How the establish company in Hong Kong or taxpayer accountable to tax from profits gained through bill of exchange, certificate of deposits, excluded income and capital receipts?

In this blog we will explore the profits obtained by taxpayers in Hong Kong and source of these profits from bill of exchange or certificate of deposits. Then we will have discussion on the topic of excluded income and capital receipts. In case of excluded income, we will discuss the setting free of profits of mutual fund and unit trust from tax. While in case of Capital receipts we will discuss what is fixed asset? And what are temporary and permanent losses of fixed asset.   

Profits from Bills of Exchange or Certificates of Deposits (CDs)

The word ‘Certificate of deposit’ is clearly defined in Section 2 (1) of Hong Kong tax law, the meaning of this word is that, a document that is related to the money, in any type of currency, that has been accumulated with its issuer or some other person, being as a document acknowledges a duty to pay a said amount to order or to bearer, without or with interest, and being as a paper that is to be delivered without or with funding, without or with interest the right to get the said amount is able to be transferred and in occurrence of any such document that is advised as instrument as described in the definition of ‘prescribed instrument’ in accordance with the Section 137 B of Banking Ordinance. That Ordinance incurs any interest or right referred to in the para b of that explanation in respect of such paper.

A certificate of deposit may be a paper or document issued by the financial institution or bank for the purpose of certifying a deposit that is made by a person having establish company in Hong Kong, the date of payment or the interest rate. Upon his/her adult hood the depositor is allowed to get his/her accumulated interest and the rate of interest back. Other than that, a certificate of deposit may be provided at a discounted amount and repaid to the applicant upon his/her adult hood at the full face value. It is up to the depositor that he/she may sell the certificate of deposit before adult hood, at a price that mirrors the accrued interest value.        

Individual Source of Profit from Bills of Exchange or Certificate of Deposit

The profits obtained from bills of exchange or certificate of deposits are allowed to tax in case of corporation either as a start up business Hong Kong or other type of corporation if:

• The source of profits is in Hong Kong. The reference for this statement is taken from the Section 15 (1) (j) of Hong Kong tax law.
• Corporation only operate its business in Hong Kong.

The profits are allowed to tax for a person except corporation either as a start up business Hong Kong or other type of corporation if:

• The business is being carried on by person in Hong Kong;
• The source of profits is in Hong Kong; and
• The profits are as a result of the business, trade or profession of a person. The reference for this statement is taken from the Section 15 (1) (k) of Hong Kong tax law.

In the judgement of the case of Hang Seng Bank it was stated that, the source of profits should be locating where the contracts are accomplished. These source of profits are profits from presentment or sale on adult hood of certificate of deposits or bills of exchange.

Excluded income

The profits tax is not allowed on the income discussed below:

• According to the Section 14 (1) of Hong Kong tax law, the profits obtained from the capital assets’ sale.
• According to the Section 14 (1) of Hong Kong tax law, income not obtained from or gained by operating in Hong Kong.
• Dividends:
• The dividends which are allowable to profits tax and received from the firms are exempt from profits tax. The reference for this statement is taken from the Section 26 (a) of Hong Kong tax law.
• The dividends are not particularly exempt that are obtained from the firm and are not allowed to Hong Kong profits tax. Let’s take an example. Dividends from an overseas company that is not subject to profits tax of Hong Kong are not exempt particularly. However, in practice these type of dividends is not taxed. There can be chances that these type of dividends are offshore as offshore incorporations HK limited in nature.
• According to the Section 26 (b) the income in advance charged to profits tax.
• The government bond is in accordance with Section 26 A (1) (b), interest on certificate of tax reserve is in accordance with Section 26 A (1) (a), an instrument of exchange Fund debt is in accordance with Section 26 A (1) (d), an instrument of long-term debt is in accordance with Section 26 A (1) (h) and a denominated Hong Kong dollar instrument for multilateral agency debt is in accordance with Section 26 A (1) (f).
• Any on sale profit, evidence or clearance in government’s bond presentation in accordance with Section 26 A (1) (c), an instrument of exchange fund debt is in accordance with Section 26 A (1) (e), an instrument of long-term debt is in accordance with Section 26 A (1) (i), and a denominated Hong Kong dollar instrument for multilateral agency debt in accordance with Section 26 A (1) (g).
• Being effected from 4 April 2014:
• Any disposal of or other on sale profit, or on the receipt of evidence or payment for, this kind is like a replacement bond. The reference for this statement is taken from the Section 26 A (1) (cb); and
• Any extra payment payable or paid on a replacement bond that was issued in relation with an abstract by the respective government in accordance with the meaning of Section 2A (2) of Loans Ordinance.

If expenses are paid by a person to the taxpayer rendering Hong Kong company incorporation service then it is not considered as profit already charged to tax. Due to this reason, the exemption on the sum received in such way could not be claimed by the taxpayer. The reference for this statement is taken from the proceeding of case D 44/04.

Exclusion of Profits of Mutual Fund, Unit Trust in accordance with the Section 26A (1A) of Hong Kong tax law

Sums including profits or gains being raised from the sale of interest or securities, accumulated to or received by:

• A approved corporation of mutual fund;
• An administrator of a approved unit trust;
• A corporation of mutual fund settled outside the Hong Kong being an authentic and corporation of widely-held investment that follows the requirements of an administrative authority within an arrangement of acceptable regulatory; or
• A person allowable to tax on profits in concerning to any collective investment scheme of same type as being an authentic broadly-held scheme of investment that follows with the supervisory authority’s requirements within the arrangements of acceptable regulatory. The reference for this statement is taken from the Section 26 A (1A) (a).

The details of exemption are given in the departmental interpretation and practice notes 20 (revised June 1998). According to the Section 26 A (1A) (b), a particular investment scheme is the scheme of investment that is approved by the Futures Commissions and Securities or the supervisory authority within the arrangements of acceptable regulatory.

Capital Receipts     

Receipts from the disposal, sale, fixed asset’s destruction or loss are capital in the nature. These receipts are also not allowed to profits tax. The basic nature of capital receipts is a main question of fact. This question in reality is determined from the scenarios of each specific case. There is no some definite rule. In common, this is a matter of degree. None of definition of fixed assets or capital receipt is laid down by the inland revenue ordinance. In case of large body of case law, references must be made.

Definition of Fixed Asset

It has been stated that, a fixed asset is used by a person either having Hong Kong company incorporation service or other businesses for the production of profits by keeping it, and current asset is used for the production of profit by separation from it.

Loss of Fixed Asset as Temporary or Permanent

Capital receipts are considered to be the receipts for a fixed loss of a permanent asset. In the case of Glenboig Union Fireclay Co Ltd.it was observed that, a railway was to be constructed over fireclay mines. These mines were operated by the taxpayer. As a result of construction of this railway the mines could no longer be operated. Because the loss in the form of non-operational mines was permanent the compensation that was paid to the taxpayer was held to be principal in nature. This was so however; the computation of compensation was based on the profits lost due to the destruction.   

In case of the Aviation Fuel Supply Company, in December 1995 the airport authority entered into:

• An operational agreement with a nominee of Aviation fuel supply company (‘the Operator’) for utilizing the facility.
• An agreement of franchise with Aviation fuel supply company that was a limited partnership consisting of 7 oil firms and two airlines, for granting the Aviation fuel supply company with the right to provide a system for aviation fuel for the period of 20 years, subject to the right of authority for the ending of lease earlier on the payment of Accelerated Facility payment (‘the accelerated payment’) from 5^th anniversary of the airport’s opening day to at any time;
• An agreement of lease to grant the rights to Aviation fuel supply company for the occupation of the facility area as occupant for 20 years. The lease on the date of Accelerated payment should be terminated.

The Aviation fuel supply company, under the agreement of franchising should be entitled to:

• Payments of annual facility over the term of the agreement of franchise from the operator. This is to enable the Aviation fuel supply company to recover its costs of providing facility (‘these necessarily incur the cost of construction of facility’) with a rate of return that is fair (‘internal rate of return that is 15 %’); and
• To claim the devaluation allowances as regarding to the facility.

In following to the agreement of franchise, the facility was designed, financed, constructed and commissioned by the Aviation fuel supply company. The facility was finished and ready to being operated on the occasion of opening of new airport on 6 July 1998. It was notified to Aviation fuel supply company by the Authority in October 2002, about its election following to the facility of cost and making of accelerated payment on 7 July 2003 (‘The date of accelerated payment’). The total accelerated payment made to Aviation fuel supply company by Authority consisted of US $ 449, 043, 000 (‘the sum’). This sum demonstrated the net present value of the anticipated facility payments for the remnant lease term that Aviation fuel supply company would have received otherwise. Following to the agreement of Franchise, the ease was ended on the date of accelerated payment. The agreement of operation survived, despite the payment of accelerated payment to the Aviation fuel supply company by the authority.      

The operator would afterwards pay the payments of facility to the authority instead of Aviation fuel supply company.