21(3) Compensation for cancellation of a sales contract – Whether the compensation received for the cancellation of the sales
contract is a capital or a revenue item. In general terms:
(a) Compensation is revenue in nature and taxable if the compensation is made to cover the revenue loss suffered from the
cancellation of a sales contract. Since income from the contract is taxable revenue income, compensation made to cover
the loss of such income is accordingly revenue in nature and taxable.
(b) Compensation for the cancellation of a sales contract which constitutes the whole business of the company leading to
the closing down of the company’s business will be regarded as capital in nature and non-taxable.
(4) Salaries – The amount, if any, of any salaries paid to the partner (Mr Lo) and his spouse. Any such amount is not deductible:
s.17(2).
(5) Contributions to mandatory provident fund scheme (MPFS) – A breakdown of the contributions to check whether they are tax
deductible. The tax treatment for contributions made to MPFS are as follows:
(a) Regular contributions to MPFS are deductible, but limited to 15% of each employee’s remuneration: ss.16(1) and
17(1)(h).
(b) Contributions other than regular contributions to MPFS are deductible over five years in equal annual instalments,
commencing from the year the contributions are made: s.16A.
(c) A provision for regular contributions (mandatory or voluntary) to MPFS is deductible, but limited to 15% of each
employee’s remuneration: ss.16(1) and 17(1)(i).
(d) Contributions to MPFS where a provision has previously been allowed as a deduction are not deductible: s.17(1)(k).
(e) Mandatory contributions to MPFS made by a self-employed person (Mr Lo as the partner) are deductible, if not otherwise
allowable and not exceeding $12,000: s.16AA.
(6) Repairs and alterations – A breakdown of the amount to check whether any capital expenditure, such as that on improvement,
was included. If any expenditure is of a capital nature, it is necessary to ascertain whether it qualifies for depreciation
allowances or is otherwise deductible as refurbishment and renovation expenses on a straight-line basis over five years under
s.16F.
(7) Interest expenses – A breakdown to check whether the general and specific provisions of s.16(1)(a) and s.16(2) are satisfied.
Interest payable to a bank is tax deductible if the following conditions are fulfilled:
(a) the bank interest is incurred in the production of assessable profits: s.16(1);
(b) the bank borrowing is not secured by any deposits or loans which derive non-taxable income in Hong Kong (the ‘secured
loan test’): s.16(2A); and
(c) there is no arrangement in place such that the interest payment is ultimately paid back to the borrower or any connected
person (the ‘interest flow-back test’): s.16(2B).
Any amount of interest paid to the partner (Mr Lo) and his spouse is not deductible: s.17(2).
(8) Rent and rates – The proportion, if any, of any rent and rates, representing private as opposed to trading expenses, and the
basis upon which the proportion is calculated. Any private portion must be disallowed: s.17(2).
(9) Legal and professional fees and sundry expenses – A breakdown to check whether any capital or private items are included.
Expenses of a revenue nature incurred in the course of business would normally be allowed. Any capital and private items
must be disallowed, particularly in the case of the purchase of non-current assets. However, legal fees in connection with the
borrowing of money used for the purpose of producing chargeable profits are specifically allowed under s.16(1)(a).
(10) Research and development – Ensure that:
(i) the expenditure is incurred on any activities in the fields of natural or applied science for the extension of knowledge;
and any systematic, investigative or experimental activities in respect of any feasibility study, or any market, business or
management research;
(ii) the scientific research is related to the partnership’s trade or class of trade; and
(iii) any capital expenditure on machinery and plant which is required for scientific research is deductible in full, but no
deduction is allowed for capital expenditure on land or buildings (depreciation allowance may be granted).
(11) Patent expenses – Ensure that the amount claimed represents a payment to purchase patent rights specifically deductible
under s.16E. To be deductible, the patent must not be purchased from an associate.
(12) Property tax – This expense has been charged as paid but no rent has been included in the accounts. This should be clarified.
(13) Dividends – A nominal adjustment may also be made in the tax computation under IRR 2C to reflect the expenses incurred
to produce non-taxable income. In other words, an amount of overhead expenditure relating to the investment portfolio should
be added back in the tax computation.
(14) Ascertain the ratio in which the partners share the profit or loss. Allocation of profits among the partners is necessary as the
corporate partner’s share of profits is taxed at the corporate rate of 16·5%.
(15) Ascertain if there is any loss brought forward for set-off against this year’s profit, and whether the partner, David Lo, will elect
for personal assessment for 2011/12.
(16) Movements of non-current assets for computing the depreciation allowance. It is necessary to ascertain whether new
additions qualify for depreciation allowances or are otherwise deductible in full as prescribed fixed assets under s.16G.
