Mid-Term Test – Marking Scheme
Answer 1
(a)
Mr Tang
Salaries tax assessment – Year of assessment 2011/12
$ / $ / MarksBasic salary / 1,440,000 / 0.5
Furniture allowance / 30,000 / 0.5
Gift vouchers / 20,000 / 0.5
Reimbursements:
Club subscription / 47,000
Children’s school fees / 38,000
Wages of domestic helper / 40,000
Electricity, etc. / 72,000
Insurance premium / 8,000
Medical expenses / 34,000
Annual subscription fee / 2,500
Car hire charges / 48,000
Car running expenses / 42,000 / 331,500 / 2
1,821,500
Less: Annual subscription fee / (2,500) / 0.5
1,819,000
Less: Contribution to RORS (maximum) / (12,000) / 0.5
1,807,000
Less: Married person’s allowance / 216,000 / 0.5
Child allowance / 120,000 / 0.5
Dependent parent allowance / 72,000 / 0.5
Disabled dependent allowance / 60,000 / 0.5
(468,000)
Net chargeable income / 1,339,000
Salaries tax at progressive rate / 215,630
Salaries tax at standard rate / 271,050
Therefore, salaries tax payable is / 215,630 / 0.5
7
Note: It is assumed that the mother-in-law is residing with Mr Tang.
(b)
A tax minimization scheme for Mr Tang would cover the following:
(1) Under s.8(1A)(b)(ii), assessable income excludes income derived from the rendering by a person outside Hong Kong of all the services in connection with his employment. But, this exemption applies to ‘employment’ and does not apply to an ‘office’. Since Mr Tang became a director as from 1 April 2012, he cannot take advantage of s.8(1A)(b)(ii) even though he will discharge all his duties in Taiwan. Global must have commercial reasons for making him a director. However, an important point of principle comes out in the Board of Review Case BR 19/74 which decided that a person could serve a company in two capacities: a director carrying out the statutory duties of a director and an employee, and that the holder of an ‘office’ was not liable to salaries tax unless he was remunerated for the ‘office’ which he held. In that case the appellant was employed by a Hong Kong company to render services outside Hong Kong. He was later appointed a director of the company and continued to receive the same salary and was not paid any fees as a director. He was not liable to salaries tax under s.8(1A)(b)(ii). Based on this principle, Mr Tang should be both a director and an employee of the company in 2012/13. He should be given an employment contract specifying his remuneration and duties in 2012/13 and the fact that he was appointed a director should be properly documented, e.g. in the company’s minutes of meetings of the board of directors. He had been entitled to remuneration as an employee for the services he had performed before his appointment as a director. Prior to his becoming a director, he was an employee of Global. The fact that he continued to serve Global as an employee after he was made a director would therefore, be consistent. Also, in view of his absence from Hong Kong, it is unlikely that what he would receive from Global was due to the duties he assumed in the capacity of a director. Mr Tang should be given a director’s fee in 2012/13 sufficient to utilise the personal allowances and the rest of his remuneration should be earned in the capacity of an employee. In order to make use of s.8(1A)(b)(ii), he should refrain from rendering any services in Hong Kong in 2012/13.
[7]
(2) In 2013/14, he will discharge all his duties in Hong Kong and so he will be taxed in the same way whether he is holding an ‘office’ or ‘employment’. Both director’s fees and salary will be taxed. However, there are various ways to minimise his salaries tax liabilities, as follows: [1]
(a) If Mr Tang was given an annual director’s fee of $2,016,000 in addition to the furniture allowance and other benefits, his total remuneration will be increased by $576,000. If the central management and control of the company is exercised in Hong Kong, his director’s fee is sourced in Hong Kong and this total fee would be assessable to salaries tax in Hong Kong. Alternatively, the total remuneration could remain the same but the increase of $576,000 could be structured as a rental reimbursement. The reimbursement would be specifically exempt from tax under s.9(1A)(a) of the IRO, and the housing benefit would only be taxed at the rental value which would be 10% of the director’s fees. [2]
(b) The furniture allowance is taxable under s.9(1)(a), but if Global were to supply Mr Tang with the use of the furniture (with the ownership of the furniture kept by Global) which he required free of charge, the benefit would not be taxable. On the other hand, Global could claim depreciation allowances on the furniture. [1]
(c) In the Board of Review Case BR 6/70, payments made to the bank accounts of a trust established by the parent company of his employer for the benefits of a taxpayer’s children were held not to be perquisites and no tax was charged. Following this decision, the company might create an educational trust which would make an educational grant for the benefit of Mr Tang’s children. [2]
(d) There is an important point of principle that benefits in kind are taxable if they are convertible into cash and that if an employee incurs liabilities and receives reimbursements of the expenses from his employer, such receipts of cash are taxable. Following this principle, the following arrangements could be made: [1]
(i) Global could take out corporate membership of the Hong Kong Jockey Club and allow officers of the company to make use of its facilities. This benefit would not be chargeable to salaries tax. [1]
(ii) Global could directly employ a domestic helper who would be made available to Mr Tang. [1]
(iii) Global could contract directly for the supply of electricity, gas and telephone. The accounts with the utility companies would be in the name of Global which would be responsible for paying all the bills for Mr Tang’s house. The bills should be sent directly to Global. [1]
(iv) Since all the officers of Global have individually taken out life insurance policies and the premiums thereon are reimbursed by Global, Global could take out a group life insurance scheme on behalf of these employees. This would not be a taxable benefit because it would not be a reimbursement of a liability incurred by an employee and the premium would not be convertible into cash. [1]
(v) Global could provide free medical treatment, instead of refunding medical expenses incurred by employees. A staff medical insurance policy could be taken out by Global. [1]
(vi) Global could hire a car in its own name and allow Mr Tang to use it. This would not be a taxable benefit. Similarly, the car expenses could be paid directly by Global. Bills should be made out in the name of Global and be sent directly to Global for settlement. [1]
(vii) Global should purchase the gifts itself. In this way, only the second hand value thereof would be taxable on Mr Tang – Wilkins v Rogerson. [1]
[21]
Answer 2
Report to Ms Mi
To: Ms Mi
From: Tax Advisor
Date: 9 December 2011
Subject: Raising finance for H Ltd
I refer to our discussion in respect of the potential financial consequences for H Ltd as a result of your husband’s withdrawal of his personal guarantee for the bank loan currently extended to H Ltd. Two proposals as suggested by your father (Papa), together with another proposal, have been discussed. As promised, I have reviewed these proposals from a Hong Kong tax perspective, and the key issues are summarised below for your consideration:
(a) Tax effectiveness of the current structure
Under the current funding structure, a bank loan is obtained by H Ltd under a personal guarantee from your husband (Hubby). Loan interest is incurred by H Ltd to the bank. The bank loan money was used by H Ltd to acquire the shareholding in K Ltd. Under the Inland Revenue Ordinance (IRO), interest payable to a bank is tax deductible if the following conditions are fulfilled:
(i) the bank interest is incurred in the production of assessable profits (s.16(1)); [0.5]
(ii) the bank borrowing is not secured by any deposits or loans which derive non-taxable income in Hong Kong (‘secured loan’ test) (s.16(2A)); and [0.5]
(iii) there is no arrangement in place such that the interest payment is ultimately paid back to the borrower or any connected person (‘interest flow-back’ test) (s.16(2B)). [0.5]
l Under the current structure, the only potential income of H Ltd from its investment in K Ltd will be dividend income. Dividends from K Ltd, a company chargeable to profits tax by virtue of holding properties in Hong Kong as trading stock, are specifically exempt from tax in Hong Kong (s.26(a)). [0.5]
l Hence, the bank interest cost incurred by H Ltd will not be regarded as incurred in the production of assessable profits; and thus will not be tax deductible. Therefore, the current loan structure is not tax effective. [0.5]
(b) Proposal 1
(i) Profits tax implications for H Ltd
Proposal 1 seeks to replace Hubby’s personal guarantee by a deposit placed by Papa with the bank’s associate in China, with a new bank loan being extended to K Ltd to replace the existing bank loan to H Ltd. From the perspective of H Ltd, no further interest cost will be incurred after the restructuring; and thus there is no tax implication for H Ltd. [1]
(ii) Profits tax implications for K Ltd
l Under Proposal 1, K Ltd will obtain a new bank loan from the bank and on-lend the loan money to H Ltd, interest free. [0.5]
l Bank interest will be incurred by K Ltd on this new loan, which is secured by a deposit placed by Papa with the bank’s associate in China. It is intended that the deposit will generate interest income at the same rate as that paid by K Ltd on the new bank loan, minus a small percentage. [0.5]
l From a profits tax perspective, K Ltd may encounter difficulty in claiming a tax deduction for the bank loan interest incurred on the new loan, because the interest is not incurred in the production of assessable profits. [0.5]
l The Inland Revenue Department (IRD) may argue that the loan money has been on-lent to H Ltd and no interest will be earned from H Ltd. As a result, s.16(1) is not satisfied.
[0.5]
l Moreover, a tax deduction for the bank loan interest will also be denied on the basis that the loan is secured by a deposit which generates interest that is not taxable in Hong Kong. [0.5]
l So the ‘secured loan test’ under s.16(2A) will not be satisfied. [0.5]
l The ‘interest flow-back’ test under s.16(2B) is also not satisfied, because the interest payment from K Ltd to the bank will, ultimately, be paid back in its majority to Papa.
[0.5]
l In conclusion, similar to the current structure, Proposal 1 is also not tax effective for K Ltd. [0.5]
(c) Proposal 2
(i) Share issue by H Ltd to P Ltd
l Under this proposal, P Ltd will hold a 50% shareholding in H Ltd. Assuming that the additional shareholding is acquired by way of a share issue by H Ltd directly to P Ltd, there will be no profits tax implication to H Ltd. [1]
l Neither does the share issue give rise to any profits tax implication for P Ltd, as any dividend subsequently distributed from H Ltd will not be taxable in the hands of P Ltd pursuant to the IRO. [1]
(ii) Share disposal by Ms Mi to P Ltd
l Under this alternative, P Ltd will acquire a 50% shareholding in H Ltd directly from you. If the share disposal gives rise to any profits, you may be subject to profits tax in respect of this profit if you are regarded as carrying on a ‘trade’ or ‘business’ in respect of the holding and the selling of the 50% shareholding in H Ltd. [1]
l The word ‘trade’ is defined to include ‘every trade and manufacture and every adventure in the nature of trade’ (s.2). [0.5]
l While it is difficult to determine the nature of an isolated transaction, it is always essential to look at the ‘intention’ of the person at the time of acquiring the asset and its subsequent disposal. [1]
l The usual criteria are known as the ‘badges of trade’, which include ‘subject matter’, ‘length of ownership’, ‘frequency of similar transactions’, ‘supplementary work done’, ‘circumstances leading to the realisation’ and ‘motive’. [3]
l Other factors may also be relevant, including the method of financing the initial acquisition and the utilisation of the sale proceeds. [1]
l In your case, the short period of holding, only one year, would be most vulnerable to challenge by the IRD as an indication of trading. [1]
l However, the most valid argument is that the share disposal is not driven by a profit-making motive but by the need to raise funds for H Ltd to repay the bank loan.
[1]
l To prove this, all or at least the majority of the proceeds from the share disposal should be on-lent to H Ltd for bank loan repayment purposes. [1]
l You have concern as to whether your tax position will be affected by the property trading intention of K Ltd. There is a possible risk that the IRD may seek to import the trading intention of K Ltd with regard to its properties into your intention as shareholder. Based on the information given, the properties held by K Ltd are accounted for as trading stock and revenue trading assets. [1]
l The issue that follows is whether or not your shareholding in K Ltd as well as H Ltd should also be regarded as trading assets rather than capital assets. It has, however, been decided that the trading motive of companies holding trading property should not be assumed to be imported into the share transactions of their shareholders (see Beautiland Co Ltd v CIR and CIR v Quitsubdue Ltd). [1]