Questions on Taxation

Published:

 Taxation I


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Q1.

  1. Direct tax

In the assessment year, taxpayers would pay taxes directly to the government on the due date and required amount. It is direct tax because of payments directly to the government.

For example, salaries tax is a direct tax. Employee directly pays their tax to the Inland Revenue Department and it is based on their salaries. Except the tax, property tax and profit tax are also direct tax.

Indirect tax

Firstly, taxpayers pay tax to intermediaries. And then, intermediaries transfer the money to the government. It is indirect tax because taxpayers pay tax to the government through intermediaries.

For instance, a first registration tax for imported car is indirect tax. It is received from the first owner of a car and subsequent owners do not pay the tax. Car owners should handle it which is charged to taxpayer as part of the price of the car.

  1. There are the objectives of a good tax system, as following:
  • To distribute goods and services equitably;
  • To protect the liberties and rights of individuals;
  • To maximize present and future output of goods and services;
  • To impose a suitable level of taxation;
  • To not increase inequality or offend equity;
  • To be efficient of tax administration;
  • To regard as tools in assisting economic growth and stability; and
  • To have tax legislation that is simple and inexpensive to administer.
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The following characteristics of a tax system, as following:

  • Neutrality

It indicates tax system minimizes the disincentive effects and fairly distributes the tax burden. The tax system should not provide any suggest and advice to allocate resource. Any action would affect its neutrality. Sometimes, the government may take action for encouraging or discouraging an industry. For example, the Inland Revenue Ordinance requests the deduction of research and development expenses in order to develop higher technology industry.

  • Equity

Individuals should pay his/her fair share of tax. The tax burden on taxpayers is distributed fairly. Every taxpayers in same situations should be treated the same. According to their income and profits, they should pay the same amount of tax on the same income or profits.

  • Efficiency

The efficiency of a tax system can reduce the compliance costs and administration costs for collecting revenue. For example, provisional tax system based on the income on current year and taxpayers will pay in advance. In pay-as-you-earn, employers need to withhold a specific amount from their employees’ salaries. To compare, provisional tax is more efficient because it can saves employers’ step.

  • Simplicity

The tax system should be transparent, predictable and intelligible so that it clear and easier understanding. For example, in Hong Kong, a taxpayer can finish his/her own tax return because the process is very easy.

  • Economic and social objectives

It indicates the government employs it to attain selected economic policy. For example, S16 G prescribed fixed assets is like computer equipment, including hardware and software.

  • Cultural

There is family concept including joint assessment in salaries tax. It also allows some allowance, such as dependent grandparent allowance, child allowance, donation allowance and brother and sister allowance.

  • Effectiveness

The effectiveness of a tax system includes revenue productive and revenue yields. Revenue productive is that it produces the amount of tax revenue on timely manner. Besides, revenue yields are sustainable for a long time and insulated as far as reasonably possible from economic cycles, such as recession.

  • Other
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The characteristics of a tax system consist of flexibility and competitive. Nowadays, internet is popular so that Inland Revenue Departmentallows that taxpayers submit tax return on internet, which is Green Tax. The tax system is flexible and capable on technological changes and commercial development. International competitiveness is to attend and follow international trends.

  1. Some people think Hong Kong has a narrow tax base. In order to broaden the tax base of Hong Kong, Goods and Services Tax is proposed for Hong Kong.

According to part b), there are the objectives and the characteristics of Goods and Services Tax, as following:

  • Neutrality and Economic

Goods and Services Tax should be economically neutral so that it should not cause market distortion. That is to say, it does not lead to resource allocation in a society.

  • Equity

It should fairly tax the individuals, business and Government in similar ways. When they face the same situation, they are treated the same. According to the selling price of goods and services, they should pay the same amount of tax on the same price.

  • Efficiency and Effectiveness

The tax can minimize the administrative costs for the Government and compliance costs for business. Therefore, it can meet efficiency and effectiveness characteristics.

  • Simplicity

Goods and Services Tax is simple and certain. It should be compatible with the existing low rate taxation system. Although it is levied at low rate, it can keep competitive advantages and make revenue in Hong Kong.

To conclude, Goods and Services Tax can generate steady revenue for the Government.

Q2.

  1. According to CIR v George Andrew Goepfert (2 HKTC 210), the following three factors of DIPN 10 are used in deciding the source of income from an employment:
  • the place where the contract of employment is negotiated, entered into, and is enforceable;
  • the place of residence of the employer; and
  • the place of payment of the remuneration.

If all the above three factors are in Hong Kong, it should be Hong Kong employment and the source of income from the employment is Hong Kong so that it is subject to salaries tax in Hong Kong. However, in the above three factors, the location of payment of the remuneration is less important.

An office is a company’s board of director or secretary. Income from an office is that the remuneration is paid to the directors or secretaries for their positions.

The factor in deciding the source of income from an office is where the central management and control of the company (McMillan v Gurest (24 TC 190)), for instance, the location of board meetings. Even if the office always travels for business purpose, it is subject to salaries tax in where the central management and control is. Unless all decision of the company is finalized by its parent company outside Hong Kong, it is not subject to salaries tax in Hong Kong.

  1. During the year of assessment 2011/12, Paul Newman is subject to salaries tax in Hong Kong according to 60 days rule.

Paul Newman was not Hong Kong’s employment because:

  1. He who is a German citizen had an employment contract in Germany.
  2. His company, Silver Corporation, was in Germany and his superior was also in Germany.
  3. His salary was paid into his bank account in Germany.

Furthermore, he did not negotiate or sign a new employment contract again. Thus, his employment was in Germany even if he worked in Hong Kong. He should be exempted from salaries tax in Hong Kong.

However, he worked in Hong Kong exceeding a total of 60 days during the year of assessment although he was a non-Hong Kong employment. The income from non-Hong Kong employment is based on the number of days spent in Hong Kong during the assessable year. The formula is

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For During the year of assessment 2012/13, the situation is as same as the year of assessment 2011/12. Paul Newman is subject to salaries tax in Hong Kong according to 60 days rule. In addition, Paul was also an office in Hong Kong so that it was subject to salaries tax in Hong Kong.

The reason is that he was a director of Copper Ltd in Hong Kong and its central management and control was in Hong Kong. Therefore, the salary of HK$60,000 should be taxed under Hong Kong salaries tax.

Paul Newman’s salaries tax computations are as follows:

$

$

Salaries (Working 1)

874,985

Director fees

60,000

Travelling allowance

28,000

Relocation fee

180,000

Share option benefits (Working 2)

72,000

1,214,985

Add: Rental value

114,299

Less: Rent suffered

(24,000)

90,299

Net assessable income (A)

1,305,284

Less: Married person’s allowance

(240,000)

Child allowance

(126,000)

Net Chargeable income (B)

939,284

Tax at standard rate (A)x15%

195,792

Tax on (B)

1st $40,000 @2%

800

2nd $40,000 @7%

2,800

3rd $40,000 @12%

4,800

Rest @17%

139,278

Tax at progressive rates

147,678

Tax payable by each spouse

147,678

Working 1:

Holidays in Hong Kong =

Holidays in China =

= $874,985

Working 2:

Share option benefits =

= $72,000

Q3.

Century City Limited

Profit tax computation for the year of assessment 2013/14

Basic period: year ended 31 December 2013

$

$

Profit per account

7,800,000

Add: Disallowed expenses / taxable income not recorded in accounts

Depreciation

300,000

Compensation for distribution agreement

300,000

Revenue from Trade Development Council

100,000

700,000

8,500,000

Less: Non-assessable or exempted income

Compensation arising out of joint venture

500,000

Compensation for landlord

150,000

650,000

7,850,000

Profits tax payable at 16.5%

1,295,250

  1. Note 1: According to the above calculation, compensation arising from joint venture agreement is non-taxable. The reason is that it is not revenue arising from ordinary business and is about company’s structure and capital. If the company enter into a joint venture and sign a formal agreement, it will change its model of operation. Moreover, it is not one of a number of contracts and is not for manufacturing. In fact, the factory does not enter a formal agreement and paid compensation for this event. The compensation for loss of the agreement is capital in nature so that $500,000 is not taxable.

Note 2: The interest income of $200,000 is received from financial institutions. The Exemption from Profit Tax (Interest Income) Order, which states interest income received by non-financial is exempted from profit tax, cannot apply. Using “operation test”, the source of interest income is from Hong Kong. Thus, the interest income is subject to profit tax in Hong Kong.

Note 3i: A sum of $150,000was paid to the landlord as compensation for leasing an office. The use of office is for its ordinary business, so it is a deductable payment to the landlord.

Note 3ii: According to section 16(1) is fulfilled, the loan also meet the condition under section 16(2)(d) which the money had borrowed from financial institution. According to section 16(2)(A), however, the interest generated by deposit or loan is not taxable in Hong Kong and the loan interest is not deductible. In this case, the fixed deposit borrowed with a bank in British Virgin Islands and generates interest in British Virgin Islands so that the loan interest is not subject to profit tax in Hong Kong.

Note 3iii: A sum of $500,000 was spent to install a testing facility in the company’s factory. Although the equipment is for manufacturing, the installment is considered in a capital nature. When the expenditures improve the useful life of the asset, it is non-deductable because it regards as capital expenditures.

  1. There are three criteria of loan interest deducted in determining Hong Kong profits tax liability, as following:
  1. To fulfill the application of section 16(1);
  2. To satisfy any one of the conditions under sections 16(2); and
  3. The expenditure is not restricted or disallowed by application of sections 16(2A), (2B) or (2C).

Section 16(1) states:

  • To be incurred during the basis period of a certain year of assessment; and
  • To the extent they are incurred in the production of profits chargeable to profits tax for any period.

(Course material P36)

The following conditions are under sections 16(2):

  • The money has been borrowed by a financial institution. (s.16(2)(a))
  • The money has been borrowed by a public utility company, such as The Hong Kong Electric Company and The Hong Kong and China and Gas Company Limited, at a rate not exceeding the rate specified by the Financial Secretary. (s.16(2)(b))
  • The money has been borrowed from a person other than financial institutions (local or overseas) and the recipient of the interest income is chargeable to tax in Hong Kong. (s.16(2)(c))
  • The money has been borrowed from financial institutions (local or overseas). (s.16(2)(d))
  • The money has been borrowed for the purpose of acquiring plant and machinery that qualifies for depreciation allowance; or for the purchase of trading stock for producing profits chargeable to profits tax; and, in either situation, the lender has been not an associate of the borrower. (s.16(2)(e))
  • The money has been borrowed by issue of debentures marketable in any stock exchange recognized by the CIR. (s.16(2)(f))

(Course material P40)

Besides, the third criteria of loan interest are:

  • It is called the ‘secured loan test.’ This restriction is imposed on the borrowers who fulfill conditions under sections 16(2)(c), (d) and (e). If the borrowers use bank deposits held by themselves or their associates as security for the loan, and the interest income from the deposits are not subject to tax in Hong Kong, then the interest expenses incurred by the borrower will be reduced by the interest income that is not taxed in Hong Kong. (s.16(2A))
  • This and section 16(2C) are known as the ‘interest flow-back test.’ This restriction is applied to a borrower who fulfils conditions under section 16(2)(c), (d) or (e). If a borrower arranges with the lender or through another person to have the interest payable ‘flowed back’ to the borrower or any connected person, then that part of the interest payable is not allowed. (s.16(2B))
  • This section is similar to section 16(2B), but the borrower fulfils the condition under section 16(2)(f) — the loan money is derived by the issue of debenture marketable in recognized stock exchanges. If the borrower or any connected person buys back the debenture wholly or partly through the stock exchanges, the interest payable by the borrower will go back to the borrower or its connected person. This part of the interest payable is therefore not allowed. (s.16(2C))

(Course material P40-41)

Reference:

ACT B414 Taxation I, Unit 1-3: OUHK

HubPages

http://leefrancesemery.hubpages.com/hub/What-is-a-Good-Tax-System

Dora Lee, Advanced Taxation in Hong Kong: Pearson, Fifteen Edition

The GST Frame work

http://www.taxreform.gov.hk/eng/pdf/Chapter_05.pdf

Goods and Services Tax

http://en.wikipedia.org/wiki/Goods_and_Services_Tax_(Hong_Kong)

A Broader-Based Tax System for Hong Kong?

http://www.info.gov.hk/archive/consult/2001/condoc-e.pdf