Profits Tax Planning
Question 1 – Determination of source of profit in HK and outside HK
Apple Ltd (Apple) was incorporated in Hong Kong in September 2009. Its business is the trading of processed food products outside Hong Kong. It intends to purchase from suppliers in Asia, excluding Hong Kong; and resell to customers in Europe and the USA.
Apple maintains offices in Taiwan and Indonesia. The two directors, who are managing the daily operations of Apple, reside in Indonesia and Taiwan respectively; and the company’s two marketing and procurement officers are located in Indonesia and Taiwan respectively. As all the negotiation processes for the sale and purchase transactions will be carried out in different countries, Apple has set up a ‘centralised administrative office’ in Hong Kong to administer and co-ordinate the work performed by the employees and directors in these various locations.
During a business trip to Indonesia, the Taiwanese director has located an Indonesian supplier, Berry Ltd (Berry); and at a French food exhibition, the Indonesian director has located a US customer, Cherry Ltd (Cherry). Communication with both the supplier and customer has been followed up outside Hong Kong via e-mail. In order to be exempt from profits tax, the accountant of Apple has suggested arranging the sale and purchase transactions in the following manner:
(1) Apple will enter into a purchase contract with the Indonesian supplier, Berry; and sales contracts with the US customer, Cherry; in their respective countries.
(2) Upon conclusion of both the purchase and sales contracts with Berry and Cherry, arrangements will be made outside Hong Kong for direct shipment of the goods from Berry to Cherry. The goods will not pass through Hong Kong and no stock of merchandise will be maintained in Hong Kong.
(3) The Hong Kong office will perform the functions of issuing orders to Berry and accepting orders from Cherry on the basis of contracts of sale or purchase already effected by the directors; arranging letters of credit; operating a bank account, making and receiving payments and maintaining the accounting records.
Required:
(a) Explain the fundamental test for determining the source of trading profits. (3 marks)
(b) Based on the Departmental Interpretation and Practice Note No. 21 entitled ‘Locality of Profits’, explain the practice adopted by the Commissioner of Inland Revenue for determining the source of trading profits. (4 marks)
(c) Discuss whether Apple Ltd’s profits from the sale and purchase transactions should be subject to, or exempt from, profits tax. If you consider that the profit is subject to profits tax, advise how Apple Ltd could restructure its transactions to ensure that the profit would be exempt from tax. (9 marks)
(16 marks)
(ACCA P6 Advanced Taxation December 2009 Q3)
Question 2 – Non-resident individual investment in HK with tax planning
Gary is a US resident. After visiting Hong Kong several times, he decided to acquire a luxury property in Hong Kong for rental income purposes.
He has the following in mind:
(1) He plans to finance 50% of the cost of acquisition with his own savings, while the remaining 50% of the acquisition cost will be financed by a loan obtained from a bank in New York. The loan will be secured by personal guarantee given by Gary.
(2) He plans to appoint a service company in Hong Kong as his agent to handle matters related to his letting activities.
(3) The property is to be let in a furnished state. He believes that furnishing the property is more likely to attract long-term tenants. He estimates that he has to spend around $100,000 on refurbishing the property and providing the necessary furniture.
Gary is now debating whether to hold the property in his own name or in the name of a limited company incorporated in Hong Kong and wholly owned by him. However, he is unsure of the tax implications of each of the investment alternatives.
Required:
(a) Advise Gary how rental income derived from the property is to be taxed under each of the alternatives. (3 marks)
(b) Based on the information above, advise Gary which alternative is more tax advantageous to him. Your answer should include an analysis of the deductibility of loan interest, service fees paid to the agent and expenses incurred in connection with refurbishing the property as mentioned in (1) to (3) above. (12 marks)
(HKICPA QP Module D Taxation May 2006 Q3)
Question 3 – Overseas company set up branch in HK
Zeta Inc (Zeta) is a large US trading corporation. It intends to expand its business and is planning to set up a branch in Hong Kong to sell some of its products in China. The branch will lease an office in Tsuen Wan, consisting of a sales and marketing department, purchasing department, shipping department, accounts department and general administration department. Sales orders from Chinese customers will be solicited by the branch’s sales and marketing staff who will travel to China to obtain orders and to promote Zeta’s products. All sales orders will be sent to and followed up by the branch in Hong Kong. Confirmation of the orders will then be sent from the branch to the customers, and letters of credit and shipment of products will also be handled by the branch. The products will be purchased by the branch from Zeta’s group companies in the US. Some of the products will be transported from the US to Hong Kong for trans-shipment to the customers in China, whereas some will be shipped directly from the US to the customers.
Required:
(a) Briefly outline the considerations that need to be taken into account by Zeta Inc in deciding whether to set up a branch in Hong Kong. (4 marks)
(b) Discuss the potential profits tax liabilities of Zeta Inc in respect of the profits made from the sale of its products by the branch to be set up in Hong Kong. (10 marks)
(c) Assuming the Hong Kong branch’s profits are chargeable to profits tax, advise Zeta Inc on how the branch’s assessable profits would be ascertained. (3 marks)
(17 marks)
(ACCA P6 Advanced Taxation June 2009 Q3)
Question 4 – Non-residents trading in HK through agent
John Yuan is a PRC citizen working in the PRC. His brother, Peter Yuan, is a tax resident living and working in Hong Kong as a registered stockbroker under Part VI of the Securities Ordinance. Since 2008, Peter has been engaged in buying and selling shares listed in both Hong Kong and the US via internet banking. The share-trading is operated through two securities accounts, one in the name of Peter Yuan and the other in the name of John Yuan. Peter usually receives instructions or guidance from John through emails or telephone calls with regard to the identities of shares to buy or sell, the acceptable price range, the period of holding etc. However, at critical moments, he will exercise his discretion to maximise his brother’s interests or minimise his loss. Peter regularly collects updated market news and analysts’ reports and sends them to John. At the end of each month, Peter prepares a transaction summary for John showing the details of the transactions done on John’s account during the month. The average size of John’s portfolio per annum is around $20 million, and the average holding period for the shares is between 10 and 30 days. Since 2008, John’s portfolio has made a profit of around $2 million.
Required:
(a) Discuss whether or not John Yuan is liable to Hong Kong tax in respect of the profits arising from the trading of shares listed in Hong Kong and the US.
Note:
(1) For this part only, you are NOT required to discuss court case decisions in detail. Where applicable, only Departmental Interpretation and Practice Notes issued by the Inland Revenue Department should be relied upon.
(2) You are NOT required to examine in detail the impact of electronic commerce on the determination of source of profits. (10 marks)
(b) Assuming that Hong Kong tax is payable by John Yuan, advise whether the Inland Revenue Department can collect tax from Peter Yuan on behalf of John Yuan, and whether Peter Yuan is protected by the Inland Revenue Ordinance from any claims by John Yuan in respect of any tax paid on his behalf. (5 marks)
(15 marks)
(ACCA P6 Advanced Taxation June 2011 Q3)
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