Taxation 2 Notes
Taxation 2 Notes
Taxation 2 Notes
What is a business?
Business includes:
a) farming,
b) poultry,
c) pig rearing,
d) letting of any premises by a corporation,&
e) sub-letting by any other person.
What is a profession?
Profession involves the exercise of intellectual and/or manual
skill, controlled by intellectual
knowledge.eg.accountancy,journalism,etc.
Excluded Income.
Ordinance,
above,
A puzzled taxpayer wrote the following letter to the IRD. Draft a reply.
Dear Sirs,
tax purpose the fine I incurred for forgetting to license my car. The car is
used in the business and the fine was an expense I had to pay in the course
Without the car, I cannot deliver goods to my client and solicit sales at all.
Furthermore, it is not a private expense because the cash payment for the
Yours faithfully
Mr. S. H. Kong
Badges of Trade
b) The motive.
The list is not exhaustive. Other badges of trade may need to be considered.
The following points have to be noted when computing profits for tax
purpose:
the trade.
Case 1. Mr. Au inherited a piece of land in Tsuen Wan on the death of his father. He
immediately sold it to a property developer. He then bought some more land in the
Tsuen Wan area at a government auction, constructed roads and drainage, advertised
the land for sale and employed staff to deal with inquiries. He finally sold all the land
at a large profit.
Was Mr. Au trading in both instances? If he sold the second piece of land to the same.
Developer, was he still trading?
Case 2.Ms. Chan wanted to live near the place where she was working. She tried to buy
on flat in this area, but the vendor was only willing to sell if she purchased all six flats
which he had redeveloped. She therefore bought all six flats and immediately resold
four of them, kept one for her own use and leased one for rental purposes. She used the
money derived from the resale to finance the original purchase.
On 2 December 2020, the IRD found out the. Above details and assessed Ms. Chan.to
profits tax on the profits derived from the sales and the rental income received for the
flat which was leased out.
Write a letter to Ms. Chan advising her what course of action should she take and advise
her whether, or to what extent, the assessment was correctly raised.
Distinction between capital and revenue receipts:
capital receipt.
c) Any sum received for temporary loss of use of capital asset or payment
receipt.
receipt.
expenditure.
allowance is due for the hypothetical repairs which might have been carried
out.
f) As for repairs to newly acquired assets, if the repairs are reflected in the
cost price and the assets have to be repaired to be usable, the cost of these
and which does not prevent the immediate use of asset, would be deductible.
revenue expenditure. Since it does not create any new intangible asset.
h) When an expenditure is made, not only once and for all, but with a view
servants.
with the company would increase the company’s goodwill by buying off
allowable
provisions
allowable on premises,plant,
machinery,implement,utensil
or article
allowable if no depreciation
allowable on trademarks,
designs or patents
Other Deductible items
In order to familiarize yourself with the necessary adjustments to be made when ascertaining
assessable profits, the following computation pro forma is for your reference.
IRO Section
Profit/(loss)per account XXX
- Excluded income X
14 - Offshore income X
14 - Profits from sale of capital assets X
26(a) - Dividends X
26(b) - Share of profit from a partnership X
26A(1) -Interest from government bonds X (XXX)
Profit tax is then charged at the standard rate on BBB (net assessable profit).
Expenditures not allowed
Below is a summary of certain items of expenditure which may appear in the financial accounts of
a business. These are not allowed to be taken into the calculation of profits tax and therefore have
to be either added back to the profit or deducted from the loss disclosed by the annual accounts in
order to arrive at the profit or loss for profits tax purpose.
a) Expenses not wholly and exclusively laid out for the purpose of the trade. profession, or business
b) Expenses for domestic and private purpose.
c) The cost of entertainment, other then for entertaining business customers and their agents.
d) The rent of property which is not used for business purposes.
e) Any capital sums used in or withdrawn from the business.
f) The cost of improvements to premises.
g) Debts, other then bad debts or those estimated to be doubtful.
h) Profit tax paid.
i) Depreciation (capital depreciation allowances are available instead)
j) Withdrawals by proprietors
k) Penalties for breaking the law and legal expenses in connection therewith.
l) Reserves (except for discounts or for specific doubtful debts)
Allowable expenditures
Any sums expended wholly and exclusively for the purpose of the business may usually be deducted
in the computation of profits tax unless the outlay was of à capital nature. The following list is not
intended to be comprehensive but is indicative of this type of expenditure which may be deducted
from business profit in order to arrive at the figure on which profits tax will be imposed.
Illustration 1
This is an example of adjusting the annual accounts of a sole trader. A retail tradesman, using a van to deliver goods
and living over his shop premises, submits the following profit and loss account for the accounting period ended 31
March 2021.It should be noted that certain items appearing in the accounts are not allowable deductions for profits
tax purposes and have to be added back to arrive at the assessable profit. Adjustment has also to be made in respect
of the trader’s living accommodation.
Profit and loss account for the period ended 31 March 2021
Gross profit from trading $68,677
Dividends from local shares $3,560
$72,237
Less: Wages $24,600
Rent $5,800*
Rates $3,034*
Lighting and heating $1,850*
Repairs to premises $3,270*
Postage and telephone $1,230
Stationery and printing $845
General expenses $1,050
Electric name sign $3,740
Depreciation for van $5,240
Running cost of van $9,070
Erection of garage for van $8,800 ($68,519)
Net profit $3,718
it has been agreed with the IRD that depreciation allowances are $4,786 and one-third of the expenses marked * are
considered to be of private nature.
Adjustments for profits tax purpose for the year of assessment 2020/2021
Sales $21,600
Purchases $14,000
Workmen’s compensation $2,800
Wages to book-keeper (wife) $400
Wages to self $1,500
Rent and rates $780
Provisional profits tax paid $160
Bank charges (including $30 interest on overdraft) $62
Depreciation $200
Legal charges $160
Bad debt written off $20
Bad debt provision (5%of outstanding debts) $200
Repairs $800
General expenses $220
Net profit $21,402
$198
1.Legal charges consist of $80 for purchase of property, $40 for debt collection, and $40 for fine
under Factories Ordinance.
2.Repairs consist of $200 for machinery repairs and $600 for building an extension to the workshop.
3.General expenses were $150 for entertainment of mother-in-law. and a donation of $70 to the
Community Chest.
4.Depreciation allowance of $140 bas been allowed by the IRD.
Adjustments for profits tax purpose for the year of assessment 2020/2021
Mr. Wong is a retail merchant who makes up his accounts to 31 March each year. The following is
his profit and loss account for the year ended 31 March 2020.
1.The bank interest of $450 was received on the savings deposit account held in the name of Mr.
Wong. It is the personal savings of Mr. Wong.
2.The dividends were derived from the shares held by Mr. Wong. The money came from business
funds.
3.In May 2020,the shop next door renovated the office. The renovation damaged Mr. Wong’s shop
and some of the merchandise. Compensation was received by Mr. Wong for the damaged
merchandise.
4.Mr. Wong’s wife carried out clerical work in the shop. Her salary was paid monthly at the rate of
$750.A further $7,000 bonus being paid in April 2020.
5.Mr. Wong’s father lives on the premises and it has been agreed with the IRD that one quarter of
the rates and insurance and of the lighting and heating bills are due to-usage by Mr. Wong’s father.
6.Repairs comprised of $6,250 for work on shop toilet and $5,000 for office conversion. The toilet
was usable although it was in bad state of repair when the shop was purchased in 2020.The office
conversion was a division of a large room into three private offices. Had the large room not been
converted into three private offices, the ceiling would have required repairs at a cost of $2,000.
7.General expenses comprised of:
Explanations:
1.Legal expenses incurred for the purchase of property are of a capital nature. and therefore not
allowed as deductible expenses. This applies also to the building extension cost of $600.
2.The fine is not an expense incurred for the production of assessable profit. General expenses in
respect of entertainment for mother-in-law is private expenditure not incurred for the production
of assessable profits.
3.Community Chest is a charitable institution approved under Section 88 of the IRO but no
deduction is allowed since the sum does not exceed $100.
4.Provisional profits tax paid is not an allowable deduction since it is an advance payment of the
profits tax liability under the IRO and will be adjusted to effect the final liability upon the
settlement of the profits tax return.
Profits Tax Calculation Problem
Avec Piano Limited, a manufacturing company, produced the following profit and loss account for the year ended 31 March 2021.
Expenditure $ Income $
(annual)
Legal and audit fees 9,900 Profit on currency exchange in respect 2,200
of trade transactions
Repairs 3,890
Advertising 1,970
Depreciation 49,540
Total 615,500
Notes:
2.Repairs include the cost of work done on repairing the property of a director of the company, estimated at $1,200
Total $9,900
Total $3,020
5.Traveling and entertainment include allowance and airfare to a director's wife in respect of a trip to Tokyo to attend a wedding reception
($5,150) and airfare for another director to the United Kingdom to open a local sales office ($6,000).
Calculate the profits tax payable by Avec Piano Limited for the year of assessment 2020/2021.Provide explanations to your adjustments.
Printing and stationery $2,500
Legal costs for debt collection $250
Legal costs for negotiation of loan $580
Accountancy $3,550
Mr. Wong’s personal VISA card $150
Donation to Community Chest $450
Entertainment $11,590
Total $19,070
8.The bank interest of $500 was paid on overdraft of the business bank account.
9.Loan interest was paid oi a loan borrowed to finance the purchase of trading merchandise. The
loan was secured by the bank deposits of Mr. Wong.
10.Bad debt amount was derived after an increase in the general debtor reserve.
11.The motor car was used by Mr. Wong both for business and private purposes. It was agreed that
half of the motor car expense is due to business purpose
12.The depreciation allowance agreed by the IRD for the year was $11,000.
Calculate the profits tax payable by Mr. Wong for the year of assessment 2020/2021.
Provide explanations to your adjustments.
Profits Tax Calculation Problem
Powelectronic Company Limited has carried on an electronic manufacturing business Hong Kong.
Its profit and loss account for the year ended 31 March 2020 as follow:
Sales $6,277,180
Less: Cost of goods sold (S4,590,540)
Gross profit $1,686,640
Other income $66,300
$1,752,940
Less: Rent and rate: $245,000
Branch office expenses $300,000
Depreciation $63,800
Office salaries $505,800
Special contribution to approved retirement scheme $200,000
Repairs and renewals $16,320
Professional charges $21,700
Bad and doubtful debts $31,400
Bank interest $12,980
Sundry expenses $11,510 ($1,408,600)
Net profit: $344,340
Additional information:
1.Powelectronic Company Limited opened a factory in China in April 2019. Before that, all the
production was done in Hong Kong and the finished products were exported to Australia and
the United States. After the production line in China was established part of the assembly work
was transferred to China with the finishing work still being carried out by the factory in Hong
Kong. All the administrative work related to the sales was done in the Hong Kong office, It was
estimated that sales related to such operations amounted to $650,000. The expenditures related
to the operations in China were debited into the branch office expense account.
2.Other income comprises:
Commission income $50,000
Interest received from a local bank $4,300
Dividend from shares of local subsidiary
(the cost of the shares was $200,000) $12,000
Total $66,300
The company eared the commission by introducing a buyer to one of the China garment factories.
One of the directors was in Australia on business and by chance discovered that an Australian
company wanted to import garments from China. He took the representative of that Australian
company to China and introduced the representative to the Chinese manufacturer.
3.Bank interest was paid on bank overdraft and was secured by the property of the managing director.
4.Professional charges were:
Legal charges for debt collection $5,400
Legal charges for setting up a retirement scheme for staff
(the scheme was an approved one) $8,000
Accountancy fee for tax appeal $5,000
Audit and accountancy fees $3,300
Total $21,700
5.Bad debts were:
Amount written off $21,000
General provision increased $5,000
$26,400
Defalcation by staff $41,400
Less: Loan to staff previously written off now recovered ($10,000)
Total $31,400
6.Sundry expenses comprise:
Cost of sending staff on production management courses $4,000
Staff annual dinner $2,000
Donations to Tung Wah Group Hospitals $5,000
Miscellaneous allowable expenses $510
Total $11,510
Prepare the profits tax computation for the year of assessment 2019/2020 for Powelectronic
Company Limited and briefly explain your adjustments in the computations. With reference to
decisions from tax cases, discuss the taxability of the profit from the China operations and the
commission under Hong Kong Profits Tax.
Figure 23.1
Summary of Personal Assessment for an Individual
Tax is then levied at progressive tax rates on L1 but limited to standard rate on J1.
Figure 23.2
Summary of Personal Assessment for husband and wife
Mr. P received the following income for the year of assessment 2020/21:
Mr. P incurred the following expenses during the year ended 31st March 2021:
Mr. P. incurred the following interest expenses during the year of assessment 2020/21:
During the year of assessment 2020/21, Mr. P donated $20,000 to an approved charitable
organization $2,000 out of the $20,000 donations has been deducted from the profits of the boutique
under profits tax.
Mr. P is a partner in a partnership business. During the year of assessment 2020/21, his share of loss
from the partnership business was $20,000.
Mr. P is a married man with one child aged 7. For the year of assessment 2020/21,he has paid the
following taxes already:
Mr. and Mrs. M had the following income and outgoings in the year of assessment
2020/21:
Mr. M Mrs. M
Property income (net assessable value) $40,000 $20,000
Salaries income $50,000 $20,000
Business income (before approved charitable donations) $70,000 $30,000
Total approved charitable donations $14,000 $6,000
Share of a partnership business loss $20,000
They have two children aged 8 and 10 respectively. They also live with Mr. M’s father who is aged
70 during the year of assessment.
Compute the personal assessment tax liability for Mr. and Mrs. M for the year of assessment 2020/21.
Mr. and Mrs. Z had the following income and outgoings in the year of assessment
2020/21:
Mr. Z Mrs. Z
Property income (net assessable value) (property tax already paid $32,000
$4,800)
Salaries income (no salaries tax paid) $102,800
Profits from proprietorship. (donations of $11,000 have been allowed $113,000
and profits tax of $16,950 already paid)
Share of partnership loss $50,000
Mortgage interest paid in respect of property $35,000
Total donations made $18,000 $4,000
The couple has one child aged 10 during the year of assessment 2020/21.
Compute the personal assessment tax liability for Mr. and Mrs. Z for the year of assessment 2020/21.
Personal Assessment Exercise
Mr. Kwok supplies you with the following information related to the year ending 31s March 2020.
a) He was employed as an accountant by Jim Chase and Co (JC), a firm carrying on construction
business in Hong Kong, and received an annual salary of $200,000.
b) He was provided with a flat in Kowloon by the firm at a monthly rental of $1,000. He also paid
management service charges amounting to $2,000 per annum.
c) He received an annual salary of $60,000 from an unincorporated business operated by his wife.
d) He received a holiday warrant from JC for $20,000 which he spent as follows: air ticket to
Singapore for himself and his wife ($5,000×2),accommodation in Singapore ($10,000).
e) It is a condition of his employment with JC that he joins the EA Club to help promote the firm’s
business interests. Annual subscription for the club members is $20,000,of which the firm
refunded him $10,000.
f) JC provides him with a company credit card which he used to purchase petrol for private motoring
for a total value of $5,000.
g) He received a cash scholarship of $3,000 from JC to study advanced accounting at an evening
course run by the Baptist University.
h) He made a donation of $25,000 to the Community Chest.
i) He received interest of $10,000 paid by the administrator of his late father's estate for delayed
payment of a legacy.
j) He owns a flat in Kowloon Bay which is leased for $4,000 per month. He paid rates on this flat
of $3,000 for the year. He also took out a mortgage to purchase the flat and total interest payments
amounted to $50,000.
k) At all times during the year he was married and maintained two children aged 17 and 20. The 20-
year-old finished schooling in September 2019 and is still looking for a job.
l) His wife operated a bakery business in Sai War, and the agreed assessable profits for the year
ending 31st March 2020 were $60,000
Calculate Mr. Kwok’s tax liability for the year of assessment 2019/2020.Assume Mr. Kwok has not
yet paid any tax for 2019/2020 and has elected for personal assessment.
(Adapted from ACCA/HKSA 3.3H D89Q6)