Hong Kong Tax Planning

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1. the Hong Kong profits tax implications to STPL in respect of its arrangement with STPCL (15 marks)

• Section 14(1) of Inland Revenue Ordinance (IRO) imposes three conditions for profits to be chargeable to Hong Kong profits tax. • There is no doubt that STPL has been carrying on a business in Hong Kong. • For manufacturing profit, the profit making activity is the manufacturing operation (see Hang Seng Bank case). • For import processing, where the Hong Kong company’s involvement in the Mainland production process is minimum, with the support from Datatronic case, the IRD takes the position that the manufacturing operations of the Mainland enterprise are not performed on behalf of , or for the account of, the Hong Kong company, and so the Hong Kong company derives trading profits instead of manufacturing profits. The source of profits of the Hong Kong company under import processing arrangement is governed by the normal sourcing rules for trading profits (i.e. not entitled to the 50:50 apportionment which applies to contract processing arrangements). • For trading profits, in the DIPN 21 (Revised 2009), the IRD maintains the position that the locations where the contracts of sale and purchase are effected are important factors when determining the source of trading profits. However, the IRD will contemplate all the relevant operations carried out to earn the profit, including the solicitation of orders, negotiation, conclusion, trade financing, shipment and performance of the contracts. The IRD’s position is that if either of the sale contract or purchase contract is effected in Hong Kong, the IRD would regard the profits as having a Hong Kong source. In this case, machinery and production knowhow are provided by STP Ltd. STPL sold raw material to STPCL and purchased finished STPCL. It seems STPL did no has substantial involvement in the mainland production activities. It is a import processing arrangement.

• If it is an import processing arrangement, the IRD would regard STPL’s profits as trading profits in determining its source. This approach is supported by Datatronic case and CG Lighting case. The IRD would look at the location where the contracts of sale and purchase were effected. The IRD would also consider other relevant factors as mentioned in the DIPN 21. Unless both the contracts of sale and purchase were effected outside Hong Kong, STPL would be successful in lodging an offshore claim. Additional information would be necessary to ascertain STPL’s tax position more exactly. This includes how and where the contracts of sale and purchase were effected, the related travel document copy for those staff travelling abroad to negotiate and conclude the contracts if any, where the trade finance, shipment and performance of contracts were done, etc. • STPL would be denied from deduction of depreciation allowances on the plant and machinery used by STPCL outside Hong Kong under section 39E.

2. the Hong Kong profits tax position of STPL in respect of the pricing adjustment to be made by the Chinese tax authority (15 marks);

• An economic double taxation would be resulted. An economic double taxation arises where two enterprises resident in different states are assessed to tax on the same profit or income, without relief provided by either state for tax imposed by the other. This double taxation may arise as a consequence of non-arm’s length transactions. The profits of one enterprise (as FKL in the case) are adjusted upwards increasing the tax charged on that enterprise in one side (i.e. a primary transfer pricing adjustment), without a corresponding downward adjustment to the tax payable of the associated enterprise (CKL) in the other side.

• In the Double Taxation Arrangement (DTA) between the Mainland China and the Hong Kong SAR, the Associated Enterprise Article provides for primary transfer pricing adjustments by either side. The Associated Enterprises Article...
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