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THE HONG KONG INSTITUTE OF CHARTERED SECRETARIES THE INSTITUTE OF CHARTERED SECRETARIES AND
ADMINISTRATORS
International Qualifying Scheme Examination
HONG KONG TAXATION JUNE 2011
Suggested Answers
The suggested answers are published for the purpose of assisting students in their
understanding of the possible principles, analysis or arguments that may be identified
in each question
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SECTION A
Q1. Mr. Lee has approached you, a tax consultant, for your advice in respect of his
Hong Kong tax affairs. In a meeting on 30 May 2011 with Mr. Lee, you obtained
the following information from him:
1. Mr. Lee was born and raised in Hong Kong. During the 1990s, Mr. Lee
emigrated to the (US) and has subsequently become a US citizen.
Meanwhile, he still retains his Hong Kong permanent resident identity card,
his bank accounts and driver’s license in Hong Kong.
2. In the US, Mr. Lee was employed by Golden Gate Electronics (US) Limited,
a large multinational company based in the US, as an engineer. Golden
Gate has subsidiaries in Hong Kong and Mainland China. In order to
develop the engineering capability in Mainland China, Golden Gate
Electronics (US) Limited decided to transfer Mr. Lee to oversee the
Shenzhen factory, which is Golden Gate Electronics (US) Limited’s
subsidiary in Mainland China.
3. For administrative convenience, Mr. Lee was attached to Golden Gate
Electronics (HK) Limited, the Hong Kong subsidiary of Golden Gate
Electronics (US) Limited, because it has an experienced team of accounting
and human resources professionals.
4. The Hong Kong subsidiary issued, under its own letterhead, a Letter of
Transfer to Mr. Lee. The letter documents that Mr. Lee is to transfer to the
Shenzhen factory for the period from 1 April 2010 to 31 March 2011. The
letter also set out Mr. Lee’s salary and benefits in detail. In particular, he is
entitled to a monthly salary of HK$60,000 and a monthly overseas
allowance of HK$40,000. After deducting for the relevant PRC Individual
Income Tax (IIT), the net amount is to be paid into Mr. Lee’s bank account in
Hong Kong.
5. Due to an agreement with the Shenzhen Local Tax Bureau, Mr. Lee’s
overseas allowance is not subject to IIT.
6. Mr. Lee arrived in Shenzhen on 1 April 2010 to carry out his employment
duties. Because of the proximity between Shenzhen and Hong Kong, Mr.
Lee occasionally crosses the border and spends the weekend in Hong
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Kong. During the year ended 31 March 2011, he spent 305 days in
Shenzhen and 60 days in Hong Kong. Sometimes, he brings documents
and samples from the Shenzhen office to the Hong Kong office and vice
versa in order to save time and shipping expenses.
7. While in Shenzhen, Mr. Lee felt in love with his assistant, who also came
from Hong Kong. As a result, Mr. Lee decided that he would not go back to
US at the end of the transfer period. In February 2011, Mr. Lee tendered his
resignation and his last working day was 31 March 2011.
8. At the end of the working day on 31 March 2011, Mr. Lee came back to
Hong Kong and has been living in his girlfriend’s apartment since then.
9. In addition, Mr. Lee made some investments in Hong Kong as follows:
a) He purchased 2,000 shares in a public company listed on the Hong
Kong stock market for $40,000 in December 2010. In January 2011, he
gave all these Hong Kong shares to a Hong Kong charitable institution.
The market value of the shares at the date of gift was $25 per share.
b) He acquired a flat in Hong Kong for $7 million in January 2011. The
provisional and final agreements for sale were signed 21 days apart.
On 1 February 2011, Mr. Lee leased the apartment to a tenant on the
following terms:
(i) Lease period: 1 February 2011 to 31 January 2014.
(ii) Monthly rent of $10,000, payable on the first day of each month
starting February 2011.
(iii) Rent deposit of $20,000 payable at the start of the lease.
(iv) Premium of $20,000 payable at the start of the lease.
10. In April 2011, Mr. Lee received a letter from Golden Gate Electronics (HK)
Limited. The letter enclosed a copy of the Employer’s Return form IR56F in
which Golden Gate (HK) reported Mr. Lee’s salary and benefits to the Hong
Kong Inland Revenue Department for the year ended 31 March 2011.
11. In early May 2011, Mr. Lee received a green envelope from the Inland
Revenue Department which contained his Individual Composite Tax Return
form BIR60. Mr. Lee believes that he can ignore his tax return because he
did not work in Hong Kong during the year ended 31 March 2011, and he
has come to you for advice.
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REQUIRED:
Q1 (a) Advise Mr. Lee whether, and if so to what extent, h e will be subject to
Hong Kong salaries tax for the year ended 31 March 2011.
Specifically, you should advise Mr. Lee about his s ource of
employment and his entitlement to all possible reli efs, including
exemptions, under the Inland Revenue Ordinance. You should also
advise Mr. Lee how much of his income would be subj ect to Hong
Kong salaries tax under the various scenarios; howe ver, you are not
required to perform any salaries tax computations.
Note: Even if you consider that Mr. Lee is not enti tled to a particular
relief, do not skip it. You should also identify th e relief and discuss
why Mr. Lee may not be entitled to claim it.
Ans (a) According to the Goepfert case and DIPN No. 10, the source of
employment is generally determined by the following three factors:
• the residence of the employer;
• the place where the contract of employment was negotiated, and
entered into, and is currently enforceable; and
• the place where the employee’s remuneration is paid to him.
In Mr. Lee’s case, it is clear that his employment during the period 1 April
2010 to 31 March 2011 is with Golden Gate Electronics (US) Limited’s
subsidiary in Mainland China. This would be considered a non-Hong Kong
employment. The issue is whether there was a change in employer (from
Golden Gate Electronics (US) Limited to its subsidiary in Mainland China)
when he was transfer to the Shenzhen factory: in either case, it is a
non-Hong Kong employment. Although Mr. Lee’s remuneration was paid
to him in Hong Kong, this factor is not a determinative factor when viewed
on its own. It could be argued that the Letter of Transfer issued by the
Hong Kong subsidiary represents a new contract, and therefore Mr. Lee’s
employer had been changed to the Hong Kong subsidiary. On the other
hand, it could be argued that the letter did not represent a new contract as
sometimes such a letter is required to support visa applications.
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(Note: It is acceptable for candidates to suggest for a Hong Kong
employment with appropriate arguments.)
If Mr. Lee had a non-Hong Kong employment, only his income related to
services rendered in Hong Kong would be subject to Hong Kong salaries
and in practice this means his total salary could be subject to the
time-apportionment claim. Mr. Lee’s total salary would be subject to time
apportionment because some services have been rendered in Hong Kong
(see discussion below).
On the other hand, Mr. Lee would be entitled to claim the
no-services-rendered exemption if he did not render any services in Hong
Kong. If successful, Mr. Lee would be fully exempt from Hong Kong
salaries tax. Based on the information in the question, Mr. Lee
occasionally brought documents and samples to and from the Shenzhen
and Hong Kong offices. Whether the activities in Hong Kong are
considered as part of employment services is fact-specific as indicated in
different decisions by the Board of Review. In D129/98, the Board of
Review held that such activities by the taxpayer were purely gratuitous
and were not duties of the taxpayer’s employment. However, in D39/04,
the Board of Review considered that the taxpayer cannot be exempt
unless he did not carry out a single jot of services in Hong Kong. The fact
that Mr. Lee carried the documents and samples in order to save the
company’s time and shipping expenses could arguably be not gratuitous.
As such there are services rendered in Hong Kong.
If Mr. Lee did perform some services in Hong Kong, he would also be
entitled to claim the 60-day exemption if he visited Hong Kong for not
more than 60 days during the relevant year of assessment. If this is
case, Mr. Lee would be fully exempt from Hong Kong salaries tax. Based
on the question, Mr. Lee came to Hong Kong for exactly 60 days so he
would meet the number-of-days requirement. However, Mr. Lee’s
coming to Hong Kong must be considered “visits”: this term is not defined
in the IRO and must be given its natural meaning. The fact that Mr. Lee
held a Hong Kong permanent ID card, and maintained bank accounts and
a driver’s license in Hong Kong are not determinative. However, the fact
that Mr. Lee returned to Hong Kong on 31 March 2011 to start a long
period of residence is likely to be devastating to his argument.
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Finally, Mr. Lee is entitled to claim the foreign tax paid exemption under
section 8(1A)(c) because he paid PRC Individual Income Tax (IIT) on his
salary. If successful, Mr. Lee could exclude the part of his income that
had been subject to PRC IIT. In other words, his overseas allowance of
$40,000 per month would still be subject to Hong Kong salaries tax.
(Note: However, in practice, this exemption would be irrelevant if Mr. Lee
had a non-Hong Kong employment because time apportionment claim
would generally be more beneficial.)
Q1 (b) Other than possible penalties for non-compliance, a dvise Mr. Lee the
consequences if he chooses to ignore his tax return and refuses to
pay any tax subsequently demanded by the Inland Rev enue
Department. (Note: You are not required to discuss the penalty
provisions under the Inland Revenue Ordinance.)
Ans (b) Consequences:
• The IRD will issue an Estimated Assessment to Mr. Lee based on
the information provided by the employer on the Employer’s
Return.
• If the Estimated Assessment demands tax payment, tax not paid by
the due date shall be deemed to be in default and a surcharge of
5% shall be added.
• If any part of the tax and surcharge remain in default for a further
six months or more, a further surcharge not exceeding 10% on the
unpaid amount shall be added.
• The CIR may also recover tax in default by taking civil action in the
district court, recover tax from a debtor of Mr. Lee (e.g. banker) and
apply to a district judge for the issue of a departure prevention
direction to prevent Mr. Lee from leaving Hong Kong.
Q1 (c) Advise Mr. Lee whether, and if so to what extent, t he documents
executed for the transactions in item 9 above attra ct Hong Kong
stamp duty.
Ans (c) Stamp duty:
• The sale and purchase of Hong Kong stock is subject to stamp duty
under Head 2.
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• The stamp duty payable = $40,000 x 0.2% + $5 = $85.
• Gifts of Hong Kong stock to a Hong Kong charitable institution is
exempt from stamp duty under section 44(1) of the Stamp Duty
Ordinance (SDO).
• An agreement for sale of residential property is subject to stamp
duty under Head 1(1A).
• Since the provisional and final agreements are 14 days apart, the
first agreement is chargeable with ad valorem stamp duty and the
second agreement is chargeable with a fixed stamp duty of $100.
• The ad valorem stamp duty = $7m x 3.75% = $262,500.
• The stamp duty on conveyance is subject to stamp duty under
Head 1.
• Since the conveyance is executed in conformity with the agreement
for sale which is stamped, the conveyance is chargeable with
stamp duty of $100 only.
• A lease of immovable property in Hong Kong is chargeable with
stamp duty under Head 1(2).
• The stamp duty payable on the lease = $20,000 x 4.25% + $10,000
x 12 x 0.5% = $850 + $600 = $1,450
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SECTION B (Answer THREE questions from this section)
Q2. In the 2010/2011 Budget, the Financial Secretary said (at paragraph 30):
“The Inland Revenue Department (IRD) has established procedures to track
property transactions involving speculation and will follow up each case closely.
If it is found that such transactions constitute a [trade or] business, the IRD will
levy profits tax on the persons or companies concerned for profits arising from
such transactions.”
REQUIRED:
Q2 (a) Explain, critically, the definition of a “trade” an d a “business” with
reference to the Inland Revenue Ordinance.
Ans (a) � Trade is defined in section 2(1) of the Inland Revenue Ordinance (IRO)
as including “every trade and manufacture, and every adventure and
concern in the nature of trade”.
� However, the definition is circular and does not assist in defining the
term.
� As a result, one usually resorts to the case law (see answer to part (b))
to determine whether a taxpayer is carrying on a trade.
� Business is defined by section 2(1) to include “agricultural undertaking,
poultry and pig rearing and the letting or sub-letting by any corporation
to any person of any premises or portion thereof, and the sub-letting by
any other person of any premises or portion of any premises held by
him under a lease or tenancy other than from the Government”.
� However, the definition is not exhaustive. It appears that business
covers a wider scope than trade.
Q2 (b) Analyse when profits arising from property transact ions will be
subject to profits tax, with reference to the six b adges of trade.
Ans (b) The six badges of trade are:
� Subject matter of transaction
� Length of ownership
� Frequency of similar transactions
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� Supplementary work on the property
� Circumstances responsible for disposal
� Profit-seeking motive
The candidates should discuss each badge in the specific circumstances
of a real property transaction.
Q2 (c) If profits arising from a property transaction are subject to profits tax
but the seller fails to notify the IRD of his charg eability to tax without
reasonable excuse, explain the potential consequenc es and
penalties under the Inland Revenue Ordinance.
Ans (c) � Any person who without reasonable excuse fails to comply with section
51(2) is liable to prosecution under section 80(2).
� The Commissioner may compound such an offence.
� If the person is prosecuted and convicted under section 80(2), a fine at
level 3 ($10,000) plus treble the amount of tax undercharged will be
imposed.
� Alternatively, the IRD can impose a penalty in the form of an additional
tax under section 82A. If an additional tax under section 82A is made,
no prosecution will be instituted under section 80(2).
� Under section 82A, the maximum amount of additional tax is treble the
amount of tax undercharged.
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Q3. Consider the following employment benefits and expenditures:
(i) Amount paid by an employer in connection with the education of a child
of an employee.
(ii) Company car made available by an employer for the private use of an
employee with an option to receive transportation allowance (in cash) in
lieu of using the car.
(iii) Payment of an employee’s utilities by the employer.
(iv) Loans provided to employees at less than market interest rates either
from the employer’s own funds or from money borrowed from the bank at
market rates by the employer.
(v) Benefits from the use of corporate credit cards for private purposes by
an employee.
(vi) Travelling expenses of an employee.
(vii) Subscriptions to professional associations by employees.
(viii) As specified in the employment contract, a sum equivalent to one month
salary is required to paid by an employee to the employer in lieu of
proper notice of resignation."
(ix) Depreciation of the cost of a computer purchased by an employee for
employment purposes.
REQUIRED:
For items (i) to (v) above, fully explain, with rea sons, whether they are
assessable under Hong Kong salaries tax.
For items (vi) to (ix) above, fully explain, with r easons, whether they are
deductible under Hong Kong salaries tax.
Consider all possibilities and make any necessary a ssumptions.
Ans (i) An amount paid by an employer in connection with the education of a
child of an employee is specifically assessable by virtue of section 9(2A).
It is irrelevant whether the liability is that of the employer or the employee.
(ii) When an employee is allowed to use for private purposes a car owned by
his employer, the benefit is not assessable, provided that the employee is
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not in any way able to convert the benefit into money. If the employer
was given a choice to receive cash or use the car, the cash offered is
assessable even though the employee chose to use the car.
(iii) Payment of utilities by the employer is not assessable if it is not a
discharge of the employee’s personal liability, e.g. when the utilities are
registered in the employer’s name. On the other hand, the benefit is
assessable if it is a discharge of the employee’s personal liability.
(iv) Low-interest loans provided to employees are not chargeable provided
that the employee cannot convert the benefit into cash. Likewise, if the
employer borrows money from a bank at a market rate and re-lends it to
the employee at a preferential rate, there is no taxable benefit unless the
employee guarantees the repayment of the loan.
(v) In DIPN 16, the IRD states that where the card is used for private
purposes by an employee, the benefit obtained is chargeable to salaries
tax. However, this is not necessarily correct. Whether the benefit is
chargeable depends on whether the liabilities (of the purchases) are
those of the employer or the employee. To ensure that the benefit is not
taxable, the employee should make clear to the supplier of goods and
services before entering into contract that he is making the contract on
behalf of his employer.
(vi) Travelling expenses between home and place of employment are not
allowable. But the expenses for travelling from one place of
employment to another are allowable.
(vii) Strictly speaking, professional subscriptions are not deductible under the
IRO. However, by concession, the IRD allows the deduction of one
professional subscription which is related to the taxpayer’s employment.
Only full membership fees are deductible.
(viii) The payment in lieu of notice is not incurred in the production of
assessable income and thus not allowable (CIR v Sin Chun Wah
HCIA000004/1987).
(ix) This depends. Depreciation allowances are granted in respect of plant
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and machinery, the use of which is essential to the production of
assessable income. An item of plant and machinery used by an
employee does not qualify for depreciation allowances if it merely
facilities his work and he can still perform his duties without the asset.
Depreciation allowances can only be granted if the employer does not
provide the equipment.
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Q4. Dolly Limited was incorporated in Hong Kong. It carries on a business as a
stationery trader in Hong Kong. For the year ended 31 December 2010, its
profit and loss account is as follows:
Notes $ $
Income
Turnover 6,000,000
Less: Cost of goods sold (4,200,000)
Gross profit 1,800,000
Unrealised exchange
gain
(i) 200,000
Compensation income (ii) 250,000
2,250,000
Expenses
Administrative expenses 20,000
Bad debt expenses (iii) 40,000
Depreciation charges 80,000
Donations (iv) 1,000,000
Employee expenses (v) 400,000
Legal and professional
fees
(vi) 30,000
Other expenses 50,000 (1,620,000)
Net profit for the year 630,000
Dolly Limited also provides you with the following additional information:
(i) The unrealised exchange gain arises from the conversion of accounts
receivable in foreign currency to local currency at the end of the
accounting period.
(ii) Compensation income represents insurance compensation for the total
loss of a company car (original cost: $400,000; 30% pool) that was
involved in a traffic accident.
(iii) Bad debt expenses: $
Write-off of a loan made to a director 60,000
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Less: Recovery of bad debt previously allowed (20,000)
40,000
(iv) Donations: $
Cash donations to Community Chest, Hong Kong 800,000
Donations in kind to Community Chest, Hong Kong 200,000
1,000,000
(v) Employee expenses: $
Salary 250,000
Payments to a retiring director for agreeing not to compete
with the company
150,000
400,000
(vi) Legal and professional fees: $
Audit fees 10,000
Tax return preparation 5,000
Objection against 2008/09 Notice of Assessment 15,000
30,000
Additional information:
As at 1 January 2010, the tax written down values of the plant and machinery
used in the business to produce assessable profits were as follows:
� 20% pool: $200,000
� 30% pool: $550,000
On 1 July 2010, the company purchased two identical pieces of office furniture
(20% pool). The purchase price of furniture item #1 of $50,000 was settled in
full in cash. Due to cash flow problems, furniture item #2 was financed by
instalments with a $20,000 upfront payment and 12 instalments of $3,000 each.
On 31 December 31, 2010, furniture item #1 was sold for $60,000.
On 1 September 2010, the company purchased a computer (30% pool) for
$30,000.
REQUIRED:
15
Q4 (a) Prepare Dolly Limited’s profits tax computation for the year of
assessment
2010/11. (Ignore provisional tax.)
Ans (a) Dolly Limited
Profits tax computation
Year of assessment 2010/11
$ $
Net profit per accounts 630,000
Add:
Bad debt expenses 60,000
Depreciation charges 80,000
Donations 1,000,000
Employee expenses 150,000
Legal and professional fees 15,000 1,305,000
1,935,000
Less:
Compensation income 250,000
Depreciation allowance
(Note 1: 154,000 + 26,800 + 30,000)
210,800
(460,800)
1,474,200
Less: Donations
(Limited to 35% of 1,474,200)
(515,970)
Assessable profits 958,230
@ 16.5%
Profits tax payable for 2010/11 158,107
Note 1: Depreciation allowance
20% Pool 30% Pool Total
WDV b/f 200,000 550,000
Addition (after IA of 60% x
$50,000 = $30,000)
20,000 30,000
Less: Disposal (50,000) (250,000)
Sub-total 170,000 300,000
AA (34,000) (90,000) 124,000
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WDV c/f 136,000 210,000 154,000
furniture
under HP
Allowances
Addition 50,000
IA: 60% on 35,000 (21,000) 21,000
29,000
AA: 20% on 29,000 (5,800) 5,800
WDV c/f 23,200
Total allowances for car under
HP
26,800
The cost of the computer, i.e. 30,000, is fully deductible as it is a
prescribed fixed asset under section 16G.
Q4 (b) Explain the tax treatment that you have applied to items (i), (ii), (iv)
and (v).
Ans (b) (i) According to DIPN No. 42, if an exchange gain/loss is recognised in
the income statement, it cannot be excluded from the tax
computation on the ground that it is unrealised. Since accounts
receivable record trading receipts, the exchange gain is revenue in
nature and therefore taxable.
(ii) Compensation for permanent loss of a fixed asset is capital in
nature, therefore not taxable. However, the amount received up to
the original cost of the asset should be removed from the
depreciation pool.
(iii) Donations must be donations of money to a recognised charity.
Donations in kind do not qualify for a deduction.
(iv) The payment is capital expenditure because it increases the
company’s goodwill. Therefore, the payment is not deductible.
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Q5. The following information pertains to Eric for the year ended 31 March 2011:
(i) Eric received a monthly basic salary of $45,000 from his employer, which
is a Hong Kong company.
(ii) During the first half of the year, Eric lived in a flat provided by his
employer. During the second half of the year, Eric lived in his newly
purchased apartment in Tai Koo Shing and received a monthly housing
allowance of $6,000 from his employer.
(iii) Eric owned a flat in Ma On Shan. On 1 April 2009, Eric rented this flat to
a tenant for $9,000 per month. In addition, Eric received non-refundable
rent of $18,000 up front. The rental period is for two years.
(iv) During the year, Eric earned $80,000 teaching guitar on a private basis.
(v) Eric paid $100,000 and $120,000 to a bank: this represents the
mortgage interest payments in respect of the Ma On Shan property and
the Tai Koo Shing property respectively.
(vi) Eric paid $2,500 per quarter and $3,000 per quarter to the government
for rates in respect of the Ma On Shan property and the Tai Koo Shing
property respectively.
(vii) During the year, Eric made various charitable donations totalling
$250,000 to approved charitable organisations.
(viii) Eric is single with no dependents.
REQUIRED:
Q5 (a) Show whether or not it is more beneficial for Eric to elect for
personal assessment for the year of assessment 2010 /11. Support
your answer with detailed computations.
Ans (a) Eric
Salaries tax computation
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Year of assessment 2010/11
$
Salary ($45,000 x 12) 540,000
Housing allowance ($6,000 x 6) 36,000
576,000
Add: Rental value ($45,000 x 6 x 10%) 27,000
Assessable income 603,000
Less: Charitable donations
(Limited to 35% x 603,000)
(211,050)
Home loan interest (100,000)
Net assessable income 291,950
Basic personal allowance (108,000)
Net chargeable income 183,950
Tax at standard rate @15% 43,792
Tax at progressive rates 19,271
Tax payable 19,271
Eric
Property tax computation
Year of assessment 2010/11
Premium ($18,000 x 12/24) 9,000
Rent ($9,000 x 12) 108,000
Assessable value 117,000
Less: Rates ($2,500 x 4) (10,000)
107,000
Less: Statutory deduction (20%) (21,400)
Net assessable value 85,600
Property tax (15%) 12,840
Eric
Profits tax computation
Year of assessment 2010/11
Net assessable profits 80,000
Profits tax (15%) 12,000
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Eric
Personal assessment computation
Year of assessment 2010/11
Net assessable income (before deduction of concessionary
deductions)
603,000
Net assessable profits 80,000
Net assessable value (NAV) 85,600
Total income 771,000
Less: Interest on rental property (limited to NAV) (85,600)
Total income after deduction of interest 683,000
Less: Charitable donations
(Limited to 35% x 683,000)
(239,050)
Home loan interest (100,000)
Reduced total income 343,950
Less: Single person allowance (108,000)
Reduced total income after personal allowance 235,950
Tax at standard rate @15% 51,592
Tax at progressive rates 28,111
Tax payable 28,111
Q5 (b) Explain why it is/is not more beneficial for Eric t o elect for personal
assessment for the year of assessment 2010/11.
(Note: Ignore provisional tax and any rebate announ ced in the
2011/12 Budget in your answers.)
Ans (b) Comparing the tax payable under personal assessment (28,111) vs
separate assessments for different incomes (19,271 + 12,840 + 12,000 =
44,111), it is more beneficial for Eric to elect for personal assessment.
It is more beneficial for Eric to elect for personal assessment because (1)
he is entitled to a larger charitable donations limit, and (2) he can deduct
the mortgage interest in respect of the rental property under personal
assessment.
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Q6. Taxpayers may set up service company arrangements to minimise their Hong
Kong tax liabilities. Two types of arrangements have been identified as causing
particular concern. The Inland Revenue Department (IRD) has classified these
two types of service companies as Type I and Type II.
Section 9A of the Inland Revenue Ordinance (IRO) was enacted to deal with
Type I cases, while Type II cases are dealt with in Department Interpretation
and Practice Notes (DIPN) No. 24.
Q6 (a) Explain how and why taxpayers structure Type I serv ice companies.
Explain how section 9A of the IRO deals with Type I service company
arrangements.
Ans (a) Type I service companies
� The nature of Type I service companies is where an individual or any of
his associates controls a service company and the company enters
into a service agreement with another person to provide the services of
the individual.
� The purpose is to disguise an employer-employee relationship so that
the income so derived is subject to profits tax instead of salaries tax.
� To deal with Type I companies, section 9A of the Inland Revenue
Ordinance (IRO) has been enacted.
� Under section 9A, the remuneration received by the service company
under the service agreement is deemed to be the income of the
individual chargeable to salaries tax.
� Section 9A does not apply if ALL of the following six criteria are
satisfied:
1) the service agreement does not provide for fringe benefits which
are commonly provided in an employment;
2) the individual provides services for other person during the term
of the agreement;
3) the individual is not subject to any control or supervision
commonly exercised by an employer;
4) the remuneration is not paid periodically or calculated on a basis
commonly used in employment contracts;
5) the payer has no right to dismiss the individual as if he is an
employee; and
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6) the individual is not held out to the public to be an officer or
employee of the payer.
Q6 (b) Explain how and why taxpayers structure Type II ser vice companies.
Explain how DIPN No. 24 deals with Type II service company
arrangements.
Ans (b) Type II service companies
� The nature of Type II service companies is where a service company
controlled by the proprietor or partners of a professional firm provides
services to the firm in return for “management fees”.
� The purpose is to reduce the overall tax liability of the total income
derived by the same person through the professional firm and the
service company. The method makes use of the deduction of
expenses, which is available to the service company, while such
expenses are not allowed in the professional firm under section 17 of
the IRO. At the same time, the proprietor or partners of the
professional firm are also directors of the service company and they
can make use of the remuneration package such as provision of
accommodation, refund of rent, etc. to minimise their salaries tax
liabilities.
� DIPN No. 24 sets out the minimum requirements which must be
satisfied to support a management fee claim, and what deductions can
be allowed.
� For non-professional services rendered to the professional firm, the
expenses plus a mark-up can be deducted by the firm. The IRD
considers a mark-up of 12.5% to be reasonable.
� For professional services rendered to the professional firm, the
expenses without any mark-up can be deducted by the firm, except
remuneration paid to the proprietor or partner of the professional firm.
END
22
Tax Rates and Allowances
Personal Allowances
2010/11
$
Basic 108,000
Married Person 216,000
Child 1st and 9th (each)
– year of birth 100,000
– other years 50,000
Dependent Brother or Dependent Sister Allowance 30,000
Dependent Parent Aged 60 or more 30,000
Aged between 55 and 59 15,000
Additional Dependent Parent Aged 60 or more 30,000
Aged between 55 and 59 15,000
Dependent Grandparent Aged 60 or more 30,000
Aged between 55 and 59 15,000
Additional Dependent Grandparent Aged 60 or more 30,000
Aged between 55 and 59 15,000
Single Parent Allowance 108,000
Disabled Dependant Allowance 60,000
Salaries Tax and Personal Assessment Tax Rates 20 10/11
Progressive Rates: First $40,000 2%
Next $40,000 7%
Next $40,000 12%
Remainder 17%
Standard Rate 15%
Profits Tax Rates (2008/09 onwards)
Unincorporated Business 15.0%
Corporation 16.5%
Property Tax Rates (2008/09 onwards) 15.0%
Depreciation Allowances (2004/05 onwards)
Plant and Machinery
Initial Allowance 60%
Annual Allowance 10%, 20% or 30% (as specified in question)
23
Industrial Building
Initial Allowance 20%
Annual Allowance 4%
Commercial Building 4%
Stamp Duty Payable (2010/11 onwards)
Head 1(1) $1 - $2,000,000 $100
& $2,000,001 - $2,351,760 $100 + 10% of value above $2,000,000
Head 1(1A) $2,351,760 - $3,000,000 1.5% of consideration
$3,000,001 - $3,290,320 $45,000 + 10% of value above $3,000,000
$3,290,321 - $4,000,000 2.25% of consideration
$4,000,001 - $4,428,570 $90,000 + 10% of value above $4,000,000
$4,428,571 - $6,000,000 3% of consideration
$6,000,001 - $6,720,000 $180,000 + 10% of value above
$6,000,000
$6,720,001 -
$20,000,000 3.75% of consideration
$20,000,000 -
$21,739,120
$750,000 + 10% of value above
$20,000,000
Above $21,739,120 4.25% of consideration
Head 1(2) Premium Same as under Head 1(1)
Rent: Uncertain term 0.25% of annual rent
Term of less than a year 0.25% of total rent
Term of 1 year to 3 years 0.5% of annual rent
Term of more than 3 years 1% of annual rent
Head 2(1) 0.1% of the consideration
Head 2(2) $5
Head 2(3) $5 + 0.2% of value
Head 2(4) $5
Head 3(1) 3% of market value
Head 3(2) $5
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