2011 Unit 1 Scope of charges - s.ppt

7/30/2019 2011 Unit 1 Scope of charges - s.ppt

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LEARNING OBJECTIVES

After this lecture, you should be able to:Define & explain the scope of charge of profits taxDefine the chargeable person to profit taxExplain the meaning of badges of trade and applythem to determine whether trade exists.Understand the rate of profit taxUnderstand the concessionary rate for qualifying debtinstruments

Unit 1 - Profits Tax ( )Scope of Charge


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Basic Charge of profits tax Section14(1) the charging section

3 conditions:1) on every person carrying on trade, profession or

business in Hong Kong ; - Carrying on businessin Hong Kong?

2) In respect of his assessable profits from such

trade, profession or business; - assessable profits?3) Profits arising in or derived from Hong Kong

sourced in Hong Kong? ( locality/source of profits)


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Exclusion from profits tax:

profits arising from sale of capital

assets (no capital gain tax): s.14(1)Therefore, no capital gain tax.


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Source PrincipleTwo tests in s14:

a person is carrying on business in HK- a practicalmatter of fact:

e.g. 1) the company is managed and controlledin HK, and

2) the profits must have a HK sourceIf satisfying both tests, the profit is chargeable in HK under this section


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THE "SOURCE" CONCEPT

In general, there are two main sources of income or profits:

1) rendering services or performing activities (e.g.commission); and

2) holding of property (e.g. interest).

The former is often described as active income incontrast with the passive income in the later.


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Active income

in general, includes: trading profits profit from purchase and sale of listed securities profit from purchase and sale of unlisted

securities

manufacturing profits commission or service fees


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Passive income

in general, includes: interest rental income from immovable property rental income from movable property

royalty or licence fees from intangibleassets.


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Tests are relevant in determining the

source of certain income1) test2) test3) test

4) testFor active income, the proper approach in ascertainingits source is usually the test .For passive income such as dividends, interest or rent,

the operations test may not be appropriate as thetaxpayer does not need to perform any activities other than making and holding the investment. In suchcircumstances, the __________________________ test may be used in determining the source of suchincome.


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Chargeable Person

A person (taxpayer) as defined in s 2,includes:

1) a corporation2) partnership3) trustee4) a body of persons


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Residence Status

The residence status of the person alone bearsno relevancy to whether the person is subject

to Hong Kong profits tax. It is the source of the profits that requires considerations.


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Definition of business

Has a wide meaningSection 2(1): includes

farming, poultry and pig rearing,letting or sub-letting of premises by a corporation,

andsub-letting of premises by any other person


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Definition of profession

Usually involves the exercise of intellectual skill or manual skill controlled by intellectual knowledge,

practically, refers to such professions as lawyers,doctors, accountants, freelancers, etc.In practice, most professions also fall within themeaning of business.

Distinction from employment ( - see unit 3 in courseof Taxation I: control test, integration test, economicreality test, totality of facts)


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Definition of trade

Section 2 : includesevery trade and manufacture, andevery adventure ( ) and concern in thenature of trade

Isolated transaction e.g. sale of property can be anadventure in the nature of trade

It is a question of fact - look at all the circumstancesof the casePractically, the words "trade" and "business" areinterchangeable


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Badges of trade 6 badges

6 factors to consider whether a trade exist(please read pp.212 - 215 for details and case law):

1) subject matter of transaction2) length of period of ownership3) frequency of similar transactions4) supplementary work 5) circumstances responsible for the realisation;6) motive


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1. Subject MatterThings are purchased usually for four purposes:

a) consumption (e.g. food); b) investment (e.g. shares, real estate);c) personal enjoyment (e.g. painting); or

d) trading (e.g. goods for resale). Things which can neither be consumed, nor yieldsincomes or personal enjoyment to the owner arelikely to have been acquired for trading purpose.


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Subject matter of transaction 1.1 Nature of asset & 1.2 Quantity of asset - whether

the asset can yield income or personal enjoyment, e.g.CIR v Fraser (1942): an isolated transaction of a largequantity of whisky by a wood cutter which was too large

for his own consumption Rutlege v CIR (1920): an isolated purchase and resale of a large quantity (1 million) of toilet rolls, this could not

be acquired for personal enjoyment or production of

income. Martin v Lowry (1926): a purchase of 44 million yards of linen by an agricultural merchant, followed by the settingup of an organisation to advertise and sell the linen


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2. Length of ownership

the shorter the period, the more likely it is a tradeException: If an asset had been acquired for long-

term investment & was sold within a short time dueto some unforeseen circumstances, the owner will not

be regarded as trading ( CIR v Beautiland Co. Ltd (1992) 3 HKTC 322)Depending on the nature of business, a sale after along period of holding will still amount to trading


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CIR v Sincere Insurance & Investment Co Ltd (1973) HKTC 602

immovable properties held for > 20 years

were held to be current assets becauseinvestment assets of an insurance company arecurrent assets which must be readily realisableto meet possible claims.


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3. Frequency / number of similar

transactionsrepeated transactions of the same kindsuggests that a trade may be carried on

In Edward v Bairstow (1955), the taxpayers purchased and sold five lots of cotton spinning plants - held to be trading


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Frequency continuesIn Leach v Pogson (1962 ), T formed & sold 30driving schools. He accepted these transactionswere trading transactions except the 1st drivingschool. Held: the subsequent sale can throwlight on the 1st sale & all 30 schools wereformed & sold in the course of trading.

even one single transaction can amount totrading (e.g. CIR v Fraser - see above)


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4. Supplementary work done

Work done or alteration to make the assetmore saleable,

Organisation set up to sell, etc?In Cape Brandy Syndicate v CIR (1921), asyndicate acquired a quantity of South African

brandy, shipped it to UK, blended it withFrench brandy, recasked ( ) & sold it innumerous lots --> a trade.


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Supplementary work done continues

In CIR v Livingston & Ors (1926), Ts purchased &converted a cargo vessel into a steam drifter & thensold it at a profit --> tradingSee Martin v Lowry , a wholesale machinery merchant

purchased a large quantity of Government surplusaircraft linen and disposed of the linen in a number of lots. It was held that a trade was carried on withregard to the methods adopted for the resale of the

linen, the number of operations entered into and thetime occupied by the resale.


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5. Circumstances responsible for

disposal The original intention is not resalereasons other than profit-making, e.g.emergency or other factorsIn D10/88 , T bought a unit in an uncompleted

building. After discovering that another property would be developed in front, thus blocking the sea-view of his unit, he sold theunit. The profit was held not taxable.


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6. Motive profit-seeking motive?

it is perhaps the most important factor The intention at the time of acquisition (theoriginal intention) is very importantIn Clark v Follett (1973), T bought a farm withimmediate intention for sale --> trading


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Motive continues

In Taylor v Good, T purchased a piece of landintending to build a house for use as his

residence. His wife refused to live in it & thehouse was sold --> not trading.T in Central Enterprises Ltd v CIR could not

provide satisfactory evidence that the originalintention was to hold the property for long-term investment --> trading.


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Motive continues

Not test is conclusive, all the circumstanceshave to be examined.

Motive is perhaps the most important factor


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Capital or Current assets

The 6 badges of trade can be used to analysewhether an asset is a fixed or current asset.

There is no capital gain tax in Hong Kong. If one can prove that the "profits" resulted from a

business activity is in fact a capital gain (e.g.

profit on sale of investments), the "profits" sogenerated are not subject to profits tax.


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Proof of profit-seeking motive

Original intention - at the time of acquisition( Lionel Simmons Properties Ltd v CIR (1980) 53TC 461).

A mere hope or wish which is not realistic andrealisable is not sufficient ( All Best Wishes v CIR (1992))the stated intention of the TP is not conclusive, in

particular self-serving statementsintention must be supported by objective evidence


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Evidence to prove motive

board of directors minutes classification of assets in

accountstax returns

prospectus

other documents


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Evidence to prove motive continues

adequacy of finance (see California Copper Syndicate Ltd v Harris (1904) TC - T did not havesufficient capital to develop the copper mines at the

time of purchase an adventure in the nature of trade)sufficiency of income, i.e. whether the assets

produce high income yield or personal satisfactioncorrespondence, internal memo & other documentswhich disclose Ts intention manner of acquisition (e.g. inheritance)


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Evidence to prove motive continues

whether depreciation allowance has beenclaimed on the assets

whether there were advertisements for resaleor rentalwhether the offer for purchase was solicited or unsolicitedtrading interests in the same field


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Other factorsa) Advertising, recruitment of salesmen, employment of agents etc,would be valid activities for securing sales.

b) The circumstances showing engagement in the same field andshowing expertise or specialised knowledge of the commodity may

be good indicators of trading.

c) The method of financing the transaction has to be considered. For example, the purchase money may have been borrowed such thatthe asset bought must be sold quickly in order to repay the loan, or that the price would be paid for out of the sale proceeds.

d) The method of acquiring the property is also relevant. If the propertyis acquired by way of gift or inheritance, it can hardly be the casethat the subsequent sale of the property is regarded as trading.

e) Destination of proceeds of sale - The way the sale proceeds are putto use may indicate the purpose for sale and thus the intention of the

person carrying on such a business. For example, whether the salemoney is retained for use in a similar activity or for another form of investment.


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Totality of Facts

None of these characteristics by itself will beconclusive of trading and none of them is

necessarily over-riding in itself.All facts must be considered as a whole beforewe can decide whether an activity amounts to a

trade and, hence, whether the activity issubject to tax.


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Corporations v Individuals

It is easier to prove that a corporation istrading than an individual

The object clause a corporationsmemorandum of association usually includesthe conduct of a trade or business


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Illegal trading

profits therefrom are taxableIn Mann v Nash (1932), profits from theoperation from illegal automatic machineswere taxableIn Partridge v Mallandaine (1886), profits of

illegal horse-racing bookmakers were held to be trading receipts.


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Betting and gambling

Gambling which is merely entertainment is nottrading even though it is habitual

In Graham v Green (1925), a regular horse-racing gambler was held not to be carrying ona business


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Speculation

Speculation may not amount to trading.In D57/94, T claimed that the losses incurred by himon Hong Seng Index Futures & Forex dealings wastrading loss.BOR refused to allow the losses on the grounds thatthe pattern of his dealings was not habitual or systematic.T was in a position no different from other privateinvestors who seeks quick fortune in those markets.


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However In Burdge v Pyne (1968), winnings of the proprietor of a club gained in card games withmembers of the club were held to be assessableas the taxpayer had some knowledge or expertise in the games.

Authorities in Australia & New Zealandconfirm that horse gambling wins of jockeys &trainers amount to receipts from a business or

profession


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In D55/87 , a gambling win of an amateur jockey was held not to be receipts from a trade, business or professionProfessional jockeys & horse trainers are likelyto be subject to profits tax on horse gamblingwins


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Mutual trading

A man cannot make profit out of himself. Thus profits from trading by a body of persons with

its members is not taxable under common law.


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Trading in / trading with HK

HK-sourced profits from trading in HongKong taxable (i.e. with permanent

establishment in Hong Kong)Profits from trading with Hong Kong non-taxable (i.e. with no permanent establishment

( ) in Hong Kong; e.g. goods merely purchased from or sold to Hong Kong by a UK company)


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Definition of permanent establishment:

(Inland Revenue Rule IRR5) See Chapter 23, p.677.A branch, management or other place of

business andAn agent who:

has and habitually exercises a general authority or

has stock of merchandise from which the agentregularly fills orders


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CIR v. Bartica Investment Ltd . (1966)Business was held to be carried on in HK based onthe following facts:

- Board meetings of the nominee directors took place in HK

- All accounting and other records were kept inHK and maintained by accountants in HK

- Legal authorized signatories of bank accountswere also in HK - money was used to secure an offshore loan for an

associated company in Australia


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Commencement & Cessation of

businessWhether a business has commenced or ceased, bothare a question of fact to be determined by looking at

the facts of individual cases


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Profits tax rate:

Standard rate (for persons other than corporations)15% - 1998/99 to 2002/03; 15.5% - 2003/04;

16% - 2004/05 to 2007/08; 15% - 2008/09 to2009/10.Corporation rate16% - 1998/99 to 2002/03; 17.5% - 2003/04 to2007/08; 16.5% - 2008/09 to 2009/10.the rates will be given in test & exam


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Concessionary tax rates

Section 14A half of tax rate for interest, profit on sale/redemption/presentment derivedfrom certain qualifying debt instruments issuedSection 14B w.e.f. 1998/99, by election, half of tax rate for

assessable profits derived from the business of reinsuring offshore risks as a professionalreinsurer;assessable profits to be determined by a formula

under 23A(2)


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Concessionary rate for qualifying

debt instrumentsdebts issued by MTRC, Airport Authority andKCRC(details can be obtained from IRD website)
http://www.hongkongairport.com/eng/index.html


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"Debt instrument"

means an instrument specified in Part I of Schedule 6of the IROwhich:

is lodged with and cleared through the Hong Kong

Monetary Authority; is issued by a person who has a suitable credit rating; has an original maturity of five years or more; has a minimum denomination of HK$50,000 (with effect

from 1 April 1999) or its equivalent in a foreign currency; is issued to the public in Hong Kong; and if it is a scriptless instrument, it is one that would qualify

if it were in a physical form.

2011 Unit 1 Scope of charges - s.ppt

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