THE ADVANCED DIPLOMA IN INTERNATIONAL TAXATION June 2008 PAPER IIC HONG KONG OPTION ADVANCED INTERNATIONAL TAXATION TIME ALLOWED 3¼ HOURS You should answer FOUR out of seven questions. Each question carries equal marks. Start each answer on a new sheet of paper. All workings should be made to the nearest month and dollar unless the question requires otherwise. Marks are specifically allocated for presentation.
Tax Rates and Allowances Tax Rates 2006/07 2007/08 Standard rate 16% 16% Corporation profits tax rate 17.5% 17.5% Progressive rates First $30,000 (06/07) 2% First $35,000 (07/08) 2% Next $30,000 (06/07) 7% Next $35,000 (07/08) 7% Next $30,000 (06/07) 13% Next $35,000 (07/08) 12% Remainder 19% 17% Personal Allowances $ $ Basic 100,000 100,000 Married person s 200,000 200,000 Child (For each dependent) the 1 st and 2 nd child 40,000 50,000 the 3 rd to 9 th child 40,000 50,000 additional allowance in the year 50,000 of birth Dependent parent/grandparent (each) Basic (aged 60 or above) 30,000 30,000 Additional (aged 60 or above) 30,000 30,000 Basic (aged 55 to 59) 15,000 15,000 Additional (aged 55 to 59) 15,000 15,000 Dependent brother/sister (each) 30,000 30,000 Single parent 100,000 100,000 Disabled dependent (each) 60,000 60,000 Concessionary Deductions Self-education expenses (maximum) 40,000 40,000 Home loan interest (maximum) 100,000 100,000 Elderly residential care expenses (maximum) 60,000 60,000 Contributions to Mandatory Provident Fund (maximum) 12,000 12,000 Stamp Duty rates (2007/08) Head 1(1) and Head 1(1A) Consideration (round up to nearest $1) Rate Up to $2,000,000 $100 $2,000,001 - $2,176,470 $15,000 + 10% of excess over $2,000,000 $2,176,471 - $3,000,000 1.50% $3,000,001 3,290,320 $45,000 + 10% of excess over $3,000,000 $3,290,321 - $4,000,000 2.25% $4,000,001 - $4,428,570 $90,000 + 10% of excess over $4,000,000 $4,428,571 $6,000,000 3% $6,000,001 - $6,720,000 $180,000 + 10% of excess over $6,000,000 Over $6,720,000 3.75% Head 1(2) Term of lease Not defined or uncertain Not exceeding 1 year Between 1 to 3 years Exceeding 3 years Rate 0.25% of yearly or average yearly rent 0.25% on total rent payable over lease term 0.5% on yearly or average yearly rent 1% on yearly or average yearly rent D/ADIT/EP/2008/HK 2
Head 2(1) Nature of Document Rate Contract Note for sale or 0.1% of the amount of the consideration or purchase of any Hong Kong of its value on every sold note and every stock bought note Transfer operating as a $5 + 0.2% of the value of the stock sold voluntary disposition inter vivos Transfer of any other kind $5 D/ADIT/EP/2008/HK 3
1. Tiger Inc. (Tiger) is a US based company and is principally engaged in the business of manufacturing and trading of toys. It has set up a trading company in Hong Kong, Cat Ltd (Cat) to serve customers in South East China. Tiger acted as the sales agent of Cat and sent two sales managers travelling around the South East China region to solicit orders for and on behalf of Cat from non-hong Kong clients, while Cat has hired four sales managers to serve Hong Kong clients. The sales managers negotiate and conclude contracts with clients at the clients offices. Cat and a PRC entity have set-up a joint venture company in Shenzhen, China to perform all the production functions. Cat purchased raw materials from suppliers in Taiwan, Hong Kong and Malaysia and sold raw materials to the joint venture at cost. Cat would then purchase finished goods back from the joint venture at a price equal to all production costs incurred by the joint venture together with the pre-agreed subcontracting fee that should be earned by the joint venture. Cat s office in Hong Kong employed around 30 staff members and was comprised of three divisions: Finance and Accounting Division, Procurement Division and Marketing Division. All products would be delivered from the joint venture to customers directly. The logistics of transportation were handled by the joint venture. Mr William was seconded from Tiger to Cat to oversee the latter s operation. Apart from the two procurement officers who were required to travelled to the Shenzhen factory around one to two days every month, all staff members principally worked in Hong Kong. Tiger has set the operation parameters for the Hong Kong office, in particular the range of purchase prices within which Cat could place orders without referring back to Tiger. Cat might sometimes need to seek Tiger s approval when the suppliers proposed prices or terms outside the normal parameters. Cat paid a royalty fee to Tiger for the right to use Tiger s patent in manufacturing and selling of the products in the South East China region. The patent was affixed on the products by the joint venture in Shenzhen. Approximately 70% of Cat s products were sold in Hong Kong, the balance 30% was sold outside Hong Kong. The royalty fee was charged at 3% of Cat s annual sales. It is planned that the arrangement of payment of royalty fee to Tiger will be terminated by the year of assessment 2009/10. After the termination of the arrangement, Cat will purchase the patent from Tiger. You are required to: 1) Comment on the Hong Kong Profits Tax implications in respect of Cat s profits derived from sale of goods manufactured in China. (7) 2) State the general rules for ascertaining taxability of royalty fees in respect of different kinds of intellectual properties received by a non-hong Kong resident person/company. Discuss the tax implications of the payment of the royalty fee to Tiger. (15) 3) Discuss the tax implications of the acquisition of the patent from Tiger. (3) D/ADIT/EP/2008/HK 4
2. 1) Lion Ltd (Lion) was a Hong Kong based company principally engaged in the business of trading of garments. Lion s profits and loss account for the year ended 31 December 2006 shows the following items: (a) (b) (c) (d) Contribution of shares worth $2 million for setting-up a Mandatory Provident Fund. Provision for annual contribution to the Mandatory Provident Fund of $200,000. Compensation received for early termination of the tenancy agreement of a retail shop amounting to $200,000. Bad debt of $200,000, which represents a write-off of the deposit of trade receipts with a bank in Hong Kong. Fixed assets expenses: (i) Replacement of office windows of $100,000. (ii) A lease payment for office equipment of $200,000. (e) (f) Exchange loss on year end conversion of a bank deposit of a US dollar trading receipt. Building decoration expenses: (i) refurbishment of office, $1 million (ii) refurbishment of directors quarters, $200,000 You are required to comment on the deductibility/taxability of each of the above items (a) to (f). If necessary, make assumptions and identify any additional information required. (12) 2) During the year ended 31 December 2006, Lion has borrowed a loan of $20 million from a bank in New York to finance purchase of trading stock of $5 million and construction of its office building of $15 million. The loan was secured by (i) a deposit of $10 million made with that bank and (ii) some shares which were also worth $10 million. Lion earned interest income of $400,000 from the deposit and incurred interest expense of $500,000 on the loan during the year. You are required to comment on the deductibility of the interest expense. (13) D/ADIT/EP/2008/HK 5
3. 1) A Ltd owns 90% and 80% of the issued share capital of B Ltd and C Ltd respectively. The following transactions were carried out amongst them: (a) (b) (c) (d) A Ltd transferred its property to B Ltd for a consideration of $3.2 million. The market value of the property as at the date of conveyance was $3.6million. Three months later, the property was sold by B Ltd to C Ltd for consideration of $9 million. The market value had increased to $10 million at the date of the sale and purchase agreement. C Ltd then let the property to A Ltd at a monthly rent of $50,000 for two years. A Ltd sold its entire shareholding in C Ltd to B Ltd for a consideration of $1 million. The Collector of Stamp Duty accepted the consideration was the fair market value. You are required to discuss the Stamp Duty implications of the above transactions. (6) 2) The following transactions were carried out: (a) H Ltd transferred 100,000 shares to its subsidiary S Ltd for a consideration of $500,000. Both of them are private companies incorporated in Hong Kong. H Ltd owns 80% of the issued share capital of S Ltd. The remaining 20% is owned by Mr A who beneficially owns all the issued share capital of H Ltd. (4) (b) The transfer of shares in Hong Kong listed companies in consideration of the transferee, an accountant, providing accounting services to the transferor. (4) (c) A conveyance of a flat in Hong Kong for $1 million subject to an existing mortgage of $5 million. The market value as at the date of contract for sale and purchase and the date of conveyance is $8 million and $9 million respectively. (4) You are required to evaluate the Stamp Duty implications of the above transactions. 3) Big Ltd (Big) is a Hong Kong company wholly-owned by Mrs Chan. Its business consists of holding leasehold properties for rental purposes. Small Ltd (Small) is a wholly-owned subsidiary of Big. Small is currently dormant but it has large carry-forward losses agreed by the Inland Revenue Department for Profits Tax purposes. In order to recoup the carry-forward losses incurred by Small, Mrs Chan s taxation adviser suggests that Big leases various properties to Small for one year at nominal rent of $10,000 per month. Small would then lease the properties to unrelated tenants at the market rent of $100,000 per month. At the end of the year, when it is estimated that all Small s losses would be recouped, the taxation adviser suggests that Small should then be liquidated. You are required to discuss the Hong Kong Profits Tax and Stamp Duty implication in respect of the above proposal. (7) D/ADIT/EP/2008/HK 6
4. 1) Mr Chan has been employed as chief financial officer and his monthly salary during the year ended 31 March 2008 was $250,000. In addition, his employer paid him $20,000 per month to partially reimburse his rental expense and building management fee respectively of $23,000 and $2,000 per month in respect of his residence. During the year, he paid $36,000 to his employer s mandatory provident fund. In March 2007, he paid tuition fees of $50,000 for a master degree course in financial planning, which commenced in May 2007. His employer paid a sum of $30,000 to him in December 2007 to reimburse his course fee. Mr Chan took a business trip to USA in December 2007 and his wife went with him. His employer paid a package tour fee for him and his wife in this regard at a discounted price of $50,000. The full market price for the package tour was $60,000. Mr Chan s wife received total salary of $100,000 and a sum in lieu of leave of $1,000 for the year 2007/08. A sum of $5,000 was deducted by her employer from her salary for contribution to mandatory provident fund. She has run a consultancy business which has an adjusted loss of $50,000 for the year of assessment 2006/07. Mrs Chan has not elected Personal Assessment for the year 2006/07. For the year of assessment 2007/08, the assessable profit (before set-off of loss brought forward) of the business is $100,000. Mr and Mrs Chan jointly own a property in Hong Kong and the property was let for $14,000 per month for the year ended 31 March 2008. They paid rates of $1,000 per quarter according to the tenancy. During the year, they incurred interest of $150,000 on the loan borrowed from Mr Chan s employer to finance the purchase of the property. You are required to: (a) Compute, with necessary explanation, the Salaries Tax liabilities of Mr and Mrs Chan for the year of assessment 2007/08 under separate taxation. (10) (b) Without computing the exact tax liability, advise Mr and Mrs Chan whether they should elect joint assessment for the year of assessment 2007/08 under s.10 of the Inland Revenue Ordinance. (3) (c) Without computing the exact tax liability, advise Mr and Mrs Chan whether there is any benefits for electing personal assessment for the year of assessment 2007/08. (3) 2) Mr Wong supplied you the following information relating to the year ended 31 March 2007: He was employed by Melon Ltd, a company incorporated in Singapore, as the finance manager of its branch in Hong Kong. His employment contract was negotiated and concluded in Singapore. He is required to look after the operation of Melon and its subsidiaries as well in the Asia-Pacific region. He is paid by the Hong Kong office, in Hong Kong dollars. During the year, he spent 90 working days outside Hong Kong. His salary for the year was $1 million. He has paid Income Tax in Singapore in respect of ALL of his income from employment with Melon. You are required to advise Mr Wong of his Hong Kong Salaries Tax position based on the above information. (9) D/ADIT/EP/2008/HK 7
5. Web Tube Ltd (Web Tube) was newly incorporated in Hong Kong and carries on the business of trading of CDs and VCDs via the internet. It maintains a website registered in Taiwan. To support the website, it rents a server operated by an independent internet service provider (ISP) in Taiwan. Web Tube owns an office in Hong Kong, and has three staff working at the office. Customers all over the world place orders via the internet to the server in Taiwan. The server will then process the orders, and payment from customers. After that, it will issue a note to the administrative staff in Hong Kong to follow up delivery of products from Web Tube s warehouse in Hong Kong. The server will also monitor Web Tube s stock level and if necessary, it will place orders to suppliers in Taiwan, Korea, Japan and Hong Kong. After placing orders, the server will issue an action note to the Hong Kong staff to follow-up the logistics on receipt of the products. Payments to the suppliers are also made by the server. The Hong Kong staff are also responsible for answering customers e-mail enquiries. The director of Web Tube will meet with the suppliers in Hong Kong to foster relationships and negotiate and conclude trading terms. He will also arrange necessary financing with banks in Hong Kong for Web Tube s operations. All selling prices and promotion strategies are set by the director in Hong Kong and input by the Taiwan ISP in the server as trading parameters that the server can follow. Web Tube provides the Hong Kong director, Mr Chan the following benefits in addition to his basic salary: a company car which he can use for private purposes. a company credit card for purchasing petrol for the car. a low-interest loan to purchase his flat, Mr Chan is entitled to claim a cash payment to replace the low-interest benefit. You are required to discuss: 1) The tax implications of the internet selling business of Web Tube Ltd with reference to the tax laws in Hong Kong. (14) 2) How the tax position of Web Tube Ltd would be different if the company sells e-cds and e-vcds instead of hard-copy CDs and VCDs and the website is still registered outside Hong Kong. (6) 3) The Salary Tax implications in respect of the three benefits provided to Mr Chan in addition to his basic salary. (5) 6. Aaron Ltd (Aaron) is incorporated in Hong Kong and is carrying on the business of trading of stationery products. Aaron has about 200 suppliers. Most suppliers are PRC companies with offices in Hong Kong, while a few suppliers are Hong Kong based companies. Aaron has about 100 agents to solicit customers overseas. The agents negotiate contracts on behalf of Aaron with customers overseas. The decision whether or not to accept the terms of sales is made by Aaron s Hong Kong office. Upon concluding terms of the sale contracts, customers would place orders to Aaron s Hong Kong office. Aaron would then place purchase orders to its suppliers. Goods would be delivered directly from its suppliers factories to the overseas customers. 1) You are required to discuss the taxability of Aaron s profits derived from trading of stationery products as described above. (12) 2) Assuming the Inland Revenue Department regard Aaron s profits as sourced from Hong Kong and hence taxable, suggest an arrangement to strengthen the offshore claim argument in respect of Aaron s trading profit. Your suggested arrangement should NOT involve establishing companies overseas. Moreover, you are not required to discuss the application of antiavoidance provisions to your suggested arrangements. (13) D/ADIT/EP/2008/HK 8
7. Mr Taxman has been engaged in trading of taxi licenses for many years and has derived several million of profits over the years, but he has only reported about $100,000 profits each year to the Inland Revenue Department. He just learned that one of his friends has been investigated by the Inland Revenue Department. The Inland Revenue Department took the case to court and his friend was imprisoned. Mr Taxman would therefore like to inform the Inland Revenue Department of his circumstances to rectify his tax position with the hope that such voluntary disclosure would reduce his penalty. Mr Taxman is also a property agent. During the year ended 31 March 2007, he negotiated the purchase of the following residential properties on behalf of a client, Mr Jerry Zhu, a wealthy man from China. Mr Zhu came to Hong Kong to sign the purchase and sales agreements and the conveyance documents. Property Location and Use Purchase price $ A Located in Repulse Bay and the property has 10,000,000 been left vacant B Located in Tsim Sha Tsui and the property was 7,000,000 acquired with an existing tenant. The tenancy will cease in March 2008 C Located in Kowloon Tong and the property has 12,000,000 been occupied by Mr Zhu s girl friend in Hong Kong for three months during the year D Located in Central and the property has been left vacant 5,000,000 In view of the booming property market, particularly for luxurious units like the properties Mr Zhu bought, around the end of 2007, Mr Zhu asked Mr Taxman to look for buyers as soon as possible. All properties were then sold in January to February 2008. You are required to: 1) Advise Mr Taxman what penalty and prosecution action (if any) could be taken by the Inland Revenue Department in respect of his taxi license trading activities. (10) 2) Outline the issues in relation to the Hong Kong tax exposure of Mr Zhu s property investments and his obligations under the tax ordinances if he is subject to tax in Hong Kong. (15) D/ADIT/EP/2008/HK 9