AC4351 Advanced Taxation City University of Hong Kong

Mid-Term Test

Time Allowed: 2 hours

Student No.:

Name:

Answer ALL the following questions on the answer book. (Total 65 marks)

Question 1

Andy has been employed by Wellbeing Ltd (‘Wellbeing’), a pharmacy company in the UK,
since 1997. Commencing from 1 April 2011, he accepted a two year secondment to Hong
Kong to handle two research projects for the Hong Kong subsidiary of Wellbeing, Healthy
Ltd (‘Healthy’). Andy reports his duties to the Hong Kong office, and is under the supervision
of the Research Director of Healthy. According to the terms of his secondment, Healthy will
pay Andy the following:

(i) monthly salary: $80,000.

(ii) housing allowance: 30% of the monthly salary.
(iii) a relocation allowance of $150,000 to cover whatever Andy may spend in relocating
himself and his family from the UK to Hong Kong. Andy is not required to account for
how he uses the sum.
(iv) a gratuity equivalent to 25% of the total salary earned during his secondment upon
completion of the secondment.

One of the two research projects is carried out for the benefit of a joint venture in China, of
which Healthy is a partner. This project requires extensive travel to the PRC. During the year
ended 31 March 2012, Andy worked for 180 days in Hong Kong, 145 days in the PRC, and
40 days (including 15 days annual leave) in the UK. Andy has the following income and
expenditure (all amounts are denominated in Hong Kong dollars):

1. Andy rented a flat for two years at a monthly rent of $20,000.

2. Andy took a 25-day business trip to the UK, and extended his stay for a further 15 days
to visit his parents. Healthy purchased a business class ticket for $26,000 for Andy, but
he paid the airline company $4,000 to exchange the ticket for two economy class tickets.
His girl friend travelled with him on one of the economy tickets, and shared the hotel
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room with him at no extra charge. Healthy approved the arrangement and paid the hotel
room charges for the entire trip totalling $24,000.
3. Wellbeing, in consideration of $2 per share, granted Andy an option without vesting
period to acquire 20,000 shares at $30 each in a UK affiliated company which was listed
on the London Stock Exchange. He acquired the option on 3 January 2011. On that date
the shares were traded at $35. On 1 October 2011, he exercised the option in Hong Kong
to acquire 12,000 shares. The shares were traded at $40 on that day. Unfortunately, the
share price dropped very sharply shortly afterwards. On 1 February 2012, he sold the
option to acquire the remaining 8,000 shares for $1 per share, and all of the 12,000
shares for $28 per share.
4. Andy had reported an income of $380,000 attributable to his services rendered in the
PRC to the PRC tax authority. Individual income tax of $130,000 was paid by Andy to
the PRC authorities. PRC individual income tax is comparable to salaries tax in Hong
Kong.

Apart from the above, the following additional information is applicable to Andy:

 His parents (aged over 70) are living in the UK. Andy remitted $3,000 per month to them
for their living expenses.
 He maintains a disabled brother, aged 25, who is the step-son of his father and is also
living in the UK.

Required:

(a) The Inland Revenue Department in Hong Kong assessed Andy’s income for the full
year to 31 March 2012 to Hong Kong salaries tax on the ground that his income was
sourced in Hong Kong.

Explain whether or not the Inland Revenue Department is correct in assessing

Andy’s income in full to Hong Kong salaries tax for the year of assessment 201/12.
(4 marks)

(b) Advise Andy on the Hong Kong salaries tax treatment of:
(i) the relocation allowance; and
(ii) the gratuity.
(4 marks)
(c) Compute Andy’s Hong Kong salaries tax liability for the year of assessment
2011/12. (6 marks)
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Ignore provisional salaries tax.

(d) Explain the tax treatment you have accorded to items 2 and 3 above. (3 marks)

(e) Assume that instead of accepting the secondment to Healthy Ltd, Andy’s contract with
Wellbeing Ltd was temporarily suspended and two separate contracts were signed
between Andy and Healthy Ltd. One contract covered Andy’s services to be rendered in
Hong Kong, the other covered his services to be rendered in the PRC. The annual
remuneration under the PRC contract would be $380,000.

Required:

Explain to Andy to what extent his salary under each of the two contracts is liable
to Hong Kong salaries tax, drawing his attention to the basis of any possible
challenge that may be made by the Inland Revenue Department. (5 marks)
(Total 25 marks)

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Question 2

Unrelated H o ld in g

G M L A L BL CL

Garment Manufacturing Limited [GML] is incorporated in Hong Kong. It is a wholly owned

subsidiary of Holding Inc. [Holding], a US company. Holding has no office in Hong Kong.
GML’s main business is the manufacturing of a range of men’s wear of various brand names.
It sells all its products in Hong Kong. It adopts the marketing policy of stratifying its products
into different brand names according to product prices.

Apple Limited [AL], Banana Limited [BL] and Cherry Limited [CL] are also wholly owned
subsidiaries of Holding and incorporated in Hong Kong. AL, BL and CL respectively carry on
business in Hong Kong of promoting the products of the brand names “Apple”, “Banana” and
“Cherry”. Unrelated Inc. [Unrelated] is a foreign company unconnected with the group
companies.

Holding and AL respectively are the first owners of the trademarks “GM” and “Apple”. BL
and CL respectively were the first owners of the trademarks “Banana” and “Cheery” but the
trademarks “Banana” and “Cherry” were respectively sold to Holding and Unrelated several
years ago.

GML has entered into royalty agreements with trademark owners who are allowed to
manufacture products with the appropriate trademarks. In the year of assessment 2011/12,
GML paid the following royalties:

Recipient
[The trademark owner] Amount Trademark
Holding $8M “GM”
AL $10M “Apple”
Holding $12M “Banana”
Unrelated $20M “Cherry”

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Due to its successful marketing strategy, GML managed to maintain high levels of profit in
the past few years notwithstanding the global economic downturn. However, CL suffered
substantial losses in recent years after selling the trademark “Cherry”, its most valuable
business asset, to Unrelated. CL’s assessed losses carried forward under profits tax for the
year of assessment 2011/12 amount to $30M. Holding considers that the continual business
losses of CL may induce adverse remarks from financial analysts. Holding is considering the
possibility of transferring its shareholding in CL to GML so that GML will become the
immediate holding company of CL. GML will then inject the profitable trading limb of the
“Cherry” products into CL. By the group restructuring, CL is expected to report taxable
profits in no more than 3 years.

To run the trading limb of the “Cherry” products, CL needs to raise a loan of $50M to finance
the purchase of trading stock. CL is considering alternative financial arrangements of
obtaining a loan from Holding, GML or a local bank as follows:

(1) Loan $50M obtained from Holding in Hong Kong

The loan was not secured by any bank deposit but a property together with some share
investments of CL.

(2) Loan $50M obtained from GML in Hong Kong

Loan was secured by a deposit $100M CL placed with AL. Such secured deposit was
placed into AL’s bank account in Hong Kong and derived interest income $1M. The
loan interest expense is also $1M.

(3) Loan $50M obtained from a local bank in Hong Kong

Loan was secured y a deposit $25M CL placed with that local bank in Hong Kong and
the deposit derived interest income $250,000. The loan interest expense is $1M.

Required:

(a) In respect of the royalties, how the relevant provisions of the Inland Revenue
Ordinance apply to the group companies and compute the amounts of assessable
profits in respect of the royalty payments with explanation. (15 marks)
(b) The deductibility of the interest expenses paid by CL on the loan to be obtained
under the three alternative financial arrangements. If only part of the interest
expense is deductible, compute the allowable amount of deduction with
explanation. (10 marks)
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(Total 25 marks)
Question 3

Mandy Limited is a trading company carrying on business in Hong Kong. Its accounts for the
year ended 31 December 2011 showed the following items:

(1) Unrealized exchange gain of $100,000 arising from the translation of the trade
receivable as at the balance sheet date.

(2) A gain of $800,000 derived from the disposal of a property which was classified as
property investment under the category of non-current asset. The property has been held
for 1 year before disposal.

Required:

Advise Mandy Limited the followings:

(a) The general principles regarding the treatment of exchange difference. (7 marks)

(b) How the unrealized exchange gain of $100,000 should be dealt with for tax
assessment purpose. (2 marks)

(c) Whether the gain of $800,000 from disposal of property should be chargeable to
Profits Tax. (6 marks)
(Total 15 marks)

~ END OF QUESTION PAPER ~