THE HONG KONG INSTITUTE OF CHARTERED SECRETARIES THE INSTITUTE OF CHARTERED SECRETARIES AND ADMINISTRATORS International Qualifying Scheme Examination HONG KONG TAXATION PILOT PAPER Marking Scheme 1 1 (a) Main points to be covered are: 1. Hong Kong is well known as a source jurisdiction. To be chargeable under Hong Kong income tax, the concept of residence is not relevant. Rather, the source of income is important. Subject to exemptions, in general a person, irrespective of whether he/she is a Hong Kong resident person or overseas resident person, is chargeable to: (a) Hong Kong property tax if he/she owns Hong Kong property which generates rental income (b) Hong Kong salaries tax if he/she is under Hong Kong employment or holds a Hong Kong office or is under foreign employment but renders services in Hong Kong (c) Hong Kong profits tax if he/she carries on a trade, profession or business in Hong Kong and derives Hong Kong sourced profits from such a trade, profession or business 2. In general, the concept of residence has no significant effect on tax exemption and deduction rules under Hong Kong income tax. Resident persons or non-resident persons are equally treated in terms of tax exemptions and deductions for outgoings and expenses. 3. The concept of residence is also irrelevant under the scope of Hong Kong stamp duty. Irrespective of whether a person is a Hong Kong resident or an overseas resident, he/she may have to pay stamp duty if he/she executes the specific instruments in respect of transactions in Hong Kong property, Hong Kong stock or Hong Kong bearer instruments. 4. However, the concept of residence is important when it comes to certain tax reliefs and allowances: (a) Personal assessment, an alternative provided for individual taxpayer to minimise his/her income tax liability, is only available to a Hong Kong permanent resident or a temporary resident. (b) One of the conditions for the parent/grandparent of a taxpayer to be eligible for dependent parent/grandparent allowance is that the parent/grandparent should be a Hong Kong permanent resident. (c) Some tax provisions or incentives are only available to non-Hong Kong resident persons. For example, section 21 of the Inland Revenue Ordinance (IRO) only applies to compute the amount of assessable profits derived from Hong Kong by a non-resident person in respect of a trade, profession or business carried on in Hong Kong. Also, sections 20AB-AE apply to exempt non-resident funds in respect of Hong Kong sourced investment profits. 5. Mr. Davidson should be advised that: (a) He is obliged under section 51(1) of the IRO to file the appropriate tax return issued by the Inland Revenue Department. The penalty for non-compliance with filing a tax return is a maximum fine of $10,000 plus three times the tax undercharged (section 80(2))or an additional tax of a maximum of treble the amount of tax undercharged (section 82A). 2 (b) He is obliged to keep rent records for property tax purposes under section 51D. The penalty for non-compliance with keeping rent records is a maximum fine of $10,000 (section 80(1)) (9 marks) (b) Main points to be covered are: 1. In accordance with the principles from the Goepfert case (CIR v Goepfert George Andrew 2HKTC 210), Mr. Davidson’s employment has its source outside Hong Kong: (i) the employment contract in question was entered into and is enforceable outside Hong Kong; (ii) his ultimate employer was PanHealth (US) Limited, which was a US company at all material times; and (iii) his remuneration is paid to him through his bank account outside Hong Kong. It is also supported by the fact that, although Mr. Davidson performed most of his work in Hong Kong, his attachment to the Hong Kong subsidiary, GoodHealth (HK) Limited, was merely a matter of convenience. Moreover, his work was for the benefit of various subsidiary companies in the Asia Pacific region, not only for the Hong Kong subsidiary. However, as Mr. Davidson performed some duties in Hong Kong, he is subject to Hong Kong salaries tax in respect of his income derived from services rendered in Hong Kong. His total employment income will be apportioned based on his time spent in Hong Kong and outside Hong Kong to ascertain the assessable income (section 8(1A)(a)). 2. In respect of the directors’ fee received from GoodHealth (HK) Limited, Mr. Davidson will be subject to Hong Kong salaries tax on the basis that the fee is sourced in Hong Kong. This is because the board meetings of GoodHealth (HK) Limited were held in Hong Kong and thus the company was managed and controlled in Hong Kong. (4 marks) 3. Mr. Davidson Salaries tax assessment for 2006/07 $ $ Employment income [$1,500,000 x (180 + 15 x 180/350)/365] 771,428 Housing benefit: Rental value: (771,428 x 10%) 77,142 Less: rent suffered 12,000 65,142 Director fee 60,000 Assessable income 896,570 Less: Married person’s allowance 200,000 Child allowances 80,000 280,000 Net chargeable income 616,570 Salaries tax liability: 16% of $896,570 143,451 Progressive tax rates ($6,600 + 19% x 526,570) 106,648 (4 marks) 3 4. Mr. Davidson Property tax assessment for 2006/07 $ 1.6 2006 – 31.3.2007 Rent ($30,000 x 10) 300,000 Premium ($80,000 x 10/24) 33,333 Assessable value 333,333 Less: Rates ($2,800/3 x 10) 9,333 324,000 Less: Statutory allowance (20%) 64,800 Net assessable value 259,200 Property tax @16% 41,472 1. The premium is spread over the lease period, which is shorter than the statutory three- year period. 2. The rent deposit is not assessed as it serves only as a security and is not consideration for the right of use of the flat. 3. Rates paid by the landlord during the period of letting are deductible but mortgage loan interest expenses are not deductible under property tax. (6 marks) (c) Main points to be covered are: 1. A valid objection must: a. be in writing; b. state precisely the grounds for objection; c. be received by the Commissioner within one month after the date of the notice of assessment. A late objection can be allowed by the Commissioner if the taxpayer has reasonable excuse such as sickness, absence from Hong Kong, etc.; and d. for an objection to an estimated assessment raised in absence of a tax return; the objection is valid only if the tax return is filed within the specified period as approved by the Commissioner. 2. In Mr. Davidson’s situation, the 2006/07 estimated salaries assessment was issued on 15 April 2008. The one-month period for lodging a valid objection has lapsed. However, as Mr. Davidson was on a business trip and absent from Hong Kong during the one month period, i.e. from 14 April to 16 May 2008, he may lodge a late objection to the Inland Revenue Department using that reason. 3. However, the 2006/07 salaries tax assessment issued to Mr. Davidson was an estimated assessment because of his failure to file his salaries tax return. To validate his objection, Mr. Davidson must also file the salaries tax return in question as soon as allowed by the Commissioner. (3 marks) 4. Mr. Davidson is chargeable to property tax on his rental income from letting of the flat. Under property tax, apart from the deduction of rates agreed and paid by the landlord, only a statutory allowance of 20% is allowable. The actual interest expenses of $51,000 and $142,000 from the two loans used to finance the acquisition of the flat are not allowable under property tax. 4 5. Mr. Davidson is eligible to elect personal assessment for 2006/07: he was a Hong Kong temporary resident in 2006/07 as he spent 195 days in Hong Kong in the year. 6. Mr. Davidson may be able to obtain relief for these interest expenses by electing personal assessment under which the interest expenses of $259,200 (not exceeding the net assessable value ($259,200) of the flat) will be allowable. 7. Whether or not Mr. Davidson’s friend, who was the recipient of the interest, is taxable in respect of his/her interest income, is irrelevant for interest deduction relief. However, the Inland Revenue Department may have to ascertain there is a genuine and arm’s length lending and borrowing transaction between Mr. Davidson and his friend for deduction purposes. (6 marks) (d) Main points to be covered are: 1. The sale and purchase of Hong Kong stock requires a bought note and a sold note for completion of the transaction. The contract notes are subject to stamp duty under Head 2(1) and the amount of stamp duty payable is: $100,000 x 0.2% + $5 = $205. 2. The gifting of Hong Kong stock is operating as a voluntary disposition inter vivos. Therefore the deed of gift attracts stamp duty under Head 2(3). The amount of stamp duty payable is: $25 x 5,000 x 0.2% + $5 = $255. 3. The formal purchase and sale agreement of the residential flat in Hong Kong is subject to stamp duty under Head 1(1A). The amount of stamp duty payable is: $7,000,000 x 3.75% = $262,500. The deed of assignment (conveyance on sale) is also subject to stamp duty at a nominal amount of $100 if the formal purchase and sale agreement was duly stamped. 4.