In this blog we will be examining expenses category in a profit tax computation. At the start of this blog first we will explore the implementation of the tax policy on the daily affairs of the taxpayer such as deposits and advances that being discuss under the Section 16 (1). So we will be understanding about these terms. Then we will explore the implementation of the profits tax on the calculation of repair to the newly obtained assets in which we will see which things are to be added for assessment of tax, then we will further discuss some other specific deductions such as research and development expense, donations for the reason of charity, expenses of technical education and the allowances of renovation. All in help of relevant Sections of Inland Revenue Ordinance.
Advances and Deposits under Section 16 (1) of IRO
In the case of Asia Securities Ltd., it was held that, mere placement of money in the institute of finance may aggregate to carrying on the moneylending’s business. Nonetheless, the proceedings with the institute of finance were countless in that case. This case was determined on its own particular facts. Many persons who placed the money with a bank would not license as lenders of money. Although, where in the normal course of business, a bad debt arises from advances or deposits, they may be permissible under the specific rules of Section 16 (1) of Inland Revenue Ordinance.
Money was deposited by an engineering set up company in HK into a bank. That bank later became bankrupt. In the proceeding of case D 55/95 it was observed that, the loss was not permissible. The loss was not either deductible expense falling within Section 16 (1) or a bad debt falling under the Section 16 (1) (d). The taxpayer corporation was not moneylender. Even considering that the loss fell under Section 16 (1), the loss was not experienced in the chargeable profits’ production. There was nothing to advise that placing remuneration in the bank was a mandatory step in holding the business of taxpayer.
As discuss in example, a marginal deposit was paid by the taxpayer having set up company in HK for the trading stock’s purchasing. Nonetheless, the supplier of trading stock became bankrupt. The taxpayer could not retrieve the marginal deposit as the goods were not delivered on time. This loss should be permissible under the Section 16 (1) of Inland Revenue Ordinance.
Seeing another example, an amount of $1,000 was lent by an employer to one of his employees. The employer was hoping that the good employer-employee relationship would be maintained by such loan and also it would keep the employee in business. Though, the employee did not repay the loan and disappeared. As being the part of the employment’s cost, the loan may be permissible under section 16 (1) of Inland Revenue Ordinance.
Repairs under Section 16 (1) (e) of Inland Revenue Ordinance
Repairs of the different stuff such as premises, implements, plant, articles, machinery or utensils that are employed in the assessable profits’ generation, are permissible. Nonetheless, the improvement’s cost is not permissible as discussed in the case of William P Lawrie where old roof’s replacement by a large roof. The complete cost of the new roof disallowed.
Renewal and repairs must be distinguished from each other’s. The renewal’s cost is not permissible. The renewal is the replacement of the whole asset while every repair is the replacement of asset’s part. The basic question here is that, ‘whether the entire asset or only a part of it is replaced by the taxpayer’. The reference for these statements is taken from the Bullcroft Main Collieries Ltd.
According to the Section 17 (1) (e) of Inland Revenue Ordinance, the amount to be deducted must be lessened by any remuneration occurred under any insurance’s contract. Let’s take an example, in following a car crash, a remuneration of amount $5,000 was spent on refurbishment, but a reimbursement of amount $3,000 was obtained from the insurance company having Hong Kong limited company registration. Only the amount $2,000 was deductible.
Repair to Newly obtained Assets
Repair to the newly obtained assets was not allowed in case of the Law shipping Co Ltd. as being the capital, but this was allowed in the case of Odeon Theatres Ltd. The appeared distinction is totally dependent on how was the treatment of expenditure in the accounts and whether the asset could be utilized to generate the profits without experiencing the repair.
Utensils, Implements and Articles
Expenses experienced in the replacement of any utensils, implements or article is permissible but as so no devaluation allowance has been requested under the Section 16 (1) (f) of Inland Revenue Ordinance. Utensils, implements or articles are defined as including cutlery and crockery, soft furnishings (for example, carpets and curtains), loose tools, kitchen utensils, etc. Only the replacement expense is permissible. The meaning of this is that the early purchase is capital in nature and it is not permissible.
Registration of the Patents, Trademarks or Designs
Payments of the patents, trademarks or designs, for example, legal fees if utilized for the production of the evaluate able profits is permissible under the Section 16 (1) (g) of Inland Revenue Ordinance. Without such an allowance, as this payment being capital in nature will be non-permissible.
Other Particular Deductions
Research and Development Expense under Section 16B of Inland Revenue Ordinance
In the field of science, marketing, technology, management or business, production, etc. the deduction totally relates to the research and development (R&D). The reference for this statement is taken from the DIPN 5. The withdrawal is not relevant to the expense experienced in the accession of rights in the Research and Development.
The deduction of the expense on the scientific research is allowed under the Section 16 B, before 1 April 2004. The Section 16 B is revised to allow the deduction for the expense on Research and Development as from the 1 April 2004. For the purpose of trade, business or profession, a deduction is allowed for the payments made to an accepted research institute for the Research and Development in relation to that profession, business or trade. Capital expense may also be debited except the expense in relation to the buildings and / or land.
Let’s discuss an example, A Ltd. is doing business in Hong Kong and on 31 March each year it prepares its account. The expense given below relating to its business was paid by the company in the year ended 31 March 2015.
A deduction of amount $500,000 can be claimed by the A Ltd. under Section 16 B of Inland Revenue Ordinance in respect of the machinery and plant used for accomplishing the scientific research. An industrial building allowance can only be claimed by it concerning the cost of the laboratory’s construction. It cannot get the withdrawal for the land’s cost.
Expense that is met by the public, Government or local authority, whether in Hong Kong or in state other than that or by some other person, shall not be considered as being occurred.
The sales transactions shall (up to the previously withdrawn amount), be treated as the receipt that is taxable. In the same way where:
The sales progresses of the right shall (to the extent of the amount withdrawal previously under the Section 16 B) be served as a receipt that is taxable.
Technical Education Expense under Section 16 C of Inland Revenue Ordinance
Where a business or trade is carried on by taxpayer company formation services in Hong Kong, and taxpayer pays any related sum for the reason of technical education to that profession, business or trade at any university college, technical college, university or other educational institution that has been approved by the director of education in writing, a deduction can be allowed. The expense of capital in nature may be allowed under such section.
Charitable Donations under Section 16 D of Inland Revenue Ordinance
The remittance must be a money’s donation, greater than or equal to amount of $100 in total, to an accepted institute of finance or to the government or to the trust of a public character, for the purpose of charity. The remittance must be the pure donation. As discussed in the proceeding of the case of Sanford Yung, none of the benefits can be obtained from the donation. After the devaluation allowance, a deduction is only limited to the 35 percent (25 percent of the assessment years 2003 / 04 to 2007 / 08) of the assessable profits but as before the charitable donations.
The remuneration must not qualify for the withdrawal as an expenditure under the Section 16 (1) of Inland Revenue Ordinance, expense on Research and Development under Section 16 B, expense on the technical education under Section 16 C or a permissible charitable donation for the reasons of the tax on salaries. Because of the 35 percent limit, the donations for the purpose of charity should be added back to the regulated profits first. The accepted donations are deducted then, against the regulated profits after the deduction of the devaluation allowances.
Considering an example, a taxpayer having Hong Kong business formation has regulated the profits of amount $100,000 after the deduction of the donations of amount $16,000 for the purpose of charity, in the assessment year 2015 / 16. He is qualified to a devaluation allowance of amount $80,000.
Computation of Profit Tax
Add: Donation for purpose of charity
Less: Devaluation allowance
Less: Approved donations for the purpose of charity 35 percent
If, after not deducting donations for the reason of charity and withdrawal of the devaluation allowance, the computation results in any compensating loss, any accepted donations for the reason of donations will not be permissible. If a gratuity does not qualify as an accepted donation for the reason of charity under the Section 16 D of Inland Revenue Ordinance, consideration may be granted to whether the expenditure qualifies for the withdrawal under the general rule of Section 16 (1) (for example, it is experienced for the reason of advertising or promoting the product of taxpayer).
Renovation Allowance under Section 16 F of Inland Revenue Ordinance
Capital expense experienced on the refurbishment or renovation of a structure or building (other than a domestic structure or building) can be withdrawn in 5 equal installments over 5 assessment years, commencing with the basis period in which the payment was made in actual under Section 16 F. The meanings of a ‘domestic structure or building’ is any structure or building used for the purpose of habitation, but does not incur any structure or building used as guest house or hotel, or any part of guest house or hotel under Section 16 F (5).
The renovation allowance will not be accessible concerning of the capital expense occurred:
Discussing an example, a company named as E Ltd. have Hong Kong limited company registration. It prepares its account on 31 March each year. An amount of $600,000 was experienced by it during the year ended 31 March 2016 for the refurbishment of its office premises. E Ltd. is qualified to a claim renovation allowance of amount $120,000 (i.e., amount of $600,000/5) in each of the 5 assessment years 2015 / 16, 2016 / 17, 2017 / 18, 2018 / 19 and 2019 / 20.
A person that is given as renovation allowance under the Section 16 F of Inland Revenue Ordinance is not qualified to claim the allowance of commercial building in respect of the same expense.