There are different profit tax that are required to be paid by corporations or taxpayer doing or starting a small business in Hong Kong. The Inland Revenue Ordinance provides regulations corresponding to different taxes that are required to be paid yearly. In this blog we will be going through how the assessable profits are computed and addition of this profit in taxpayer yearly tax payment. For the computation of these taxes it is required to have knowledge of the principles of commercial accounting, date when income arises, payment for the procurement of actual property by installment, sale of the property already completed, income of interest. We will explore the implementation of assessable profits on post termination of the payments and receipts, trading stock and some decision of court. Relevant case studies will also be presented.
Determination of Assessable Profits
Principles of Commercial Accounting
The complete code on how the profits that are assessable which to be calculated for taxpayer setting up an office in Hong Kong is not laid down by the Inland Revenue Ordinance. The constitutional rules are laid down in the Section 15, 16 and 17 on items that are chargeable, as which objects are withdrawable and the valuation of the trading goods that can be done in specific scenarios. Other than that, it was held by the Privy Council in Lo & Lo that, in continuing the Inland Revenue Ordinance, commercial suppositions are pertinent. Due to that reason, it subject to the case and statue law, evaluate able profits are usually assured by reference to broadly acceptable principles of accounting.
Proofs of ordinarily acceptable principles of accounting are pertinent (commonly given by the accountants that are qualified as expert observer in the Court), but not resultant in the conclusion of Inland Revenue Ordinance. The reference for this statement is taken from the case of Jones. The concluding say which rests with the Court, as to what generally represents acceptable principles of accounting.
In the case D 8/10 it was observed that, the profit of taxpayer from the sale of alighted property was evaluated by the Inland Revenue Department based on the difference between the purchase price and sale price of the property. Some of the arguments of taxpayer were not accepted by the Board of Review. One among that arguments was that, when computing the profit for selling the land of property, the expenses should be the sums paid to the previous shareholders by the current shareholders for accessing its shares. In the case D 9/10 the decision was followed with same facts.
Income Arises Date
Section 14 (1) of Inland Revenue Ordinance imposes profits deriving from or arising in Hong Kong holding company formation. Generally, profit is evaluated on an earnings grounds, not when it is obtained. In the case of Arthur Murray Pty Ltd it was observed that, payment was received by the dancing school for lessons in advance. If that lessons were not taken by the taxpayer, there could be a refund. It was the taxpayer’s accounting practice to incur the only fees for lessons thought in the loss and profit account. The treatment of the court was upheld by the taxpayer.
A remuneration that is received subject to a dependent liability of repayment is evaluate able in the year of receipt. This was happened in the case of Lo Tim Fat¸ where remunerations were received by an insurance agent from the insurance company in the first year of commitment that were liable to be reimbursed to the insurance company in specific scenarios including the cessation of the commitment within 5 years, failure to attain specific amount of instalment for the business of insurance written by the respective insurance company by the agency of taxpayer. It was held by the High Court that; remunerations were held wholly in the first year. If the sums were obtained as money paid in account or loan or as a security for satisfying the accountability of the insurance company in the upcoming days, then the position may be different.
Payment for the Procurement of Actual Property by Installment
In the case of Montana Lands Ltd it was observed that, the properties were sold by the taxpayer. The purchasers paid the payment in the form of installments over a period of 100 months. As long as the final installment was not paid, the assignment of the property did not take place. It was adopted by the taxpayer the practice of acknowledging profits in its accounts when the installments were obtained, not at the time the purchase and sale contract was undertaken. It was argued for the reasons of tax by CIR that, the treatment of taxpayer was not correct. In the case D 103 / 99 the principle of this case was followed. The key point to note here is that, in this case the installments were paid to the developer of property. In many cases of the property purchase, the purchase was financed by the purchaser by reasons of mortgage loans from banks. The installments in mortgage loan’s repayment are made to the bank, not to the developer of property.
Sale of the Property already completed
The developers of the property or taxpayers setting up an office in Hong Kong, before completion of the building often trade units in the buildings. The buyers enter into the purchase and sale agreements with the developer. A deposit of 10% to 20% of the purchase price need to be remunerated at that time. At the time of assignment, the remuneration of the purchase price will be made. The allocation will only be made when the items are ready for delivery to the buyer. This will not happen before the supply of an occupation allowance by the related department of government. According to the acceptable principles of accounting, at the time of entering into the purchase and sale agreement, no profit is considered. Credit for the complete gain will be brought into account in the base period in which the occupation allowance is issued.
Income of Interest
In the case D 14 / 88 it was observed that, the loans were advanced by the taxpayer Hong Kong holding company formation (an affiliated company). The interest for the assessment years 1981 and 1982 was not remunerated, but was considered and taxed. The affiliated company was not able to pay the interest and it was claimed by the company that the accounting treatment for assessment years 1981 and 1982 was wrong. It was held by the Board of Review that, the taxpayer had gone through proper practice of accounting in including the interest in the assessment year 1981 and 1982 and that it could not claim subsequently the interest that was not evaluate able until it was obtained. The board of review stated that regarding the date of interest’s accrual, it was not right to lay down a hard and fast rule. Behind each case there should be some particular facts.
Interests does not accumulate until the beneficiary has a right to request the payment (i.e., in general the due date or the date of maturity). The original date of payment is not the date of accumulation for tax reasons. In the case of a time down payment, the interest should emerge on the date deposit on which it grows up as the depositor is not qualified to any interest before that day. But, in the case of account interest of savings, it accumulates as the holder from day to day is qualified to the interest on a day-to-day basis. A key point to note here is that, income of bank interest is now exempt.
Post-termination Receipts and Payments under Section 15D of Inland Revenue Ordinance
Remuneration obtained after termination shall be included in evaluate able profit for the final assessment year given that the remuneration will be contained in evaluate able profits if the remuneration has been obtained before the termination. Remuneration paid after termination can be withdrawable from the evaluate bale profits for the final assessment year given that the remuneration are expenditures that are evaluate able if they were paid before the termination.
Let’s take an example, if after the termination, an amount was paid by the taxpayer working for local or offshore incorporations HK, as damage for inferior items supplied, the payment will be deductible in calculating the profits that are evaluate able of the year of termination. If the post-termination expenditures evaluate able is under the Inland Revenue Ordinance. For example, asset is in capital nature or not being experienced in the generation of evaluate able profits, to this Section 15 D of Inland Revenue Ordinance does not allow a deduction. The reference for these statement is taken from the case of Overseas Textiles Ltd. The key point to note here is that Section 15 D of Inland Revenue Ordinance uses the word ‘paid’. Due to that reason, if the good does not include a payment, no withdrawal can be provisioned, for example, debt becoming bad after termination will not be withdrawable.
Stock at Trading
Subject to the case law and constitutional rule, the common way to assure the losses or profits of business for the reasons of tax to receive principle of commercial accountancy. The reference for this statement is taken from the case of Jones. Other than the Section 15 C of Inland Revenue Ordinance that deals with the termination of business, there is no allowance in the Inland Revenue Ordinance on the evaluation of the stock of trading for tax purposes. Some legal issues were laid down by the number of court cases on the issue of stock evaluation. The advices given in HKAS 2 Inventories provided by the HKICPA are acceptable broadly to the Inland Revenue Department. The doubts of the Inland Revenue Department concerning of these guidance are set out in the departmental interpretation and practice notes 1 (Revised). It have been established by the cases of court for tax, as its stock should be evaluated at market value or lower cost. The reference for this case is taken from the case of Whimster & Co. The meanings of cost is either historical or actual cost. This contains all expenses experienced directly on the conversion, purchase and bringing the stock its existing condition and location. Also incorporated is any overhead expense that can be allocated adequately to the stock’s cost and carried forward in the scenarios of business, other than being acknowledged as a revenue expenditure in the term in which it was experienced. The reference for these statements is taken from the departmental interpretation and practice notes 1 (Revised). Market value is generally required by the Inland Revenue Department to be the ‘net realizable value’. The meanings if this is that, the cost of replacement is not ordinarily acceptable.
The meanings of the net realizable value are that ‘the approximated price of selling in the common course of business less the supposed cost of completion and approximated cost necessary to make the sale’. The reference for this statement is taken from the (HKAS 2). The general costs of selling should not be included in the ‘approximated costs mandatory to make the sale’. The reference for this statement is taken from the departmental interpretation and practice notes 1 (Revised). As practice, particular identifiable stuff of the expense is related directly to the in question stock, including the allowance of commission and stock broker’s business that would have been experienced on sale, would be permitted.
Other Decisions of Court