How the deduction in prescribed fixed asset and capital expense are made in tax calculation and the expenses not deductible for taxpayer having HK company registration in profit tax?

In this blog we will start our discussion with the exploration of deduction of the expenses that are related to the prescribed fixed asset under Section 16 G of Inland Revenue Ordinance. After that we will discuss some of the expenses that are not deductible such as expenditures and costs of improvements.

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 In these topics we will also discuss some of the case studies. Then we will further discuss some of the capital expenditures such as cancellation of the agreements, accession of the business, employee’s dismissal and fee of franchise. We will be explaining all these in relation with different Sections as described in Inland Revenue Ordinance for taxpayer owns or work in a company having Hong Kong incorporation.

Deduction in Prescribed Fixed Asset (PFA) Cost

The complete withdrawal is allowed to the expense that are capital in nature on the allowance of a prescribed fixed asset (PFA) in the year of procurement. The meanings of PFA is:

  • Machinery and plant that is directly and specifically used for any process of manufacturing, for example, machinery and plant used for manufacturing of electronics and plastic; and
  • Hardware of computer, other than that which is an important part of any plant or machinery; and
  • Computer systems and computer software.

There is no demand for the computer software and computer hardware to be in utilization in the ground period, but the withdrawal is subject to the belonging that being utilized eventually in the generation of profits that are chargeable. The Inland Revenue Ordinance should be notified by a taxpayer, if the concerned asset is used eventually outside the Hong Kong or not utilized at all. The reference for these statements is taken from the Tax Bulletin 24, 2013.

A PFA does not consist the fixed asset in which rights are held by any person having Hong Kong incorporation company as a lessee under a lease. Under the Section 16 G of Inland Revenue Ordinance, no deduction may be permissible for:

  • Capital expense experienced under an agreement of hire-purchase; and
  • Capital expense that may be deducted under any sections other than Section 16 G.

Where partial use of PFA is done to generate profit that is chargeable, the deduction shall be limited to the extent of the utilization of the belongings used in this way.

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Situation when PFA are sold

When a PFA is sold, the transactions from the sale may to the extent that is not chargeable otherwise to tax on profits and does not overreach the amount of the withdrawal, be treated as the receipt that is taxable. If only the part of capital expense has been allowed, the suitable part of the transactions from the sale shall be used as receipt of trading. If PFA is demolished, the moneys from insurance or compensation other than that, shall be used as if they were the sale transactions.

Where ever the seller has the control or hold on buyer, or buyer has the hold on seller, or both the seller and buyer are in the possession of hold of other individual, or the seller and buyer are wife and husband, it is the duty of CIR, if he is of the opinion that the transactions from sale does not relate the true value of market at that time of sale, so change that true value of market for the growths from sale.

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Expense not Deductible under the Section 17 of Inland Revenue Ordinance

Even if the outgoings or expenses comes under the Section 16 (1), it is however mandatory to suppose whether they would be not included under the Section 17. Describes below a number of expenditures that are not deductible under Section 17:

  • Expenditures that are private or domestic in nature, that include the travelling cost between place of residence and business. The reference for this statement is taken from the Section 17 1 (a).
  • In the case of Anthony Patrick Fahy trading Co it was observed that, T having sole proprietorship HK was the only proprietor of an accounting firm that was practicing. He went through an accident was and his leg was injured. The rod of metal had been entered into the injured leg of T and medical expenditures were experienced by him. The metal rod was linked by T to the supply of plant or machinery for the reasons of carrying the business, it was his views that there should not be any dissimilarity as the ‘plant’ or ‘machinery’ was installed in his body rather than in office of him. The decision was given by the High Court in favor of the CIR on the basis that the purpose of medical expenditures was dual, partly of the private or domestic nature, and partly for the reasons of the conservation of the taxpayer of his own individual as a belonging to the business. These type of expenditures were not permissible as there could not be any realistic allocation of the medical expenditures if that elements of the reason could not be differentiated and the expense was one non –divisible matter.
  • Payments or the expenditures that are not exhausted for the reason of generating the evaluate able profits. The reference for this statement is taken from the Section 17 1 (b).

In the case D 4/13 it was observed that, T was a firm of lawyers. A person named as Mr. A was one of the partners and he was only the equity partner of T. The disciplinary tribunal of lawyers (the Tribunal) Hong Kong’s law society begun an inquiry into the professional conduct of Mr. A. A separate set of transactions was begun by the Mr. A against the Tribunal.

From both, before the court of appeal and CIR he was not successful and was ordered to pay the Tribunal’s cost. It was seeking by T to deduct the costs. The appeal of T was dismissed the Board of Review due to the following reasons:

  • The costs were not allowed under the Section 17, as T was not passed to establish the how the different set of transactions might be valid for the reason of generating its evaluate able profits.
  • The costs were in original the cost of the Tribunal in the isolated set of transactions, which the Court instructed against the Mr. A. Had the cost been permitted, if would have meant that they may split by the community.
  • The expenses that are capital in nature under Section 17 (1) (c).
  • Cost of the improvements under the Section 17 (1) (d).
  • Remuneration recoverable under a contract or insurance under the Section 17 (1) (e).
  • Expenses and rent for locations that are not used for generating the profits that are evaluate able under the Section 17 (1) (f).
  • Any taxes that are payable under the Inland Revenue Ordinance except the tax on salaries paid on the behalf of an employee under the Section 17 (1) (g).
  • The salaries of partner and proprietor and of their spouses or loan paid or the interest on capital or payable to proprietor, partner or their mates under Section 17 (2).
  • Devaluation provided for, or charged in to accounts. Instead, devaluation allowances are provided under the Part VI of the Inland Revenue Ordinance on some belongings utilized for generating the profits that are permissible under Section 17 (1) (c).
  • Participation made to a mandatory provident fund scheme in concerning of spouse of the proprietor, a partner or spouse of a partner under in concerning with Section 17 (2) of Inland Revenue Ordinance.

Capital Expense 

After Hong Kong limited company formation, any expense experienced in relation with the accession of a fixed belongings is capital expense (CE). Expense experienced in accessing a current belonging, for example, stock for trading, is revenue expense. A capital expense is experienced usually once and for all and guide the benefit to the trade. The reference for this statement is taken from the case of British Insulated & Helsby Cables Limited.

Agreements being cancelled

The cost of getting rid of or accessing the contracts that are capital in nature is capital expense. A rent is the fixed belonging to the occupant, thus the repayment paid to cancel a rent is an expense and nature of which is capital. The reference for these statements is taken from the case of Staveley Coal and Iron Corporation Limited.

Also consider the case D 58/02. In that case it was ruled by the Board of Review that, when upon the termination the rental deposit of the rent was not returned to the lender due to the default of lessor, the loss in actual was the loss of asset that was capital in nature, in the same way to a loss of deposit at a bank that went bankrupt, and not an expenditure experienced.

Payment to avoid the non-profitable normal contract of trading is revenue in nature that can be compared. The reference for this statement is taken from the case of Anglo-Persian Oil Corporation Limited. 

Accession of the Business

In the case of John Smith and Son, it was observed that, the business of agent of the coal was taken over by the taxpayers having HK company registration. The business assets were paid by them at valuation. The assets incorporated the contracts’ benefit for the supply of coal.

It was claimed by them that; the payment should be allowed as being the chunk of the coal’s coast. It was held by the House of Lord that as given that the duration of the contracts were short, they were the part of the confirmed capital, and the cost was not permissible.

Employee Dismissal

A payment to avoid an unsatisfactory director is a normal gross expenditure. The reference for this statement is taken from the case of Mitchell Ltd. Now new belonging was created; the goodwill was not increased rather it remained the same.

But, payments to the directors that are being retired, for agreeing not to have competition with the company were considered to be expenses that are capital in nature these was due to the reason that, these enhanced the goodwill of company. The reference for these statements is taken from the proceeding of case Associated Portland Cement Manufacturers Ltd.

Fee of Franchise

A fee of franchise of a Hong Kong limited company formation was held to be expense that is capital in nature and it was paid to buy the right for the operation of a store for the 7 years and not deductible as being experienced in the accession of the everlasting structure of which the income was to be fruit or produce. 

The Section 16 E is not applicable as the right to design or trademark has been eliminated from the section in year 1982 as observed in the case D 21/06.

In another same case, it was considered by the board of review that, the fee of franchise did not charter for deduction under the Section 16 E because under the agreement of franchise, the fee was rewarded for the license to utilize the franchise for only 7 years, not for the allocation of any touchable right such as trademark, secrets of trade, advertising or copyright owned by the licensor.

 As the franchise was for the period of 7 years, an undergoing benefit was accessed in a way that the nature of expense was capital. The reference for this statement is taken from the case D 28/06.

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