Taxation Policies for Expenses in Profit Tax with relation to Borrowing Capitalization of Interest and Expenses, Rent and Bad Debts for Taxpayer having HK Business Registration


04 Jan

In this blog we will explore different aspects of the capitalization of interest and expenses of borrowing along with different cases. Inclusion of rent in expenses discuss under the Section 16 1 (b), then we will be going through Non-Hong Kong Income tax on Interest income explained under the respected sections and at last of this blog we will be discussing the bad and doubtful debts, as knowing about them and what are their role in calculation of profit tax. We will also be analyzing that how taxation policy of Hong Kong applies on these different scenarios. For this discussion we will be referring to the different Sections of the Inland Revenue Ordinance.   

Expenses and Interest of Borrowing in regard to Capitalization

Some expenditures of borrowing like (handling charges, fees of commitments, legal fees) and the interest should make part of the asset’s cost until at that time when for the generation of chargeable profits, the asset is competent of being used. Let’s take an example, in case of a building, in the cost of the building the interest should be included until the building is built completely and available for utilization to earnt the profits (for example, used in the let out for rental income or trade). The reference for this example is taken from the case of Wharf Properties Ltd. The key thing to note here is that, it is stated by the Section 40 (1) of Inland Revenue Ordinance that, capital expenses for the reason of devaluation allowance incurs fees of commitment and interest includes concerning of a debt made for the sole reason of financing the asset’s provision.

Once the building is built completely and is used to produce the income, then after that expense of interest will be deductible. The place where asset is to be utilized as stock of trading, the asset’s cost, including any borrowing expenditure and pre-completion interest, is evaluate able against the sale of asset’s proceed. The reference for these statements is taken from the case of Secan Ltd (2000) 5 Hong Kong Trust Company.

In the case of the Secan Ltd 5 Hong Kong Trust Company it was observed that, the properties of resale were developed by the taxpayer company incorporation HK. The interest expenditures of amount $873 Million were incurred by the company on a project, up to 31 December 1991. The amount $63 Million of that interest expenditures was deducted in the audited account for the year terminated 31 December 1991. The remuneration of $63 Million depicted interest experienced on the finished portion of the Phase 1 of the project. Nonetheless, in the computation of the tax, the deduction for the complete remuneration of $873 Million was claimed by the taxpayer company. It was ruled by the court of final appeal that, amount of only $63 million was deductible as claimed in the audited accounts. Principles obtained in this decision:

  • Accountancy principles’ application to the Inland Revenue Ordinance, where the statements of finance of the taxpayer are drawn up correctly concerning the common principles of commercial accounting and in traditionalism with the Inland Revenue Ordinance, no alterations other than that are permitted or required. 
  • If trading stock is in the form of asset, the alternative ground in the treatment of expenses of interest for tax purposes can be adopted by a taxpayer:
  • Withdraw the complete remuneration of interest in the loss and profit account as earlier as it was experienced; or
  • Finance the interest, i.e., include to the cost of deduction of claim and the development only, upon the finishing of the development.

Nonetheless, once it has adopted on the grounds, as in the case of Secan where the ground of sale of capital stock was chosen, it is certain by its choice. However, Section 16 (1) of Inland Revenue Ordinance allows the exclusion of the expenditures as and when experienced.

Rent under Section 16 (1) (b) of Inland Revenue Ordinance

Rent in regard of the buildings or land occupied for the reason of generating the assessable profits is deductible. In the case of lease paid by the sole proprietor to his / her partner, the amount of allowable lease is restricted to the property’s assessable value for the reason of property tax. In case of the lease paid by the partnership to one or more than partners or their spouses, the amount of allowable lease is limited to the assessable value for the reasons of property tax. A key thing to note here is that, rent obtained by the spouse or partner is accountable to tax on property for taxpayer who hold certificate of incorporation Hong Kong.

Premium or Rent

A premium in actual is whole amount paid at the grant of a rent. As being capital in nature it is not deductible, however it may be paid in the form of instalments. The reference for these statements is taken from the case of Grafton Hotel Ltd. In the further case of D 26/06 it was observed that, factory premises were leased by a Hong Kong taxpayer from a Mainland village committee for the duration of 50 years. For this reason, a transfer fee was paid by the Hong Kong taxpayer to the person who built an extension at the premises of factory and another remuneration of RMB 800,000 to the Mainland village committee. By the 6 yearly instalments, the latter remuneration was payable. The claim for the withdrawal of the two remunerations as being rent was not accepted by the Board of Review.

Non-Hong Kong Income Tax calculation on Interest Income under Section 16 (1) (c) of Inland Revenue Ordinance

A withdrawal can be requested by:

  • A corporation; or
  • An individual other than the corporation; or

By whom the trade, business or profession in Hong Kong is being carried on, for the overseas income tax paid on the profits given below:

  • Income of interest; or
  • Profits from the bills of exchange or certificates of deposit (CDs),

That are evaluate able for the tax on profits under Sections 15 (1) (f), (g), (i), (j), (k) or (l) of Inland Revenue Ordinances, given that no withdrawal will be made under the Section 16 (1) (c) of Inland Revenue Ordinance if the concerned person or company incorporation HK is entitled for the relief under the part VIII ‘Double Taxation Relief’ in regard of such profits. A withdrawal is not allowed under the Section 16 (1) (c) of Inland Revenue Ordinance if the concerned tax is not a tax on income (for example, tax on sales, turnover tax or VAT).

Foreign tax deductibility falling outside the Section 16 (1) (c) of Inland Revenue Ordinance is regulated by the general deduction under Section 16 (1). For the determination of whether the overseas tax is deductible under Section 16 (1), the questions given below need to be alleged:

  • Whether the tax is payment on the profits themselves; or
  • Whether the tax is expenditure that must be carried despite of whether a profit is obtained.

Overseas tax falling under the first class is not withdrawable as not being ‘experienced in the generation of taxable profits’ or ‘remuneration expended for the reason of generating these profits’ and in this way not allowed under the Section 17 (1) (b) of Inland Revenue Ordinance. It is an allocation of profits. The overseas tax coming under the second class is evaluate able. It is the payment on the earnings, not profits, for example, withholding tax on royalties or interest (Departmental Interpretation and practice notes 28). The tax on sales or custom duties also fall under the second class. In the case D 43 / 91 it was observed that, tax calculated as a percentage of earn shipping income was consider to be deductible.

Doubtful and Bad Debts under Section 16 (1) (d) of Inland Revenue Ordinance

The given below are the conditions to deduct the doubtful and bad debts:

  • The debt is manifested to the assessor’s satisfaction to have become bad. Ordinarily, the meanings of this is that, positive steps have been taken for the collection of payment (for example, by means of legitimate action) and this has been manifested un successful there is better purpose to rationalize the non-action (for example, bankruptcy or liquidation); and
  • The debt must have been included as a receipt of trading originally or in the case of a business of moneylending, the debt has been remuneration lent in the common course of the business of money lending.  

In the case of allowance of the bad debt, for only a particular allowance the deduction can be claimed. For the bad debt, the general allowance is not deductible. With the assumption of Hong Kong accounting standard 39 instruments of finance: Measurement and Recognition, trade amounts owed to a business are categorized as assets of finance and the term ‘provision for doubtful debts’ is now ordinarily known as ‘allowance for doubtful debts’ or ‘impairment loss for doubtful debts’.

Bad debts that have been allowed previously and recovered subsequently are regarded as taxable in the year of recovery.

Moneylender

Advances to the affiliated corporations or loans that have not been included as receipts of trading are not permissible. There are various cases where the it is claimed by the taxpayer companies that, they were the lenders of money, this is for the reason that, advances to the affiliated corporations are permissible as being lent in the common course of the moneylender’s business.

The question that, whether a taxpayer having HK business registration is a moneylender for the reasons of tax was alleged in Hong Kong in the case of Shun Lee Investment Co Ltd. and in a number of decisions of Board of Review. The reference for these statements is taken from the cases D 38/98 and D 67/91. Following characteristics should be exhibited by the moneylender depending on the authorities described earlier:

  • Some degree of continuity and system in the transactions for the reason of moneylending;    
  • The readiness to lend miscellaneous and to all given that the possible debtor is, eligible from the point of view of the lender of money;
  • Having a continual turnover of the remuneration in the business’s course;
  • The generating of the numerous short-term loans of little amount despite of a slight number of long-term debt of huge amounts; and
  • Not only regular and continual payment by the way of interest, but also the consistent repayments on the account of principal.      

Possession of the license of the moneylender is not conclusive. The question that, whether or not a person is a moneylender is the basic question of fact depending on the scenarios of each case. Let’s discuss an example, in the case D 38/89 it was observed that, a taxpayer had a license of a moneylender, yet was not alleged to be a moneylender.

In the case D 153/98 it was observed that, loss on a debt to an affiliated Hong Kong open company was permitted by the Board of Review. A license of moneylender was held by the taxpayer company. It was ruled out by the Board of Review that, a person holds a business of moneylending if he is willful to give loan to everyone. A moneylending’s business suggests some continuity, system and repetition. Those loans were not capital investments in the affiliated company by the taxpayer company rather those were genuine loans.


In the case D 18/14 it was observed that, a money lending business was carried on by T. It was claimed by T that, bad debt’s deduction of amount $ A due from the Company J (‘the debt’), consisting of the principal of amount $ B (‘the loan’) and the interest of amount $ C. It was further claimed by T that the loan was taken by the company J for the reason of financing the cost of furnishing and renovating a hotel in the Mainland China. That project of hotel was not successful. Some holders of the shares and T’s directors were also the director and shareholders of the Hong Kong open company that was owned completely by the Company J. No legal proceeding was taken for the recovery of the debt and the reason for this was that, company J and T were same majority shareholder. It was asked by the Inland Revenue Department for the particulars including the way the principal was constructed to Company J and accounting documents’ copies. T did not answer the query. So the appeal of T against the Inland Revenue Department’s disallowance of bad debt was dismissed by the Board of Review. The board of review was also not satisfied with the said remuneration of amount $ B for the reason of a money lending transaction. It was thought by the board of review that, there was force in the argument of the Inland Revenue Department that, the remunerations were in actuality investment in hostel project of Company J.


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