Case 9
Mr. Peter Yuan, a Hong Kong resident, is 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 through two securities accounts, one in the name of Peter Yuan and the other in the name of Peter’s brother, John Yuan, who is a PRC citizen working in the PRC.
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 in 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.
Peter is expecting the growth of the property market in Hong Kong and considers diversifying his investment by buying a property in Hong Kong and holding it through AB Co Ltd, a company incorporated in Hong Kong in 1998 solely owned by him. AB Co Ltd has been actively engaged in trading of toys and accessories in Hong Kong since its incorporation. Funds will be sourced from a bank. The property will be let out for rental. The following structural options are available:
In reviewing AB Co Ltd’s projected profit and loss account for the year ended 31 December 2012, the company's financial controller was concerned about the significant profits earned resulting in an increase in both the 2012/13 final profits tax and the 2013/14 provisional profits tax payable. He has the following ideas in mind:
(a)He has identified two fee invoices that have been issued to customers on 30 November 2012. Corresponding credit notes will be issued to cancel the invoices; and identical invoices will be re-issued to the customers in January 2013.
(b)An expense voucher will be prepared to claim a whole year's salary payable to an independent consultant engaged to work for AB Co Ltd during the year ended 31 December 2012. The named consultant is the financial controller's mother, who is a full-time housewife.
Required:
(a)Assume today is 1 December 2012. In the context of tax avoidance, discuss the extent of risk to AB Co Ltd arising from the implementation of the financial controller's ideas.
(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.
(c)Evaluate the options available in respect of providing the funding to AB Co Ltd for the property acquisition.
Your answer should explain the tax deductibility of the loan interest arising under each of the options, and any possible restrictions that may apply to the interest deduction in the context of extending guarantees to the bank should this be required.
You may assume that all the loans referred to are interest bearing at the market rate.
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