Taxation Law in Hong Kong: An Analysis of Key Concepts

This assignment solution provides a detailed analysis of key aspects of taxation law in Hong Kong. It begins by examining the profits tax, particularly focusing on interest expenditure under Section 16(2) of the Inland Revenue Ordinance (IRO) and its various subsections related to financial institutions, utility companies, and common businesses. The solution elaborates on the definition of 'business' and the criteria for determining its existence, as established in relevant court cases. Furthermore, it discusses the deductibility of interest expenses based on the purpose of borrowed funds, referencing Subsection 16(2)(e). The assignment then transitions to financial instruments, defining them according to Hong Kong Accounting Standard (HKAS) 32 and explaining the tax exemption for interest income from deposits with authorized financial institutions. Finally, it addresses gift tax in Hong Kong, outlining the progressive rates and conditions under which stamp duty applies to inter-vivos gifts. Desklib offers more solved assignments and study resources for students.

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TAXATION LAW: HONG KONG
ANSWER – 1
In the case of Commercial Holdings Limited (CHL), the involvement of Profits Tax -
Interest expenditure is of main consideration and this has been covered under Section
16(2) of the Inland Revenue Rules covered under The Inland Revenue Ordinance (IRO)
which was first enacted in 1947 for imposing income taxes in Hong Kong. There are
three main sub-sections –
Sub-Section 16(2)(a) deals with interest paid on borrowings by a financial institutions.
Sub-Section 16(2)(b) deals with interest paid by a utility company.
Sub-Section 16(2)(c), (d) and (e) deal with interest factors of common businesses, such
as CHL, according to IRD, Hong Kong, (2018).
Before going into the merits of the applicable sections, it is important to understand the
term business. This has a very broad meaning and has a wider concept as compared to
trade or profession (Refer to Kwan-Nang Kwong & Anor v Commissioner of Inland
Revenue (1989) 1 HKRC 90-017 and Lam Woo Shang v CIR (1961) 1 HKTC 123).
Whereas trade and profession are considered to be the involvement of the taxpayer in
some active function, business refers to the circumstances which are conducive in
creating a passive receipt of investment income for the taxpayer (Refer to Ferguson v
FC of T (1979) 79 ATC 4261). In this case, the court mentioned four factors for
determining whether the taxpayer was carrying on a business, as per Littlewood, (2010).
1. System: organised activities; maintenance of records.
2. Scale: capital value and magnitude of the activities.
3. Repetition: continuity of the activities.
4. Profit: as the main motive.
These are since known as indicia of a business.
Under subsection 16(2)(c), (d) and (e), which deal with the cases of common businesses,
any interest payable by the borrower on borrowings from a financial institution and it
includes even foreign institutions, will be allowed as deductible in case the loan
obtained has not been secured against a deposit from the borrower or from a connected

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entity/person and such a deposit is producing an interest which is not chargeable to tax
under the relevant statutes of the IRD, asserts CCH Editor, (2008). The statute under
subsection (d) and (e) explains the term connected person as someone who is a
shareholder, partner, director, member or a close relative of any of the above or is an
associated entity in case the connected person is an entity.
However, in the present case study of CHL, there is no connected person/entity nor is
there any pledge of a deposit by such a person/entity to the lending institution, hence the
applicable statute is singularly the Sub-Section 16(2)(e), as per IRD, Hong Kong,
(2018). This Subsection 16(2)(e) deals exclusively with interest factor of borrowed
funds by looking into the purpose of the borrowed amount. In case the borrowed money
is to be used exclusively and wholly for the purpose of acquisition through financing of
a building or plant and machinery or trading stock in the normal course of business
activity of the borrowing entity and which will result in the production of assessable
profits for the borrower and the borrower is not connected with the lender, the interest
shall be allowed as a deductible expense, asserts Brown (ed), (2017).
ANSWER – 2
Financial Instrument
According to the Hong Kong Accounting Standard (HKAS) 32, financial instrument is
defined as “any contract that gives rise to a financial asset of one entity and a financial
liability or equity instrument of another entity”. Hence, any interest income accruing to
a taxpayer, from a deposit which has been placed with any authorised financial
institution in Hong Kong on or after 22 June 1998 is totally exempt from any profits tax.
However, the exemption is not applicable to deposits which are used for securing or are
offered as guarantee against a loan in which any of the condition mentioned under
sections 16(2) (c), (d) or (e) of the IRO are satisfied and also any restriction on
deduction of interest expenses under section 16(2)(A) is not applicable, as per CCH
Editor, (2008).
Gift tax in Hong Kong is levied under a progressive rate. All Inter-vivos gifts, not made
for any valuable considerations, attract a stamp duty charge of up to 2.75% in case the

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value of the gift is in excess of US$513,000. However, no tax is to be paid in case the
value of the gift is less than US$128,000 or the recipient is a charitable organization.
An Inter-vivos gift is a gift given by the grantor during his/her lifetime. The grantor has
no right on the inter vivos gift and cannot get it back without permission of the party to
whom it is gifted.
REFERENCE LIST
Brown, K.B. (ed). 2017. Taxation and Development - A Comparative Study. Springer,
Cheltenham.
CCH Editor. 2008. Hong Kong Master Tax Guide 2008/09, 17th ed. CCH Hong Kong
Limited, Hong Kong.
IRD, Hong Kong. 2018. Publications and Press Releases, Departmental Interpretation
and Practice Notes. Inland Revenue Department, The Government of the Hong Kong
Special Administrative Region. Retrieved on 27 May 2018 from
https://www.ird.gov.hk/eng/ppr/dip.htm
Littlewood, M. 2010. Taxation Without Representation: The History of Hong Kong's
Troublingly Successful Tax System. Hong Kong University Press, Hong Kong.