Question

CC Inc. (the Company) is incorporated and carrying on a retailing business through various retailers in the US and does not maintain any management or control in Hong Kong. To be in line with the group’s long-term strategy, the Company is considering expanding into the Hong Kong market. There are two expansion proposals: Proposal 1: To set up a subsidiary in Hong Kong, which will buy the goods from the Company and sell them in Hong Kong via retail outlets. All transactions are conducted at arm’s length. Proposal 2: To set up a branch in Hong Kong (HK Branch) to liaise directly with the potential customers in Hong Kong. HK Branch will be responsible to negotiate with customers on the terms of purchase based on a set of prescribed policy from the Company. Customers’ orders will be accepted and signed by the HK Branch, following which goods will be shipped directly from the US to the buyers in Hong Kong. The Branch will remain as a cost centre without making any profits.

Required: (a) Based on the Inland Revenue Ordinance and Rules, discuss the circumstances in which a non-resident company can be assessable to profits tax in Hong Kong.

(b) For each of the two proposals described, discuss the Hong Kong profits tax implications for CC Inc., including whether CC Inc. would be considered as carrying on business in Hong Kong, and if so, how assessable profits could be determined. (Note: Transfer pricing issue is not required to be discussed.)

Answer 1

1

Special Provisions for Ascertaining Liability to Profits Tax

Certain Amounts Deemed to be Trading Receipts

The following sums are deemed to be receipts arising in or derived from Hong Kong from a trade, profession or business carried on in Hong Kong under the Inland Revenue Ordinance (I.R.O.) :-

1. Sums received from the exhibition or use in Hong Kong of cinematography or television film or tape, sound recording or their connected advertising materials [section 15(1)(a)].
2. Sums received for the use, or the right to the use, in Hong Kong of any patent, design, trade mark, copyright material, *layout-design (topography) of an integrated circuit, *performer's right, *plant variety right, secret process or formula [section 15(1)(b)].
3. Sums received for the use, or the right to the use, outside Hong Kong when such sums are deductible in ascertaining the assessable profits of a person under Profits Tax, of any patent, design, trade mark, copyright material, *layout-design (topography) of an integrated circuit, *performer's right, *plant variety right, secret process or formula [section 15(1)(ba)].
4. Sums for an assignment of, or an agreement to assign, a performer's right in relation to a performance given by a performer in Hong Kong on or after 29 June 2018 and the sums were paid or accrued to the performer or an organizer [section 15(1)(bb)].
5. Sums received by or accrued to a person carrying on business in Hong Kong by way of grant, subsidy or similar financial assistance other than sums in connection with capital expenditure [section 15(1)(c)].
6. Sums received by way of hire, rental or similar charges for the use of movable property or the right to use movable property in Hong Kong [section 15(1)(d)].

(*not applicable for sums received or accrued before 29 June 2018)

Non-Residents and Agents Dealing with Non-Residents

1. A non-resident is chargeable to tax either directly or in the name of his agent in respect of all his profits arising in or derived from Hong Kong, from any trade, profession or business carried on there, whether or not the agent has the receipt of the profits, and the tax may be recovered out of the assets of the non-resident or from the agent. The agent is required to retain from the assets sufficient money to pay the tax.
2. A non-resident who receives sums specified in section 15(1)(a), (b), (ba) and (bb), or a non-resident entertainer or sportsman who receives sums from the performance in Hong Kong of an activity in his character as entertainer or sportsman is chargeable to tax in the name of the person who paid or credited the sums to the non-resident. The person who pays or credits such sum is required at the time he makes the payment or credit to deduct from those sums an amount sufficient to meet the tax due.
3. Resident consignees are required to furnish quarterly returns to the Commissioner showing the gross proceeds from sales on behalf of their non-resident consignors and to pay to the Commissioner a sum equal to one per cent of such proceeds, or such lesser sum as may have been agreed with the Commissioner.
4. Where the true profits of a non-resident from a trade, profession or business carried on in Hong Kong cannot be readily ascertained, they may be computed on a fair percentage of the turnover in Hong Kong.
5. Where the accounts of a non-resident whose head office is outside Hong Kong do not disclose the true profits of a Hong Kong permanent establishment, the profit of the branch for tax purposes is taken to be the amount which bears to the taxpayer's total profits the same proportion as his turnover in Hong Kong bears to his total turnover.

More information:

• Taxation of Non-resident Entertainers and Sportsmen in Hong Kong
• FAQ: Non-resident Persons (Other Than Individuals)
• Non-resident Professionals
• Payments to Non-residents Professionals

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Assessable Profits

The Assessable Profits (or Adjusted Loss) are the net profits (or loss) [other than profits (or loss) arising from the sale of capital assets] for the basis period, arising in or derived from Hong Kong, calculated in accordance with the provisions of Part IV of the I.R.O.

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Basis Period

The Basis period is either:-

1. the year ended 31 March during the relevant year;
2. where the annual accounts are made up to any day other than 31 March, the year ended on that day in the relevant year;
3. where the accounts are made up for each lunar year, the lunar year ended in the relevant year;
4. where you commenced or ceased to carry on a business or changed its accounting date, the special period prescribed by sections 18C, 18D or 18E of the I.R.O.;
5. for commencement case, if accounts for this period have not been prepared the profits to be returned may be calculated by apportioning the profits shown by the accounts which cover the period; or
6. for cessation/transfer of business case, special rules apply:-
   • where the business does not cease but, in whole or in part, is transferred to or carried on by another person;
   • in the case of cessation occurring on or after 1 April 1979 of a business which commenced before 1 April 1974.

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Exemption

The following sums are excluded from the assessable profits:-

• dividends received from a corporation which is subject to Hong Kong Profits Tax;
• amounts already included in the assessable profits of other persons chargeable to Profits Tax;
• interest on Tax Reserve Certificates;
• interest on, and any profit made in respect of a bond issued under the Loans Ordinance (Cap. 61) or the Loans (Government Bonds) Ordinance (Cap. 64), or in respect of an Exchange Fund debt instrument or in respect of a Hong Kong dollar-denominated multilateral agency debt instrument;
• interest income and trading profits derived from long term debt instruments;
• interest, profits or gains from qualifying debt instruments (issued on or after 1 April 2018) exempted from payment of Profits Tax; and
• sums received or accrued in respect of a specified investment scheme by or to the person as: -
  1. a person chargeable to Profits Tax in respect of a mutual fund, unit trust or similar investment scheme that is authorized as a collective investment scheme under section 104 of the Securities and Futures Ordinance (Cap. 571); or
  2. a person chargeable to Profits Tax in respect of a mutual fund, unit trust or similar investment scheme where the Commissioner is satisfied that the mutual fund, unit trust or investment scheme is a bona fide widely held investment scheme which complies with the requirements of a supervisory authority within an acceptable regulatory regime.

A person is exempt from payment of profits tax in respect of the following sums:-

• interest (accrued on or after 22 June 1998) that is derived from any deposit placed in Hong Kong with an authorized institution, excluding interest received by or accrued to a financial institution; and
• starting from the year of assessment 2009/10, interest on and any profit made in respect of Renminbi sovereign bonds.

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Deductions

Deductible Expenses

Generally, all outgoings and expenses, to the extent to which they have been incurred by the taxpayer in the production of chargeable profits, are allowed as deductions. Reference can be made to section 16 of the I.R.O.

A transfer of certain allowable head office administrative expenses by means of a charge to a local branch or subsidiary in Hong Kong would be allowed as a deduction for Hong Kong tax purposes, to the extent to which they were incurred during the basis period for the year of assessment in the production of profits chargeable to tax.

Non-deductible Items

In computing the assessable profits deduction is specifically prohibited in respect of the following:-

• domestic or private expenses and any sums not expended for the purpose of producing the profits;
• any loss or withdrawal of capital, the cost of improvements and any expenditure of a capital nature;
• any sum recoverable under insurance or contract of indemnity;
• rent of or expenses relating to premises not occupied or used for the purpose of producing the profits;
• taxes payable under the I.R.O., except Salaries Tax paid in respect of employees' remuneration;
• any remuneration or interest on capital or loans payable to or, subject to section 16AA, contribution made to a mandatory provident fund scheme in respect of the proprietor or the proprietor's spouse or, in case of a partnership, to its partners or their spouses.

Expenditure on Building Refurbishment

A person who incurs capital expenditure on the renovation or refurbishment of business premises is allowed to deduct that expenditure over a period of 5 years in equal instalments commencing in the year in which the expenditure is made.

Expenditure on plant and machinery specially related to manufacturing, and on computer hardware and software

For this kind of expenditure, a full deduction is allowed in the basis period in which the expenditure was incurred.

Expenditure on Environmental Protection Facilities

1. Expenditure on environmental protection machinery
   • With effect from the year of assessment 2008/09, a full deduction is allowed during the basis period in which the expenditure is incurred.
2. Expenditure on environmental protection installation
   • With effect from the year of assessment 2008/09, a deduction at 20% of the expenditure is allowed in each of the 5 consecutive years commencing from the year in which the expenditure is incurred.
   • With effect from the year of assessment 2018/19, a full deduction is allowed during the basis period (instead of over five years) in which the expenditure is incurred for procuring environmental protection installations [including any part of expenditure on environmental protection installation that remains to be deducted (and is to be fully deducted) in the year of assessment 2018/19].
3. Expenditure on environment-friendly vehicle
   • With effect from the year of assessment 2010/11, a full deduction is allowed during the basis period in which the expenditure is incurred.

Depreciation Allowances

1. Industrial Buildings Allowances on Industrial Buildings and Structures
   • Initial allowance: 20% on the cost of construction of the premises
   • Annual allowance: 4% on the cost of construction of the premises
   • Balancing allowance or charge will be due upon disposal of the premises
2. Commercial Buildings Allowances on Commercial Buildings and Structures
   • Annual allowance: 4% on the cost of construction of the premises
   • Balancing allowance or charge will be due upon disposal of the premises
3. Plant and Machinery
   • Initial allowance: 60% on the cost
   • Annual allowance: at rates of 10%, 20% or 30% as prescribed by the Board of Inland Revenue in the Inland Revenue Rules, on the reducing value of the asset. Items qualifying for the same rate of annual allowance are grouped under one "pool".
   • A balancing allowance is available only on cessation of a business to which there is no successor. A balancing charge can, however, arise whenever the disposal proceeds of one or more assets exceed the reducing value of the whole "pool" of assets to which the disposed items belong.

Donations

Charitable donations made to approved charitable institutions or trusts of a public character or to the Government of the Hong Kong Special Administrative Region, amounting in aggregate not less than $100 but not exceeding 35% (10% for years of assessment up to and including 2002/03; and 25% for years of assessment 2003/04 to 2007/08) of the adjusted assessable profits before deduction of donations, are allowable for deduction in computing the assessable profits.

More information:

• Specified Rate of Interest for the Purposes of Section 16(2)(b) of the IRO
• Approved Institutes under Section 16B and 16C of IRO
• Stock Exchanges and Major Financial Centres outside Hong Kong
• FAQ: Keyman Insurance Policy
• DIPN 5 (Revised) : Profits tax deductions
• DIPN 49 (Part A) : Profits tax deduction of capital expenditure on relevant intellectual property rights
• FAQ : Tax Deduction for Environment-friendly Vehicles

answer 2

The carrying on business in Hong Kong, and if so, how assessable profits could be determined

The proposa 1 was accepted, because of set up a subsidiary in Hong Kong, which will buy the goods from the Company and sell them in Hong Kong via retail outlets. All transactions are conducted at arm’s length.

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