Section A – BOTH questions are compulsory and MUST be attempted1.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)
Under the current structure, P Ltd owns all the shares in A Ltd and B Ltd. A Ltd, in turn, owns all the shares in C Ltd. P Ltd is incorporated in Bermuda. A Ltd, B Ltd and C Ltd are all incorporated in Hong Kong. C Ltd owns a commercial property in Hong Kong, which is mortgaged in favour of the Citibank for an amount of $70 million.It is proposed to restructure the group in January 2013 as follows:Step 1: A Ltd will transfer 100% of the shares in C Ltd to B Ltd. The consideration will be $30 million payable to A Ltd, plus another $70 million payable direct to the Citibank on behalf of C Ltd.Step 2: B Ltd will issue shares equivalent to 10% of its total new shareholdings to an unrelated third party for $4 million. The amount so raised will not be used in Step 1.Step 3: A Ltd will then be liquidated.Required:Explain the stamp duty implications arising from the transfer of the shares in C Ltd (Step 1). Clearly identify any available exemptions and analyse the extent to which these exemptions may be affected by Steps 2 and 3 in the restructuring proposal. (11 marks)(b) After the restructuring, C Ltd will lease the commercial property to B Ltd for four years. Under the lease agreement, B Ltd will pay C Ltd $50,000 per month plus 3% of B Ltd’s gross turnover each month from the business conducted in the property. The market rental of the property is $80,000 per month.Required:Explain the stamp duty implications of this leasing arrangement. (5 marks)
