Tax Regulations on Exchange Profits, Borrowing and Lending of Stock in relation to Taxpayers having Company Incorporation HK

In this following blog we will explore the different aspects of an exchange profits such as, how these exchange profits are raised, what is general principals of these profits, unrealized exchange loss / profits, temporary credit facilities etc. and many more. After that we will have thorough discussion on the stock lending and borrowing transactions.    

Exchange Profits

How profits on exchange arise?

In the proceeding of case Malaysian Airline Systems Berhad it was observed that, the profit tax was evaluated on profits that were demonstrated in currency of Hong Kong. In order to assure the assessable profit, the accounts composed in currencies of foreign must be converted to currency of Hong Kong.

General Principle

Receipts that are revenue in nature are allowed to tax, while exchange receipts are not revenue rather capital in nature and hence are taxable.

A profit on exchange has the similar nature as the liability or asset from which it generates. Due to this reason:

  • The profits of exchange ascending from the repayment or capital of loans on long-term basis are capital in nature.
  • The profits of exchange arising from disposal or acquiring of fixed assets are also capital in nature.
  • The profits of exchange or those profits that are arising from the transaction of trading. These include trading stock acquisition, trade debts’ settlement etc. These profits are revenue. Due to this reason these profits were held to be assessable in the case of Imperial Tobacco Co Ltd. In that specific case, US dollars were accrued of tobacco processing for the purpose of financing its procurement of the leaves of US tobacco. The profits on exchange arose from the US dollars’ sale.

Now we will discuss an example. A Hong Kong open company named as Gold Ltd. sold 100k goods’ units on 1 October 2015, to a Utopian firm at a price of Utopian 5$ each. At that date the rate of exchange was Hong Kong $1 for $2 Utopian so the trade debt was Hong Kong $2.5 million at that date. The debt was settled by the merchant of Utopia on 30 November 2015. At that date dollar of Utopia prized to Hong Kong $1 for 1.667 Utopian dollar.

Non-realized Exchange Loss/Profit

At the end of the period of accounting, the non-realized exchange profits arise as a result of conversion the balance sheet. If exchange profit / loss is brought up into account consistently by the taxpayer having company incorporation HK, then the non-realized exchange profits / losses can be deductible / assessable. The principal was laid down by the case of Secan that, the treatment of tax for sure follow the treatment of accounting. While following the Secan, departmental interpretation and practice notes 42 (part B) with title ‘Taxation of foreign exchange differences’ was issued by the Inland Revenue department. This was issued for the purpose of setting out the new policy. The new policy of Inland Revenue department is that, if in the account of losses or profits, the loss or profit is recognized then it cannot be removed from the computation of tax on the ground that it is non-realized.

Exchange Profits on Loans’ Payment 

To look merely at the utilization of loan is not correct. If the nature of loan is long-term, then it is capital given that it may be used for acquiring of current assets. The reference for this statement is taken from the case of Hunter Douglas Ltd. 

The revenue or capital nature of exchange profit depends on whether loan establishes part of the permanent capital of taxpayer. It is totally dependent on the intention of the taxpayer having set up Hong Kong limited company, whether the loan is only a short-term accommodation or proposed to enlarge the fixed capital. For the purpose of determination of loans, the relevant factors are use of that loan and term of loan. It is dependent on the reality of each case.

If, though, borrowing establishes a mandatory part of the profit-making activities, the exchange loss / profit will be revenue in nature (for example, in the process of purchasing the trading stock, the borrowing is a mandatory part). This is demonstrated in the case of Thiess Toyota Pty Ltd. in that specific case, a bank gave the letters of credit for the reason of trading stock acquisition. So as a result, the role of a trade creditor was thus taken over by the bank.

Short Term Credit Facilities

If the facilities keep on being increased, then short term facilities of credit may be considered as increasing the base that is capital in nature of a taxpayer. In the case D 77/88 it was observed that, a US dollar was borrowed by a trading Hong Kong open company from the bank. The reason behind that borrowing with respect to taxpayer was to accept the short term bills. On a monthly basis and for a period of 3.5 years the billed were routed. The funds obtained from such borrowing was located with its parent company. The placement was partial for the purpose of discharging the good’s cost procured from the parent company and limited for some other purposes. This exchange loss that raised on the borrowing was imprisoned to be capital in nature.

Finance Company

The profits / loss on exchange by a company of finance are more probably to be revenue in nature than in some other business. Money to a trader of money is same as the stock-in-trade of the trader. A finance company can also be the source of money for a money lander. In case of Chinachem Finance Co Ltd. it was observed that, the loans were borrowed by the taxpayer having company of Hong Kong incorporation and were repayable on demand, but in reality the lent for different periods of till 9.5 years. The loss on exchange was held to be the chargeable.


Trader in Overseas Currencies      

As the overseas currencies are the trading stock hence exchange losses / profits of a convertibility trader are revenue in nature.

Cash at Bank

If cash is placed in the bank by a company doing trade in Hong Kong, then it is held to be the capital asset. Due to that reason, the exchange losses or gains that are being raised from the bank balances’ translation are capital in nature, given that cash may have been obtained from the trading receipt. The reference for this statement is taken from the case of Li & Fung. 

Thought, the bank’s cash is same as the trading stock of the business of trading, and he exchange losses or profits arising as a result of that business are revenue in nature. The reference for this statement is taken from the case of Hang Seng Bank.

Fixed Quota

The nature of receipts for permanent quota’s sale is capital. If the quota is not for long-term rather short-term then receipt for sale pf that quota is taxable in same way as the revenue receipt.

Voluntary Receipts

If the nature of receipts is voluntary, then these can be taxable. In the case of Falkirk Ice Rink Ltd. it was observed that, a rink of ice was owned by a taxpayer having set up Hong Kong limited company. For the reason of covering the extra cost of wrapping at the rink of ice, it obtained the donation. The sum was detained to be taxable. 


Borrowing and Lending of Stock

In 1994 the Section 15 E of Inland Revenue Ordinance was performed for the purpose of providing relief from tax on profits for re-purchase transactions and stock lending and borrowing transactions. For the purpose of stock lending and borrowing transactions stamp duty relief is also available. Departmental interpretation and practice notes 27 was issued for the purpose of explaining the practices of Inland Revenue department that are related to the tax liabilities of stock lending and borrowing transactions.          

Stock Lending and Borrowing Transaction  

A stock lending and borrowing transaction is a specific type of agreement under which securities are borrowed by the borrower from a lender for the reason of settling a transaction. That transaction is called stock borrowing. Borrower might have been entered into the stock borrowing due to the reason that sale to a purchaser has been effected by the borrower but it does not have securities to deliver to the purchaser. In this scenario the purchaser is a short seller.

Once stock has been borrowed by the borrower, then it is required by him to return to the lander the stock of the same kind within the period that is specified in borrowing argument. The borrowing argument is also called stock return. A fee (borrowing fee) is usually paid by the borrower as a tax or compensation for the service rendered (i.e., the lending). During the period of borrowing, any type of dividend or some other distribution on the securities is payable to the borrower. A borrower is further required to pay over to lender the payment of compensation (sometime known as ‘produced dividend’) or distribution.

Sometime for the reason of returning the securities securely the collateral is provided by the borrower. That collateral include cash, equity securities or debt etc. A fee will be paid by the lander to borrower for the compensation of loss of interest if the collateral is specifically cash. This fee is called loan rebate fee. If the collateral is not a cash or debt rather a non-cash asset, the real distributions will be paid over on compensatory payments or asset in respect to that distributions.

A stock lending and borrowing transaction is purchase and sale legally due to the reason that, beneficial and legal title of the securities are attained by the borrowers. So, there will be suggestions of stamp duty or profits tax. Other than that, if the title to collateral id provided, it passes from borrower to lender in a way that allowance of collateral also has suggestion of stamp duty or profits tax.


A repo is basically a utility for transaction under which debt securities or equity is sold by the seller for cash to a buyer. On demand or at a subsequent date it is agreed by the buyer to sell identical stock at a specified price to the seller. A re-purchased price is paid to the buyer by seller. A predetermined premium is included in that re-purchase price. That premium is referred usually as a ‘price differential’.

A reverse repo is initiated by the respective buyer other than that it is necessarily the same as repo. The basic purpose to carry out reverse repo or repo is for exchanging the cash for stock for:

  • A short-term period; or
  • To ‘fails’ to provide the customer or to cover short sales.

Section 15 E of Inland Revenue Ordinance

In the case of the true stock lending and borrowing transaction, the lender is treated in a way as if the stock lending and borrowing transaction had not been gone through. While computing the any evaluate able profits of borrower, the borrower is to be treated in such a way that as if the return of stock or borrowing of stock had been carried out at a supposition that is equal to the market value of the stock borrowed at time of borrowing. In the hand of lender, the fee of borrowing is taxable.

Eligible Debt Instruments

The chargeable profit of a person for remuneration obtained or accumulated to the person as:

  • Interest payable or paid on a short-term debt instrument or medium-term debt instrument, totally dependent on the issuance date.
  • Any profit or gain on the sale or on retrieval on the maturity or some kind of other disposal or demonstration of debt instrument for short-term or debt instrument of medium term, depending on the issuance date.

Are allowable to tax half of the usual tax rate. The reference for this statement is taken from the Section 14 A (1) of Inland Revenue Ordinance.

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