Question 1
You are an independent tax advisor and one of your clients, Triceratops Toys Manufacturing Limited, has provided you with the following information.
Triceratops Toys Manufacturing Limited was incorporated in Hong Kong in 2002. The company was formed to take over the partnership business owned by the Cheung brothers, Albert Cheung and Bernard Cheung. Albert and Bernard each own 40% of the shares of the company and the remaining 20% of the shares are owned by their sister, Crystal. The original board of directors consists of the Cheung brothers and their sister, Crystal. In addition to being directors of the company, Albert and Bernard are responsible for the running of the company. Albert is the managing director and is responsible for the sales operations. Bernard holds the title of finance manager and is in charge of the company's finances. Their brother-in-law, Dickson Tang, is employed as the production manager to oversee the manufacturing operations.
The company has been profitable with an annual turnover of over HK$20 million. The profits of the company have mainly been derived from exporting toys to overseas countries. The manufacturing operations had been carried out in Hong Kong until 31 July 2012, when the company moved its manufacturing operations to mainland China.
The manufacturing operations in China began in August 2012. Although the manufacturing operations are now in China, the company maintains its purchase, sales and other administrative functions in Hong Kong. Materials for production are either purchased in Hong Kong or imported from overseas. They are stored in Hong Kong until they are required for production. Then the required materials will be delivered to the factory in China. Workers for the manufacturing operations are employed in China except for two supervisors who have been employed by the company in Hong Kong since 2009. Dickson Tang, as the production manager, supervises the China operations. The production machines were transferred from Hong Kong. Finished products are shipped to Hong Kong where they are put into bags and boxes. Usually they are stored in Hong Kong for one to two weeks before they are loaded into containers for shipment. The shipping arrangements are made in Hong Kong. Credit arrangement is made with a Hong Kong bank to finance the working capital.
Being in charge of the manufacturing operations, Dickson and his wife, Crystal, have lived in China since January 2012. Dickson was given the responsibility of looking for an appropriate location for the new factory in China and of arranging the necessary registrations for the company to operate in China. A Chinese resident, Liu Chang, was appointed as a director of the company in January 2012, assisting the company to establish its China operations. A fee of $100,000 was paid to Liu Chang as remuneration for the year ended 31 March 2012. Because two of the directors, Crystal Cheung and Liu Chang, lived in China, meetings of the board of directors have been held in China for ease of administration.
Dickson Tang has been in charge of the China production operations since July 2012 and seldom returns to Hong Kong. He communicates with the Hong Kong office via telephone or email. Occasionally he returns to Hong Kong to report to Albert and was in Hong Kong for 45 days for business purposes and another 20 days for holidays during the year ended 31 March 2013. His salaries and bonus for the year ended 31 March 2013 amount to $800,000. The company rented a flat in China for his family to stay in and purchased medical insurance for his family. The costs to the company of providing him with a flat and medical insurance were $50,000 and $10,000 respectively.
Required:
a Discuss whether Triceratops Toys Manufacturing Limited's profits are subject to Hong Kong profits tax for the year of assessment 2012/13. The financial year of Triceratops Toys Manufacturing Limited ends on 31 March each year.
b Is Dickson Tang liable to salaries tax for the year of assessment 2012/13? Discuss with reference to the relevant tax exemptions and tax cases where appropriate.
c Assume that Dickson Tang's income from Triceratops Toys Manufacturing Limited is fully taxable under Hong Kong salaries tax for the year of assessment 2012/13, determine his assessable income. Explain your calculation and treatment of significant items.
d Is Liu Chang liable to Hong Kong salaries tax for the year of assessment 2011/12? Discuss with reference to the relevant tax provision and/or tax case where appropriate.
Question 2
a Tax avoidance and tax evasion are two very different concepts. Compare and contrast the differences between tax avoidance and tax evasion. Give two examples of each to support your discussion.
b Under the Inland Revenue Ordinance, there are many provisions targeting anti-avoidance activities. While specific anti-avoidance provisions tackle specific situations or industries, there are the general anti-avoidance provisions that have wide application in different situations. Briefly explain the general anti-avoidance provisions and cite examples or cases where the general anti-avoidance provisions are applicable.
Question 3
A Korean Company is considering selling certain electronic gadgets to Hong Kong in an effort to develop its overseas market. His business consultant has advised him of the following options from a commercial perspective:
• Option 1: Sell the products to a wholesaler in Hong Kong who would then market the product and sell to the consumers in Hong Kong
• Option 2: Set up a wholly owned subsidiary in Hong Kong, who would then sell products to consumers in Hong Kong
• Option 3: Set up a branch in Hong Kong for the purpose of selling to Hong Kong consumers
• Option 4: Engage a consignment agent in Hong Kong to sell the products through this consignment agent.
In evaluating the options, the directors of this company would like to take into account the taxation implications of the various options as well and come to you, a tax consultant, for advice.
Required:
Advise the directors as to the Hong Kong profits tax implications in relation to the taxability of profits of the Korean Company, as well as the profits accruing to the Hong Kong entity involved. You are not required to conclude which option is the best option, as the information provided at this stage is not detailed enough to do a thorough comparison and determination.
Question 4
For many years Mr Leung has been employed as a sales representative of a real estate company, Hit and Run Limited (‘HAR'). At all relevant times, he has paid salaries tax on his earnings at the standard rate. His earnings consist of a basic salary (which must be repaid if his sales results do not reach a prescribed minimum level) plus commission. His commission earned over the past two years has been very high. He has a wife who operates a trading business. The couple has two young children attending schools in Hong Kong.
Mr Leung has been told that the test of deductibility for outgoings and expenses for salaries tax purposes is ‘notoriously rigid, narrow and restrictive.' Mr Leung thinks that if he were subject to profits tax instead of salaries tax he would be able to claim many deductions for outgoings and expenses that are presently not allowable to him for salaries tax purposes.
Mr Leung therefore approached the accountant of HAR for advice. The accountant advised him to resign from his job with the company, incorporate a new company, Leung Fun Limited (‘LFL'), and arrange for LFL to enter into a new contract with HAR to provide Mr Leung's services as a sales representative. Under this arrangement, LFL would receive income from HAR and claim against this all allowable expenses.
LFL would employ Mr Leung at a reasonable salary to provide the agreed sales services on its behalf to HAR. A few days ago, HAR's accountant informed Mr Leung that the company will agree to enter into the proposed arrangement on basically the same terms as it now employs Mr Leung, but without any obligation to pay any minimum monthly sum to LFL.
Required:
a Evaluate the comment by the accountant of HAR in respect of the deductibility of expenses and outgoings under Hong Kong salaries tax and profits tax.
b Explain in detail to Mr Leung whether there is any danger of the Commissioner challenging the suggested arrangement and the possible consequences, quoting the relevant sections of the Inland Revenue Ordinance where appropriate. Further, advise Mr Leung on what he can do to lessen the chance of the application of the relevant Inland Revenue Ordinance provisions in a situation like this.