Following is the speech (English only) by the Secretary for the Treasury, Miss Denise Yue, in moving the second reading of the Inland Revenue (Amendment) Bill 2000 in the Legislative Council today (October 18):
I move that the Inland Revenue (Amendment) Bill 2000 be read the second time.
This is a composite bill seeking to amend a number of provisions in the Inland Revenue Ordinance. Firstly, it seeks to amend the provisions relating to profits tax on royalty income for revenue protection reasons. Secondly, it seeks to tighten anti-avoidance provisions on interest payment deductions. Thirdly, it seeks to revise provisions on depreciation allowances for buildings having regard to the latest market practices. Lastly, it seeks to make a number of miscellaneous amendments for the purposes of remedying irregularities identified in the light of operational experience, streamlining legislative procedures relating to determination of certain costs and fees for tax appeal cases, and repealing spent provisions.
Amendments relating to profits tax on royalty income
The provisions in the Bill on profits tax relate to royalty income received by an overseas business entity in respect of the use of its trademark in Hong Kong. They have the effect of deeming the royalty income earned by a non-Hong Kong business entity to be chargeable to profits tax where the payer of royalty, namely a business entity in Hong Kong, is allowed a deduction in respect of the royalty paid as an expense incurred in deriving assessable profits in Hong Kong.
The need for this amendment stems from a recent decision of the Court of Final Appeal over a case submitted before it. In that case, the Court ruled that only that part of the royalty income relating to goods manufactured in Hong Kong should be chargeable to profits tax, and that royalties paid in respect of goods manufactured outside Hong Kong were not chargeable. This deviates from the practice adopted by the Inland Revenue Department since 1971 when the present provision relating to royalty income came into effect. Under this long standing practice, royalty income has been charged to profits tax as long as the trademark has been used by a Hong Kong business entity in producing assessable profits, irrespective of where the goods concerned were manufactured or sold. Given that a substantial part of our manufacturing activities has been re-located outside Hong Kong, this decision may give rise to significant loss of profits tax revenue, estimated to be in the order of $200 million a year. Our proposed amendment enables the Inland Revenue Department to continue with its long standing assessing practice, which has been widely accepted by taxpayers who had organised their affairs accordingly.
Amendments relating to anti-avoidance provisions on profits tax deductions for interest payments
The Bill also seeks to strengthen anti-avoidance provisions on profits tax deductions for interest payments. To qualify for deduction, the interest payment has to satisfy the conditions prescribed for anti-avoidance purposes under the Ordinance. In essence, these conditions aim at combating tax avoidance schemes which seek to create allowable interest deductions where the corresponding interest income is not taxable, or where the actual recipient of the interest income is an associate of the borrower.
We consider it necessary to tighten the existing anti-avoidance provisions, in the wake of increasing incidence of aggressive tax avoidance schemes which cannot readily be caught by such provisions. They involve schemes making use of various tax planning tools, such as alienation of interest income, artificial public issue of debenture in overseas stock exchanges, and the use of trusts to disguise associate relationships between borrowers and lenders. These schemes generally have the common purpose of engineering artificial interest payment situations through circular flows of funds within companies in a group, without any genuine external borrowing which requires real interest expenses. Such tax avoidance arrangements are now tackled by a general anti-avoidance provision on a case by case basis. This general provision, however, is not fool-proof and cannot be taken as a long-term solution. To counteract the identified types of tax avoidance arrangements, we propose to amend the specific tax-avoidance provisions by restricting more stringently the conditions governing deduction of interest payments to ensure that deduction will only be allowed if the payments are genuine interest expenses which have been made to non-associated parties.
Amendments relating to depreciation allowances for buildings
The Bill further seeks to amend some provisions relating to depreciation allowances for capital expenditure on industrial and commercial buildings under profits tax. Under the existing provisions, when a building, used exclusively as an industrial or commercial building throughout its period of ownership, is disposed of, the difference between the disposal price and the written down value of the building will either be granted as a balancing allowance to the taxpayer if the disposal price falls below the written down value, or imposed as a balancing charge on the taxpayer if the disposal price exceeds the written down value. However, the existing calculation of the balancing allowance or balancing charge only takes into account the allowances granted in respect of the current use of the building at the time of its disposal. In other words, if the use has been changed any time prior to its disposal, that is from industrial to commercial or vice-versa, all the allowances granted in respect of its previous use are not taken into account. This is not our policy intention. As it is now quite common for industrial buildings to be converted into commercial buildings, the existing provisions are vulnerable to abuse through deliberate tax planning.
We propose to amend the Ordinance to the effect that any initial, annual and balancing allowances granted, and balancing charges made, when a building was used for a different purpose in the past will be aggregated with the allowances granted under its current usage to derive the net overall position when calculating the balancing charge or allowance at the time of the building's disposal. The amendments will also provide for the appropriate calculation of annual allowances where a change of use has taken place.
We have also included a number of miscellaneous amendments in the Bill. These may be divided into three categories: one seeking to remedy irregularities so as to clarify legislative intent, another aims to streamline the legislative procedures regarding revision of costs and fees relating to tax appeal cases, and the third seeks to repeal a number of spent provisions.
Amendments to clarify the original legislative intent in the Ordinance cover five areas. The first area concerns the scope of "self-education expenses". We propose to broaden its scope by including examination fees paid on a standalone basis in respect of qualifications for use in any employment. The existing definition of "self-education expenses" is not capable of covering the situation whereby a taxpayer merely sits for a relevant examination and pays only the examination fees, that is without paying other course fees. This is contrary to the policy intent of allowing all employment-related self-education expenses in connection with a qualified course of education to be deductible from the assessable income of a person, subject to the maximum amount of deduction specified in the Ordinance. Accordingly, we need to make the necessary amendment.
Secondly, we also propose to remove a mandatory requirement relating to mortgage loan interest deduction under salaries tax. This requirement stipulates that a car parking space must be valued together with the dwelling concerned as a single tenement by the Rating and Valuation Department in order to qualify for the deduction. This has resulted in many taxpayers applying to the Commissioner of Rating and Valuation to consolidate separate assessments into joint assessments, causing considerable inconvenience to taxpayers and additional workload for the Rating and Valuation Department. Again, this is not our legislative intent. We therefore propose to remove this requirement, so that a car parking space will qualify for mortgage loan interest deduction as long as the car parking space is purchased with the same mortgage loan as the dwelling. This amendment is proposed to take effect from the 1998-99 year of assessment, that is from the first year this deduction was introduced.
Thirdly, we propose to empower the Board of Review to extend the period for lodging an appeal against the imposition of additional tax under prescribed circumstances. In the absence of such a provision at present, the Board has no power to extend the current one-month period, even where it is satisfied that an appellant was prevented by illness or absence from Hong Kong, or other reasonable cause, from giving notice of appeal within the prescribed period. We therefore propose this amendment in order to remove the present rigidity.
Fourthly, we propose to make a technical amendment to the provision in the Chinese text relating to exemption granted to charitable bodies in respect of taxes that would otherwise be imposed by the Inland Revenue Ordinance. The amendment makes it clear that the exemption applies to any charitable institution of a public nature or any charitable trust of a public nature. The amendment will ensure that the English and Chinese texts carry the same meaning.
Fifthly, we propose to make a technical amendment to section 70 of the Ordinance which sets out the circumstances under which an assessment became final and conclusive, by substituting a reference to section 68(2A) of the Ordinance which has already been repealed, with section 68(1A)(a) which contains the substance of the repealed section. Section 68(1A)(a) permits a taxpayer who has appealed to the Board of Review to give the Board written notice of withdrawal of the appeal at any time prior to its hearing. Under Section 70, once such a written notice has been given, the assessment would become final and conclusive. This amendment seeks to make this condition clear and avoid possible doubts.
The second category of miscellaneous amendments relate to costs and fees for tax appeal cases. The amendments propose to transfer both the costs which the Board of Review may impose on taxpayers lodging frivolous tax appeal cases, as well as the application fee for requiring the Board to state a case on a question of law, from the principal Ordinance to the Schedule. They also seek to empower the Secretary for the Treasury to vary the actual amount by an order, which will be subject to negative vetting by this Council. The purpose is to streamline the legislative process.
The last category of miscellaneous amendments is to repeal spent provisions, which concern transitional arrangements which are applicable only to the 1989-90 year of assessment. Under the existing Ordinance, any assessment or additional assessment can only be raised within six years after the end of a particular year of assessment. Assessments for the 1989-90 year of assessment have therefore already been time-barred since April 1996. In other words, section 89(1) and Schedule 5 are no longer necessary. We therefore propose to repeal them.
President, with these remarks, I commend the Bill to Members.
End/Wednesday, October 18, 2000