ASSIGNMENT
PolyStar Ltd is a company carrying on manufacturing and trading business in Hong Kong. For the year ended 31 December 2016, the company's audited financial statements reveal a profit before taxation of $5,200,000 after crediting and charging the following items of income and expenses:
Note $
Income:
|
Compensation received
|
1
|
157,000
|
|
Dividend
|
|
75,000
|
|
Interest income
|
2
|
106,700
|
|
Profit on sale of patent
|
3
|
200,000
|
|
Exchange difference
|
4
|
81,000
|
Expenses:
|
Bad debts
|
5
|
140,500
|
|
|
Depreciation
|
|
373,000
|
|
|
Interest expenses
|
6
|
234,400
|
|
|
Repairs and maintenance
|
7
|
166,700
|
|
|
Contributions to MPF scheme
|
8
|
1,430,000
|
|
|
Donations
|
9
|
156,000
|
|
Notes: $
|
1. Compensation for cancellation of a sale contract
|
74,000
|
|
Insurance compensation for the loss of machinery during shipment
|
|
from the supplier
|
|
|
83,000
|
|
|
|
|
157,000
|
|
2. Interest on deposits placed with the Shenzhen branch of
|
|
Bank of China (see note 6 below)
|
|
|
57,400
|
|
Interest on deposits placed with the Hung Hom branch
|
|
of HSBC bank (see note 6 below)
|
|
|
33,300
|
|
Interest on tax reserve certificates
|
|
|
5,000
|
|
Interest charged on overdue trade accounts
|
|
11,000
|
|
|
|
106,700
|
3. The patent was purchased in 2012 at a cost of $500,000 from an associated corporation and used in its manufacturing operation generating taxable profits. The patent was sold for $700,000 during the year and a profit of $200,000 was made.
|
4. Exchange gain on collection of trade debts
|
46,000
|
|
Exchange gain on conversion of foreign currency time deposits
|
35,000
|
|
|
81,000
|
|
5. Trade debts written off
|
$ 36,500
|
|
Staff loan written off
|
100,000
|
|
Recovery of trade debts previously written off
|
(16,000)
|
|
Increase in general provision for doubtful debts
|
20,000
|
|
|
140,500
|
|
6. Bank loan interest - Bank of China, Hong Kong branch
|
99,400
|
|
Bank overdraft interest - HSBC bank, Kowloon branch
|
62,000
|
|
Interest on a loan borrowed from Mr. Lam, a director
|
70,000
|
|
Hire purchase interest (for purchase of a delivery truck)
|
3,000
|
|
|
234,400
|
|
The loan borrowed from the Bank of China was secured placed with its Shenzhen branch (see note 2 above).
|
by time deposits
|
The bank overdraft facilities with HSBC bank was secured by the time deposits placed with the bank and a personal guarantee given by the company's directors (see note 2 above).
The loan from Mr. Lam was made available to the company in Singapore. All the borrowings were used to finance the company's daily operations.
|
7. Repairs of office equipment
|
15,000
|
|
Renovation of a workshop and converted it into a showroom
|
80,000
|
|
Purchase of loose tools (70% for replacement)
|
6,000
|
|
Others (allowable)
|
65,700
|
|
|
166,700
|
|
8. Ordinary contribution for employees
|
250,000
|
|
Ordinary contribution for directors
|
680,000
|
|
Special contribution paid to the scheme
|
500,000
|
|
|
1,430,000
|
Ordinary contributions for employees and directors were made at the rate of 5% and 20% of their respective remuneration.
9. The sum represents donation of cash made to The Hong Kong Polytechnic University ($100,000) and company's products (with a cost of $56,000) to Hong Kong Red Cross, an approved charity.
10. Total amount of depreciation allowances agreed with the Inland Revenue Department was $650,000 for the year.
With a view of minimizing the profits tax payable by PolyStar Ltd in Hong Kong, Annie Wong, the General Manager, proposed to set up a trademark holding company in Cayman Islands (TM Ltd) and dispose of certain trademarks currently owned and used by the company to TM Ltd. This will be followed by the licensing back of the right of use of the trademarks to PolyStar Ltd at an arm-length's price. She explained that this would increase the allowable deduction for PolyStar Ltd in Hong Kong, while at the same time the income received by TM Ltd would not be chargeable to profits tax as it has no permanent establishment in Hong Kong.
Currently, PolyStar Ltd also licensed the use of these trademarks to several customers in Hong Kong in return for a royalty fee. After the transfer of the trademarks, TM Ltd may enter into agreement with those companies for using the trademarks in Hong Kong.
Required:
(a) Prepare the Hong Kong profits tax computation of PolyStar Ltd for the year of assessment 2016/17. Ignore provisional tax.
(b) Explain your tax treatments accorded to various items in your tax computation, including those which require no adjustments in the tax computation.
(c) Explain to Annie the Hong Kong profits tax implications of her proposal, and advise whether or not this is effective in minimizing the profits tax liability of the group in Hong Kong. You may ignore the tax liability of the group outside Hong Kong.