Download Computation of assessable profits from cinematograph films, patents

Inland Revenue Department Hong Kong
DEPARTMENTAL INTERPRETATION AND PRACTICE NOTES
NO. 22 (REVISED)
COMPUTATION OF ASSESSABLE PROFITS FROM CINEMATOGRAPH FILMS, PATENTS, TRADEMARKS, ETC. These notes are issued for the information and guidance of taxpayers
and their authorised representatives. They have no binding force and do not
affect a person’s right of objection and appeal to the Commissioner, the Board of
Review or the Courts.
These notes replace those issued in July 2003.
LAU MAK Yee-ming, Alice
Commissioner of Inland Revenue
January 2005
Our web site : www.ird.gov.hk
DEPARTMENTAL INTERPRETATION AND PRACTICE NOTES No. 22 (REVISED) CONTENT
Paragraph
Introduction
1
Amendments to section 21A Inland Revenue (Amendment)(No.4) Ordinance 1993
5
How the 1993 amendments addressed the situation
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Revenue (No.2) Ordinance 2003
11
The Inland Revenue (Amendment) Ordinance 2004
12
Application of section 21A
15
Advance rulings
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INTRODUCTION Section 21A, along with a number of other provisions, was
introduced by the Inland Revenue (Amendment) Ordinance 1971 to implement
recommendations of the Second Inland Revenue Review Committee. The
purpose of introducing the section and related section 15(1)(a) and (b) was to
ensure that certain sums which arise from or in connection with business
activity in Hong Kong are chargeable to tax here and to prescribe the
percentage to be taken as assessable profits. The relevant categories of receipts
are specified in section 15(1)(a) and (b), and in broad terms they cover royalties
and licence fees for the use of or right to use in Hong Kong certain industrial
and intellectual property. More particularly, the receipts comprise sums, not
otherwise taxable, received by or accrued to a person from the exhibition or use
in Hong Kong of cinema or television film or tape, any sound recording, or any
advertising material connected with such items [section 15(1)(a)] and for the
use of or right to use in Hong Kong any patent, design, trademark, copyright
material, secret process or formula or similar property, or for imparting or
undertaking to impart knowledge connected with such items [section 15(1)(b)].
2.
Initially, section 21A provided that the assessable profits of a person
in respect of a sum deemed by section 15(1)(a) or (b) to be a receipt arising in
or derived from Hong Kong from a trade, profession or business carried on in
Hong Kong, were taken to be 10% of that sum, in all cases. However,
subsequent amendments to the section, resulting from the enactment of the
Inland Revenue (Amendment)(No. 4) Ordinance 1993 and the Revenue (No. 2)
Ordinance 2003, altered that position. These amendments are further discussed
in paragraphs 5 to 11 below.
3.
Following the enactment of the Inland Revenue (Amendment)
Ordinance 2004, a further deeming section i.e. section 15(1)(ba) was
introduced and section 21A was correspondingly expanded to cover receipts
under section 15(1)(ba). The method of computing assessable profits under
section 21A, however, remains unchanged.
4.
The purpose of introducing section 15(1)(ba) is to bring into charge
sums, not otherwise taxable, received by or accrued to a person for the use of
or right to use outside Hong Kong any patent, design, trademark, copyright
material, secret process or formula or other property of a similar nature, or for
imparting or undertaking to impart knowledge connected with such items,
which are deductible in ascertaining the assessable profits of a person for the
purpose of Profits Tax. These amendments are further discussed in paragraphs
12 to 14 below.
AMENDMENTS TO SECTION 21A
Inland Revenue (Amendment)(No. 4) Ordinance 1993
5.
The 1993 amendments were introduced to counter attempts made by
a number of Hong Kong companies to exploit section 21A by entering into
arrangements with overseas associates.
6.
Typically, a section 21A “scheme” involved a Hong Kong company
making use of a trademark it had developed “in-house”. Whilst it retained
ownership of the trademark, it did not incur any deductible expense in respect
of its use. The usual approach was for the Hong Kong company to enter into a
“sale and licence back” arrangement with a subsidiary incorporated offshore
(e.g. in the British Virgin Islands). The Hong Kong company transferred
ownership of property of a kind referred to in section 15(1)(a) or (b) to the
offshore subsidiary which then granted back to the Hong Kong company, for a
substantial royalty or fee, the right to continue to use the property in Hong
Kong. The objective for tax purposes was for the Hong Kong business to
obtain a deduction under section 16(1) of the Ordinance, for the full amount of
the royalty or fee paid, with the offshore subsidiary being taxed under section
21A on only 10% of the sums it received. In other words, funds remained
within the group, but a 90% deduction was created in respect of the royalties or
fees involved.
7.
Although the general anti-avoidance provision of the Ordinance,
section 61A, can be invoked, and indeed has been used, to strike down schemes
directed at exploiting section 21A, it will be a time-consuming and expensive
exercise to argue its application in every case. In order to provide certainty to
both Taxpayers and the Revenue, and in accordance with the Government’s
commitment to close avenues for avoidance, the Financial Secretary proposed
in his March 1993 Budget Speech that section 21A should be amended.
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How the 1993 amendments addressed the situation
8.
Exploitation of the section arose because relevant sums were
generally fully deductible to the payer, whereas in the hands of the recipient, by
virtue of then section 21A (which contained no reference to the relationship of
the parties involved), only 10% was treated as assessable profits. The fact that
it was a relatively simple matter for a Hong Kong group to incorporate a
subsidiary outside Hong Kong and to ensure that the subsidiary did not carry
on business in Hong Kong was also pertinent.
9.
The amendments addressed the situation by providing that where a
payment was derived from an associate, the general position was that 100% of
the amount of the payment (i.e. no deduction for expenses), rather than 10% of
it, would be treated as assessable profits.
10.
However, the straightforward application of the 100% rate would be
restrictive, in the sense that if the 100% rate were to apply to all payments to
associates, it could have an adverse bearing on the importation of technology
into Hong Kong by multinational groups. In the absence of any indication that
section 21A had been exploited by multinationals in respect of technology
developed overseas, a provision was added to exclude the relevant payments
from the application of the 100% rate under a certain circumstance. By virtue
of the proviso to section 21A(1)(a), the relevant amendment provided that the
100% rate would not apply in respect of any sum derived from an associate
“where the Commissioner is satisfied that no person carrying on a trade,
profession or business in Hong Kong has at any time wholly or partly owned
the property in respect of which the sum is paid”. In such cases, and also
where a relevant sum was derived from a person who was not an associate, the
10% rate would continue to apply.
Revenue (No. 2) Ordinance 2003
11.
The 2003 amendments were proposed in the Financial Secretary’s
March 2003 Budget Speech and enacted in July 2003. The amendments have
the effect of increasing the assessable profits deeming rate from 10% to 30%
for payments which come within the scope of section 21A and are not subject
to the 100% rate. The new rate of 30% applies to sums received or accrued on
or after 1 April 2003. However, if the sum accrues before that date but is
received on or after that date, the old rate of 10% would still apply.
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The Inland Revenue (Amendment) Ordinance 2004
12.
In view of an unfavourable court decision, a new section 15(1)(ba)
was enacted in 2004 to enable this Department to continue a long-standing and
hitherto widely accepted assessing practice in respect of royalty payments.
This new section deems as the recipient’s chargeable profits sums for the use of
or right to use outside Hong Kong any of the intellectual properties enumerated
in section 15(1)(b), which are deductible expenses in ascertaining a person’s
chargeable profits. The section does not apply to sums received or accrued
before 25 June 2004.
13.
The need of the 2004 amendments stemmed from the Court of
Final Appeal decision in CIR v. Emerson Radio Corporation [1999] 5 HKTC
122. The decision was inconsistent with this Department’s interpretation of
section 15(1)(b) held since its enactment in 1971. Prior to the Emerson case,
this Department had all along taken the view that an intellectual property right
was “used in Hong Kong” for the purpose of section 15(1)(b) if the payer
carried on a business in Hong Kong and used the property right to produce
chargeable profits, irrespective of where the goods concerned were
manufactured or sold. The Court of Final Appeal however held in Emerson
that only royalties relating to goods manufactured in Hong Kong could be
chargeable to tax under section 15(1)(b) and royalties paid in respect of goods
manufactured outside Hong Kong were not chargeable. Given that most of our
manufacturing base has been relocated outside Hong Kong, the decision might
lead to a significant loss of revenue in terms of Profits Tax because the royalty
payment would be tax deductible on the part of the payer but tax exempt in the
hands of the non-resident recipient.
14.
The new section 15(1)(ba) therefore maintains a tax symmetry to
avoid possible loss of revenue and is consistent with the original legislative
intent of section 15(1)(b). It is noted that similar provisions for royalty
payments are adopted by other jurisdictions to protect revenue. The 2004
amendments also expanded the scope of section 21A such that it does not only
apply to sums deemed to be taxable under section 15(1)(a) and (b) but also
those under section 15(1)(ba).
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APPLICATION OF SECTION 21A
15.
Generally, payments to which section 21A applies are derived by
non-residents. Where this is the case, section 20B of the Ordinance provides
for the assessment and collection of the tax due. Departmental Interpretation
and Practice Notes No. 17 discusses the relevant provisions and, in particular,
the taxation responsibilities of persons in Hong Kong who may be chargeable
to Profits Tax on behalf of such non-residents.
16.
As far as the payer is concerned, the amendments made in 1993,
2003 and 2004 to section 21A have not affected the deductibility of royalty
payments etc. The issue of deductibility continues to be determined in
accordance with the terms of section 16(1) of the Ordinance.
17.
With regard to section 21A, in considering whether the assessable
profits in respect of a relevant sum should be taken to be the lower rate (i.e.
10% or 30%, as the case may be) or 100%, the first question to be determined
is, of course, whether the sum was derived from an associate. The term
“associate” is defined widely in section 21A(3) in order to prevent
circumvention of the provisions by the interposition of third parties. For the
purpose of ascertaining whether a sum was derived from an associate, regard
must also be had to section 21A(2), which covers the situation where a sum is
derived from or by a trustee of a trust estate or a corporation controlled by such
a trustee. In such cases, the sum is deemed to have been derived from, or by,
as the case may be, each of the trustee, the corporation and the beneficiary
under the trust.
18.
The provisions concerning associates, and the related definitions in
section 21A(3) of “associated corporation”, “beneficiary under the trust”,
“control”, “principal officer” and “relative”, are along similar lines to those
contained in sections 16E and 39E of the Ordinance.
19.
Where, having regard to the relevant provisions of section 21A, it is
concluded that a sum was not derived from an associate, the lower rate is
applied to the sum in order to determine the assessable profits. However,
where the sum has been derived from an associate, 100% must be treated as
assessable unless “the Commissioner is satisfied that no person carrying on a
trade, profession or business in Hong Kong has at any time wholly or partly
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owned the property in respect of which the sum is paid”. In this regard, the
Department accepts that “owned” refers to direct ownership. For example,
although a shareholder is a proportionate owner of a company, the shareholder
does not own the assets of the company – they are owned by the company itself
as a separate and independent legal entity.
20.
If a sum is to be paid to an associate and either the person
responsible for making the payment or the recipient considers that the
ownership history of the relevant property is such that the Commissioner would
be “satisfied” in terms of the proviso referred to above, confirmation may be
obtained by way of an advance ruling from the Commissioner as to whether the
lower rate is applicable. It should, however, be noted that rulings will not be
provided in respect of hypothetical situations.
ADVANCE RULINGS
21.
In addition to providing the information and documents listed in
paragraph 15 of Departmental Interpretation and Practice Notes No. 31
(“Advance Rulings”), a request for an advance ruling concerning the
application of section 21A should comply with the following requirements (a) The request must be signed by the person responsible for
making the payment (“the payer”), the person who owns the
relevant property (“the taxpayer”), or by the authorised
representative of either party.
(b) A copy of the agreement under which the taxpayer acquired
the property and a statement of the reasons for acquisition
should be submitted.
(c) A copy of the agreement under which the payment is to be
made should be submitted.
(d) If the property is not wholly owned by the taxpayer, details
should be provided of other owners, their respective interests
in the property and, if an associate, the nature of the
relationship with the taxpayer.
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(e) A statement should be provided of the full ownership history
of the property. If for some reason it is not possible to
provide a full history of the ownership, an explanation should
be provided with the application. In any event, where a
previous owner was, or is, an associate of the taxpayer, details
should be included of the nature of the relationship.
(f)
A declaration, signed by both parties, is required to the effect
that, to the best of the knowledge of the taxpayer and the
payer, no person carrying on a trade, profession or business in
Hong Kong has at any time wholly or partly owned the
relevant property.
22.
Given the nature of the property involved, cases with a complicated
history of ownership should be the exception rather than the rule. The current
owner obviously should know the details of the party, if any, from whom the
property had been purchased. In many cases, relevant property would have
been developed by the current owner and, as such, there would not be a
previous owner.
23.
Generally where the information referred to above is provided, it
should be sufficient to allow a ruling to be made. In such cases, it will be
issued in letter form signed by the Commissioner or an authorised officer. In
some cases, however, it may be necessary for the Department to seek further
information from the taxpayer or a third party before a ruling can be given.
24.
A case by case approach will be adopted by the Department in
relation to the issue of rulings. Accordingly, a ruling given in one case should
not be regarded as requiring the Department to issue a like ruling in a
subsequent similar case.
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