Hong Kong Tax Alert: 30 May 2013

Decision of the Board of Review

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D21/12 was the lengthiest decision among the 4 cases and related to the additional assessments raised on A1 and A2 under sections 61 and 61A as determined by the CIR. 

As regards the restructuring undertaken in 1996, on the facts and evidence presented, the BOR rejected Group A’s claim that Hong Kong’s reversion of its sovereignty to China in 1997 was a valid reason for the restructuring. 

The BOR went on to find that both A3 and A4 had no employees of their own inside or outside of Hong Kong. Senior staff members of Group A were all employed by A1 or A2.

The BOR also found that A3 was not a manufacturer. Instead the products were manufactured by the factories in mainland China, which were separate and distinct legal entities from A3 and any other companies of Group A. 

In short, A3 only contracted with the mainland factories to manufacture the products on its behalf.  As regards A3 supplying raw materials to the mainland factories, this was done by A2 in Hong Kong on A3’s behalf, all shipments taking place from Hong Kong to the mainland factories. The products manufactured by the mainland factories were delivered to A1 as consignee in Hong Kong. A1 then shipped the products from Hong Kong to A4’s customers overseas on behalf of A4.

As regards the substance of the operational arrangements between A1 and A4, A2 and A3, and A3 and A4, the BOR found that the service fees paid by A4 to A1, and by A3 to A2, were only affected by way of a single year-end accounting entry.

Similarly, the sales of products by A3 to A4 were only effected by way of a single year-end accounting entry, A3 issuing no sales invoices to A4 and A4 never making any cash settlement of the amounts due to A3. As such, the BOR held that these arrangements were not genuine arm’s length transactions.

Based on the above findings, the BOR considered that the manufacturing operation claimed by Group A was in essence a procurement and sales or marketing operation split between A3 and A4. The BOR further noted that the aforesaid functions of A3 and A4 were in fact performed in Hong Kong on behalf of A3 and A4 by A2 and A1 respectively. The BOR therefore considered that the interposition of A3 and A4 had no reason other than to supply a basis for seeking to argue that A3 and A4, being overseas incorporated companies, were not liable to pay profits tax in Hong Kong.

The BOR then concluded that without the tax benefit sought, the purchase and sale of products to customers would most likely have been undertaken by A1 (the party which in practice handled all the sales and trading acts for A4), while the party most likely to have performed the procurement function would be A2 (the party which in practice handled all the procurement acts for A3).

On the above basis, the BOR considered that the sole or dominant purpose for the interposition of A3 and A4 was to enable A1 and A2 to obtain a tax benefit. Hence, the BOR held that the CIR was justified under section 61A in charging A1 and A2 with the profits as reflected in the accounts of A4 and A3 respectively and thereby counteracting the tax benefit which would otherwise have been obtained.

Aside from relying on section 61A as explained above, the BOR also considered that the additional assessments on A1 and A2 should also be upheld under the provisions of section 61. The BOR considered that the interposition of A4 and A3 on top of A1 and A2 had no commercial sense and purpose other than a reduction in the tax liabilities of A1 and A2. As such, the BOR held that the interposition should also be disregarded as being an artificial transaction and A1 and A2 should be assessed to tax accordingly under the terms of section 61.

Separately, in its decisions as reported in the cases D23/12 and D24/12, the BOR also upheld the assessments raised on A3 and A4 under section 14 of the IRO. In this regard, the BOR held that the profits of A3 and A4 which were claimed as offshore were essentially Hong Kong sourced profits derived from a business carried on by each in Hong Kong through A2 and A1 acting as their agents respectively. 

It should however be noted that the assessments raised on A3 and A4 under section 14 were alternative to the additional assessments raised on A1 and A2 under sections 61 and 61A. As such, it is presumed that the CIR would only recover the taxes involved based on one of the two sets of assessments upheld, otherwise double taxation would occur1


It appears that these four cases were more concerned with the source of profits involved under section 14 of the IRO than the application of the general anti-avoidance provisions of sections 61 and 61A to that restructuring.

As illustrated by these cases, where A3 and A4 were found to be chargeable to tax in Hong Kong under section 14 of the IRO, the CIR did not need to rely on sections 61 and 61A.  Furthermore, if on general principles the profits of A3 and A4 were found to be sourced offshore Hong Kong, it is perhaps doubtful whether the CIR could invoke the general anti-avoidance provisions under sections 61 and 61A to treat such offshore profits as being onshore 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.

1 In an earlier judicial review decision Canray International Limited and others v CIR HCAL 18/2011, the taxpayers challenged the authority of the Inland Revenue Department (IRD) to issue multiple assessments to different taxpayers on alternative bases in respect of the same set of profits.  In that case the IRD had submitted that it was never its intention to seek to tax the same profits more than once.  Rather, the IRD’s intention was to put forward alternative bases on which the profits might be taxed owing to the information available being insufficient.

The judgment of the case indicated that the making of assessments on alternative bases is permissible, provided it is not for the purpose of the double recovery of the tax involved.