Money Matter

Correct procedures help avoid tax headaches

Article exclusively contributed by
Asia Progress (Tax Division)

Our previous article dealt with the case of Mr Chan, who found himself under investigation by the Inland Revenue Department (IRD) for matters relating to his company's tax filings.

To recap the main points, tax investigations usually fall into one of four major categories: those started after reports from third parties; those generated from internal IRD sources; project-based investigations, such as into motor vehicle trading; and those which result from consistent late filing, or failure to file, by a company or individual. In particular, the IRD will often want to look into the reasons for late filing of a company's profit tax returns.

There can be a variety of other causes. These include questions about the actual figures in the financial statement submitted by the taxpayer, or significant amounts outstanding in the "due to directors" section of the current accounts. Similarly, an auditor's report signed with qualifications, unreasonable fluctuations in the gross profit ratio, and a large total of accounts receivable can all act as a red flag to the IRD. Much time and trouble can be avoided by ensuring that correct company procedures are followed as a matter of course.

As Mr Chan had been unable to give complete answers about his business during the initial interview with the IRD, the assessor arranged a site visit in order to review the company's books and records. The aim was to reconcile the profit figures shown there with those in the profit tax return. As a first step, the assessor checked the previous year's BIR56A and IR56B (forms stating remuneration and pensions paid by the employer), and asked Mr Chan to provide the following information:

1. Identity card details of selected employees
2. The method of salary payment (cheque, autopay or cash)
3. Details of the job duties of certain staff
4. Copies of employment contracts.

When reviewing these documents, the assessor noticed that some employees had received a salary from the company, but no corresponding IR56B had been filed. Others had been paid without having a contract of employment. Therefore, the assessor immediately set up a meeting with the human resources manager and Mr Chan to investigate the reasons.

The HR manager said that an IR56B had not been filed for the employees in question because they were seconded to an overseas factory. They returned every weekend and spent only eight or ten days in Hong Kong each month. They should not, suggested the HR manager, be subject to local income tax. Consequently, the company had not filed any return for them.

The assessor, however, warned that these employees might still be subject to Hong Kong income tax. This would apply if they had remained in the same employment under the same contract and spent more than 60 days in Hong Kong. Mr Chan was asked to provide a copy of the travel schedules for each of these employees as proof that their services had been rendered outside Hong Kong, and that they had visited Hong Kong for less than 60 days in any tax period. Additionally, he was asked to demonstrate that they had not performed any duties relating to their employment while visiting Hong Kong.

Regarding the employees receiving a salary without a proper employment contract, Mr Chan confirmed their status was as sole agents for the company. Their income was based on the sales figures they achieved every month.

Since they were not regarded as full employees, no contracts of employment had been signed with them. Nevertheless, the commission paid to them had been booked by the company as salary expenses.

The assessor noticed that in each year's profit tax filing, the company had not indicated in the profit tax return whether they made any commission payment to a sales agency. Mr Chan was warned that the Inland Revenue Department must be notified of any such payment.

In the next article, we will see how Mr Chan's case proceeds. We will also explain how the IRD deals with employees whose services are rendered in China or elsewhere overseas.

Q&A on income issues which can relate to profit tax
Q1 Under what conditions is income taxable in Hong Kong?
A1 Income is taxable in Hong Kong if it arose in or was derived from services rendered in Hong Kong. The key factors which the Inland Revenue Department considers, when determining sources of income, are the following:
1. Where the employment contract was signed
2. The employee's place of residence; and
3. Where remuneration is paid.

Q2 Are workers on overseas secondment subject to income tax?
A2 If a Hong Kong employee is seconded to work overseas and renders services entirely outside Hong Kong during the year of assessment, income received will not be subject to Hong Kong income tax in accordance with section 8(1A)(b) of the Inland Revenue Ordinance.

Q3 What is the 60 days rule relating to an employee seconded overseas?
A3 Under the Inland Revenue Ordinance, if a person seconded overseas spends less than 60 days in Hong Kong during the period of assessment, he will not be liable for income tax. This assumes he performs no duties in Hong Kong save for minor assignments.

Taken from Career Times 17 September 2004

(Last review date: 23 August 2013)

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Disclaimer: The opinions expressed in this article are those of the contributor.

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