©Y Y Butt 190619 T LT3

THE CHINESE UNIVERSITY OF HONG KONG

School of Accountancy
Taxation

Lecture for week 3

Scope of lecture

3.1 Capital receipts

3.2 Change of intention
3.3 Compensation for loss of an asset
3.4 Compensation for cancellation/termination of contracts
3.5 Lease Premium
3.6 Deemed trading receipts
3.7 Excluded income
3.8 Qualifying debt instruments – s 14A
3.9 Qualifying reinsurance and captive insurance business – s 14B
3.10 Qualifying corporate treasury centre
3.11 Exchange difference
3.12 Income from sale of patent

3.1 Capital receipts

Basic concepts
S 14.

Revenue income produced from capital assets

Profit from disposal of assets – capital or revenue?

When a taxpayer has disposed of an asset, particularly property, it must be determined
whether the taxpayer was

• Realising an investment (disposing a fixed asset); or

• Trading (disposing a trading asset).

How would you determine this?

The more important factor is the taxpayer’s intention towards the assets

3.2 Change of intention

Two scenarios:
• Capital asset being transferred to trading stock
• Trading stock being transferred to a capital asset

Legal principles derived from the case:

Sharkey v Wernher [1956]

There was doubt on whether the Sharkey v Wernher principle is applicable in Hong
Kong based on past deliberations of the Hong Kong courts.

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In view of the uncertainties, the government codified the principle as s 15BA in 2018.

Capital asset being transferred to trading stock

• The business is deemed to have sold a capital asset and purchased a trading stock
on the date of change of intention.
• The difference between the original cost of the asset and its deemed cost of trading
stock is a capital gain and not subject to Profits Tax.
• The market value of the capital asset is taken as the deemed cost of the trading
stock for the purpose of computation of assessable profit when that particular asset
is disposed in future.
• The assessable profit on the sale of the asset is the excess of the sales proceeds
over the market value of the asset at the date of change of intention.

Review example
Rich Ltd ("RL") purchased a flat on 1/1/1995 for letting purposes at HK$5m. On
1/1/2000, RL's director resolved that RL would change its business strategy from
property holding to property dealing (market value of the property on that day is
HK8m). On 1/2/2000, RL sold the flat for HK10m.

Required
What are the Hong Kong Profits Tax implications in respect of the above transactions?

Trading stock being transferred to a capital asset

• The business may be deemed to have sold that particular trading stock and
purchased a capital on the date of change of intention.
• The market value of the trading stock is taken as the deemed sales proceeds of the
deemed disposal of the trading stock although no money is received by the
company for such a transfer of asset.
• The notional profit on such deemed disposal is assessable in the year of
assessment when the change of intention takes place. The taxable amount is the
excess of the market value of the asset (i.e., the deemed sales proceeds) over its
historical cost.
• Any gain on subsequent disposal of the asset is not taxable because the company
is selling a capital asset.

Review example
Rich Ltd ("RL") purchased a flat on 1/1/1980 for trading purposes at HK$1m. RL has
been unable to find any buyer. On 1/1/1982, RL's director resolved that RL would
change its business strategy from property dealing to property holding (market value of
the property on that day is HK2m). On 1/2/2000, RL sold the flat for HK10m.

Required
What are the Hong Kong Profits Tax implications in respect of the above transactions?

3.3 Compensation for loss of an asset

Glenboig Union Fireclay Co. Ltd. v CIR (1922) 12 TC 427
• It was held that the sum of compensation for not operating a certain fireclay bed
where a railway would be laid thereon, was not assessable because the loss of the
asset was permanent.
• It was irrelevant that the compensation was computed on the basis of profits lost
due to the destruction.
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Burmah Steam Ship Co. Ltd. v CIR (1930) 16 TC 67

• A repairer could not meet the delivery date for repairing a ship for a shipping
company.
• The delay by the repairer resulted in a claim for damages by the shipping company
which was calculated by reference to the estimated loss of profits due to a delay.
• It was held that the compensation was assessable because it was paid for a
temporary loss of a fixed asset's revenue.

What are the underlying concepts derived from the two cases?

3.4 Compensation for cancellation/termination of contracts

Barr, Crombie & Co. Ltd. v CIR (1945) 26 TC 406
• The taxpayer's business was mainly the management of ships for one shipping
company, and the loss of the management agreement represented a loss of the
company's total operation.
• It was held that the compensation paid to the taxpayer for the termination of the
management agreement was capital in nature, and the sum was not taxable.

Short Bros. Ltd. v CIR (1927) 12 TC 955

• The taxpayer was a shipping company and received a compensation from a
customer for the cancellation of an order for a ship.
• It was held that the compensation was received by the taxpayer in the ordinary
course of its business.
• The payment represented a compensation paid for the cancellation relating to one
of the taxpayer's trading contracts.
• There was no loss of capital asset by the taxpayer. Thus, the compensation is of
revenue nature and taxable.

What have we learned?

3.5 Lease Premium

• Assessable

• DIPN 4. If the taxpayer’s accounts spread the lease premium over the period of the
lease in accordance with GAAP, the IRD recognises the treatment as assess the
premium based its accounting treatment.

3.6 Deemed trading receipts

• Royalty income received by a person for the exhibition or use in Hong Kong of
cinematography or television film: s 15(1)(a).

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• Royalty income received by a person for the use of or right to use in Hong Kong a
patent, design, trademark, copyright material or secret process or formula or other
property of a similar nature: s15 (1)(b).

• Royalty, received by or accrued to a person for the use of or right to use outside
Hong Kong a patent, design, trademark, copyright material or secret process or
formula or other properties of a similar nature, which is deductible in ascertaining
the assessable profits of a person in Hong Kong: s 15(1)(ba).

• Royalty, received by or accrued to, a performer or an organizer, for an assignment

of, or an agreement to assign, a performer’s right in relation to a performance given
by the performer in Hong Kong: s 15(1)(bb).

• Royalty, received by or accrued to a taxpayer:

➢ for the use, or the right to the use, outside Hong Kong of any intellectual
property or know-how generated from any R&D activity in respect of which
deduction is claimed by the taxpayer under section 16B; or
➢ for imparting or undertaking to impart knowledge directly or indirectly connected
with the use outside Hong Kong of any such property or know-how: s15(1)(bc).

• Financial assistance, grant or subsidy received by a person in connection with the

carrying on of a trade, a profession or a business in Hong Kong, excluding financial
assistance provided for capital expenditure: s 15(1)(c).

• Income by way of hire, rental or similar charges for the use of movable property in
Hong Kong or the right to use movable property in Hong Kong: s 15(1)(d).

• Refunds to an employer in respect of contributions to recognized occupational

retirement scheme, so far as the sums were previously allowed as deduction: s
15(1)(h).

• Interest income earned by financial institutions of its business in Hong Kong,

notwithstanding that the provision of credit is outside Hong Kong: s 15(1)(i).

• Interest income received by corporate treasury centre carrying on intra group

financing activities in Hong Kong, notwithstanding that the provision of credit is
outside Hong Kong: s15(1)(ia).

• Interest income earned by a LAC banking entity in respect of regulatory capital

security from carrying on the entity in Hong Kong, even if the moneys laid out for
the acquisition of the security in respect of which the interest is received are made
available outside Hong Kong: s15(1)(ib).

• Gains/profits arising in or derived from Hong Kong from the disposal or redemption
of a certificate of deposit or bill of exchange by a taxpayer carrying on business in
Hong Kong: s 15(1)(j)/(k).

• Gains/profits from the disposal or redemption of a certificate of deposit or bill of

exchange by Hong Kong financial institution as well as corporate treasury centre,
notwithstanding that the profit is sourced outside Hong Kong : s 15(1)(l)/(la).

• Income from the transfer of a right to receive income from property is taxable
unless the property is also sold to the transferee before or at the same time of such
transfer: s 15(1)(m), s 15A.

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• Income earned by corporation carrying on business in Hong Kong from:

➢ granting a right to use an aircraft to another person (aircraft business); or
➢ managing an aircraft business,
is assessable, even the aircraft is used outside Hong Kong: s 15(1)(n).

• Where a deduction had been allowed for a debt incurred, and that the debt is
subsequently released wholly or partly, the part released is treated as assessable:
s 15(2).

3.7 Excluded income

• Stock borrowing and lending transactions: s 15E.
• Dividends: s 26(a).
• Profits already assessed: s 26(b).
• Interest on tax reserve certificates: s 26A(1)(a).
• Interest on Hong Kong government bonds: s 26A(1)(b).
• Profits on disposal of Hong Kong government bonds: s 26A(1)(c).
• Certain exchange fund debt instrument interest and disposal profits: ss 26A(1)(d) –
(i).
• Certain mutual funds, unit trust and other investment scheme profits: ss 261A.

3.8 Qualifying debt instruments – s 14A

• Sums received in respect of certain short term as well as medium term qualifying
debts instruments (including interest and gains on disposal/redemption) less
outgoings and expenses, will be taxable at half the standard or corporate rate.

• Sums received in respect of certain long term qualifying debts instruments

(including interest and gains on disposal/redemption) less outgoings and expenses,
will be fully exempt from profits tax.

3.9 Qualifying reinsurance and captive insurance business – s 14B

• S 14B provides that the assessable profits of a reinsurance corporation or a captive
insurance corporation are chargeable to at ½ the profits tax rate if they are insuring
against offshore risk within the meanings of s 23A(2) and s 23A(2A).

• Election in writing is essential. However, once election is made, it is irrevocable.

3.10 Qualifying corporate treasury centre

• Section 14D provides assessable profits of a qualifying corporate treasury centre
are chargeable to at ½ the profits tax rate.

3.11 Exchange difference

Exchange receipts may be
• capital in nature;
• or revenue in nature.

Exchange receipts may be

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• onshore; or
• offshore in nature.

An exchange receipt has the same character as the asset or liability from which it
arises.

How would you determine whether the exchange difference is revenue or capital /
onshore or offshore in nature?

• An exchange receipt has the same character as the asset or liability from which it
arises.

Exchange difference arise from the conversion of balance sheet items.

• It may be treated as assessable/ deductible or non-assessable / non-deductible
provided consistent tax treatment is adopted from year to year

Unrealised exchange difference.

• Unrealised exchange difference may be treated in the same way as realised
exchange difference.
• Alternatively, taxpayer may elect to delay the recognition of the unrealised
difference in the tax computation in the year when they are recorded in the
accounts.
• However, such exchange difference is deemed realised in the subsequent year of
assessment.
• Consistent tax treatment should be adopted from year to year.

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