Mid-term Test Marking Scheme (2013)
Answer 1
(a)
If an employment is located in Hong Kong, all income from that employment is, subject to certain limited exceptions, liable to Hong Kong salaries tax. If, on the other hand, an employment is located outside Hong Kong, only income referable to Hong Kong services is subject to salaries tax. This is usually determined on a days in/days out basis (see s.8(1A)).
On the basis of a decision in the Goepfert’s case, the location of employment is generally determined by the IRD as outside Hong Kong where the following three factors are present (see DIPN 10):
(i) the contract of employment was negotiated, entered into, and enforceable outside Hong Kong;
(ii) the employer is resident outside Hong Kong; and
(iii) the employee’s remuneration is paid to him outside Hong Kong.
If not all of the above factors are outside Hong Kong, the employment is primarily a Hong Kong employment, though in practice the IRD may disregard the place of payment of remuneration. If a person is recruited by an employer who is resident in Hong Kong, the employment is unlikely to be located outside Hong Kong, even though the contract is concluded outside Hong Kong and his remuneration is paid outside Hong Kong.
[1.5 marks]
In Andy’s case, although he is employed by the US company, he is seconded to Hong Kong to handle two projects for the Hong Kong subsidiary, and all his remuneration is paid by the Hong Kong subsidiary. He reports to the Hong Kong office and is under the control of the Hong Kong subsidiary. Irrespective of whether or not he has a separate contract of employment with the Hong Kong subsidiary, during the period of secondment Andy is effectively under the employment of the Hong Kong subsidiary which is located in Hong Kong. Andy’s income should therefore be assessed in full to Hong Kong salaries tax.
[1.5 marks]
However, as tax similar to salaries tax is paid on income referable to the services performed in the PRC, Andy is entitled to claim the exemption under s.8(1A)(c). Section 8(1A)(c) excludes income from services rendered outside Hong Kong (i.e. $380,000) if the taxpayer is chargeable to tax in the country in which the services are rendered and tax has been paid in respect of the income attributable to the services rendered in that country. [1 mark]
(b)(i)
The relocation allowance
The relocation allowance of $150,000 is chargeable to salaries tax under s.8(1) if it is ‘income from employment’ as defined in s.9(1)(a). Based on the principle in Hochstrasser v Mayer (38TC673), it may be argued that the lump sum is paid for the financial loss Andy could incur from the secondment, not for any services rendered and hence it is not chargeable to tax. However, the Board of Review in a few decisions, e.g. D19/92 and D36/92, has held as taxable a lump sum paid at the commencement of employment. The Board of Review have held that taxable payments are not restricted to rewards for services rendered or to be rendered. What matters is whether the source of the payment is the employment and if so, it is taxable.
[2 marks]
In Andy’s case, the relocation allowance is payable by Healthy Ltd to compensate him for the removal expenses that he would incur in coming to Hong Kong. It is non-accountable, paid regardless of the actual nature and amount of expenses. It also seems to be a financial inducement to Andy to take up the secondment (and hence for services to be rendered). It is not a gift but a contractual payment. It is a payment related to his secondment and an integral part of Andy’s income from his employment. As the source of the payment was a Hong Kong employment, the allowance would be chargeable to salaries tax. [2 marks]
(b)(ii)
The gratuity
The gratuity is a contractual payment and a reward made for the services provided by Andy for a Hong Kong employment. Hence the gratuity is wholly chargeable to salaries tax under s.8.
[1 mark]
Pursuant to s.11D(b), the gratuity will accrue on 31 March 2006, the date on which the secondment is completed and when Andy is entitled to claim the payment. The whole sum will be subject to salaries tax for the year of assessment 2005/06. [1 mark]
However, proviso (i) to s.11D(b) allows Andy to apply to have the gratuity related back and deemed to be income accrued during the two years of his secondment. The gratuity will then be assessed over the two years of assessment 2004/05 and 2005/06, normally by time apportionment. The application must be lodged in writing not later than 31 March 2008, i.e. within two years after the end of the year of assessment in which the payment of gratuity was made. [1 mark]
(c)
Andy’s salaries tax computation for 2011/12
$ / $ / MarksSalary / 960,000 / 0.5
Housing allowance / 288,000 / 0.5
Relocation allowance / 150,000 / 0.5
Holiday journey benefit
- air ticket for girlfriend [(26,000 + 4,000)/2 – 4,000] / 11,000 / 1
- hotel room charges (24,000 × 15/40) / 9,000 / 20,000 / 1
1,418,000
Less: Income exempt under s. 8(1A)(c) / (380,000) / 0.5
1,038,000
Less: Basic allowance / 108,000 / 0.5
Dependent brother allowance / 30,000 / 138,000 / 0.5
Net chargeable income / 908,000
Salaries tax at progressive rates / 142,360 / 0.5
Salaries tax at standard rate (1,038,000 × 15%) / 155,700 / 0.5
(d)
Explanatory notes to the items:
1. Any amount paid by an employer in connection with a holiday journey is taxable under s.9(2A)(c), and the benefit is assessed by reference to the cost incurred by the employer (see DIPN No. 41, para 6). Where a holiday journey benefit is associated with or attributable to a cost paid by an employer, that benefit is taxable notwithstanding that the employer does not incur any additional, or incremental, costs for that benefit (see DIPN No. 41, para 11). In Andy’s case, the cost of his girl friend’s ticket is actually borne by Healthy and is therefore taxable. [1 mark]
Where a trip is taken partly for business and partly for holiday, if a clearly identifiable part of the journey is taken for holiday purposes, the expenses relating to that part of the journey are taxable. In Andy’s case, the extended stay cannot be regarded as being incidental to the business trip and is therefore taxable. Since the expenses relating to such part cannot be readily ascertained, an apportionment based on the ‘holiday-days basis’ will generally be adopted (see DIPN No. 41, para 14 and 15). [1 mark]
2. Section 9(1)(d) deems any gain realised on the exercise, release or assignment of a share option to be income from employment or office. However, the exercise of the share option on 1 October 2011 is not taxable as the option was granted before Andy was seconded to the Hong Kong subsidiary. Although the option was exercised in Hong Kong, the benefit arising from the option is not attributable to services rendered in Hong Kong. [1 mark]
(e)
The Hong Kong subsidiary, the employer, is carrying on a business in Hong Kong. In some decided cases, the Board of Review regarded a company carrying on business in Hong Kong as resident in Hong Kong for the purpose of deciding whether the situs of employment of its staff is in Hong Kong. Based on such cases, it is very likely that the IRD will take the same position. In such case, Andy’s income will be regarded as sourced in Hong Kong. The place where services are rendered is not relevant to the determination of the location of employment (CIR v Goepfert). It follows that Andy’s total remuneration under both contracts will be liable to Hong Kong salaries tax under s.8(1)(a), unless exempted by s.8(1A)(b)(ii)and/or s.8((1A)(c). [1.5 marks]
If the IRD accepts that Andy has two separate and distinct employments under the two contracts, the remuneration accrued to him under the second contract (which covers the services to be rendered in the PRC) will be exempted from salaries tax as he renders all services in connection with his employment under the second contract outside Hong Kong. His remuneration accrued under the first contract (which covers the services to be rendered in Hong Kong) remains taxable. [1.5 amrks]
However, the Commissioner may look behind the legal form and take the substance instead. The Commissioner is entitled to scrutinise all relevant evidence, such as the intent of the Hong Kong subsidiary and Andy, the basis for the apportionment of the remuneration between the two contracts, the scope of duties and responsibilities, the nature of services rendered and the time spent by Andy in and outside Hong Kong. Depending on the actual facts, the Commissioner may or may not accept that there are two contracts of employment between the Hong Kong subsidiary and Andy. The Commissioner may also invoke ss.61 and 61A to counteract Andy’s exemption claim concerning the second contract. [2 marks]
Answer 2
(a)
Section 15(1)(b) of the IRO deems the sums received by a non-resident person for the use in HK a trademark to be receipts arising in HK from a trade, profession or business carried on in HK. [1 mark]
Holding and Unrelated are foreign companies which have no office in HK. So, these companies are not chargeable to profits tax under section 14 but the royalties received by them are chargeable to profits tax under s. 15(1)(b) if royalty is paid for the use of intellectual property in HK. [1 mark]
The trademark “GM”, “Banana” and “Cherry” were used by GML in manufacturing its products for sale only in HK. The trademarks apparently were used in HK. Section 15(1)(b) would operate to bring the royalties received by Holding and Unrelated into the charge of profits tax. [1 mark]
On the other hand, AL is a company incorporated and carrying on a business in HK. The royalty received by it for the trademark “Apple” was part of its business income subject to the charge of profits tax under s. 14. [1 mark]
Section 14 imposes 3 conditions for profits tax to be chargeable:
(a) the taxpayer carries on a trade, profession or business in HK;
(b) the profits are derived from such trade, profession or business; and
(c) the profits arise in or derived from HK.
[1 mark]
In respect of the royalty income received by AL, the first 2 conditions obviously are satisfied. As both AL and GML are companies carrying on business in HK and the trademark “Apple” was used by GML exclusively in HK, the third condition is likely satisfied as well. In this circumstances, the royalty received by AL is chargeable to profits tax under s. 14. [1 mark]
Under s. 21A(1), the assessable profits in respect of a sum deemed by s. 15(1)(b) shall be taken to be:
(a) 100% of the sum if the sum is derived from an associate – this 100% however does not apply if the CIR is satisfied that no person carrying on a trade, profession or business in HK has at any time wholly or partly owned the property in respect of which the sum is paid; or
(b) 30% of the sum in any other case.
[2 marks]
Royalty of $8m received by Holding in respect of the trademark “GM”
Holding is an associate of GML. However, Holding is the first owner of the trademark, i.e. it has not been owned by a person carrying on a business in HK before. The assessable profits is $8m × 30% = $2.4m [1 mark]
Royalty of $10m received by AL in respect of the trademark “Apple”
As AL is carrying in business in HK and the royalty income $10m would just be its normal business income chargeable to profits tax under s. 14, so the amount of assessable profits would be the royalty income after deducting the relevant expenses incurred in producing such royalty income. [1 mark]
Royalty of $12m received by Holding in respect of the trademark “Banana”
Holding is an associate of GML. The trademark was purchased from BL, i.e. it has been owned by a person carrying on a business in HK before. The assessable profits is $12m × 100% = $12m. [1 mark]
Royalty of $20m received by Unrelated in respect of the trademark “Cherry”
Unrelated is unconnected with GML. That the trademark was purchased from CL (i.e. it has been owned by a person carrying on a business in HK before) is irrelevant. The assessable profits is $20m × 30% = $6m. [1 mark]
Section 20B(2) provides that, in respect of a sum deemed to be a taxable receipt by virtue of s. 15(1)(b), the non-resident person is chargeable to profits tax in the name of the person in HK who paid the sum. [1 mark]
GML as the payer in HK of the royalties to Holding and Unrelated accordingly would be charged to profits tax with assessable profits of $2.4m, $12m and $6m as computed above. Section 20B(2) also provides that the tax so charged on GML shall be recoverable from GML.
[1 mark]
Section 20B(3) further provides that GML as the payer in HK should at the time it makes payment to Holding or Unrelated deduct a sufficient sum from the payment as is sufficient to produce the amount of tax recoverable from it. [1 mark]
(b)
Loan $50m from Holding
As the loan was used to acquire trading stock. So, the interest was incurred in the production of chargeable profits and thus deductible under s. 16(1)(a). However, we have to further consider s. 16(2) conditions. [1 mark]
As Holding does not carrying on business in HK and so the interest income received by Holding is not liable to profits tax, so interest expense is not deductible under s. 16(2)(c). In addition, though the loan was used to acquire trading stock, the lender Holding is an associate of CL and so interest expense is also not deductible under s. 16(2)(e). [2 marks]
As none of the conditions in s. 16(2) is satisfied, interest expense is fully not deductible though it satisfied the secured loan test under s. 16(2A) by using only the property and investment shares as security for loan borrowing. [1 mark]