In two recent decisions by the Board of Review (BOR), the Commissioner of Inland Revenue (CIR) successfully invoked the general anti-avoidance provisions of sections 61 and 61A to assess to tax profits claimed as offshore by two foreign incorporated companies.
The BOR also separately held the profits claimed as offshore were in fact Hong Kong sourced profits derived by the two foreign companies from a business carried on by each of them through an agent in Hong Kong. Therefore, the two foreign companies were also chargeable to tax under section 14, the normal charging section for Profits Tax under the Inland Revenue Ordinance (IRO).
As such, it appears that the CIR did not need to rely on sections 61 and 61A to charge the relevant profits to tax in Hong Kong. The interaction between the source of profits under section 14 and the potential application of sections 61 and 61A to such profits could nonetheless be a controversial issue. Where necessary, clients should seek professional tax advice.
Prior to a restructuring in 1996, Group A had two Hong Kong incorporated subsidiaries, A1 and A2. A1 had claimed to be carrying on a business of design and manufacture of computer related components while A2 had been dormant.
Under the restructuring two foreign companies A3 and A4 were incorporated in Country B, Country B presumably being a tax haven jurisdiction. Group A claimed that after the restructuring, A3 was responsible for manufacturing and A4 for sales and marketing. A1 became a company which only provided services in Hong Kong to A4 under a service agreement signed between the two parties. A2 was activated and also became a company providing services in Hong Kong, in this case to A3 under a service agreement signed between the two parties.
After the restructuring, A4 used a business centre operated by an independent third party in Macau as its address in Macau. Customers’ orders were presumably sent to the Macau address of A4. Apparently, the staff members of the business centre in Macau (who were not employees of A4) acknowledged the customers’ orders in Macau on behalf of A4 and then sent the orders to A1 in Hong Kong for further processing. From that point onwards, A1 would then process the orders in Hong Kong on behalf of A4 up to and including the delivery of the products to the customers of A4.
For the years of assessment from 1999/2000 to 2006/07, most of the profits of Group A were reflected in the accounts of A3 and A4. A3 and A4 did not report the relevant profits as chargeable to tax in Hong Kong on the basis that the profits were offshore in nature, not being derived from a business carried on in Hong Kong. The service fees received by A1 and A2 from A4 and A3 respectively were relatively small and were reported as taxable income subject to tax in Hong Kong.
Subsequent to a tax audit on Group A, the assessors and Group A failed to reach an agreement in respect of Group A’s objections to the relevant assessments or additional assessments raised. The Commissioner of Inland Revenue (CIR) then made the following determinations against A1, A2, A3 and A4.
A1 and A2 determined that under the general anti-avoidance provisions of sections 61 and 61A of the IRO, A1 and A2 were chargeable to tax under the additional assessments raised for the years of assessment from 1999/2000 to 2006/07 in respect of profits as reflected in the accounts of A4 and A3 respectively for the relevant years. These additional assessments were to charge A1 and A2 to tax in Hong Kong on relevant profits over-and-above the service fees received by them from A4 and A3 respectively.
The basis for the determination of these additional assessments on A1 and A2 under section 61A was that the CIR considered that the sole or dominant purpose of the interposition of A4 and A3 on top of A1 and A2 was for the purposes of enabling A1 and A2 to obtain a tax benefit. Therefore, under section 61A(2), to counteract the tax benefit sought, the CIR disregarded A4 and A3 and treated the purchase and sale of the products as being made by A1 and A2 respectively.
The basis for the determination under section 61 was that the interposition of A4 and A3 on top of A1 and A2 was an artificial or fictitious transaction that can be disregarded. Therefore, A1 and A2 should also be assessed accordingly under the terms of section 61.
A3 and A4 – as alternative assessments to the additional assessments raised on A1 and A2 above, the CIR also determined that A3 and A4 were chargeable to tax in Hong Kong under section 14 of the IRO for the years of assessment from 1999/2000 to 2006/07 in respect of the profits as reflected in the their respective accounts for the relevant years. These alternative assessments under section 14 were made on the basis that A3 and A4 had each derived Hong Kong sourced profits from a business carried on in Hong Kong for the relevant years.
Aggrieved by the CIR’s determination against them in respect of the assessments or additional assessments as detailed above, A1, A2, A3 and A4 each lodged appeals to the Board of Review (BOR). The BOR heard the relevant appeals together and reported its decisions separately in cases D21/12, D22/12, D23/12 and D24/12, with cross-references being made among the cases where appropriate.