Case 5
Assume that you are a tax advisor in a consultancy firm. Consider in details and make advice for the following scenarios.
Scenario I
ABC Ltd was incorporated in Hong Kong on 1 January 2011. ABC Ltd leased a retail unit in Hong Kong, to sell second-hand fashion and drew up its first accounts for the year to 31 December 2011.
Required:
As the tax advisor of ABC Ltd, address the followingthree areas of concern, which have been identified during the course of the audit and in preparing the taxcomputation. Where applicable, you should cover the Hong Kong tax implications for all of the partiesinvolved, including any statutory compliance obligations and possible risks arising.
(a)A Singapore company supplies goods to ABC Ltd on consignment sales. During the year ended 31 December2011, ABC Ltd’s income statement showed a profit of $200,000 relating to goods from this supplier. ABC Ltd has informed you that they make a profit of 0.5% on these sales.
(b)ABC Ltd paid a royalty of $50,000 to a Cayman Islands subsidiary company, for the use of a trade mark, whichhad been transferred from ABC Ltd to the Cayman Islands subsidiary on 2 July 2011, for $1. The royalty waspayable at 5% on sales, and tax of 5.25% was withheld by ABC Ltd.
(c)ABC Ltd has a 100% British Virgin Islands subsidiary, BVI Co. BVI Co was set up initially on 1 March 2011 toprovide a loan of $2,100,000 to ABC Ltd at an interest rate of 10% per annum. ABC Ltd now intends to enterinto a service agreement with BVI Co for a service fee of $200,000 per annum, with effect from 1 January2013.
Scenario II
Bob is a musician in a band. He works for two nightclubs operated by Pearl Ltd. Bob’s terms ofremuneration are as follows:
(1)He has no fixed remuneration. He plays an agreed number of hours per month (which is subject to changes) andis paid at a fixed hourly rate each month.
(2)There is no fixed period of engagement, nor was there any notice period for termination of the engagement.
(3)He is not entitled to sick leave, holidays, or severance pay.
(4)Other members of the band are also paid by the nightclubs.
(5)Instruments are supplied by the nightclubs for the use of both Bob and the other band members.
(6)He practices at home, using his own guitar.
Recently Bob’s accountant advised him that there are tax advantages of being classified as an independentcontractor. He therefore proposed to Pearl Ltd that he would cease to work for the company, and insteadcould provide his services on basically the same terms as before through a Hong Kong company which he wouldestablish and own with his wife. Under this arrangement, the Hong Kong company would receive income from Pearl Ltd and claim against this all allowable expenses. The Hong Kong company would employ Bob ata reasonable salary to provide the agreed services on its behalf to Pearl Ltd.
Required:
(a)Determine whether Bob’s income from Pearl Ltd should be subject to profits tax or salaries tax,giving reasons for your conclusion.
(b)In accordance with the provisions of the Inland Revenue Ordinance, explain how it will be determinedwhether the proposed arrangement between Pearl Ltd and the Hong Kong company involves acontract for service or a contract of service. If you consider you need further information to answer thisquestion fully, you should state what that information is and why it is needed.
(c)Explain the tax implications, including any compliance obligations imposed underthe Inland RevenueOrdinance (if any) for Bob, his Hong Kong company and Pearl Ltd, if the proposed arrangementbetween Pearl Ltd and the Hong Kong company is regarded as a contract of service.
(d)Assuming for the purposes of this paragraph only, that Pearl Ltd does not know whether theproposed arrangement will be regarded as a contract of service, advise Pearl Ltd of any method(s)or procedure(s) by which this uncertainty can be resolved.
Scenario III
MRMWKam had been working for BB Ltd for several years until February 2011 when his employment wasterminated. Since then, he has not been able to find a new job. On 14 November 2011, he received a notice ofassessment for the year of assessment 2010/11 dated 10 November 2011, showing the following:
$Chargeable income / 2,200,000
Tax at 15% / 330,000
Less: provisional tax paid / (200,000)
Balance payable / 130,000
Provisional tax 2011/12 / 330,000
Total tax payable / 460,000
Payable by 4 January 2012 / 377,500
Payable by 4 April 2012 / 82,500
Assessor’s notes: Assessment issued as per employer’s return.
Mr Kam noted the date of tax payment of 4 January 2012, and thus kept the assessment in a drawer until15 December 2011 when she discovered the following two errors in the notice of assessment.
1.His bonus for the year was only $100,000 instead of $1,000,000 which was the amount erroneously shownon the employer’s return; and
2.An amount of $80,000 paid in lieu of 3 months’ notice was included in his terminal payment of $200,000which was shown as a lump-sum in the employer’s return.
MrKam’s own individual tax return had already excluded the payment in lieu of notice and disclosed the correctamount of bonus. He is very concerned about the overcharged tax arising from the above two errors.
Required:
(a)Explain the course(s) of action that might be available to Mr Kam in respect of the two errors.
(b)Advise Mr Kam on the course(s) of action that might be available to him to reduce the total tax payable.
(c)Advise Mr Kam of the consequences that may arise if he does not settle the tax payment by the due date.
(d)Mr Kam has also noticed that in addition to the other errors, the notice of assessment is addressed to Mr WMKam, instead of MrMWKam. State, giving reasons, whether or not this error would have the effect ofnullifying the notice of assessment.
Scenario IV
Mr W and Mr X are both interested in acquiring a property located in Hong Kong. They have agreed that theywill jointly own the property which would be let out for investment purposes. However, they are not certain as to howthe ownership should be best structured from a Hong Kong tax perspective. Mr W and Mr X are both HongKong residents earning employment income in Hong Kong but both will require bank borrowings to fund the propertyacquisition.
The following ownership options have been identified by Mr W:
Option A / Option B / Option C / Option DMr W Mr X
50% 50%
Property
(as co-owners) /
Mr W Mr X
50% 50%
100%
Property /
Mr W Mr X
50% 50%
Property
(as co-owners) /
Mr W Mr X
50% 50%
100%
Property
Required:
As the tax advisor of Mr W and Mr X, draft a letter to them advising on the Hong Kong tax implicationsarising from each of the ownership options. Your advice should include consideration of how the tax position willbe affected if the bank borrowings were to be arranged differently and in the event of a future disposal of theinvestment.
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