Question

Section 17(1)(c) of the Ordinance prohibits deducting expenditure of a capital nature in ascertaining assessable profits for profits tax purposes. In so far as principles in deciding capital expenditure are concerned, the most frequently cited authority is the UK case of British Insulated and Helsby Cables v Atherton in which Lord Cave stated:

But when an expenditure is made, not only once and for all but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, I think that is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such expenditure as properly attributable, not to revenue, but to capital.

Below are cases where the companies involved suffered losses or incurred certain expenditure:

i      Company A placed the sales proceeds it received from a local customer into a short-term deposit account it maintained with a bank in Hong Kong. The account was in Euros. However, owing to fluctuation in the exchange rate, it suffered an exchange loss when converting the deposit back to Hong Kong dollars.

ii     Company B is operating a car park business. It succeeded in bidding for a five-year lease for a piece of vacant land in the New Territories. The company’s intention was to use the land as a parking lot for container trucks. However, the company later abandoned its plan and the deposit paid to the land owner was forfeited.

iii    Company C is an international medicine manufacturer. One of its chief researchers retired and the company paid him a substantial sum of money for entering into a covenant whereby he agreed not to be involved in any activities which might compete directly or indirectly with the company’s business.

iv    A dye manufacturing business, Company D, paid a fee to an engineering company for installing a dye mixing plant in its factory.

v     Company E is a garment manufacturer. For the purpose of business expansion, it moved into a bigger factory and incurred expenses in dismantling, transporting, and re-erecting of machinery.

vi    Company F, a trading company in Hong Kong, pays a big sum of money to a foreign company for a registered trademark. Company F intends to market the trademark-related products in Singapore and Hong Kong.

Required

Evaluate whether the loss suffered or expenditure incurred by each of the above companies is or is not deductible for profits tax purposes.

Answer 1

i      Company A placed the sales proceeds it received from a local customer into a short-term deposit account it maintained with a bank in Hong Kong. The account was in Euros. However, owing to fluctuation in the exchange rate, it suffered an exchange loss when converting the deposit back to Hong Kong dollars.

Ans

          If loss or gain from foreign exchange on fixed deposits with bank is capital in nature hence not allowed as deduction under profits tax purposes. Hence Company A is not in business of trading currencies but made short term fixed deposit from sale proceeds and exchange loss is not deductible for profits tax purposes.

ii     Company B is operating a car park business. It succeeded in bidding for a five-year lease for a piece of vacant land in the New Territories. The company’s intention was to use the land as a parking lot for container trucks. However, the company later abandoned its plan and the deposit paid to the land owner was forfeited.

Ans

In this case Lease for company B is capital in nature and any cost for cancellation of lease is capital in nature and not deductible for profits tax purposes.

iii    Company C is an international medicine manufacturer. One of its chief researchers retired and the company paid him a substantial sum of money for entering into a covenant whereby he agreed not to be involved in any activities which might compete directly or indirectly with the company’s business.

Ans

Payment made to chief researchers who retired by entering into a covenant whereby he agreed not to be involved in any activities which might compete directly or indirectly with the company’s business is capital in nature because it increased the company goodwill. Hence not deductible for profits tax purposes

iv    A dye manufacturing business, Company D, paid a fee to an engineering company for installing a dye mixing plant in its factory.

Ans

Dye mixing plant is capital asset any expenses on installation are capital in nature and are capitalized. Hence a fee to an engineering company for installing a dye mixing plant in its factory is not deductible for profits tax purposes

v     Company E is a garment manufacturer. For the purpose of business expansion, it moved into a bigger factory and incurred expenses in dismantling, transporting, and re-erecting of machinery

Ans

If the purpose is for business expansion expenses incurred in dismantling, transporting, and re-erecting of machinery will be treated as qualifying expenses for depreciation allowance hence are capital in nature and not deductible for profits tax purposes