Defining the terms Collateral Deposit, Flow-back Interest and Associate described under the Inland Revenue Ordinance for businesses having Business Registration Hong Kong


04 Jan

We will be going through some of expenses related in a profit tax, as which expenses need to be added in tax calculation. Starting in this blog first we will explore collateral deposit that being discuss under the exemption order in Section 16 2A of IRO. We will explore the implementation of the profits tax on interest flow-back in which we will see who are excluded persons from interest flow-back and get a knowledge about what is debenture movable in market means, then we will go through the topic of associates, as what are their role in expenses calculation under profit tax in this we will be discussing, associated corporations, control, associated person and overseas financial institution. Discussing all these in reference taken from the corresponding Sections of Inland Revenue Ordinance.    

Collateral Deposit under the Exemption Order of 1998     

The deduction of interest on the debiting is restricted by the Section 16 (2A) of Inland Revenue Ordinance if the income of interest on the deposit is utilized to guard the debiting (‘collateral deposit’) not evaluate able to tax under the Inland Revenue Ordinance. Some examples of the interest not evaluate able under the Inland Revenue Ordinance are:

  • Interest from a non-onshore deposit; or
  • Income on interest earned by an individual does not doing business in the Hong Kong.

The main point to note here is that, these type of interests are not evaluate able whether the Exemption Order 1998 for the income of interest is applicable or not, because they are exclude from Section 14 or 15 of Inland Revenue Ordinance in any type of event.

The Exemption Order 1998 excludes all the income of bank interest present in Hong Kong with a local bank. This Order is allowed under the Section 87 of Inland Revenue Ordinance. The one major exception of the exclusion is where the income on interest is obtained from a bank deposit utilized to guarantee / secure money withdrawn where the situations under Section 16 2 (c), (d) or (e) of IRO are satisfied and Section 16 (2A) does not manage to prohibit the deduction. Due to that reason, the income of bank interest from a collateral local deposit grossed by a party that carries on a business in Hong Kong is not exclude under the Order

In this type of case, the income of interest is not excluded but the expense on interest is permissible. This is accordingly straight if there are securities other than that, for example, income of interest on the debt or real properties for the loan is lower than the income of interest is grossed from the deposit. Incomplete exemption is prohibited. Due to that reason, the taxpayer having Hong Kong holding company formation cannot select to give up the deduction of interest expense and request the exclusion of the income of interest. The reference for this statement is taken from the DIPN 13A (Revised).

 

Flow-Back Interest under the Section 16 (2B) of Inland Revenue Ordinance

Applicable from the date of 25 June, in the year of 2004, for the Sections 16 (2) (c), 16 (2) (d) or 16 (2) (e) cases, where the preparation are in position through which any of the interest on the debited money is required to be paid, whether in direct way or through any mediate person, to a taxpayer having business registration Hong Kong, who is in connection with the borrower or to a debtor. In either case the taxpayer or debtor as according to the case may be, is not an excluded person, the amount of interest’s deduction shall be lessened. An allocation may be build where the preparation applies to the bit of loan or for the bit of the ground period.

Person who are excluded, includes:

  • A person who is accountable to tax on profits in respect of the income on interest.; or
  • In the case of an individual (other than the lender of money who is in connection with the debtor), a recipient of a unit trust concerning a particular investment scheme to which the Section 26A (1A) of Inland Revenue Ordinance applies, a trustee, a body corporate in which more than half symbolic value of the issued share capital is owned by the Government, an institute of finance.

The prohibition of Section 16 (2B) of Inland Revenue Ordinance is applicable to any other debt involved in the preparation.

A tax avoidance scheme known as loan participation is counteracted by the Section 16 (2B) of Inland Revenue Ordinance. A scheme is considered as the typical scheme in which funds are provided to the borrower by the institute of finance. The funds, through in a rotational way, would return back to the institute of finance and to the debtor. The determination is to have expenses of interest for the purpose of deduction of tax. The reference for this statement is taken from the proceeding of case D 94 / 04.

Some examples are given in Departmental interpretation and practice notes 13A. These examples are reproduced underneath:

  • Example # 11 of Departmental Interpretation and Practice Notes 13A
  • An amount of worth $100 Million was borrowed by an open company in HK named as H from the Bank J. Another company named as K was an affiliated Company of H. It advanced amount $100 Million to Bank J on the terms that the repayment of the interest of this debt and principal by Bank J to the company K would only be made on the term of repayment of the interest of the loan and principal due to Bank J by Company H, means, there is no risk for Bank J. As to the affiliated company of Company H the interest was paid, the deduction of interest claim by the Company H would not be accepted.


  • Example # 12 of Departmental Interpretation and Practice Notes 13A
  • An amount of worth $10 Million was borrowed by establish company in Hong Kong named as L from Bank M. The interest rate decided on this amount was 10 percent per annum. Of the loan, an amount of worth $7 Million was participated partially by a company N. This company is an affiliated company of company L. The repayment to company N by bank M of the interest of $7 Million and principal was made secured by or made the repayment of interest of the $10 Million loan and principal to the Bank M by the company L. The interest was paid of amount $1 Million by company L to the Bank M. The interest was paid by the Bank M attributable to company N to the $7 Million loan.

The interests given below would not be allowed:


  • Example # 13 of Departmental Interpretation and Practice Notes 13A
  • If in the example given above, the amount of $7 Million was participated partly by the establish company in Hong Kong named as N for the period of only 6 months during the basis period of the concerned assessment year, then the interest deductible is calculated as follows:

   


$ Million

Interest to be paid on the part of loan that was participated partly to company N

0.70

Deduct:


183 (days) / 365 (days) * $ 0.7 Million

0.35

0.35

Add:


Interest on the loan’s portion that is not participated partly

$ 3 Million / $ 10 Million * $ 1 Million

0.30


Interest deduction in Total

0.65


 

Debenture Movable in Market under Flow-back Interest Section 16 2C of Inland Revenue Ordinance

Applicable from the date of 25 June, in the year of 2004, for the case of Section 16 (2) (f) of Inland Revenue Ordinance, where the preparation are in place, through which any interest on the instrument or legal document, whether through any mediate person or directly, was paid to the borrower or to taxpayer, who is in connection with the borrower and in both cases the taxpayer or borrower, according to the case, is not a excluded person, the deduction amount would have been lessened. The definition of the excluded person is same as described in the Section 16 (2E) (c) of Inland Revenue Ordinance.

Associate under Section 16 (3) of Inland Revenue Ordinance

In relation to a person ‘Associate’ includes:

  • Where the person is natural:
  • A person’s partner;
  • A person’s relative (the meanings of ‘relative’ include parent, brother or sister, child, spouse);
  • Any corporation managed by the person, by the person’s partner or by a partnership in which the partner is person;
  • A principal officer or director of any type of corporation as is discussed above;
  • A type of partnership in which a person is partner;
  • Where the partnership is the person:
  • Any partnership’s partner;
  • Any corporation for which the designation of a person is of principal officer or director;
  • Any principle officer or a corporation’s director;
  • Any partnership being controlled by any partner or partnership therefrom.
  • Where the corporation is person:
  • Any affiliated corporation;
  • Any principal officer or director of that corporation or of any affiliated corporation and any relation of any such officer or director;
  • Any person that manages the any partner of such person or corporation where this type of person is a natural person, any relation of this type of person;
  • Any partner of the company and, where this type of partner of a natural person, any relation of this type of partner.

Associated Corporations under Section 16 (3) of Inland Revenue Ordinance

In relation to a person ‘Associated Corporation’ means:

  • A corporation of which a person has control;
  • If the corporation is person:
  • A person over which corporation has control; or
  • The same person that have control over the corporation as the first-mentioned person defined under the Section 16 (3) of Inland Revenue Ordinance.

Control under Section 16 (3A) of Inland Revenue Ordinance

In the Section 16:

  • An open company in HK or a corporation shall be considered as being agreement by a person if that person has the power to guard:
  • By means of the carrying of possession of voting power or shares in or related to that or any other corporation; or
  • By morality of any power conversed by the articles of association or any other document adjusting that or the corporation other than that, the relationships of the earlier mentioned company are conducted in conformity with his wishes; and
  • A person (other than a company) shall be considered as being controlled by the another person if the earlier mentioned person is usual or under a commitment:
  • Whether implied or express; and
  • Whether or not executable or intended to be executable by some legal proceedings.

In order to act, in relating to his business affairs or investment, concerning the instructions, or directions of that specific person. The reference for these statements is taken from the Section 16 3 (A) of Inland Revenue Ordinance.

Associated Person under Section 16 (3B) of Inland Revenue Ordinance

If a person satisfies the certain conditions then only, in accordance with the Section 16 of Inland Revenue Ordinance, he/she shall be considered as being in connection with a borrower. These conditions are:

  • A person is the affiliated corporation of the borrower;
  • A person (not a corporation);
  • By whom a borrower is being controlled;
  • Who is being controlled by the borrower; or
  • Who is being controlled directly by the same person as the borrower?

Institute of the Finance in the Foreign under Section 16 (4) of Inland Revenue Ordinance

It may be determined by the CIR for the reasons of the Section 16 of Inland Revenue Ordinance that, a person shall not be acknowledged as an institute of finance in the foreign if in case he is of the belief that deposit or deposit taking business of the person is not sufficiently administered by an administrator authority. If that person beliefs in this statement than only he shall be acknowledged as overseas financial institution. The reference for this statement is taken from the Section 16 (4) of the Inland Revenue Ordinance.   

 

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