Case 6
Edotcom Inc is an electronic manufacturing company. The company looks for efficient manufacturing and transportation facilities in Asia. The president of the company is in favour of Hong Kong’s efficient working environment and the relatively low production cost in Mainland China. The company is prepared to incorporate a subsidiary in Hong Kong for distribution purposes. It aims at starting a manufacturing arm in GuangdongProvince by the incorporation of a wholly foreign owned enterprise (WFOE) in Mainland.
The Hong Kong subsidiary is responsible for purchase of materials and manufacturing machines from overseas to be used in the WFOE. The finished goods will be sold by Hong Kong subsidiary to customers worldwide (excluding Mainland China). In order to ensure that the goods manufactured in Mainland are up to the company’s standard, the Hong Kong subsidiary will send technical staff to oversea the production in the Mainland.
The Hong Kong subsidiary is going to send a quality control team to station in the factory of the WFOE in the Mainland. The team sent to the Mainland factory is Hong Kong residents with their families living in Hong Kong. They will station in the Mainland, and come back to Hong Kong office every two weeks to report the progress of the manufacturing process and all related matters to the general manager in the Hong Kong subsidiary. They are allowed to take leave and come back to Hong Kong for those long public holidays in the Mainland.
Required:
(a)Explain the additional information required to determine whether the profit made from the sale of the finished goods by the Hong Kong subsidiary is chargeable to Hong Kong profits tax.
(b)Explain whether the Hong Kong subsidiary is entitled to any depreciation allowance in respect of the machines used by the WFOE.
(c)What is your advice on how to minimize the Hong Kong’s subsidiary’s profits tax liability in respect of its sale of finished goods and use of manufacturing machinery?
(d)Explain the exposure of the Hong Kong quality control team’s individual tax liability in Hong Kong and Mainland China.
(e)Explain how the Hong Kong quality control team may avoid the tax exposure of PRC individual income tax.
(f)Edotcom Inc is evaluating the different methods of financing the working capital of Hong Kong subsidiary.
Explain the profits tax exposure of the following five methods of finance from (i) to (v), and choose the one which would minimize the profits tax liability of the Hong Kongsubsidiary:
(i)a grant of HK$10,000,000 from Edotcom Inc to the Hong Kong subsidiary;
(ii)an injection of share of capital of HK$10,000,000 from Edotcom Inc to the Hong Kong subsidiary;
(iii)an interest free loan of HK$10,000,000 from Edotcom Inc to the Hong Kong subsidiary, and the Hong Kong subsidiary will impute interest expense at the market interest rate of 5% per annum to its income statement as required under HKFRS;
(iv)a loan of HK$10,000,000 at the market interest rate of 5% per annum from Edotcom Inc to the Hong Kong subsidiary;
(v)a loan of US$1,250,000 from an overseas bank lent to the Hong Kong subsidiary arranged by Edotcom Inc at the interest rate of 1% above the Hong Kong market interest rates.
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