SUPPLEMENTARY INSTRUCTIONS 1. You should assume that the tax rates and allowances shown below will continue to apply for the foreseeable future. 2. Calculations and workings should be rounded down to the nearest HK$. 3. Apportionments need only be made to the nearest month, unless the law and prevailing practice require otherwise. 4. All workings should be shown. TAX RATES AND ALLOWANCES The following 2011/12 tax rates and allowances are to be used in answering the questions. Section A – BOTH questions are compulsory and MUST be attempted 1. Organic World Inc (the Parent), a company incorporated in the US, has since September 2006 wholly-owned a subsidiary in Hong Kong, Green HK Ltd (Green-HK). Green-HK operates a retail store in Hong Kong and imports organic goods from the Parent and sells the goods in the store. It closes its accounts on 31 December. Starting from January 2010, the Parent also has another wholly-owned subsidiary in China, Green China Ltd (Green-China), which operates a similar retail store in Mainland China but not in Hong Kong. Green-China has been performing very well in these two years, showing continuous increases in profitability, but Green-HK’s business has been declining significantly. The Chief Executive Officer (CEO) of Green-HK called a meeting at which the following was discussed: (1) The following extract of management accounts as at 30 November 2011 was presented: (2) The Parent decided to cease the business in Hong Kong with effect from 1 January 2012. Before the store is closed on 31 December 2011, all the assets and liabilities of Green-HK would need to be cleared according to the following proposal: (i) The land and store building would be sold to a potential purchaser, and the offer is still under negotiation. The tentative sale consideration is $12,000,000 comprising $11,000,000 for the land and $1,000,000 for the store building. The purchaser has counter-offered that if Green-HK were to demolish the building and sell the land site only, a higher offer might be considered. Based on Green-HK’s tax records, the land and building were acquired in July 2006 directly from the property developer at $10,000,000, 50% of which was attributed to the building. The CEO is wondering how the different modes of sale would impact the tax position of Green-HK. Moreover, the CEO is interested to know how much annual depreciation allowance the purchaser, who makes up his accounts to 31 March, might be entitled to claim if he continued to use the store as it is. (ii) All the store equipment would be donated to a charitable organisation in Hong Kong. Any remaining minor furniture and fixtures not accepted by the charity would be scrapped. The CEO is wondering if the net book value of the equipment would be eligible for a tax deduction as a charitable donation, and whether it would be better if the equipment was sold first and then the sale money was donated to the charity. (iii) To clear the trading stock on hand, Green-HK would sell it to Green-China at a price to be mutually agreed. Discussions with Green-China so far indicate that the deal would not be made unless the price was fixed at 30% below the usual market price. Although this is not desirable to Green-HK, it was expected that the Parent would consent to this deal. The CEO is concerned about the impact of the deal on Green-HK, especially in the light of the recent development of the transfer pricing principle in Hong Kong. (iv) The amount due to the Parent of $15,000,000 would be waived by the Parent since Green-HK would not be likely to have the ability to pay. Green-HK’s records indicated that most of the amount represents the purchase cost of goods imported from the Parent for sale in the store in previous years but which remained unsettled. (3) All staff members would be made redundant. On top of the statutory amount of redundancy payment, Green-HK was considering paying an additional gratuity representing two months’ salary. Before making the decision, the CEO wants to assess whether these payments would be tax deductible to Green-HK. (4) Based on the tax records, Green-HK has brought forward tax losses of around $2,000,000 from 2010/11. The tax written down values for the plant and machinery pools are insignificant. Required: As the tax advisor to Green HK Ltd (Green-HK), prepare a report for the Chief Executive Officer (CEO) addressing the tax issues raised in the meeting as follows, providing supporting calculations where appropriate. (a) Sale of land and store building (per item (2) (i) of the meeting notes): (i) The tax implication to Green-HK arising from the sale of the land and store building, including a computation of the applicable depreciation allowance for each year of ownership and in the year of disposal; (4 marks) (ii) The impact of the potential purchaser’s counter-offer on the tax position of Green-HK; (4 marks) (iii) The annual depreciation allowance that might be available to the purchaser upon his acquisition of the land and store building, assuming that the store continued to be used as it was. (3 marks) (b) Donation of equipment (per item (2) (ii) of the meeting notes): (i) Whether, and if so how, the donation would qualify as a tax deduction for Green-HK; (4 marks) (ii) Whether, and if so how, the alternative suggested by the CEO would help Green-HK get the tax deduction. (3 marks) (c) Sale of trading stock (per item (2)(iii) of the meeting notes): (i) The tax implication to Green-HK arising from the sale of trading stock to Green China Ltd (Green-China) at the price suggested by Green-China; Note: You are not required to discuss the transfer pricing implications in this part. (4 marks) (ii) The impact of the current development of transfer pricing principles in Hong Kong on the suggested sale transaction. (5 marks) (d) Waiver of inter-company balance by Organic Worldwide Inc (the Parent) (per item (2)(iv) of the meeting notes): Whether, and if so to what extent, the waiver would be tax effective for Green-HK. If you consider it not tax effective, give suggestions. (4 marks) (e) Redundancy payment and additional gratuity (per item (3) of the meeting notes): Whether, and if so how, the redundancy payment and additional gratuity would be tax deductible to Green-HK. If applicable, give an alternative suggestion. (4 marks) Professional marks will be awarded in question 1 for the appropriateness of the format and presentation of the report and the effectiveness with which its advice is communicated. (4 marks) 2. Antony and Rebecca are a married couple who are seeking professional tax advice on their tax positions. The following information relates to their affairs for the year ended 31 March 2012: (1) Antony was previously employed by Mix and Match Ltd, a Hong Kong-listed company. On 1 March 2011, he was offered a lump sum payment of $300,000 to join Modern Home Ltd (MHL), an interior decoration firm resident in Hong Kong, as head designer. On 1 April 2011 he accepted the offer, received the payment and started working for MHL. (2) His salary with MHL is $100,000 per month. Antony contributed 5% of his total salary to MHL’s Mandatory Provident Fund Scheme; MHL contributed 10% to the Scheme. (3) Antony received a ‘housing allowance’ of $30,000 per month. However, he only spent $25,000 per month on rent, government rates and management fees associated with his rented flat. His employment contract states that his rental allowance is designed to enable him to afford accommodation in Hong Kong, and that it may be applied by him towards rent or a home purchase. MHL requires Antony to provide a copy of his lease and monthly rental receipts, but has never queried the fact that he does not spend the whole of his housing allowance on accommodation. (4) MHL provided Antony with a new car (cost $500,000) which he could, and did, use for private (50%) as well as business (50%) purposes. MHL also provided him with a petrol station card taken out in the name of MHL. Antony charged all his expenditure on petrol, totalling $48,000, to this card. (5) MHL paid a club membership for Antony at the Hong Kong Designers Club. The annual membership fee was $32,000 and the membership was in Antony’s name. Antony regularly used the club for entertaining MHL’s clients. His total entertainment expenditure at the club was $38,000, of which MHL reimbursed him $28,000 upon production of vouchers showing client entertainment and promotion. (6) Antony received a share option in the year of assessment 2009/10 while he was working for Mix and Match Ltd. Under the terms of his share option, Mix and Match Ltd would either pay him the cash value of his option or provide him with shares. Antony could not insist on receiving shares. The option became exercisable in the year of assessment 2011/12. When Antony exercised his option, Mix and Match Ltd exercised its right to pay cash instead of providing shares; and Antony received $100,000. (7) After work hours, Antony devoted his time to writing numerous articles on interior design for magazines and newspapers. From this activity, he earned $90,000 in the year 2011/12. (8) Antony earned $15,000 in royalties in 2011/12 from a book on interior design that he had written the previous year. The publisher who paid him the royalties is based in Singapore, and the book was published and sold only in Singapore. (9) Rebecca is a housewife. In her spare time, she sells home products to friends on behalf of a Taiwan company. For this purpose, the company sends her a stock of products each month, and Rebecca arranges home parties to which she invites friends and demonstrates the products. She earns a commission of 20% of the gross sales proceeds of the goods she sells on behalf of the company. In the year of assessment 2011/12, Rebecca earned commissions totalling $80,000. Required: (a) Advise Antony and Rebecca of their respective tax positions for the year of assessment 2011/12. Support your advice with a comput