How the capital receipt of aviation fuel supply company are accumulated for taxpayer having set up company in HK and compensation for loss of contract along with lease premiums?


04 Jan

In this blog we will explore that what kind of receipts are considered to be capital in nature and how these are dealt by the court of appeal, Inland Revenue department and some other authorities of Hong Kong. A taxpayer in Hong Kong should be aware of tax implementation on these type of receipts and also on the compensation for loss of contracts between different taxpayer companies or individuals that either have established business in Hong Kong or looking for opening a business in Hong Kong.


Accounting Treatment of Aviation Fuel Supply Company

The accounts were audited of Aviation Fuel Supply Company, for the whole of period from accomplishment of the facility until the concerned assessment year, treated:

  • The space as a permanent asset of the Aviation Fuel Supply Company; and
  • Have a tendency to the payments of facility as its income, embracing a policy of acknowledging the payments of facility as income in the respective period in which Aviation Fuel Supply Company provided services (these type of services being the allowance of the facility to the operator used by it).

Tax returns of Aviation Fuel Supply Company 

Tax returns on profits was filed by the Aviation Fuel Supply Company. It was filed together with its evidences of tax computations for the assessment years 1997/98 through to 2003 /04 and including details of financial statements. In each of these two types of tax returns, the tax was charged on the payments of facility that were received from the operator and were proposed to the profits tax assessment. In the assessment year 2003/04, on the grounds that, remuneration was to be considered as compensation for the yielding of business hence that remuneration was not offered for assessment of profits tax. As this remuneration was a payment made by the authority for the acquisition of business of Aviation fuel supply company and also it was capital in nature and not taxable in accordance with the Section 14 of Hong Kong tax law.

The views considered by the Inland Revenue department

The point of view of the assessors was that:

  • The sum was neither capital in nature nor reward for the loss in business;
  • The receipt of round sum payment in substitute of the payments of monthly facility (that were considered to be allowed to tax) did not change the nature of income of the payment; and
  • The sums were considered to be a receipt of trading allowable to tax on profits followed to Section 15 (1) (m) of Hong Kong tax law.

The assessment was upheld by the CIR and the reasons given below were considered by it:

  • Sum is taxable income as it was supposition for the transfer of right to receive income from the real estate business in accordance with the Sections 14, 15 (1) (m) and 15A of Hong Kong tax law.
  • There was no major difference between the sum for purposes of tax and the payments of facility, due to this reason both were to be considered as receipts of income of business of Aviation Fuel Supply Company; or other than that;
  • The remuneration could be considered as being in replacement for the payments of facility, so it should be allowed to tax as income, considering the characters of payments for which it was replaced.

Conclusions and Findings of the Court of First Instance

It was found by the judge Hon Barma J that, sum caused transfer of the ownership of the facility to authority from Aviation Fuel Supply Company. It was received upon the refinement of business of Aviation Fuel Supply Company. It was stated by the judge that:

  • The basic intention behind the business of Aviation Fuel Supply Company was to utilize the facility for the purpose of earning the payment instead of just constructing or designing the facility as a service provided to authority as a return for a fee.
  • The business of Aviation Fuel Supply Company was not used to derive the business.
  • The nature of sum was different from the facility payments, it was capital receipt and so not taxable under Section 14 of Hong Kong tax law.
  • The purpose of remuneration was not for the transfer of right to receive the income from property and due to this reason it was not taxable under Section 15 (1) (m) and 15 A of Hong Kong tax law; or as a replacement, Aviation Fuel Supply Company was capable of bringing itself within the variance contained in the Section 15 A (3) of Hong Kong tax law. Due to this reason the remuneration was not allowed to tax under Sections 15 (1) (m) and 15 A of Hong Kong tax law.

The appeal of CIR was dismissed by the court of appeal. It was held by the court of appeal in decision of that case, that round sum obtained by the taxpayer having set up company in HK was not allowed to tax and it should not be used in the calculation of balancing charge. On that appeal of court of final appeal, the CIR was not anymore observed to argue that the sum was income. The two major issues of the court of final appeal were that:

  • Should the balancing charges be attracted by the receipt of the remuneration?
  • Whether in the court of appeal, the CIR should have been permitted to elevate the query of a balancing charge in the court of appeal as this query has never been raised earlier.

By just considering the first issue, Section 67 7 (b) of Inland Revenue Ordinance permits the court to make any type of assessment guarding the taxpayer who is running business having Hong Kong business registry but as that decision can also be made by the CIR by using its power and in this way it consults a judgement. The most important question here was that, if it was just for the court of appeal to consider the submission of CIR that, in the present scenario, Aviation Fuel Supply Company should be evaluated on the ground of a balancing charge. The given below are the two factors that were taken into account by court of final appeal:

  • It would be fair or not to drill the power to make an evaluation on a different ground after the completion of the limitation period of 6 year specified under Section 60 (1) of Inland Revenue ordinance pointed at guarding the taxpayer from having to explore the transactions that have lessened more than 6 years into past; and
  • Whether further exploration of the facts would be required by the grounds. As both if these factors were connected to each-others, it was held by court of final appeal that this would not be fair to release the Aviation Fuel Supply Company from protection of limited period since facts finding and further enhanced investigations would be required by the new grounds. The appeal was dismissed by the court of final appeal due to this procedural issue.

It was found by the court of final appeal that; it is not requisite to take the second issue under consideration. However, the court of final appeal had requested the court of final appeal to provide the information on one feature of decision of court of appeal. That feature was concerning about proper explanation of Section 39 B (7). This section is basically responsible for the treatment of capital allowances. But as a short note, the capital allowance is related to when a person flourishes to a business and machinery and plant related to it passes to him otherwise than by the incidentally of sale. According to the judgement of Lord Hoffman, the facility’s transfer to the authority by Aviation Fuel Supply Company was by incident of sale and not by the way of accession. On structures, industrial buildings or earlier described fixed assets the section 39 B (7) was not applicable. The CIR was so supported by the court of final appeal that balancing charge should be applicable. As the CIR lost on the operational issue, no balancing charge could be assessed that was arising from the sale.

Revenue are the receipts for non-permanent loss of permanent assets. In case of the Burmah Steamship Co. it was observed that, a ship was placed with a repairer by a shipping company for the purpose of reconditioning. As the repairer delayed the overhauling it was considered and claimed by the shipping company as damages. That loss was calculated by reference to the approximated loss of profit due to that delay. That compensation obtained by the shipping company was held to be allowed a taxable receipt.

A revenue receipt includes compensation for the trading stock’s loss including the compensation for insurance. The reference for this statement is taken from the case of Green v J Gliksten & Son Ltd.     

Compensation as regard to Loss of Contract

As long as the contract consists of the material part or the whole business of taxpayer or is relevant to the complete structure of profit making equipment of company, a compensation is capital in nature that is on its cancellation. The reference for this statement is taken from the case of Van den Berghs Ltd.

In a further case of D 64/98 it was observed that, a sole scattering arrangement judged for the 50% or 60% of the business of taxpayer who have Hong Kong business registry. That termination of the agreement further resulted in shutdown of the most important department of the company. The compensation as an outcome of that termination was confined to be capital in nature.

If the contract is only one among the many contracts of taxpayer, then the compensation for termination of contract in nature will be revenue. The reference for this statement is taken from the case of Kelsaal parsons & Co.

Termination or Cancellation of Tenancy Agreement

A compensation was received by an incorporate HK company from the tenant upon ingenuous cancellation of agreement of the tenancy. Other than that, the rental deposit was also hand over by the rental deposit. It was held by the board of review that, the rental deposit or compensation hand over were allowable to profits tax. If a sum is received and that is for the capital assets’ user and not for their pursuit, then such received remuneration is a trading receipt. The hand over rental deposit and the compensation were to reimburse for the loss of bartering receipts, i.e. rental receipts. The reference for this statement is taken from the case D 170/98.

 

Lease Premium

It is considered by the Inland Revenue ordinance that, payments of lease or sums other than that received by a landlord with allowing of properties such as deposits that are non-returnable or fees of construction are more probably to be the revenue in nature and not a capital. If it is considered that a landlord is carrying on the profession, business or trade, then these type of receipts are part of the receipts that are taxable. This is due to the reason that, payments were obtained for the utilization of assets that are capital in nature and not for the accomplishment of that asset. In the departmental interpretation and practice notes 4 (revised February 2006) the Inland Revenue department stated that, the requirements of commonly accepted accounting practice will be followed by it. And that commonly accepted accounting practice is that, for the reason of acknowledging the payment receipts as income it should be spread over the lease’s term.

Now we will discuss an example, there is a running incorporate HK company named as X. That company carries on its property-allowing business and terminated its accounts on 31 March every year. While keeping all the awards and risks considerably identical to its ownership, one of its properties was leased by the company for a term of 4 years beginning from the 1 April 2015 at a premium of amount $ 1, 200, 000. The accounting standard of Hong Kong is followed by the X and it leases income for preparation of its accounts.                

According to the accounting standards of Hong Kong, the lease will completely be an operating lease and due to this reason the lease premium ‘shall be acknowledged in income in a continuous manner basis over that lease term’, i.e. over the period of 4 years. Due to this reason for each of the assessment years 2015/16, 2016/17, 2017/18 and 2018/19, ¼ of the premium will be evaluated.

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