deducted from the assessable income. The following tests must be satisfied in relation to the expenditure: x It must have been ‘incurred’ x It must have arisen ‘wholly and exclusively’ in the production of income; and x It must have been ‘necessary’ in the production of the income Depreciation allowances on plant and machinery s. 12 (1)(b) Depreciation allowance on machinery and plant essentially used by a taxpayer in the production of assessable income are allowable.

Elderly residential care expenses s. 26D Any residential are expenses paid by a person or his/her spouse in respect of a parent/grandparent of his/her spouse are allowable under salaries tax (or personal assessment) if the parent/grandparent is at any time in the year of assessment: x > 60; or x eligible to claim an allowance under the Government’s Disability Allowance Scheme

Loss brought forward s. 12 (1)(c) If a loss is suffered when the allowable deductions exceed the assessable income, such loss will be carried forward to offset future assessable income.

The maximum allowable deduction of each parent/grandparent is HK$60,000. However, the person claiming for deduction under this section should not b entitled to a dependent parent/grandparent allowance in respect of the same parent or grandparent.

Allowable deductions of a spouse under joint assessment s. 12(1)(d)

Home loan interest s. 26E

The allowable deductions of a spouse not fully utilized by that person can be deducted from the assessable income of the other spouse under joint assessment.

A person may be able to claim deduction of home loan interest during any year of assessment in respect of a dwelling, which is used at any time in that year of assessment by the person exclusively or partly as his place of residence.

Self-education expenses s. 12(1)(e) The maximum amount allowable or self-education expenses is HK$60,000, with effect from the year of assessment 2007/08. With effect from the year of assessment 2004/05 ‘expenses of self-education’ means expenses paid by the taxpayer as: x Fees, including tuition and examination fees, in connection with a prescribed course of education undertaken by the taxpayer; or x Fees in respect of an examination set by education provider, or by a trade, professional or business association or its members, and undertaken by the taxpayer to gain/maintain qualifications for use in any employment But does NOT include: x Expenses for which a deduction is allowable in any year of assessment under any other provision of the IRO; or x Expenses to the extent to which they have been reimbursed to the taxpayer by the employer/any other person, unless the reimbursement has been/will be included in the assessable income of the taxpayer QP Module D (Feb 09) – Essentials

Under s. 26F, if the person entitled to the deduction has no income chargeable to tax that year of assessment, his/her spouse may be nominated to claim the deduction for that year of assessment. A person may claim deduction of home loan interest for ten years of assessment. The maximum amount allowable in each year of assessment is HK$100,000. Contributions to recognized retirement schemes s. 26G The amount of deduction allowable shall be the smallest of the following three amounts: x x x

HK$12,000 contributions paid by the taxpayer as an employee to the scheme; or mandatory contributions that the taxpayer would have been required to pay as a participant in a MPF scheme

QP Module D (Feb 09) – Essentials

ESSENTIALS

Personal Allowances

The progressive rates are as follows:

The following are the personal allowances:

2003/04

Year of assessment

2003/04

2004/05

Section 28 29 31

HK$ 104,000 208,000 30,000 30,000 -

HK$ 100,000 200,000 30,000 30,000 -

30/30A

30B 31A 32

Allowance Basic allowance Married person’s allowance Child allowance – 1st to 2nd (each) - 3rd to 9th (each) - for each child born during the year Dependant parent/grandparent allowance (each) - 60 or eligible for Government’s Disability Allowance Scheme -55 to 59 Additional dependant parent /grandparent allowance (each) - 60 or eligible for Government’s Disability Allowance Scheme -55 to 59 Dependant brother/sister allowance (each) Disabled dependant allowance (each) Single parent allowance (irrespective of the number of children being maintained)

2005/06 to 2006/07 HK$ 100,000 200,000 40,000 40,000 -

2007/08

2008/09

HK$ 100,000 200,000 50,000 50,000 50,000

HK$ 108,000 216,000 50,000 50,000 50,000

30,000

15,000

30,000

First HK$32,500 Next HK$32,500 Next HK$32,500 Balance

2% 7.5% 13% 20%

2004/05 & 2005/06 First 2% HK$30,000 Next 8% HK$30,000 Next 14% HK$30,000 Balance 19%

2006/07 First HK$30,000 Next HK$30,000 Next HK$30,000 Balance

2007/08 2%

First HK$35,000 Next HK$35,000 Next HK$35,000 Balance

7% 13% 19%

30,000

15,000 30,000

60,000

104,000

100,000

108,000

Assessable income Less: Allowable outgoings and expenses (s. 12(1)(a)) Depreciation allowances (s. 12(1)(b)) Losses brought forward (s. 12(1)('c) Allowable outgoings and expenses/depreciation allowances of a spouse not fully utilised (s. 12(1)(d)) * Self-education expenses (s. 12(1)(e)) Net assessable income Less: Concessionary deductions: Approved charitable donations (s. 26C) ** Elderly residential care expenses (s. 26D)*** Home loan interest (s. 26E) Contribution to recognised retirement schemes (s. 26G) Personal allowances

Computation of Salaries Tax Lump sum payment on cessation of employment or deferred pay s. 11D(b)(i) – within two years after the end of the year of assessment in which a lump sum payment on cessation of office/employment, termination of employment contract or deferred pay was received, application in writing can be made to have that lump sum payment related back for a period of: x 36 months; or x actual period of employment whichever is shorter. The lump sum payments that may be related back are: x lump sum payment or gratuity granted upon retirement or termination of office/employment or contract of employment; or x lump sum payment of deferred pay or arrears of pay

7% 12% 17%

First HK$40,000 Next HK$40,000 Next HK$40,000 Balance

2% 7% 12% 17%

A salaries tax computation schedule is as follows: A B C D E F G H

30,000

2008/09

K L M N P R

Net chargeable income Tax thereon: Lower of: I) Standard rate x (H-P); and ii) T at progressive tax rates * Under joint assessment ** Limited to 35% (or 25% for years of assessment 04/05 to 07/08) of (A-B-C) *** Not to be claimed if Dependant Parent Allowance in respect of the same parent has been granted

S T

Salaries Tax Computation Salaries tax is the lower of: x net assessable income less allowable deductions, charged at the standard rate; or x net assessable income less allowable deductions and personal allowances, charged at progressive rates.

QP Module D (Feb 09) – Essentials

ESSENTIALS

Husband and wife Unless joint assessment under s. 10(2) is made, salaries tax will be payable on the net chargeable income of each spouse.

CHAPTER - 6

An election under s. 10(2) may be made if: x either the husband or wife is entitled to concessionary deductions under Part IVA and personal allowances under Part V which, in aggregate, are in excess of his/her net assessable income ; or x lower tax will be payable on their aggregate income under joint assessment

Scope of charge – s 5(1)

Such election has to be made: x within that year of assessment or the following year of assessment; or x before expiry of one month from time when assessment or the year becomes final and conclusive under s. 70 whichever is later; or x within such further time as the Commissioner considers reasonable in the circumstances.

Year assessment Standard rate

HONG KONG PROPERTY TAX

Under s.5 of the IRO, property tax is charged for each year of assessment on the owners of any land or buildings or land and buildings situated in Hong Kong on the net assessable value at the standard rate. of

2003/04 15.5%

2004/05 to 2007/08 16%

2008/09 15%

Definition of owner – s2(1) x x x x x x x x x

A person holding directly from the Government (i.e. the Government lessee) A beneficial owner A tenant for life A mortgagor A mortgagee in possession A person with adverse title to land who is receiving rent from buildings or other structures erected on the land A person who is making payments to a co-operative society registered under the Co-operative Societies Ordinance for the purpose of the purchase thereof A person who holds land or buildings subject to a ground rent or other annual charge; and An executor of the estate of an owner

Exemption The following owners of property are exempt from property tax: x Government x Consular (for property used for consular purposes or residence of consular employee) x Charitable bodies x Corporations carrying on business in Hong Kong (with rental income chargeable to profits tax)* x Those with exemptions granted by the Chief Executive in Council * If the owner is a corporation, it can apply in writing to the Commissioner for exemption from Property Tax under s 5(2)(a) of the IRO if its rental income is chargeable to Profits Tax. Once the exemption is granted, the corporation must inform the Commissioner of any change in ownership or change in use of the property within 30 days after the change.

QP Module D (Feb 09) – Essentials

ESSENTIALS

Assessable value of land or buildings or land and buildings x s. 5B(2) Consideration payable in money’s worth in respect of the right to use land/buildings

Allowable deductions under property tax

Bad debts

s. 5B(6) Includes any consideration payable in respect of the services/benefits in connection with the use of the property

provisions

any

Statutory outgoings

A deposit with the landlord for any possible damages to the premises and refundable upon termination of the lease is NOT a consideration chargeable for property tax. Any consideration previously deducted as irrecoverable and recovered during any year of assessment shall be treated as consideration payable in that year of assessment (i.e. taxable in year of recovery). A tenant may also be required to pay a lump sum payment (i.e. a premium) in addition to the monthly rent in order to obtain a lease of property in Hong Kong. The premium is not refundable to the tenant upon termination of the lease. Premium refers to the consideration payable in respect of a period of the right of use that is not contained within any one year of assessment. Premium shall be deemed to be payable in equal monthly instalments either: x during the period of the right of use; or x during a period of three years commencing at the start of the period of the right of use to which the consideration relates, whichever is shorter.

Conditions If owner agrees to pay the rates, the rates paid by him are deductible from the assessable value Any consideration proved to the satisfaction of the assessor as irrecoverable during the year of assessment is deductible. If there is no or insufficient assessable value for deduction, the amount of unrelieved bad debts can be deducted from the assessable value in the latest year of assessment in which the assessable value is sufficient.

Assessable value includes: ¡ Rent ¡ Any payments for right of use ¡ Lump sum premium ¡ Service charge, management fee paid to owner ¡ Owner's expenditure borne by the tenant ¡ Recovered irrecoverable rent ¡ Deduction of irrecoverable rent

QP Module D (Feb 09) – Essentials

Allowable deduction Rates

There is a notional deduction for repairs and outgoings of 20% of the assessable value after deduction of any rates agreed to be borne and paid by an owner. Actual expenses incurred on repairs and maintenance are ignored for tax purposes.

Property tax computation The following is a general format of a property tax computation: HK$ Consideration receivable A Premium (related to that year of assessment) B Bad debt recovery C D Less: Bad debts E Unrelieved bad debts (bought from subsequent year(s) of assessment) F Assessable value G Less: Rates paid by the owner

H J

Less: Statutory outgoings (20% of J) Net assessable value Tax thereon at standard rate (L x tax rate)

K L M

Note: Actual expenses incurred by the property owner are ignored by statute. Only a notional amount (20% on assessable value less rates) of statutory outgoings is allowable.

QP Module D (Feb 09) – Essentials

ESSENTIALS

CHAPTER – 7

Time limit for election for personal assessment

PERSONAL ASSESSMENT

Application for personal assessment must be made in writing and lodged with the Commissioner within: x two years after the end of the year of assessment in respect of which the election is made; or x one month after an assessment of income or profits forming part of individual’s total income for such year of assessment becomes final and conclusive under s.70; or x such further period, if any, as the commissioner may allow as being reasonable in the particular circumstances, whichever is later.

Definition and meaning Personal assessment is an alternative method of computing the tax liability of an individual (and spouse) by aggregating that individual’s (and spouse’s) taxable income under property tax, salaries tax and profits tax. Persons who may elect for personal assessment 1. General criteria Personal assessment may be elected by: x An individual x Aged 18 or above, or under that are if both parents are dead; and x Either a permanent or temporary resident in Hong Kong, or if he/she is married, whose spouse is either a permanent or temporary resident Permanent resident means an individual who ordinarily resides in Hong Kong. Temporary resident refers to an individual who stays in Hong Kong for more than: x 180 days during the year of assessment in respect of which the election is made; or x 300 days in two consecutive years of assessment, one of which is the year of assessment in respect of which he desires for personal assessment 2. Husband and wife

Personal Assessment Computation The benefits from electing for personal assessment are likely to be derived from the following deductions: x interest incurred on money borrowed for the purpose of producing property income (the amount deductible should not exceed the net assessable value of each individual property) x approved charitable donations x elderly residential care expenses x home loan interest x business losses incurred in the year of assessment x losses brought forward from previous years under Personal Assessment; and x personal allowances However, depending on the individual’s circumstances, personal assessment may not always be beneficial.

Where an individual is married and not living apart from his spouse and both that individual and his spouse: x have income assessable under the IRO; and x are eligible to make an election for personal assessment then that individual may not make an election for personal assessment unless his spouse does as well. 3. Deceased taxpayer For a deceased taxpayer who was eligible to elect for personal assessment, his/her executor shall have the same right to elect for personal assessment on the total income as the deceased would have had if he/she was alive.

QP Module D (Feb 09) – Essentials

ESSENTIALS

CHAPTER- 8

Deemed trading receipts

NON-RESIDENTS Definitions and meaning: A non-resident is a person who has no permanent business presence in Hong Kong. Permanent establishment means a branch, management or other place of business and includes an agency only if the agent habitually exercises a general authority to negotiate and conclude contracts on behalf of his principal. Scope A non-resident may be liable to property tax, salaries tax or profits tax if he has income arising in Hong Kong falling within the scope of charge of these three taxes. Methods of Assessment The three alternative methods of assessing a non-resident’s liability to tax in Hong Kong include: x s. 20A – Direct assessment on the non-resident person x s. 20A – Assessment raised in the name of the non-resident person’s agent in Hong Kong x s. 20B – Assessment raised in the name of any person who has directly/indirectly paid/credited a non-resident person for royalties or license fees or who is an entertainer or sportsman who has performed in Hong Kong A person who is chargeable to tax on behalf of a non-resident is required to deduct a sum, sufficient to meet the non-resident’s tax liability in Hong Kong, at the time he pays or credits the non-resident. Provisions concerning non-residents

Section

Scope

15(l)(a), (b) and (ba) 20

Deemed trading receipts

20A

Goods on consignment

20B

Business with closely connected residents

s.20 deems the business done by the non-resident to be carried on in Hong Kong and the profits arising therefrom are to be taxed in the name of the resident person as if the resident were the agent of the non-resident.

Stockbroker and approved investment advisers not to be treated as agents of non-residents Withholding obligation on resident paying or crediting certain payments to non-residents

Assessment by using a fair percentage of turnover

21A

Assessable profits from deemed trading receipts

QP Module D (Feb 09) – Essentials

A non-resident person who does not carry on any trade, professions or business in Hong Kong may still be chargeable for profits tax in respect of the following: x s. 15(1)(a) – Sums not otherwise chargeable to profits tax, received/receivable from the exhibition/use in Hong Kong of o cinematograph or television film or tape o any sound recording o any connected advertising material x s. 15(1)(b) – Sums not otherwise chargeable to profits tax received/receivable for the use/right to use in Hong Kong any o patent, design, trademark, copyright material, secret process or formula or other property of similar nature, or o for imparting knowledge directly/indirectly connected with the use in Hong Kong of the above x s. 15(1)(ba) – Sums not otherwise chargeable for profits tax, received/receivable for the use/right to use outside Hong Kong any o patent, design, trademark, copyright material, secret process or formula or other property of similar nature, or o for imparting knowledge directly/indirectly connected with the use in Hong Kong of the above which are deductible in ascertaining the assessable profits of a person under profits tax.

Under s.20 of the IRO, a person is closely connected with another person where the Commissioner considers that: x such persons are substantially identical or x such persons are ultimately owned (directly or indirectly) by the same beneficial interest.

Specific sections in the IRO

20AA

ESSENTIALS

Goods on consignment Under s.20A, when an agent sells goods in Hong Kong on behalf of a non-resident person, he must furnish quarterly returns to the commissioner showing the gross proceeds from the sales. The agent is also required to pay 1% of the sale proceeds to the Commissioner. (In practice, only 0.5% is payable). The agent must also retain an amount from the assets in the agent’s possession that is sufficient to meet the tax liability of the principal.

QP Module D (Feb 09) – Essentials

ESSENTIALS

Stockbroker and approved investment advisers not to be treated as agents of non-residents s.20AA(1) excludes stockbrokers and approved investment advisers from potential profits tax liability as agents in respect of securities trading and investments profits derived by the non-residents for whom they act. s.20AA(1) applies in the following cases: Transaction through broker: x the taxable profits consist of profits arising from a securities transaction carried out through the broker x at the time of the transaction, the broker was carrying on the business of a broker x the transaction was carried out by the broker for the non-resident person in the ordinary course of business x the remuneration received by the broker for the services provided was at a rate not less than customary for the class of business x the broker is not the agent of the non-resident under s. 20AA in respect of any other profits chargeable to tax in the same year of assessment x the broker was not an associate of the non-resident person Transaction through approved investment adviser: x the taxable profits consist of : o gains/profits arising from the sale/disposal/redemption on maturity/presentation of securities o gains/profits under a foreign exchange contract or futures contract o interest x at the time of the transaction, the approved investment adviser was carrying on business of an approved investment adviser x the transaction was carried out by the broker for the non-resident person in the ordinary course of business x the remuneration received by the broker for the services provided was at a rate not less than customary for the class of business x the broker is not the agent of the non-resident under s. 20AA in respect of any other profits chargeable to tax in the same year of assessment x the broker was not an associate of the non-resident person x the approved investment adviser, when he acted or the non-resident did so in an independent capacity

QP Module D (Feb 09) – Essentials

ESSENTIALS

Offshore Funds Exemption Exemption provisions: Under s.20AC, a “non-resident person” who only carries on a trade, profession or business in Hong Kong involving “specified transactions” (including transactions incidental to the carrying out of the specified transactions) through or arranged by “specified persons” is exempt from profits tax in respect of profits derived from the “specified transactions” “Non-resident person” means: 1) For an individual x Not ordinarily resides in Hong Kong; OR x Stays in Hong Kong for less than 180 days during the relevant year of assessment or less than 300 days in 2 consecutive years of assessment, one of which is the relevant year of assessment 2) For a non-individual entity (like corporation) x Central management and control outside Hong Kong “Specified transactions” includes: x A transaction in securities x A transaction in future contracts x A transaction in foreign exchange contracts x A transaction consisting in the making of a deposit other than by way of money-lending business x A transaction in foreign currencies x A transaction in exchange-trade commodities “Specified person” means: x In relation to a transaction carried out on or after 1 April 2003, a corporation licensed or an authorized financial institution registered under the SFO, Chapter 571 for carrying on a business in any regulated activity within the meaning of the SFO. Deeming provisions: A Hong Kong resident person who 1) alone or jointly with his associates, holds direct and/or indirect beneficial interest of 30% or more in a tax-exempt offshore fund, or 2) holds any percentage in a tax-exempt offshore fund if the tax-exempt offshore fund is his associate, will be deemed to have derived assessable profits in respect of the trading profits earned by the offshore fund from specified transactions and incidental transactions.

QP Module D (Feb 09) – Essentials

ESSENTIALS

Withholding obligation on resident person paying or crediting certain payments to non-residents s. 20B imposes a withholding obligation on the resident person who pays/credits a nonresident the following sums: x sums chargeable under s15(1)(a), s15(1)(b) or s15(1)(ba) x sums derived from a performance given in Hong Kong by a non-resident entertainer/sportsman The amounts to be withheld are as follows: Situation Sums taxable under s.15(1)(a), s.15(1)(b), or s.15(1)(ba) Sums payable for performance of a nonresident sportsman/entertainer in connection with a commercial occasion or event

Tax to be withheld on behalf of nonresident person Standard rate or 16.5% on 30% or 100% of the sums Standard rate or 16.5% on 2/3 of the sums

ESSENTIALS

CHAPTER - 9 GENERAL INTRODUCTION TO TAX PLANNING Meaning Tax planning includes: x tax avoidance (i.e. minimization of tax liability); and x tax deferral (i.e. delaying tax payment) Tax planning involves the legitimate arrangement of a taxpayer’s affairs. It is a management function. Tax evasion, is an offence punishable by a fine and/or imprisonment and involves: x deliberate non-lodgement of a return x deliberate understatement of income or over-claiming of deductions; x understatement of income or over-claiming deductions due to ignorance of taxation obligations; and x overly aggressive tax planning Anti-avoidance provisions under the IRO The major anti-avoidance provisions under the IRO are as follows:

Assessment by fair percentage of turnover

Certain transactions and dispositions to be disregarded – s.61

Under s. 21 of the IRO, where it is difficult to determine the true assessable profits of a non-resident person, it may be computed on the basis of a fair percentage of turnover of the trade or business in Hong Kong.

Where an assessor is of the opinion that any transaction reduces/would reduce the amount of tax payable is artificial/fictitious, he may disregard any such transaction and the person shall be assessed accordingly.

Assessable profits from deemed trading receipts under s.15(1)(a), s.15(1)(b) or s.15(1)(ba)

Transactions designed to avoid liability to tax – s.61A

Under s. 21A, the assessable profits from deemed trading receipts are deemed to be either 30% or 100% as follows: Situation Payment is made by an associate and the intellectual property was previously owned by a person carrying on business in Hong Kong Other cases

QP Module D (Feb 09) – Essentials

Deemed profits 100%

30%

When a transaction is entered into, having regard to the following criteria, for the sole or dominant purpose of obtaining a tax benefit on a person, the assessor may disregard the transaction and raise assessment to the person accordingly. The criteria are: x The manner in which the transaction was entered into or carried out x The form and substance of the transaction x The result that would have been achieved by the transaction x Any change in financial position that is reasonably expected to result from the transaction x Any change in financial position of a person who is connected to the relevant person, being a change that may be reasonably expected to result from the transaction x Whether the transaction has created rights/obligations not normal in an arm’s length transaction x The participation in the transaction of a corporation resident or carrying on business outside Hong Kong

QP Module D (Feb 09) – Essentials

ESSENTIALS

The Assistant Commissioner has the powers to raise an assessment on the relevant person as follows: x As if the transaction/or any part had not been entered into; or x In such other manner as he considers appropriate to counteract the tax benefit which would otherwise be obtained. Utilisation of losses to avoid tax – s. 61B The Commissioner shall disallow the set-off of any loss or balance of loss if he is satisfied that: x Any change in the shareholding as a direct/indirect result of which profits have been received has been effected by any person after 13 March 1986; and x The sole purpose of the change was for utilizing any loss sustained by the corporation, in order to avoid liability for the payment of tax or reduce the amount thereof. Remuneration under certain agreements treated as income derived from an employment of profit – s. 9A

ESSENTIALS

Liability of certain non-resident persons – s. 20 s. 20 applies on the following transactions between a resident and a non-resident: x The resident and the non-resident are closely connected x There are no profits or les than ordinary profits for the resident person Where s. 20 applies, the IRD will deem the non-resident person’s business as business carried on in Hong Kong and assess the non-resident person as if the resident were the non-resident’s agent. The resident and the non-resident are regarded as closely connected if: x The Commissioner considers that they are substantially identical; or x The ultimate controlling interest of each is owned/deemed to be owned by the same person. Limited partner loss relief – s. 22B s. 22B(3) restricts the loss relief available to a limited partner of a partnership to the lesser of: x The amount of loss shared from the partnership; or x The relevant sum

s. 9A(1) applies where: x There is an agreement x Services have been carried out under the agreement by an individual and x Remuneration for the services has been paid/credited to a corporation

Commissioner’s power to determine the true value of an asset on sale – s. 38B The Commissioner has the power to determine the value of plant and machinery when disposed at a price other than the market price, in the following circumstances: x The buyer is a person over whom the seller has control; or x The seller is a person over whom the buyer has control; or x Both seller and buyer are persons over both of whom some other person has control; or x The sale is between a husband and wife, not being wife living apart.

Transfer of right to receive income – s. 15A

Depreciation allowances on leased machinery and plant – s. 39E

The consideration received by person in respect of a transfer of a right to receive income from property from that person to another person will be treated as a trading receipt.

This Section was enacted to deny depreciation allowances to the lessor of plant and machinery acquired under a contract after 13 March 1986 in the following circumstances: x The machinery or plant was acquired under a sale and leaseback transaction; or x The machinery or plant, other than a ship or aircraft is, while the lease in force: o Used wholly/principally outside Hong Kong by a person other than the taxpayer; or o The whole or predominant part of cost of acquisition/construction of the machinery or plant was financed directly/indirectly by a non-recourse debt x The machinery or plant is a ship or aircraft and o The lessee is not an operator of a Hong Kong ship or aircraft; or o The whole or predominant part of the cost of acquisition/construction of the machinery or plant was financed directly/indirectly by a non-recourse debt

This section was enacted to deter the use of service companies to disguise the true employer-employee relationships.

Commissioner’s power to determine the true value of a prescribed fixed asset on sale – s. 16G(3)(c) The Commissioner has the power to determine the value of a prescribed fixed asset when it is being disposed at a price other than the true market price in the following circumstances: x The buyer is a person over whom the seller has control; or x The seller is a person over whom the buyer has control; or x Both seller and buyer are persons over both of whom some other person has control; or x The sale is between a husband and wife, not being wife living apart from her husband

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Practical Considerations in Tax Planning

CHAPTER - 10

General planning strategies Tax planning strategies, in general, include: x Strategies, which look at the overall structure of a business entity and seek to identify the most tax-efficient organization structure and operation structure x Strategies which seek to minimise the tax consequence of a particular transaction or to defer the tax liability arising from that transaction

TAX INVESTIGATION AND FIELD AUDIT

Planning for the overall structure of a business enterprise or a group of companies Issues include: x Tax havens x Setting up a holding company x Setting up a branch or a subsidiary x Setting up a finance company x Setting up a management or service company x International transfer pricing Planning for business transactions When a person enters into business transactions, the following are relevant considerations: x Interest of the parties involved x Commercial considerations of the parties x Profit motives of the parties x Costs (including opportunity costs) involved in the transaction x Legal issues x Timing of transaction x Methods of financing the transaction x Contractual matters of the transaction x Taxation issues The following are examples of some common types of business transactions to illustrate the different ways of structuring a transaction that may have different tax consequences: x Purchase and sale of immovable property x Purchase and sale of shares or assets of a business x Buying or leasing an asset x Structure the borrowing for a development project

Meaning Investigation unit – was set up by the IRD to deter tax evasion through in-depth investigation where tax evasion was suspected. Field Audit – aimed at : x Non-lodgement of tax returns x Failure to inform the Commissioner of the chargeability for tax x Incorrect returns resulting from understatement of income and/or overstatement of deductions x Failure to keep sufficient business records x Other non-compliance offences x Over-aggressive tax planning They are aimed at tax recovery and improvement in taxpayer’s records. Scope Investigation or field audit is initiated by the IRD where characteristics or indications of non-compliance, such as the following, are present: x Qualified audit report of accounts of incorporated business x Unreasonably low turnover or profit percentage in any business x Persistent failure to lodge/late lodgement of tax returns x Failure to keep proper business records x Failure to provide material information requested by assessor Field audit cases may be selected: x By IRD officers by exercising their professional judgement and experience x On a random basis as a means of promoting voluntary compliance Other investigation and field audit cases may be initiated by information provided by the press, police or informers.

Conduct of tax investigation/field audit In conducting a tax investigation/field audit, the IRD will examine the records of the taxpayer to ascertain whether any tax is undercharged. The IRD may also contact third parties e.g. customers, bankers, auditors, solicitors etc., for additional information regarding financial affairs of the taxpayer. The steps involved in a typical field audit are as follows: 1. Pre audit notification An invitation letter is issued to taxpayer. 2. Initial interview IRD will explain the objective of tax investigation/field audit to the taxpayer and will seek information on:

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x x x

Details of day-to-day operations of the business Accounting and bookkeeping procedures Details of personal affairs of taxpayer and associated persons

Taxpayer’s attitudes towards a tax investigation/field audit

After the initial interview, the IRD will send a copy of the meeting notes to the taxpayer for his review and confirmation. 3. Field visit and examination of books and records After collecting information on business operations and details of accounting records, the IRD will carry out the basic audit work such as vouching, casting ratio analysis and projection of profit/income. Then a more detailed audit is undertaken. 4. Post audit meeting The IRD will identify the basis of settlement using the following methods (nonexhaustive) to quantify the amount of tax undercharged: x Direct quantification, if the taxpayer’s books and records are reliable x Assets Betterment Statement (ABS) or net worth method x Bank deposits method x Profit percentage method x Reconstruction of accounting records The taxpayer is allowed to examine the finding of the IRD and provide feedback on the settlement basis. Final settlement is signed by the taxpayer to confirm his acceptance. 5. Assessments or additional assessments If there is an agreed settlement basis, the IRD will issue assessment or additional assessments based on the agreed discrepancy. If no basis of settlement is reached, the IRD will raise estimated assessments and the taxpayer’s objection is submitted to the Commissioner for determination. 6. Penal actions Penal actions will be taken in cases determined by the Commissioner or Board of Review. The Commissioner will take into account the following factors while considering penal actions: x x x x

Degree of co-operation Extent of voluntary disclosure Time span of non-compliance Other aggravating or mitigating factors

Taxpayers are advised to adopt a positive attitude to minimize the time and effort in agreeing a settlement with the IRD. To expedite an early settlement with the IRD, the taxpayer should: x Seek professional advice x Identify possible causes of the investigation/field audit x Identify process and consequences of investigation/field audit x Review business records and personal financial affairs x Identify problem areas x Prepare for initial interview with IRD with assistance from professional tax advisor x Show willingness to co-operate with IRD in the initial interview x Ensure all accounting records are readily available to IRD for inspection during the field visit x Respond promptly to IRD enquiries x Evaluate settlement proposals suggested by IRD or professional tax advisers x Propose basis of settlement to IRD x Conduct negotiations with the IRD and seek early compromise with assistance of professional tax advisers Tax representative’s role in a tax investigation/field audit Tax representatives may: x Provide professional advice on technical and procedural issues x Protect the interest of the client x Conduct preliminary review of taxpayer’s business and personal financial records x Negotiate with the IRD on the conduct of the investigation x Accompany the taxpayer to attend interviews with the IRD x Prepare replies to enquiries of IRD x Prepare proposals for settlement with the IRD x Negotiate with IRD to resolve areas of contention x Identify reasons for understatement of profits x Identify circumstances for reduced penalty x Help improve the taxpayer’s future compliance Under s. 80 (4) of the IRO, any person who aids/abets/incites another person to commit an offence under s. 80 shall be deemed to have committed the same offence and to be liable to the same penalty. Business Records

Penal actions include: x Prosecution under s. 82(1) for willful evasion x Prosecution under s. 80(2) for incorrect returns or failure to inform chargeability to tax without a reasonable excuse x Prosecution under s. 80(1) for other offence (e.g. failure to notify change of address) x Prosecution under s. 80(1A) for failure to keep proper business records x Additional tax assessments raised by the Commissioner/Deputy Commissioner personally under s. 82A

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Sufficient business records can be used to: x Satisfy legal obligations x Substantiate the returned profits of the taxpayer in a tax investigation/field audit x Provide information to management for better control of the business The business records required by statute i.e. s. 51C are as follows: x Books of account recording receipts and payments, or income and expenditure; and x Vouchers, bank statements, invoices, receipts and other documents necessary to verify the entries in the books of account QP Module D (Feb 09) – Essentials

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Other records to be kept and retained include: x A record of the assets and liabilities of the person in relation to that trade, profession or business x A record of all entries relating to all sums of money received and expended by the person in relation to that trade, profession or business x Where the trade, profession or business involves dealing in goods: o A record of all goods purchased and sold, details of sellers and buyers together with readily verifiable quantities and values of goods and all invoices relating thereto o Statements of trading stock held by the person: At the end of each year of assessment; or At the account closing date, if other than 31 March x Records of services in sufficient detail for ready verification if the trade, profession or business involves provision of services Rights of taxpayers The taxpayers are entitled to the following rights: x Payment of only the amount of tax due under the law x Courteous treatment in their dealings with the IRD x Receive service of IRD in a timely manner in accordance with their pledged standards x Assistance from IRD to help them understand and meet their tax obligations x Expect IRD to act in an impartial, professional and fair manner x Expect that information provided to IRD will be confidential unless if authorized by law x Access their own tax information held by the IRD as permitted by law x Service of IRD in Chinese or English, at their choice x Comment and complain to the IRD about their service x Object and appeal if they disagree with the amount of tax assessed Obligations of taxpayers The taxpayers have the following obligations: x They should be honest in their dealings with the IRD x They should file correct returns and documents and provide complete and accurate information within time limits specified x They should pay their tax due on time x They should keep sufficient records to enable their tax liability to be ascertained accurately x They should keep the IRD informed upon change of business or correspondence address

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CHAPTER - 11 TAX COMPLIANCE AND TAX ADVISORY Tax Compliance within An Organization The compliance work of an organization will largely depend on its size and the nature of its business. General tax compliance issues of an organization include: 1.

Profits tax filing

Profits tax returns Form BIR 51 for a corporation, Form BIR 52 for a business other than corporation are issued by the IRD on 1 April each year. Depending on the accounting date of the business, returns have to be completed and filed with the IRD within the time limit as follows: Accounting date 1 Apr – 30 Nov 1 Dec – 31 Dec 1 Jan – 31 Mar

Code N D M

Tax filing deadline 30 April (no extension) 15 August 15 Nov (further extension to 31 Jan for tax loss cases)

Except for small corporation/business, the profits tax return has to be filed with: A certified copy of the Balance Sheet, Auditors report (for corporation) and Profit and Loss Account A tax computation showing how the Assessable Profits/adjusted Loss is arrived at; and Sufficient supporting schedules and explanatory notes on exceptional and material items Though the small corporation/business is exempt from submitting supporting documents, these should be prepared before the return is completed. 2. Application for exemption to property tax Application can be made in property tax returns Form BIR 57. When no application is made, any property tax paid by the company may be used to offset the company’s profit tax liability under s. 25 of the IRO. When a change in ownership/use of property/circumstances affecting exemption exists, corporations exempted from property tax should inform the Commissioner of the change within 30 days after the event.

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3. Salaries Tax filing

transactions/operations. Failure to maintain proper records may be penalized by a fine at HK$100,000.

The IRD issues employers’ returns Form BIR 56A and Form IR 56B on 1 Aril each year. These have to be completed and submitted by the end of April.

Business records include: Records of assets and liabilities Records of trading stocks Records of receipts and revenue Records of payments and expenses Records of bank accounts Records of depreciation allowances

An employer also needs to submit the following returns: Return Employer’s Return on commencement of employment Employer’s Return on cessation of employment Employer’s Return in respect of an employee who is about to leave Hong Kong

Form IR 56E IR 56F IR 56G

Time limit Three months from date of commencement of employment One month before date of cessation of employment One month before date of departure

The IRD may accept shorter notice if there is a reasonable cause. For non-compliance offence without a reasonable excuse, the maximum penalty is a fine at HK$10,000 and the Court may grant an order requesting employer to submit return within the time specified in the order. 4. Recording tax liability and arranging payment of tax It is important for a business to record tax liability and make proper arrangements for payment of tax. Late payment may give rise to 5% and 10% surcharges and recovery actions through district courts. The making of a provision of profits tax in accounting records does not mean that there is sufficient cash for the payment of tax when due. Although, tax is payable only after some time after the demand notice is received, management should plan for the impact of tax payments in their cash flow forecast. IRD encourages taxpayers to make payment of tax using Tax Reserve Certificates. 5. Providing further information as required by the tax authority If any enquiries are raised by the IRD, the taxpayer will need to provide further information within the time limit specified (usually one month after the date of the notice). The enquiries may either be facts or arguments. Advice from tax professionals may be needed in such a case, with reference to judicial precedents. 6. Keeping sufficient business records Taxpayers liable to profits tax in Hong Kong need to keep sufficient business records in Chinese or English for at least seven years after completion of the QP Module D (Feb 09) – Essentials

Records need not be kept: For a corporation which has been dissolved; or If approval has been obtained from the Commissioner 7. Management of taxation work and projects Taxation work in an organization needs proper planning, implementation and evaluation. The impact of tax (including deferred tax) should be duly considered by management in planning any strategic move of the business. 8. Staffing the taxation function in an organization The taxation function in an organization is primarily carried out by the Accounting Department. Taxation work involves various aspects some of which require high degree of confidentiality and competency. The work should be assigned carefully depending on the skills needed for each job. Tax Compliance Services by Tax Representatives Tax compliance services provided by tax representatives may include: x Profits tax filing x Salaries tax filing (employer’s return and individual’s composite tax return) x Property tax filing 1. Profits tax filing The obligation to submit a correct return within the time limit always lies with the taxpayer. The taxpayer may use the services of a tax representative in completing a profits tax return. Profits tax filing by tax representatives also follows the block extension system. The IRD also requires that the returns handled by tax representatives need to be submitted in accordance with a target percentage. Time is needed to prepare tax returns and supporting tax computation schedules and obtaining approval from clients before returns are filed with IRD. After submitting the tax returns, the tax representatives may provide follow-up services such as: x Providing further information as required by the tax authority x Lodging objections against incorrect assessments x Lodging s70A claim to correct an error or omission in a tax return x Submitting a holdover application for provisional profits tax In general, the fees paid to tax representatives for profits tax filing are tax deductible.

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2. Application for exemption from property tax

CHAPTER - 12

A client’s approval of the application is obtained before the property tax return is prepared by the tax representatives.

DOUBLE TAXATION ARRANGEMENT AND AGREEMENTS

3. Salaries tax filing

1. Avoidance of Double Taxation arrangement between the HKSAR and the Mainland

Employer’s returns may be prepared by the tax representatives to preserve confidentiality. However, there is no block extension under this scheme. Individual’s composite tax returns may also be prepared by the tax representatives. The IRD usually allows an additional one month for individual’s composite tax returns handled by tax representatives. The fees paid to tax representatives by the individuals are not allowable deductions under salaries tax. If payment is made and borne by employer, it is chargeable for salaries tax as an additional emolument of the employee. However, nothing will be charged if the employer contracts with the tax representatives for the filing services of its employees and takes up the liability of the professional fees.

The HKSAR and the Mainland entered into a new arrangement for the Avoidance of Double Taxation on Income and Prevention of Fiscal Evasion on 21 August 2006. The new Arrangement extends the scope of the original Arrangement on business profits and income from personal services. It covers direct income (such as operating profits and the employment income) as well as indirect income (such ad dividends, interest and royalties). DIPN 44 (Revised) was issued in December 2006 to clarify various issues arising from the Arrangement 2006. Income from immovable properties (Article 6) Income derived by a resident of One Side from immovable property situated in the Other Side is taxable in the Other Side irrespective of whether the resident has a permanent establishment on the Other Side.

Tax Advisory Services by Tax Representatives Tax advisory services provided by tax representatives include: x Group restructuring x Acquisition and merger x Pre-listing review x Buy or lease transaction x Financial arrangements

Business profits (Article 7) The Arrangement uses the concept of a "permanent establishment" to determine where tax is to be imposed and hence addresses the issue of double taxation.

Since acquisitions, mergers, listing, group restructuring or buying a capital assets will affect the structure of the business enterprise, the advisory fees are therefore of a capital nature and not deductible for tax purposes. Advisory fees on short term financing arrangements (including a lease) are generally allowable as the arrangements will only have a temporary impact on the business and the fees are likely to recur. To avoid misunderstanding, tax advisers should issue tax engagements letters to clients specifying the scope of the tax advisory work. A tax advisor should communicate effectively with both the IRD and his clients.

Profits of an enterprise of One Side shall be taxable only in that Side unless the enterprise carries on business in the Other Side through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in that Other Side, but only so much of them as is attributable to the permanent establishment. Dividends (Article 10) For dividends received by a Hong Kong resident from the Mainland will be reduced to 5% if the Hong Kong business holds at least 25% of the capital of the Mainland enterprise. In all other cases, a 10% rate is applied. Interest (Article 11) For interest received by a Hong Kong resident and a Hong Kong business from the Mainland will be reduced to 7%.

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Royalties (Article 12) Income arising from use or right to use of cinematographic or television file or tape, patent copyrights, trademark etc paid by a Chinese entity to a Hong Kong entity will be subject to a 7% withholding tax on the gross amount in Hong Kong.

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The new Arrangement allows taxation authorities of Both Sides to exchange such information as is necessary for carrying out the provisions of the new Arrangement or of the domestic laws of Both Sides concerning taxes covered by the new Arrangement. 2. Avoidance of Double Taxation Agreement between the HKSAR and Belgium

Capital Gains (Article 13) The taxing right is allocated to Hong Kong if a Hong Kong company disposes of less than 25% equity interest in a mainland company and the assets of that company are not mainly immovable properties situated on the mainland. Since Hong Kong does not tax capital gains, the effective tax rate is 0%. For all other cases, the taxing right is allocated to the mainland. The withholding tax rate is 10%. Summary: New tax rates on passive income: Dividend Interest

Mainland-HK tax treaty rate Mainland nontreaty rate

Royalty

5% or 10%

Capital gain on disposal of equity interest 0% or 10%

10%*

10%

*under the prevailing mainland tax regime, dividends paid by a foreign investment company to its foreign investor are currently exempt from withholding tax. Should the exemption be withdrawn, dividends paid to foreign investors may be subject to the original tax rate of 10%.

The HKSAR signed its first comprehensive agreement with Belgium on avoidance of double taxation on 10 Dec 2003. The agreement requires ratification before it becomes effective. Once ratified, the arrangement would become effective retroactively, as follows: Country Type of taxes Effective from Belgium Withholding and capital On or after 1 Jan 2004 taxes Other taxes Hong Kong

Taxable period beginning on or after 1 Jan 2004 Years of assessment beginning on or after 1 April 2004

All taxes

The Agreement specifies the allocation of taxing rights between the HKSAR and Belgium and specifies methods for elimination of double taxation where income has been doubly assessed.

Employment income (Article 14) Employment income derived by a resident of One Side is taxable in that Side unless the employment is exercised in the Other Side. Remuneration derived by resident of One Side in respect of employment exercised in the Other Side will be exempt from tax in the Other Side provided that: (1)

(2) (3)

the taxpayer stays in the Other Side for a period or periods not exceeding in the aggregate 183 days in any 12-month period commencing or ending in the taxable period concerned; the remuneration is paid by or on behalf of an employer who is not a resident of the Other Side; and the remuneration is not borne by a permanent establishment which the employer has in Other Side.

Methods of elimination of double taxation (Article 21) Taxes paid on One Side shall be allowed as a credit against taxes payable on the Other Side in respect of the same item of income. However, the amount of tax credit shall not exceed the amount of tax computed in respect of that income in accordance with the taxation laws and regulations of the resident’s home jurisdiction. Exchange of Information (Article 24)

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The Belgian withholding tax on royalties will be reduced to 5% if the gross amount of royalties, whereas the Belgian withholding tax on interest will be reduced from the current 15% to 10% of the gross amount under the Agreement. Profits from international shipping transport earned by Hong Kong residents that arise in Belgium (which are currently subject to income tax in Belgium) will enjoy exemption under the Agreement. 3. Avoidance of Double Taxation Agreement between the HKSAR and Thailand The HKSAR signed a comprehensive agreement with Thailand on avoidance of double taxation on 7 September 2005. Under the Agreement, income or profits of an enterprise of a contracting party derived in the other contracting party from the operation of ships in international traffic may be taxed in the other contracting party but the tax so charged shall be reduced by an amount equal to 50% thereof. The withholding tax on dividend shall not exceed 10% of the gross amount of the dividends. Withholding tax on interest shall not exceed (10%-15%), withholding tax on royalties shall not exceed (5% to 15%).

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4. Avoidance of Double Taxation Agreement between the HKSAR and Luxembourg On 2 November 2007, the HKSAR signed a comprehensive agreement with Luxembourg on avoidance of double taxation. The Agreement with Luxembourg will come into effect in Hong Kong starting from the year of assessment 2008/09 after ratification on both sides. Income or profits of an enterprise of a contracting party derived in the other contracting party from the operation of ships or aircrafts in international traffic shall only be taxed in that contracting party. In general, withholding tax on dividend shall not exceed 10% of the gross amount of the dividends. No withholding tax is charged on interest. The withholding tax on royalties shall not exceed 3%. 5. Avoidance of Double Taxation agreement between the HKSAR and Vietnam On 16 December, 2008, Hong Kong has signed an Agreement with Vietnam for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income. The Agreement eliminates the uncertainty of tax liability for the investors and traders of both economies and creates a more favourable bilateral business environment. The agreement will come into force after completion of ratification procedures for both sides.

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