What are the premium to be paid to the owner of land by the tenants who acquired it for opening a business in Hong Kong?


In this blog we will be discussing on the spreading over of the lump sum premium that is to be paid by tenants to the owner of buildings and / or land in Hong Kong. We will be also discussing about the assessment values. And as a last part, we will be seeing on, what the bad debts are and its impact on the lender and tenant.   

Assessment Value

The forms given below may take into account by agreements of investment:

  • An agreement in which an originator is appointed by bond issuer as it’s agent in order to manage an asset that is acquired for the generation of investment return is called agency agreement.
  • An arrangement in which assets acquired by bond issuer are sold out to the originator with a markup that is used for the generation of investment return is called sale and purchase arrangement.
  • An arrangement in which an originator is entered into a lease with bond issuer in respect of a required asset for the generation of an investment return is called lease arrangement.
  • An arrangement in which bond issuer enters into bond undertaking with an originator for the purpose of doing activities such as opening a business in Hong Kong for generation of investment return is called profits sharing arrangement.

In accordance with the QIA (qualified investment arrangement) between bond issuer and an originator for the sake of underlying assets of a mentioned alternative bond schemes:

  • The interest that is payable on the money which is borrowed form bond issuer by an originator is known as investment return.
  • The money that is borrowed from bond issuer by an originator is known as the acquisition cost.

The word ‘qualified investment arrangement’ is defined in Section 13 of schedule 17A.

It is provided in line with above that the transactions of certain asset like disposal, acquisition and leasing:

  • Between bond undertaking and the originator (entered into between the bond issuer and originator)
  • Between bond issuer and the originator,

Are not regarded for the purpose of tax on profits. In these cases, the originator is considered as the owner of any income, profits, asset required, depreciation allowance, gain or losses arise from or referable to the asset for tax purposes that belong to the originator.

The effect of this thing is that any expenditure, profits, income, losses or gains that are arise from or referable to the asset that are held by:

  • Bond undertaking; or
  • The bond issuer

And belong to originator for purposes of tax.

Under Section 5B and 5B (7) of Hong Kong tax law, any such investment returns like rental paid to bond issuer by originator is not regarded as consideration that is payable for the sake of right of use of building and / or land for the purposes of property tax.

Whether to Divide the Rent that is Payable in Advance

In a case D 49/12 it was observed that two persons named as T1 and T2 respectively were partners. T1 was rendering services to Hong Kong incorporation services. A property was owned by both of them. Both of them let the property to a tenant under a tenancy agreement for a term comprised of 2 years. Tenant bought that property for purpose to start up business Hong Kong. Under such tenancy agreement, it was held that tenant would pay the rent in advance on the first and second day of each month. When 26 days passed to the tenancy agreement between T’s and tenant, a new agreement was held between T1 and tenant for the early termination of tenancy agreement. According to this agreement a rental deposit and vacant ownership would be delivered to T’s by tenant and the rent that was paid by tenant for first month would be deprived as a penalty for compensation. During the tax assessment session by Inland Revenue department first property tax was assessed on T’s by dividing the monthly tax by 26 days instead of 31 days. But later Inland Revenue department revised that assessment and assessed the property tax from entire monthly rent. It was contended by T1 that,

 

  • There was no rent on daily basis as tenancy agreement was made on the monthly basis.
  • As it was contemplated in the agreement for termination, the amount that was deprived as a penalty for compensation represented as compensation for violence of tenant for tenancy agreement.
  • And as long as violence occurred the tenancy agreement was cancelled as if it were not present form its commencement.

Due to that reason no part of amount that was deprived as a penalty for compensation was allowable to property tax.

According to board of revenue, if a contract was ended for a violence or by agreement, the contract was not cancelled from the beginning and the termination agreement could not be interpreted to have changed the type of monthly rent. The monthly test was considered as assessable for tax on property if it was paid in accordance with right to use property for first month. The monthly rent that is paid to Ts by tenant would not be allocated if relevant delivery of Apportionment Ordinancethat was same as to the provision in the United Kingdom, did not apply. Following the United Kingdom authorities, the whole monthly rent should be assessed fully as the tenancy agreement did not provide otherwise.

In a case D 16/14 a person named as T asked if the Inland Revenue department had the power to assess in the current assessment year rent proceeded from the following assessment year. As it was unable to prove that all the rent was payable in liabilities, the board of revenue ruled that, all the rent should be assessed that is demanded by T as owner of lands and / or building from his / her tenant in an assessment year.

Spreading over of Lump Sum Premiums

Under Section 5B, any consideration that is payable for a period more than one assessment year is considered to be payable during the period for which it is paid up in equal monthly installments to a maximum of 3 years.

Discussing an example to understand such situation, a property say ‘A’ was owned by Mr. Chan in Hong Kong. On 1 April 2012, Mr. Chan let that property for a period of 4 years to Mr. Lee, who needed it for start up business Hong Kong. The monthly rent was demanded as $2,000 by Mr. Chan from Mr. Lee. That rent was payable on the first day of each month. There was also a premium of amount $18,000 that was payable on 1 April 2012. In accordance with Section 5B not all of that premium was assessable in the assessment year 2012 / 13. That premium can be spread over the maximum span of 36 months. During the period of letting the assessment values of property A are:

Assessment year

 

 

 

(a)

Rent

 

 

 

(b)

Premium

Assessable Value

2012 / 13

$ 24,000

$ 6,000

$ 30,000

2013 / 14

$ 24,000

$ 6,000

$ 30,000

2014 / 15

$ 24,000

$ 6,000

$ 30,000

2015 / 16

$ 24,000

----

$ 24,000

  

  • 12 months * $ 2,000 per month (1 April 2012 to 31 March 2013)
  • 12 months * $ 18,000 / 36 months

Seeing another example, a property B was let by Mr. Cheung to Mr. Leung on 1 October 2013, for a period spanning 2 years. Mr. Leung was an expat living in Hong Kong. He wants to use that property for starting a business in Hong Kong as an expat. The monthly rent of the property was $ 10,000 and it was payable on first day of each month. The premium for the property was $ 30,000 and it was payable on 1 October 2013. The period of letting was 24 months that is less than 36 months, the period for spreading over round sum is limited to 24 months. This is also the complete period of letting. In the table given below is the assessment values of property B during the period of letting:

Assessment year


Rent


Premium

Assessable Value

2013 / 14

(a)

$ 60,000

(b)

$ 7,500

$ 67,500

2014 / 15

(c)

$ 120,000

(d)

$ 15,000

$ 135,000

2015 / 16

(e)

$ 60,000

(f)

$ 7,500

$ 67,500

  • 6 months * $ 10,000 per month (1 October 2013 to 31 March 2014)
  • 6 months * $ 30,000 / 24 months
  • 12 months * $ 10,000 per month (1 April 2014 to 31 March 2015)
  • 12 months * $ 30,000 / 24 months
  • 6 months * $ 10,000 per month (1 April 2015 to 30 September 2015)
  • 6 months * $ 30,000 / 24 months

Bad Debts

According to the Section 7C (1), any consideration that is approved to be non-recoverable in any assessment year to the satisfaction of assessor can be deducted in the calculation of the assessment value in that assessment year.

Given below are the example of cases where it is feasible to manifest that rent or some other considerations become bad:

  • Rent remains irrecoverable despite of taking the all reasonable actions including legal actions.
  • There is a case of bankruptcy on the tenant or has been liquidated in case of any corporation.

According to Section 7C (3), in the immediate following year any excess will be carried backward to be subtracted from the assessment value of that property.

According to Section 7 (2), any recovery of the amount as irrecoverable deducted previously should be incorporated as assessment value in the recovery year.

Considering another example, Mr. Wong was owner of a property C in Hong Kong. He let that property to Mr. Lai for a term of 2 years on 1 April 2014. Mr. Lai acquired that property for starting a business in Hong Kong as an expat. The monthly rent of property was $ 15,000 and it was payable at the commencement of each month. The rates amounting $ 4,000 and $ 4,500 were paid by Mr. Wong in the assessment years 2014/15 and 2015/16 respectively. The rent was not paid by Mr. Lai from 1 January 2015. It was told by Mr. Lai to Mr. Wong that he was facing some problems related to temporary cash flow would pay the rent to him later. Mr. Lai disappeared on 1 June 2015. Mr. Wong came to know in February 2016 that Mr. Lai was declared as bankrupt by authorities and due to that reason he was unable to pay his secured creditors.

Even though Mr. Wong did not receive the rent for 3 months (January 2015 to March 2015) from Mr. Lai, he cannot get a deduction of the rent that was not paid to him from the AV in that assessment year. This was because the rent has not been proved irrecoverable yet. The property tax liability of Mr. Wong is computed according to the procedure as follows:

 Mr. Wong

Property C

Assessment year 2014 to 15

Basic period: 1 April 2014 to 31 March 2015

 

Assessable value (12 * $ 15,000)                                                    $ 180,000

Less: rates paid by Mr. Wong                                                       $(4,000)

                                                                                        ------------

                                                                            $ 176,000

Less: Statutory deductions (20 % * $ 176,000)                                     $(35,200)

                                                                                        -------------

Net assessable value                                                                       $ 140,800

                                                                                      --------------

Property tax thereon (15 % * $ 140,800)                                                $ 21,120

During the year ended on 31 March 2016, it was found that Mr. Lai is bankrupt. It is likely to be happen that assessors could be satisfied that during the assessment year 2015 to 16 the rent outstanding has become bad. And during that year, the bad debt can be deducted from the assessment value of property C. The procedure to calculate the property tax liability of Mr. Wong for the assessment year 2015 to 16 is calculated as follows:

   Mr. Wong

Property C

Assessment year 2014 / 15

Basic period: 1 April 2014 to 31 March 2015

From 1 April 2015 to 31 May (2015) rent receivable (2 * $ 15,000)$ 30,000

Less: the rent that is irrecoverable from 1 January 2015 to 31 May 2015 (5 * $ 15,000) $(75,000)

                                                                                                                                            ------------

Amount to be assessable                                                                                                        Nil

                                                                                                                                        -------------------

Payable property tax                                                                                                               Nil

                                                                                                                                        -------------------

Bad debt that is to be carried back ($ 75,000 - $ 30,000)                                                       $ 45,000

The key thing to note here is that as there is no assessment value to set-off so the rate of $4,500 cannot be deducted.

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