Views of Inland Revenue Department on Court Cases of Taxpayer rendering Hong Kong Company Incorporation Service and Methods for the Calculation of Profit Tax Receipts for Tax Computation

In this blog we will throw the light on views of Inland Revenue department in the judgement of the case of ‘Li & Fung Ltd.’. Then we will have thorough discussion on the receipts of profit tax. 

View of Inland Revenue Department on Li & Fund Ltd. Case

From the article known as ‘The effects of Li & Fung v CIR case on management of supply chain’, one can found the views of Inland Revenue department. The following table summarizes the key points from that article:


Court judgements and decision of the board of review

It was not considered by the board of review that:

  • Operations performed;
  • The used assets; and
  • Risks carried

By LFT in the Hong Kong; and the profits capable of being attributed to these economic operations or activities.

It was considered by the court of appeal that, the facts that were found by the board of review justified the retribution of the court of final instance.


CIR lost on the non-theoretical bases

Even though the CIR had a reputable case, at present tax appeal was controlled by the case stated methods.

The CIR did not pass in his applications for a modification of the described case to incur the extra facts to demonstrate that the operations staged by the LFT in Hong Kong produce a profit. That profit was split to LFT. Due to that reason, the courts did not have possibility to take into account the complete facts of the case and as a result dismissed the appeal of CIR.

It should be the duty of tax accountants to take note of the profits tax treatment of Inland Revenue department for a business of supply chain management.


  • The affiliated company was paid on a length of arm bases.
  • A foreign trade through an affiliated acting as a dependent agent.

No profit other than that to be assigned to the permanent establishment over and above the amount that had been taxed already as length of arm payment of the agent.


The origin standard

Although the CIR mislaid the appeal but the law focusing on the profits’ source has not been changed.

Due to that reason, the judgement of court of appeal should not have broad application to other cases’ source.


Agency and sourcing activities

Profits that are obtained from the agency and sourcing activities taken into account in the Hong Kong should be allowable to profits tax. These activities also include the supply chain management.

In the case of Li & Fung, it was not faced by the CIR that the activities of LFT foreign sourcing associates were not pertinent for the determination of source of profits. The claim of CIR was that the court of final instance and board of review had not taken into account that:

  • The operation considered by the LFT in Hong Kong in accordance to the agreements with customers had produced the 6 % gross commission.
  • The gross commission should be divided by suggestion to the operations of the foreign sourcing associates and those of LFT.

At the conclusion of the day, this is an accurate matter that whether a person is acting for another or on his behalf and for that person’s account. The Inland Revenue department remains of the view that, any individual carried out in the foreign should not be attributed easily to taxpayer having start up business Hong Kong.


Supply chain management’s taxation

The court of appeal in its judgement:

  • Did not detail anything on the management business’s supply chain taxation.
  • Conserved LFT as a commission agent.

As law was not changed and any judicial precedents did not overturn in the case of Li & Fung, the Inland Revenue department will keep on applying the broad guiding principle continually, ignore the necessary support provided to the primary organization, focus on the effectual causes and ignore the ancestor in the determination of the source of profits obtained from the business of supply chain management.

Under the tax treaties’ context, in a supply chain management business attribution of the profits between affiliated companies with a global or regional platform has become more extensive in Hong Kong. The principle of arm’s-length is the standard that is accepted internationally. The profits or aggregate income must be chop among the organization within the supply chain that is based on the:

  • Performed operations;
  • Used assets; and
  • Risks carried

By each of the organizations involved.

Where there is an affiliated and establish company in Hong Kong located in a no or low tax authority, the Inland Revenue department will inspect the structure completely for the determination of whether profits have been allotted to centralized hub or supply chain hub located in Hong Kong.

Profits Tax: Receipts

According to the Section 15 the receipts given below are considered to be taxable:

Certain Receipts of Foreigner

The sums received by the foreigner are covered by the Section 15 (1) (a), (b), (ba), and (d). The foreigner are those people who do not run a business in Hong Kong.

Utilization of Films, Sound Recordings, Cinematograph etc.

Sums not or else accountable to the profits tax, obtained by or accumulated to a person from the expo or use in Hong Kong of any television film or cinematograph, any sound or tape recording or any other advertising material associated with any of these type of properties are considered to be the receipts derived from or arising in Hong Kong as a result of a trade, business or profession carried on in the Hong Kong. The reference for this statement is taken from the Section 15 (1) (a).

Royalties from the Copyright, Patent or some other Intellectual Property

Sums not other than accountable to profits tax, received by a person rendering Hong Kong company incorporation service:

  • For the use or fair to use the intellectual properties registered in Section 15 (1) (b) or for communicating or undertaking to communicate the knowledge with the use of these type of intellectual properties in foreign that are deductible in assuring the person’s assessable profits under tax on profits, taken from the Section 15 (1) (ba); or
  • For the use or fair to derived from or use in Hong Kong any design, copyright material, trademark, patent, formula or secret process or other property that is similar in nature; or
  • For communicating or undertaking to communicate the knowledge that is connected indirectly or directly with the use of any such intellectual properties in Hong Kong, taken from the Section 15 (1) (b).    

In case of the Emerson Radio Corporation, a royalty was paid by an establish company in Hong Kong to its parent company that was based in the United States. This royalty was paid for company imported at 1.8 percent of the price of sales or products sold to the United States in consideration for placing the ‘Emerson’ brand on the products. These products were manufactured partially in the Hong Kong and partially elsewhere. No items among these productions were sold in Hong Kong.

It was held by the court of final appeal that, the royalty obtained by the company of United States for the items manufactured in Hong Kong was seized by the Section 15 (1) (b). The royalty that was obtained for the items manufactured overseas was not subjected to the tax.

Relationship between distinct Paragraphs of Section 15  

It was observed in the case of the Turner Entertainment Networks Asia, Inc., that T is near to start up business Hong Kong:

  • to exhibit some series of TV program in Taiwan, T paid license fee for the rights and technical costs for the allowance of subtitled and dubbed tracks to a foreigner for the TV program, and   
  • T claimed deductions for the above mentioned payments in computation of its profits tax.

The deductions were allowed by the Inland Revenue department. That department also applied the Section 15 (1) (ba) of Hong Kong tax law and evaluated the foreigner for the aggregated amounts received in the name of T under Section 20B (2). An appeal was done by T to the court of first instance directly hence it bypassed the board of review. That appeal was on the bases that, aggregated amounts received by that foreigner were offshore from his offshore incorporation Hong Kong, the programs of TV were showed outside the Hong Kong and also the services for the non-theoretical costs were rendered outside the Hong Kong and Sections 14, 15(1) (a), (b) and (ba) were not applicable.

The points given below were considered by the court of first instance:

  • The word ‘right to use or for the use of’ are not special. These words are also non-technical. The word ‘use’ is employs or utilizes or otherwise derives the benefits from the evolution of something.
  • There can be the possibilities of overlap between the different paragraphs of Section 15 (1), as each of that paragraph is pointed at different misbehavior. It cannot be concluded that they were or were deliberate to be conflicting. Section 15 (1) (b) and (ba), cover a more specific range of rights of intellectual property than Section 15 (1) (a).

The appeal of T was allowed by the court of first instance partially and it held the following points. According to these points:

  • The payment of the non-theoretical costs was for the allowance of the material that is ready for the license. This payment is not for the right to use the material under the license. These costs did not fall under the Section 15 (1) (ba).
  • The license fee remunerated must have been remunerated ‘for’ the ‘use’ or ‘right to use’ IP rights. These fees fell under the Section 15 (1) (ba).

The counsel of the T repeated the argument before the court of appeal in the court of first instance. The argument was that, the word ‘use’ in Section 15 (1) (b) and 15 (1) (ba) was required to be interpreted in the sense of technical intellectual property. This is as referring to the complete rights that are consulted by the ownership of intellectual property on the owner to use it. It is not referred to some wide economic sense of utilizing, employing or otherwise obtaining from the deployment of something. It was argued by the council of T that, payments remunerated for the use of copyright material are not the pertinent payments for the reasons of Section 15 (1) (ba). These copyright materials do not include computer programs that are regenerated on being loaded each time they come into play. The reasons for these payments for not being pertinent is that the use did not aggregate to violating the rights of the owner of copyright. Thus Section 15 (1) (b) and (ba) can have no appeal to the copy right works other than programs of computer. It was relied by him on the case of Emerson Radio Corp.

This argument was not accepted by the court of appeal. Emerson radio is the case in which trademark was involved. Different types of intellectual properties are covered by the Section 15 (1) (b) and (ba). It cannot be stated that, the explanation given for the use of trademarks is applicable equally to the other types of IP. Sections 15 (1) (ba) and (b) are considered allowances in the tax prescription. The purpose of that tax prescription is protection of revenue.

On this argument that, amount in question should be charged under the Section 15 (1) (a) and as such Section 15 (1) (b) or (ba) cannot tax the remunerations. The court of appeal agreed with the counsel of CIR that Section 15 (1) (a) or more connects to a scenario in which the owner of sound recording or film is incurred in the expo or other use of it. Although, Sections 15 (1) (b) and (ba) is related to a situation where he is at least or not at all where the ‘use’ is by other or the ‘right to use’ it is awarded on another. Moreover, Section 15 (1) (a) does not view to cover an arrangement of licensing under which payment is given by someone other than the owner for the ‘use’ or ‘right to use’ the in question ‘media works’.

As a conclusion the appeal of T was not accepted by the court of appeal.       

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