Consider this: If a taxpayer is unable to settle an objection against an assessment, the case will be referred to the Commissioner of Inland Revenue (CIR) for his determination. I have only a vague recollection of a case ever being overturned by the CIR. The next step is to appeal the CIR’s determination to the Board of Review (BOR). This requires a case stated, which will incur professional fees.

The BOR is an independent tribunal charged with establishing the facts and expressing a legal opinion based on those facts. A taxpayer with a factually sound case has a reasonable chance of success at the BOR, but more professional fees will be incurred and they cannot be reclaimed, even if the taxpayer should ultimately win the appeal.

Assuming the case was won at the BOR, the taxpayer must expect the CIR to appeal the decision to the Court of First Instance or the Court of Appeal. Why? Because the CIR’s costs are met by the HK Government out of taxpayers’ taxes, whereas the taxpayer will be faced with meeting all the costs, including those of the CIR, should the appeal fail. However, that is not the only reason. Consider also the fact that most tax appeals heard by the Court of Appeal, under the Hon Tang Ag, CJHC, fail. Worse still, we have recently seen that even if a taxpayer was inclined to pursue a case to the Court of Final Appeal (“CFA”), the CFA either has no wish to be inundated by tax cases or is just too busy to hear more appeals from lower costs, so there is little chance of having the case heard by the CFA. The result is that the case will get no further than the Court of Appeal, which appears to be very pro the CIR.

So at the end of the day, the taxpayer will have lost his appeal and will be required to pay the tax in dispute, plus possibly interest as well, and will have incurred around HK3-4 million in professional fees. Would you appeal? Probably not, so do not be surprised if the CIR becomes more aggressive in pursuing tax cases.

The Appeal Committee’s determination was issued on 24th August 2011 and, for the first time in 16 tax appeals to the CFA, leave to appeal was refused. To be honest, it has taken me two months to be objective as opposed to venting my thorough disgust at the action of the Department and the judiciary system.

Let me go back to the beginning of this saga. CGL structured its affairs in accordance with paragraphs 15 and 16 of the Inland Revenue Department’s Departmental Interpretation and Practice Notes (“DIPN”) No.21 (Revised) issued in March 1998 (a revised version of DIPN21 was subsequently issued in December 2009). CGL’s objective was to take advantage of the 50% tax concession given by the Department to Hong Kong taxpayers who manufactured their products in both Hong Kong and Mainland China. Paragraphs (15) and (16) DIPN 21 provided that:

“(15) A Hong Kong manufacturing business, which does not have a licence to carry on a business in the Mainland, may enter into a processing or assembly arrangement with the Mainland entity. Under these arrangements, the Mainland entity is responsible for processing, manufacturing or assembling the goods that are required to be exported to places outside the Mainland. The Mainland entity provides the factory premises, the land and labour. For this, it charges a processing fee and exports the completed goods to the Hong Kong manufacturing business. The Hong Kong manufacturing business normally provides the raw materials. It may also provide technical know-how, management, production skills, design, skilled labour, training and supervision for the locally recruited labour and the manufacturing plant and machinery. The design and technical know-how development are usually carried out in Hong Kong.

(16) In law, the Mainland processing unit is a sub-contractor separate and distinct from the Hong Kong manufacturing business, and the question of apportionment strictly does not arise. However, recognising that the Hong Kong manufacturing business is involved in the manufacturing activities in the Mainland (in particular in the supply of raw materials and the training and supervision of the local labour) the Department is prepared to concede, in cases of this nature, that the profits on the sale of the goods in question can be apportioned. In line with paragraphs 21-22 below, this apportionment will generally be on a 50:50 basis.”

CGL had always described its principal business activity to be that of a manufacturer, and its audited accounts have reflected that CGL owned all the unused raw materials, unfinished products and finished products at the factory. The factory was owned by its wholly owned subsidiary, CGES, in the PRC, and CGL provided the factory with all the raw materials, technical know-how, management staff, production skill, computer software, product design, skilled labour, family, supervision and the manufacturing plant and equipment. CGL did not charge for the provision of this assistance. There were no sales and purchase agreements between CGL and the factory – CGL merely paid the factory a processing fee.

However, every DIPN comes with the following health warning:

“These notes are issued for the information of taxpayers and their tax representatives. They contain the Department’s interpretation and practices in relation to the law as it stood at the date of publication. Taxpayers are reminded their right of objection against the assessment and their right of appeal to the Commissioner, the Board of Review or the Court are not affected by the application of these notes.”

Nonetheless, I had always assumed that any reasonable person would expect that reliance could be placed on the information provided by the Department in its own DIPNs, otherwise what is the point in publishing them? Hence it came as a complete surprise to the taxpayer, the taxpayer’s counsel and to myself that Mr Eugene Fung, Counsel for the Commissioner of Inland Revenue (“CIR”), stated at the commencement of the Board of Review (“BOR”) hearing that the CIR was not bound by its own concession set out in DIPN21 and that the case should be determined on established source principles.

The BOR was then faced with a need to establish the facts and, based on its findings, to determine:

(1) what the operations of CGL were that produced the relevant profits, and
(2) where those operations took place.

The BOR reached the determination that:

“In respect of the first question, the profits in question did not arise from a trading operation, as contended by the CIR. With respect, such contention is premised upon the Company D documents and ignores a raft of materials produced by the Taxpayer to demonstrate otherwise.”

However, whilst rejecting the contention that CGL was a trader, the BOR equally rejected the contention that CGL was a manufacturer. In the BOR’s words:

“This is a case where the Taxpayer was a seller of Product J which it designed and participated in their production… We believe that in a case, like here, where the operation is a multi-facet one, this Board must have regard to the commercial reality. Such reality dictates that the Taxpayer’s participation in the production process was as much as part of its profit-producing transaction as the obtaining of a purchase order.

Plainly, part of the Taxpayer’s profit making transactions was located in the Mainland and therefore its contention that part of its profits was sourced from outside Hong Kong and not chargeable to profits tax is correct.”

The BOR remitted the case back to the CIR for apportionment.

This was a determination that everyone, other than the CIR, had hoped for. It was an accurate reflection of the facts and the evidence given by CGL. It reflected the practice that the CIR had adopted for many years and on which CGL had relied and had arranged its affairs.

The CIR appealed the decision to The High Court of the Hong Kong Special Administrative Region Court of First Instance. Benjamin Yu SC, Counsel for the CIR, submitted that:

(1) the BOR had erred in law by failing to focus on the geographical location of the actual profit-producing activities of CGL, i.e., the sale of goods, and

(2) the activities undertaken by CGL outside Hong Kong were antecedent or incidental and therefore legally irrelevant.

(3) In the light of (2) above;

“Having taken into account antecedent or incidental matters that are legally irrelevant, the Board’s conclusion that the source of the Taxpayer’s profits was partly Hong Kong and partly outside Hong Kong is one which no reasonable tribunal properly directed could reach.”

In the court of First Instance, the Hon Fok J, having reviewed the BOR’s decision and relevant case law, concluded that:

“It is necessary to recognize that the Board in the present case found that CGES was the manufacturer and did not find that CGES was an agent of the Taxpayer in the production of the lighting fixtures. This is a material finding and is not affected by the fact that, because of the relationship between it and the Taxpayer, CGES only received a processing fee which was no greater than its operating cost and overheads.

Once it is accepted that the manufacturer of the lighting fixtures was CGES and not the Taxpayer and that CGES was not the agent of the Taxpayer in the manufacturing process, I do not see that it is possible to avoid the conclusion that the activities of the Taxpayer in relation to the manufacturing process itself are simply antecedent or incidental to the profit-producing transactions here.”

Hence Fok J found for the CIR on the basis that CGL was not the manufacturer and that the activities that CGL undertook to support the manufacturing process were “antecedent or incidental”. Incidentally, the question of CGES being an agent for CGL was not raised in the BOR. Whilst the judgment was extremely clear and well written, it left the general public clearly confused.

Following Fok J’s decision, a parent company that owns all the raw materials and finished goods located at a factory owned by a third party, and that is responsible for every facet of the manufacturing activity, cannot be considered to be significantly involved in the manufacturing of its own products, notwithstanding the fact that Fok J accepted that there were no sales and purchase activities between CGL and CGES and that CGL simply paid CGES a processing fee for the manufacture/assembly of its products. Therefore are we to assume that the word “manufacturer” can only be applied to the person who physically owns the factory?

I strongly believe that the Counsel for the CIR was surprised that he was successful at the Court of First Instance, particularly as Fok J appears to have based his decision on Counsel’s secondary submission that no reasonable person could conclude that CGL was the manufacturer. CGL appealed the case to the Court of Appeal and sought to establish that Fok J had:

a) not understood the reality of CGL’s case and that the involvement of CGL in the manufacturing process was not “antecedent” or “incidental”;
b) substituted his own view of the facts as opposed to the determination of the facts found by the BOR;
c) adopted an incorrect legal analysis of the facts found by the BOR, and
d) incorrectly concluded that the BOR’s decision was unreasonable.

The judgment of Court of Appeal was delivered by the Hon Tang Ag CJHC. In my opinion it must rank as one of the poorest judgments regarding taxation that I have read. The judgment simply reiterates the facts, attempts to interpret the facts in a manner inconsistent with the decision of the BOR, and makes no attempt to independently analyse the law other that to express the view that the BOR might have reached a different decision had the case been heard after the Court of Appeal’s decision in CIR v Datatronic [2009] 4 HKC 518, a case heard by the Hon Tang Ag CJHC himself. An example of this can be found in paragraph 21 of the judgment:

“The Board’s finding that the reality of the transaction between CGES and the Taxpayer was that there was no sale of the finished products by CGES to the Taxpayer was not challenged on the case stated. It is therefore not something with which we are required to deal. The implication of the Taxpayer’s case appeared to be that all the raw material supplied by the Taxpayer to CGES as well as the finished products belonged to the Taxpayer throughout. However, I do not wish to give the impression that I agree with the Board’s finding. With respect, what the Board referred to as the reality of the situation probably only represented the subjective intention of the Taxpayer, namely, that for Hong Kong tax purposes it should be regarded as the owner of the raw material and the finished products. That is presumably because the Taxpayer thought that from the Hong Kong tax liability point of view it would be advantageous that its transactions with CGES should be not regarded as a sale of the finished product by CGES to the Taxpayer. I doubt whether the ownership of goods could solely depend on the subjective intent of the Taxpayer. But, as I have said, this is not something we need to decide.”

It therefore came as no surprise that the appeal was dismissed. In my view, one would be forgiven for thinking that the judgment was given on the assumption that the case would be appealed to the CFA where the facts would be reviewed together with the decision of the BOR, the decision given by Fok J in the Court of First Instance and the relevant case law in order to provide much-needed guidance on the location of the source of profits made by Hong Kong taxpayers from manufacturing in Mainland China by way of a processing agreement with a third party.

Nobody was under the illusion that Tang Ag CJHC would find in favour of the taxpayer. It was always anticipated that the case would need to be heard by the CFA, which would normally seek to have a UK judge specialising in taxation sitting on the bench.

However, when the CIR was asked to consent to CGL’s application for leave to appeal to the CFA, being as of right, the CIR refused. Of the 16 tax cases that have previously been appealed to the CFA, the CIR has given consent on each occasion. Again, one would be forgiven for believing that the CIR had been advised that the CFA had decided to restrict the number of cases to be heard before it, and certainly taxpayers should not consider that the CFA was obligated to hear tax appeals. Clearly, the progress of the case relating to Nina Wang’s estate would have endorsed the view that the CFA intended to take a harder approach to adding to its case load.

The application for leave to appeal to the CFA was referred back to the Court of Appeal for its approval. The Hon Tang Ag CJHC dismissed CGL’s application for leave to appeal on the grounds that the application did not satisfy the provision of Section 22(1)(a) or 22(1)(b) of the Hong Kong Court of Final Appeal Ordinance.

Section 22(1)(a) allows a case to be heard by the CFA “as of right” in a civil matter where the amount in dispute amounts to the value of HK$1,000,000. The second option is where the Court can, at its discretion, allow the appeal on the basis that it is a question of great general or public importance or the Court otherwise believes the appeal ought to proceed.

The Hon Tang Ag CJHC was of the opinion that the tax in dispute was similar to the assessment of unliquidated damages and therefore did not satisfy Section 22(1)(a). With regard to Section 22(1)(b) Tang was of the opinion that the law had been correctly applied by referring to the CFA’s decisions in Ing Barings & Securities (Hong Kong) Limited v CIR (2007) to HKCFAR 417 and Ngai Lik Electronics Co. Ltd v CIR (2009) 12 HKCFA 296. Tang further stated that:

“It is said that we have misapplied or misunderstood the decisions. Even if that is right, that is not a question of great general or public importance … In any event, the solution is not leave to appeal to the Court of Final Appeal but legislation.”

Leave to Appeal to the CFA having been dismissed by the Hon Tang Ag CJHC, CGL’s remaining option was to appeal directly to the Leave Committee of Court of Final Appeal. In his determination, Mr Justice Bokhary PJ stated:

“Monetary claims which require assessment – and are therefore unliquidated rather than liquidated – do not come within S22(1)(a). Tax requires assessment. So tax demands do not come within S22(1)(a). The appeal which the taxpayer seeks to bring does not lie as of right.”

As Mr Justice Bokhary PJ was also of the opinion that there was no legal principle to be resolved, leave to appeal was refused and so the case became final without a satisfactory conclusion.

Several very interesting issues arise from this. Firstly, nowhere in S22(1)(c) is reference made to liquidated damages. If such a phrase was used, I disagree that a person’s tax liability could be described as “unliquidated”, as it has already been assessed and quantified. At the appeal hearing, the Court asked whether it should be “harried” with every tax dispute appealed from a lower court, a view enhanced by the CIR, who suggested that hearing tax appeals, as of right, would open the “floodgates” for tax litigation. My answer to this is quite simple – is that not every taxpayer’s right? Why should a taxpayer’s right of appeal be prejudiced by the apparent workload of the CFA? Equally, I was very surprised that the CIR and Mr Justice Bokhary PJ concluded that this case was not of “general or public importance”, when every tax professional, manufacturing association and manufacturer had followed this case with great interest.

In my opinion, this was a very distasteful end to an unsatisfactory case.

Corporate groups in Hong Kong may:
• pay tax as a group even though the consolidated group accounts may show a loss
• have a higher effective tax rate
• be disadvantaged from a cashflow standpoint
• feel forced to adopt contrived strategies to utilise stranded tax losses
• have inadequate resources to embark on new business initiatives that would suffer losses in the initial years of operation

In March this year, Professor KC Chan, the Secretary for Financial Services and the Treasury, stated:

“The “group loss relief” suggestion involves a number of complicated issues, such as how to ascertain whether companies are members of the same group, and their loss set-off arrangements with each other. The proposed measure could also be easily abused for tax avoidance. Hence, its implementation must be complemented by complicated legislative provisions to define clearly the scope of application so as to avoid tax abuse. This would inevitably complicate our simple tax regime. Separately, as small and medium enterprises (SMEs) in general do not operate as a group, the “group loss relief” suggestion would not benefit the SMEs at large, which constitute 98% of business establishments in Hong Kong.
As for the “loss carry-back” suggestion, since the proposed measure may result in tax refunds at any time, it may cause drastic and unpredictable fluctuations in tax revenue, rendering the tax revenue more vulnerable to economic cycles. We believe that our current arrangement for enterprises to carry forward their losses without time limit to offset profits in future years should be able to assist enterprises to manage their losses and remains attractive to investors.
Given the above considerations, we are of the view that it is not appropriate to introduce the “group loss relief” and “loss carry-back” arrangements at this juncture.”
This view is not shared by our neighbours, with which Hong Kong competes to be recognised as the favoured location for the establishment of regional headquarters or as a base for Asian business operations. Australia, New Zealand, Singapore, Malaysia and Japan, Hong Kong’s principal competitors, permit group relief, whether on consolidation or in the form of loss transfer.
Personally, I find the reasons advanced by the Government a poor excuse for its failure to undertake a thorough review of this issue. It is also very sad that the Government does not feel it appropriate to issue a consultation paper to the appropriate interested parties for their views and recommendations as to how group relief could be implemented in Hong Kong. Of course doing nothing is the easier option.

The examples I am referring to are as follows:

• The increase in stamp duty payable on properties acquired after November 20, 2010, and sold within 24 months after acquisition. Despite the fact that Hong Kong’s existing corporate tax legislation provides a mechanism to charge property speculators a profits tax on their profits from the purchase and sale of property, the Government clearly believes that the use of stamp duty is an effective tool to dampen the surge in property prices. I would like to think the Government recognises that this is only a temporary measure and not a reason for ignoring Hong Kong people’s real need: affordable accommodation.

• The Government has increased the first registration tax by 15% on private cars costing more than HK$200,000. The purpose of this increase in indirect tax is to reduce road congestion, particularly as “new infrastructure is becoming expensive and difficult to control in Hong Kong’s unique geographic situation”. What happened to the “user pays” principle, i.e. ERP, or other ideas that have been suggested? Again, is this just an easy way out? Certainly the one thing that will happen is that people will be likely to think twice about buying a new car – great for pollution!

• Finally the duty on cigarettes and other tobacco products has been increased by 41.5%. A recent advertising campaign has advised us that smoking costs the Government substantial sums of money in relation to the provision of medical services to deal with smoking-related illnesses and the loss of productivity through smoking-related sickness. I am a non-smoker who has no wish to inhale second-hand smoke, but I feel that the use of indirect tax to make smoking more expensive is simply delaying a decision the Government needs to make, i.e., whether to further restrict the smoking of tobacco. If the decision is to permit smoking, albeit in restricted locations, why should it become a luxury that only the more affluent can afford?

You may consider these issues to be insignificant, but to my mind, the use of taxation for social engineering is a trend that should be avoided. I would encourage the Government to address the true causes of the problems rather than using taxation as a quick fix or band-aid.

At the Board of Review, the Commissioner of Inland Revenue (“the CIR”) suggested that L&F operated a “supply chain management business” and that the 4% commission paid to the affiliates was for the offshore services, whilst the 2% retained by L&F was for the management of the services undertaken in Hong Kong, and was therefore taxable. The Board of Review applied the principles enunciated by the Court of Final Appeal’s judgment in ING Baring Securities (Hong Kong) Ltd v CIR (2007) to HKCFAR 417, namely that section 14 of the Inland Revenue Ordinance required the identification of those activities that directly gave rise to the earning of the commission profits as opposed to those activities that, whilst important, were incidental or antecedent. Having ascertained the relevant activities, it was then essential to determine where they were performed.

The Board of Review held that L&F was a commission agent and that the services for which it received a commission were undertaken offshore. Accordingly, the Board held that L&F’s profits from this source had been correctly filed as offshore and were not taxable.

On appeal to the Court of First Instance, Mr Benjamin Yu, SC on behalf of the CIR, suggested that the commission income was derived from both a Hong Kong source and an offshore source and hence should be apportioned. This opinion was based on the “brain analogy”, in that the knowledge of the business rested with the senior management, to whom junior staff frequently referred. Reyes J rejected the “brain analogy”, previously cited in ING Barings, on the basis that the administrative and oversight functions undertaken in Hong Kong were not relevant criteria for ascertaining the geographical location of the commission profit.

Reyes J concluded that the Board of Review had directed itself correctly in the analysis of the facts, in that “it was not the Board’s function to investigate every facet of L&F’s operations and then decide which matters were qualitatively the most important towards making a profit. What instead had to be done was what the Board actually did. That was to discern in a practical manner those activities of L&F which directly (as opposed to indirectly) led to the production of profits”.

Inevitably Reyes J, having decided in favour of the taxpayer, has had his judgment appealed by the CIR to the Court of Appeal, which, as we have seen, has a track record of finding in favour of the CIR. I await the decision with interest, and am also curious to see which judges are chosen to sit on this case.

In response to this proposal, The Secretary for Financial Services and The Treasury stated that there was no need to amend the IRO. The reasons given were:

(1) A tax deduction in the form of depreciation allowances may already be claimed by a Hong Kong taxpayer in respect of plant and machinery used in Mainland China for the purposes of manufacturing under a “contract processing” agreement. However, as only 50% of the profits generated under a contract processing agreement are assessed to Hong Kong tax, the depreciation allowances claimed in respect of the plant and machinery used for this purposes are also reduced by 50%.

(2) Profits derived from “import processing”, i.e. an agreement under which the PRC manufacturer raises a sales invoice for the goods manufactured, are not considered to be manufacturing profits, but are instead considered to be trading profits from the purchase and sale of goods. Hence, the cost of the plant and machinery, purchased by the Hong Kong taxpayer and provided free of any form of rent, which is used for the manufacture of the goods in the PRC, is deemed by the Inland Revenue Department not to have been incurred in respect of the business carried on in Hong Kong. Furthermore, had rent been received for the hire of the plant and machinery, this would have been derived from a non-Hong Kong source of profit and therefore depreciation allowances would not have been available.

As mentioned in previous articles, the concept of import and contract processing has been included in the Inland Revenue Department’s Departmental Interpretation and Practice Notes No 21 (Revised) (“DIPN”) “Locality of Profits”, issued in December 2009, shortly before the Commissioner of Inland Revenue at that time, Lau Mak Yee-ming, Alice, retired. Whilst the DIPNs are issued for information purposes only, they are stated as including “the Department’s interpretation and practices in relation to the law as it stood at the date of publication”. It is interesting to note that this was not the approach adopted by the Department’s counsel in the case of CG Lighting, where Counsel stated that he was not bound by the DIPNs and wished to resort to basic principles.

In my opinion, the concept of “import processing” as the sole means of characterising the nature of a person’s trade is inappropriate. The IRO makes no reference to import and contract processing, clearly seeking to tax only those profits that arise in or are derived from Hong Kong and that accrue to a business carried on in Hong Kong. The Courts have made it clear that to determine whether a profit has been derived from Hong Kong, you must first look to see what the taxpayer did to earn the profit and then where the activities were undertaken. Furthermore, the Inland Revenue Department, in applying the concept of import processing, has adopted a form-over-substance approach by ignoring the involvement of the Hong Kong taxpayer in the offshore manufacturing activity on the basis that all such activities are antecedent or incidental, simply because purchase and sales invoices were issued. This appears to be the case, notwithstanding the fact that the Hong Kong company has total day-to-day management control of the subsidiary company manufacturing in the PRC.

The continued adoption of the concept of import processing, as a means to determine the nature of a business conducted by a Hong Kong taxpayer, needs to stop. The Inland Revenue Department should assess a taxpayer based on the totality of the facts presented to it, evaluating the involvement of the taxpayer and its relevance to the earning of the profit in question.

Withholding Tax Rates Under Hong Kong Treaties

Secretary for Financial Services & the Treasury, Professor Chan commented that “the agreement will encourage Hong Kong enterprises to leverage on the success of Irish companies in the areas of technology, research and development, while facilitating Irish enterprises to tap into the Asian market, particularly the vast mainland market, using Hong Kong as a gateway”.

Under the CDTA, the withholding tax deducted from the payment of dividends by an Irish company to a Hong Kong resident has been reduced from 20% to nil.  The withholding tax on the payment of royalties and interest will be capped at 3% and reduced to 10% respectively.

As with the CDTAs concluded since the enactment of the Inland Revenue (Amendment) Ordinance 2010, the Hong Kong/Ireland CDTA adopts the latest Organization for Economic Co-operation and Development standard on the Exchange of Information.

Under the CDTA, dividends paid by a company will be exempt from tax, and dividends paid by a UK Real Estate Investment Trust will be subject to a withholding tax of 15% (previously 20%).  Hong Kong residents receiving royalties and interest from the UK are subject to a current withholding tax rate of 20% respectively in the UK.  Under the CDTA, the royalty withholding tax rate will be capped at 3% and the withholding tax on interest will be exempted.

Of particular relevance to Hong Kong expats returning to the UK is Article 17 of the CDTA, which provides that:

“Pensions and other similar remuneration (including a lump sum payment) arising in a Contracting Party and paid to a resident of the other Contracting Party in consideration of past employment or self-employment and social security pensions shall be taxable only in the first mentioned Party.”

This will enable Hong Kong expats planning to return to the UK to ensure that pensions payable by a Hong Kong company are structured in a tax-efficient manner.

The term “resident” is not a normal feature of Hong Kong tax legislation.  However, since a liability to tax is dependent on the source of income (and, in the case of corporations, whether the corporation is also carrying on business in Hong Kong), it is interesting to note the definition given in Article 4.

The term “a resident of Hong Kong” means:

1. an individual who ordinarily resides in Hong Kong,
2. a person who stays in Hong Kong for more than 180 days during a year of assessment or for more than 300 days in two consecutive years of assessment, one of which is the relevant year of assessment, or
3. a company incorporated in Hong Kong and a company centrally managed and controlled in Hong Kong.

As with all treaties concluded in 2010 by Hong Kong, the CDTA with the UK incorporates the latest Organization for Economic Co-operation and Development standard on Exchange of Information.

Following the enactment of the Inland Revenue (Amendment) Ordinance 2010 (“IR(A)O 2010”) and the Inland Revenue (Disclosure of Information) Rules, Cap.112 BI (“Disclosure Rules”), the Department now has the authority to collect and disclose tax information, from whatever source is available to it, in order to comply with a tax treaty partner’s request for information regarding a taxpayer’s affairs. There is no requirement for the Department to seek approval from a court of law before releasing the information.

In an effort to assure taxpayers that information will not be provided indiscriminately, the Department has stated that:

a) the Department will restrict the exchange of information to specific requests, and that there will be no automatic or spontaneous exchanges,

b) information will only be provided with regard to bona fide requests from the competent authority of a treaty partner in justifiable cases, and

c) only information that is considered “foreseeably relevant to secure the correct application of the provisions of the CDTA or of the domestic law of the contracting party” shall be provided.

With regard to (c) above, to avoid “fishing expeditions” the Department has published details of the “Particulars to be Contained in a Disclosure Request”. These are very comprehensive, and include the following:

(a) a statement of the information requested and its relevance to the disclosure request, and

(b) the grounds for believing that such information is available in Hong Kong, and

(c) a statement that the government of the contracting party has pursued all means available in its territory to obtain the information, and

(d) if applicable, reasons why the disclosure of the request to the taxpayer may frustrate or undermine the enforcement of tax laws in the treaty partner’s jurisdiction.

Subject to the Department’s agreement to (d) above, details of the request for information will be provided to the taxpayer. The taxpayer will, in most cases, be allowed to review the information and correct any errors of a genuine nature. However, it is unlikely that any amendments will be entertained if they are not received in a timely manner. Taxpayers should be aware that the Department will adhere to the OECD’s standard response time of 90 days.

Where does this leave Hong Kong? It is abundantly clear that the Hong Kong Government and the Department want to be seen to be supporting the concept of tax transparency and the effective exchange of tax information, and do not wish to stand in the way of the development of Hong Kong as a financial centre.

However, it is difficult to evaluate the impact of this “modernisation” of Hong Kong’s tax regime until such time as we are able to gauge the validity of new treaty partners’ desire for information and the willingness of the Department to undertake a rigorous review of all requests for information before sending it to such treaty partners.