Tax-Profit

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In order to expand its market in PRC, KK(HK)Ltd is going to set up a subsidiary in PRC. Other than the injection of initial capital, KK(HK)Ltd will finance the funding of the subsidiary by way of interest bearing loan. It is estimated that the funding required from Hong Kong by the PRC subsidiary is as follows:

| |2009 (3 months) |2010 (12 months) |2011 (12 months) | |Funding required |$1,500,000 |$5,000,000 |$2,000,000 | |Estimated Interest rate |5% |5% |5% |

KK(HK)Ltd will obtain the funding through bank borrowings.

The director of KK(HK)Ltd approaches you for advice.

Required
Comment on the Hong Kong tax position of KK(HK)Ltd in respect of the fund cost in respect of the provision of funding to the PRC subsidiary in the form of an interest bearing loan. (Note to students: consider the conditions governing the deduction of interest expense, the treatment of interest received and how the source of interest is ascertained and the withholding tax under PRC under CDTA)

Answer:

It is the intention of KK (HK) Ltd. to obtain bank borrowings to fund the operation in the PRC. Interest would be incurred on the bank loan. From the HK tax perspective, KK (HK) Ltd would be able to obtain a tax deduction for the interest expense if it is incurred in the production of assessable profits (i.e. the bank loan money is being used to produce HK taxable profit) so that it should be assessed by Profit tax.

If funding is injected in the form of an interest bearing loan, interest income would be received from the PRC subsidiary. Any interest paid by the PRC subsidiary to KK (HK) Ltd would be subject to a PRC withholding tax.

From the perspective of KK (HK) Ltd, the taxability of the interest income in HK would depend on the...
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