Hong Kong Tax Alert: 8 February 2013
At the time the section 16G legislation was presented to the Legislative Council in 1998 for scrutiny and enactment in the form of a bill, few people realized that the statutory definition of the term “lease” could be interpreted so widely as to cover the types of arrangement similar to that pertaining to the Taxpayer as described above.
In fact, in 1998, it appeared that the CIR had not questioned whether the provision of plant or machinery by a Hong Kong taxpayer to its contract manufacturer in mainland China under a typical import processing arrangement might constitute a “lease” arrangement, even for the purposes of section 39E of the IRO.
Subsequently, the CIR took a very literal interpretation of the statutory definition of “lease” in section 2(1) as covering import-processing type arrangements. Applying this literal interpretation of the statutory definition of “lease”, the CIR has since been denying tax depreciation allowances on machinery or plant provided by a Hong Kong taxpayer to its contract manufacturer in mainland China under a typical import processing arrangement.
The CIR has adopted this approach even though the legislative intent of section 39E has been admitted by the government as specifically targeting “sale and lease-back” and “leveraged leasing” arrangements, but not commercial import processing arrangements.
The Taxpayer in this case did not lodge an alternative claim for relief by way of tax depreciation allowances on the moulds under the pooling system. This is possibly because Counsel sought to argue that in contrast to section 39E which as an anti-avoidance provision requiring the application of the wider statutory meaning of “lease”, the context of section 16G as a relief provision required that the statutory definition should not be applied.
Therefore, the CA did not need to consider whether the provision of the moulds by the Taxpayer to its contract manufacturers constituted a “lease” arrangement for the purpose of section 39E (an issue which would have required consideration if the Taxpayer had lodged an alternative claim for tax depreciation allowances in respect of the moulds). In this regard however, at least two previous decisions by the BOR have held that such an arrangement would also constitute a “lease” for the purpose of section 39E.
Nonetheless, taxpayers facing the same issue should consider whether it would be advisable to litigate claims for both a section 16G deduction and tax depreciation allowances in respect of relevant plant or machinery (if they qualify for both).
Another possible ground for litigation which Counsel of the Taxpayer did not explore at the CA, is what constitutes a “right to use” for the purposes of the statutory definition of “lease” in section 2(1) of the IRO. There are views if a taxpayer only permits its contract manufacturer to use plant or machinery in specified and limited circumstances (as in the case of the above Taxpayer), this should not amount to the taxpayer granting its manufacturer the “right to use” the plant or machinery even within the extended definition of “lease” in section 2(1) of the IRO.
Tax dispute or litigation is by its nature a complicated matter, clients facing similar situations should seek professional tax advice where appropriate.