Cases Study on Calculation of Profit Tax Receipts and how Exemption of Offshore Funds are given to Taxpayer having Company Incorporation HK

In this blog we will have discussion on the decisions of court of final instance and board of review on the cases of the taxation of inherent gains and some financial instruments. Then we will have thorough discuss on the offshore funds exemption. The subheadings that we will cover under this main heading includes incidental transaction, round tripping and effective date etc. Then in the last part of the blog we will throw some light on the amendments in the Inland Revenue Ordinance 2015.      

Following to the judgement of the court of final appeal in case of Hong Kong open company Nice Cheer Investment Ltd the Inland Revenue department has not updated the departmental interpretation and practice notes 42 yet at the schedule of writing. In accordance with the announcement of Inland Revenue department on the date 4 March 2014:

  • It was requested to the Inland Revenue department to accept the statements of finance. These statements will form part of the tax return on profits for assessment year 2013 / 14 and this statement was prepared on the basis of fair value for reporting of tax.
  • It was agreed by the Inland Revenue department to accept the tax returns on profit for assessment year 2013 / 14. In that tax return the chargeable profits were calculated on an equitable value basis as a meantime measure of administration.
  • The Inland Revenue department, bureau of treasury and the financial services are analyzing the issues that are arising from the judgement.
  • The Inland Revenue department decide to calculate the chargeable profits of assessment year 2013 / 14 on the basis of fair value if the realization basis is adopted by the taxpayer subsequently. Yet, any appeal for the purpose of re-calculation should be made inside the time limits described in the Section 64 or 70A of the Inland Revenue Ordinance.

It was also announced by the Inland Revenue department later that, the department would accept the profits tax return for assessment year 2014 / 15 and 2015 / 16 administratively in which the profits that are chargeable are calculated on the basis of fair value.

In the case D 32 / 12 it was observed that, objection was made by T a taxpayer working for Hong Kong open company to the assessments of profits tax for the assessment year 2004 / 05, 2005 / 06, 2007 / 08 and the extra profits tax assessment for the assessment year 2006 / 07. It was contended by T that for those related assessment year:

  • Gain in foreign stock exchange on the trading of offshore securities was not sourced inside rather outside Hong Kong.
  • Inherent gains on other foreign investments were not allowable to tax on profits until maturity.
  • Interest income from other foreign investment / foreign securities of held-to-maturity debt (equity linked notes, accumulated notes and the lagard equity linked notes that were for arrangements of loans) was not sourced inside rather outside the Hong Kong.
  • Gain on offshore subordinates trading / securities of held-to-maturity debt (inherent gains of equity linked notes, derivative, barrier call options of OTC, accumulative note, inherent loss of equity linked notes written back) was not sourced inside rather outside Hong Kong.     
  • Gain on the ejection of available-for-sale securities detained as investment for long-term. The asset that is capital in nature was not evaluate able to profits tax; and
  • Modifications in equitable value of available-for-sale securities should not be allowed to the tax on profits and reason behind this is that, (1) T planned to hold them as investment for long term and (2) they were inherent profits.    

It was considered by the board of review that:

  • T was unable to release the responsibility of the evidence that; securities were dealt in foreign stock exchange.
  • The board of review is bounced by the decision of the case of Nice Cheer Investment Limited, that under the Inland Revenue ordinance the inherent profits are not assessable to profits tax.
  • Other than the statements and confirmations provided by the bank D in connection to the two yield currency option proceedings in assessment year 2004 / 05 and a yield currency option proceeding in the assessment year 2006 / 07 and that the inherent gain or inherent loss written at the back of equity linked note and accumulated note were not allowed to tax, T was not able to discharge its burden of proof on the issue of source for the loss or gain on call options of barrier of OTC and derivative.
  • The foreign investment / foreign securities of held-to-maturity debt were not the arrangement of loan to institutions of finance for income of interest. The agreements were done with Bank D by T in Hong Kong. Both the Bank D and taxpayer T operate in Hong Kong. the contract between both of these was terminated in the Hong Kong. The source of return on investment must be in Hong Kong.
  • Board minutes of T was not an acceptable piece of proof of T’s aim to hold the respective shares for long duration. The proofs of the two witnesses named as Mr. B and Mr. C, although honest, has not bestowed with claim of T to hold the respective shares for long duration on accession.
  • The burden of the evidence of claim to hold the available for sale securities as investment for long period has not been discharged by the T. Although, the board of review is bound by the case Nice Cheer, that inherent profits and inherent changes in equitable value of available for sale securities are not evaluate able to tax on profits.

Exemption of Funds for Offshore Incorporation Hong Kong

The offshore funds discussed below are exempted by the Section 20 AC of Inland Revenue Ordinance:

  • A person not a resident of Hong Kong; and
  • Whose business in Hong Kong does not include the proceedings other than following designated transactions:
  • Future contracts;
  • Securities;
  • Making of an installment other than by way of a business of moneylending;
  • Contracts of overseas exchange;
  • Overseas currencies; and
  • Commodities of exchange-trade (for example, silver or gold dealt in the exchange of Hong Kong commodity).

The specified proceedings must be managed through an institution of finance registered or licensed corporation under Securities and Futures Ordinance (SFO).

A taxpayer having company incorporation HK can be:

  • An individual; or
  • Not an individual entity (for example, a partnership, a corporation or an administrator of trust estate).

The meaning of a non-resident person of Hong Kong is person that is not a resident person of Hong Kong.

A person is considered as the resident person if he / she:

  • Lives ordinarily in Hong Kong in that assessment year; or
  • Stopovers in Hong Kong for a term or number of terms amounting to:
  • More than one hundred and eighty days in that assessment year; or
  • More than three hundred days in 2 consecutive assessment years. One among those 2 is that assessment year.

A partnership, a corporation or a trustee of an estate of trust is considered as a resident person in relation to the assessment year if the central control and management of the partnership, corporation or trust estate is employed in that assessment year in Hong Kong.

Central management and control or CMC refers to the top level of the control of a company. It is a question of reality that, what is location of the central management and control. Generally, if in the board meetings the central management and control is employed by the directors, and the pertinent locality is that where those meeting takes place. According to the departmental interpretation and practice notes 43 ‘the exemption of profits tax for offshore funds (revised Feb. 2010)’, for the determination of location of a central management and control of company, the trivial fact that maximum directors of the company’s management board are residents in Hong Kong. These directors would not disturb the application of the exemption of tax prejudicially by itself under the exemption of offshore funds.

Meanings of securities:

  • Options;
  • Stock, loan stock, shares, debenture; and
  • Options, excludes shares, etc., of non-government companies.

Meanings of Future Contracts:

  • Options or contracts traded or listed on Hong Kong Future Exchange Ltd.; and
  • ‘the contracts for differences’ including the derivatives of finance (for example, Hang Seng Futures Contracts, commodity futures Contracts):
  • Traded on or listed on future exchanges or stated stock exchanges;
  • Entered into, under the Ordinance of Banking by sanctioned institutions; or
  • The proceeding in respect of which is adjusted by the Securities and Future Ordinances.

Incidental Transactions 

If the receipts from unspecified proceedings do not increase 5 percent of the entire receipts of entire transaction, then the dispensation will not be strayed. In the computation of non-taxable income, trading receipts, for example, dividends, capital gains, interest of bank are not included.

If the reception from an unspecified transaction increases 5 percent, the reception from the similar proceedings are evaluate able but the transactions specified remain exempt.

According to the departmental interpretation and practice notes 43, the examples of subsidiary non-specified proceedings are interest, guardianship of securities or dividends.

Round Tripping

In order to avoid the ‘round tripping’ there are some adverse avoidance provisions (the ‘deeming provisions’). A ‘round tripping’ is like a resident disguised as a non-resident for the exemption obtaining purpose.

A resident individual doing business in Hong Kong who, jointly with his affiliates or alone, holds indirect and / or direct beneficial interest of:

  • 30 percent or more than that in a tax-exempt offshore fund; or
  • Any amount of percentage if the offshore fund is the associate of resident person,

Will be considered to have obtained chargeable profits for the purpose of trading profits justified by the offshore fund.

The considering allowances are not applicable to a taxpayer doing business in Hong Kong if the CIR is pleased that favorable interests in the concerned offshore funds are authentic widely held. The reference for this statement is taken from the Section 20AE (8) of the Inland Revenue Ordinance.

In the Inland Revenue Ordinance term ‘Authentic widely held’ is not defined. The Inland Revenue department embraces the same practices as those for exception for Mutual Fund Corporation, unit trusts, etc., under the Section 26A (1A). This is due to the reason that, if during the assessment year in question:

  • Did lesser than 50 persons hold all of the shares or units in the scheme at no time; and
  • Did lesser than 2 persons hold shares or units that, qualified the shareholders to 75 percent or more than that, of property or income of the scheme at almost zero time during the year.

Optionally, it is accepted by the Inland Revenue department that fund is authentic widely held if:

  • It is comprehensible from the scheme’s constitutional documents and other related material that; it was substantiated with a view to enhance the participation of public; and
  • With the aim to achieve that objective, the real efforts are being taken. These include that there is nothing to propose that the intention of scheme is to be a closely-owned vehicle of investment.

Amendment (No. 2) in Inland Revenue Ordinance 2015 

As before 17 July, 2015 and from the assessment year 1996/ 97, non-resident funds, in distinct forms are exempt from tax on profits derived from:

  • Transactions specified; and
  • Incidental transactions to be carrying out of the designated transactions.

Designated transactions must be arranged by or carried out through some designated persons (i.e., corporation registered or licensed under the Ordinance of Futures and Securities.)

For the purpose of following the offshore private fair funds that are not controlled or managed by Securities and Futures Ordinance licensees to also take benefit of tax exception, the (Amendment) (No. 2) of the Inland Revenue Ordinance 2015 was approved on 17 June 2015.

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