How the profit receipts in terms of qualifying debt and financial taxation instruments are defined under Inland Revenue Ordinance for taxpayer having Hong Kong business formation?


04 Jan

We are discussing in this blog the profits tax: receipt on qualifying debt instruments. We will see debt instrument and some of its types such as medium-term debt instrument and short-term debt instrument. Then we will throw light on the qualifying reinsurance and captive insurance of a taxpayer. And at the ending of this blog we will go through the taxation of above described financial instruments. In this we will explore the timing of assessment, assortment of non-derivative financial assets and insurance. These all information is required if a taxpayer is going to start up business Hong Kong.


Qualifying Debt Instruments

 

The exemption and concession discussed below are generally applicable on Hong Kong business formation to the income of interest and profits on the transfer of qualifying instruments of debt (QDIs).


Exemption / concession

Issuance date

24 May 1996 to 4 March 2003

5 March 2003 to 24 March 2011

From 25 March 2011

Period of maturity

100 % exemption in accordance with the Section 26 A (1) (i) of Inland Revenue Ordinance.

N / A

> = 7 years

> = 7 years

50 % rate of profits tax in accordance with the Section 14 A (1) of Inland Revenue Ordinance.

> = 5 years

> = 3 years to < 7 years

< 7 years

   

The tax exemption and concession that is discussed above will not be applicable in relation to a qualifying debt instrument. That qualifying debt instrument was issued in 25 March 2011, if at that time during which the income of trading profits and interest is/are so accumulated or received by the taxpayer who establish company in Hong Kong as an affiliate of the qualifying debt instrument’s issuer. The reference for this statement is taken from the Sections 14 A (1A) and 26 A (1B) of Inland Revenue Ordinance.

Some related definitions are given below:

Debt Instrument

The meaning of debt instrument is the instrument that:

  • Is provided to the Hong Kong’s public.
  • Is related to the issue of debt, which has been submitted with and cleared by the Unit of Central Money market. This money market is administrated by the monetary authority.
  • If it is not a usable instrument, it were in its physical form then it is the instrument that would qualify in regard of this definition.
  • Has a minimum cult of amount $ 500, 000 or equivalent to that in overseas currency.  
  • Is issued by a person in Hong Kong and that person has at all related times a rating of credit accepted to the authority of monetary from an agency related to the rating of credit and known by the Monetary authority.

The secretary of finance has to manage to:

  • Announce that accounts do not apply that are mentioned in Section (b) of Inland Revenue Ordinance and relating to a rating of credit.
  • Apply a minimal cult that is not same as the above mentioned amounts.

From the ahead of date 25 March 2011, for the purpose of fulfilling the criteria ‘issued to the public’ the state of instrument should be issuance, issued in the Hong Kong to:

  • 10 persons or more than that; or
  • If less than 10 persons, then according to the Section 14 A (4) of Inland Revenue Ordinance, none of which is an affiliate of the instruments

Debt Instrument for Medium Term

An instrument of debt that:

  • Is issued before the date 5 March 2003;
  • Can be rescued within 7 years from its issuance date but not within the 1st 3 years.
  • Has an indigenous maturity of period less than 7 years, but is undated or not less than 3 years.

Debt Instrument for Debt Short-Term

  • Is issued after or on 25 March 2011;
  • Can be justified within 3 years from the issuance date;
  • Is not updated or have indigenous maturity of period less than 3 years.

Captive Insurance and Qualifying Reinsurance Business

Chargeable profits of a company or firm or corporation are subjected to profits tax. This tax of taxpayer having Hong Kong company incorporation service is one-half of the usual profits tax rate of corporation to the scope that profits are:

  • In accordance with the Section 14 B (1) of Inland Revenue Ordinance, the chargeable profits of a corporation obtained from the offshore reinsurance business risks as a white-collar reinsurer.
  • The chargeable profits of company or corporation or firm obtained from the offshore insurance business risks as a sanctioned captive insurer as described in Section 14 B (1) (b) of Inland Revenue Ordinance, with applicable from the assessment year 2013 / 14.

If the corporation has selected in writing that sections 14 B (1) (a) or (b) so applicable to it then to that corporation only one-half tax rate would apply. The reference for this statement is taken from the Section 14 B (2) (a). According to Section 14 b (2) (b), if the election is made once then it is not revocable.

The meanings of ‘Sanctioned captive insurer’ is that:

  • Defined in Section 2 (7) (a) of the Ordinance of Insurance Companies as a captive insurer (Cap 41); and
  • Fully sanctioned to carry on or from business of insurance in Hong Kong as this type of a captive insurer under Section 8 of Insurance Companies Ordinance. The reference for this statement is taken from the Section 23A (3). 

The meanings of the ‘professional insurer’ is an authorized company to carry on or from business of reinsurance only in Hong Kong under Section 8 of the Ordinance of the Insurance companies. The reference for this statement is taken from the Section 23A (3).    

Financial Instruments Taxation (DIPN 42 (Part 1)) 

In the Hong Kong accreditation service 32 the financial instrument is defined. This accreditation system is issued as ‘any contract that generates instrument of equity of one entity or a financial liability and another entity’s financial asset’ and issued by the Hong Kong Institute of Certified Public Accountants. The most suitable example for such taxation system is the loan note provided by one establish company in Hong Kong while subscribed for another company. That financial instrument can also be used for the purposes of investment, hedging or trading.


Assessment’s Timing 

These treatments of accounting as described in Hong Kong accreditation service 39 are approved by the Inland Revenue department alternatively specified (DIPN 42):

  • Financial liabilities or financial asset that are included or acquired for the purposes of trading are calculated at reasonable value with all the concluding losses or gains known in the loss and profit account and evaluate able or taxable for the purposes of tax.
  • ‘Loan and receivable’ and ‘held-to-maturity investments’ are interpreted at a reduced cost (using the method of effective interest rate, i.e., by discounting the receipts or approximated payments of future cash through the financial instruments’ life). The losses and profits are acknowledged upon disablement (including the allowance for poor debt in case of receivables and loans), through defrayal and are evaluate able / deductible or taxable.

The sum for which a liability or an asset could be between learned, willing parties in a remote transaction is known as ‘Fair value’. Some of the previous valuation processes such as net realizable value or lessen of cost will no more be accepted.

One example provides by the Inland Revenue department that, Securities Trading Company name as A operating in Hong Kong. That company purchases the note of medium-term due in 2008. That note is issued by a listed company. The face value and interest of note is $ 100,000 and 8 % per annum. The interest rate is payable at the end of each year. At the end of year, the face value of that note is $ 110, 000 and reason for that is the interest rate of market has fallen. If that company A takes the accumulated interest of amount $ 8, 000 and profit of amount $ 10, 000 ($ 110, 000 - $ 100, 000) into account in conformity with Hong Kong accreditation service 39, then the stated interest and profit are chargeable although the note has not been disposed of. If in the following year company disposed of that note at amount $ 130, 000 then the gain of amount $ 20, 000 will be evaluated in the subsequent year.

Non-Derivative Financial Year’s Re-Classification 

The Hong Kong Institute of Certified Public Accountants in October 2008 issued the modifications to Hong Kong accreditation system 39 allowing re-classification of some non-derivative assets of finance if the conditions identified in the modifications were met. It was allowed by the companies by amendments to assorted:

  • Assets of finance under Available for the sale into receivables and loans.
  • Assets of finance under fair value through loss and profit into some other categories.

Before the reclassification, the non-realized losses / gains obtained from the fair value through loss and profit were deductible / evaluate able if their origin was in Hong Kong. In the official meeting in February 2009 between The Hong Kong Institute of Certified Public Accountants and Inland Revenue department, the Institute asked the department to suggest on the evaluating practice for assets of finance under fair value through loss and profit that were re-categorized both:

  • Following to the re-classification; and
  • At the schedule of re-classification.

According to the Inland Revenue department, whether the nature of asset was capital or revenue was a query and consideration of accounting treatment including all the circumstances of surrounding was required by it. This technique resumed to apply to assets of finance categorized following to modifications to the Hong Kong accreditation system 39. It was necessary to assure:

  • The purpose at the time of acquiring; and
  • Whether upon re-classification there was modifications of plan or not.

The question of actuality to be decided was that whether there was a modifications of purpose all consideration of all the related scenarios and actualities. Under the modifications to Hong Kong accreditation system 39, the assets of financed that could be assorted out of the fair value through loss and profit category might incur:

  • Instruments of debt; and
  • Instruments of equity.

For the assorted debts and equity instruments out of the fair value through loss and profit category, the major difference between:

  • The fair value at the assortment taken to the loss and profit account; and
  • The amount carrying in earlier statements of finance.

Was chargeable / allowable or assessable, according to the respective case.

If it is not agreed by the Inland Revenue department that, there was a change in plan towards the debts and equity instruments upon assortment, then the loss or gain obtained from their following ejection would be evaluated / allowed or taxed accordingly. If it is accepted as there was a change of plan towards the debts and equity instruments upon assortment then the following amendments in value after the assortment would be capital in nature. The total responsibility is on the taxpayer doing start up business Hong Kong for the establishment of any change in the plan.


Derivatives

A financial liability or financial asset at reasonable value through loss or profit incurs an asset of finance or liability of finance that is detained for the trading. Except for, a derivative is appointed and effectual surrounded instrument, an imitative will be sorted as detain for the purpose of trading.

Business of finance or insurance

The instruments of finance detained by the institution of finance or a taxpayer which operate on moneylending, an insurance, and business of finance or dealing of securities are the assets of trading. The reference for this statement is taken from the case of Sincere Insurance & Investment Co Ltd.

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