Question

For many years, Mr Leung has been employed as a sales representative of a real estate company, Hit and Run Limited (‘HAR’). At all relevant times, he has paid salaries tax on his earnings at the standard rate. His earnings consist of a basic salary (which must be repaid if his sales results do not reach a prescribed minimum level) plus commission. His commission earned over the past two years has been very high. He has a wife who operates a trading business. The couple has two young children attending schools in Hong Kong.

Mr Leung has been told that the test of deductibility for outgoings and expenses for salaries tax purposes is ‘notoriously rigid, narrow and restrictive.’ Mr Leung thinks that, if he were subject to profits tax instead of salaries tax, he would be able to claim many deductions for outgoings and expenses which are presently not allowable to him for salaries tax purposes.

Mr Leung therefore approached the accountant of HAR for advice. The accountant advised him to resign from his job with the company, incorporate a new company, Leung Fun Ltd (‘LFL’), and arrange for LFL to enter into a new contract with HAR to provide Mr Leung’s services as a sales representative. Under this arrangement, LFL would receive income from HAR and claim against this all allowable expenses. LFL would employ Mr Leung at a reasonable salary to provide the agreed sales services on its behalf to HAR.

A few days ago, HAR’s accountant informed Mr Leung that the company will agree to enter into the proposed arrangement on basically the same terms as it now employs Mr Leung, but without any obligation to pay any minimum monthly sum to LFL.

Required

a    Evaluate the comment by the accountant of HAR about the deductibility of expenses and outgoings under Hong Kong salaries tax and profits tax.

b    Explain in detail to Mr Leung whether there is any danger of the Commissioner challenging the suggested arrangement and the possible consequences, quoting the relevant sections of the Inland Revenue Ordinance where appropriate. Further, advise Mr Leung what he can do to lessen the chance of the application of the relevant Inland Revenue Ordinance provisions in a situation like this.

Answer 1

Ans. (a) In Salaries Tax, the chargeable income to tax is the Total Income of employee (-) deductions and allowances received. These deductions referred here includes:

• Any membership taken by the employee of any association then its professional membership dues will be considered as deduction.
• Donations within the maximum and minimum limits
• loan interest home subject to a limit of 15years
• Self education expenses.
• Allowances are also there which are benificial to married persons, single parents and various dependents. Whereas Profits tax which means business profits in financial year and it allows deductions like depreciation, incomes not liable to taxability, donations given, etc.

Both the terms mentioned above has its own benifits and cannot be compared. So, therefore, if Mr Leung thinks that, if he were subject to profits tax instead of salaries tax, he would be able to claim many deductions for outgoings and expenses which are presently not allowable to him for salaries tax purposes, then it is his opinion according to his income and tax structure.

But the comment by the accountant of HAR about the deductibility of expenses and outgoings under Hong Kong salaries tax and profits tax might be tax saving but not ethically right and not even lawful practice to adopt that i.eev this leads to the tax evasion in other terms.

(b)

Although according to the opinion of the accountant of HAR, he might considers it as Tax Planning but actually It leads to the tax evasion. This is considered as tax evasion as It is a planned work to evade tax and for which new company is formed. And the relationship of HAR and new company i.e Leung Fun Ltd (‘LFL’) is formed just for the purpose of settling income of Mr. Leung.

Here I remmember of one more concept that is of 'Corporate Veil' which means to find out the true situation and fraudulent activity it is needed to lift the corporate veil and treat company and owner as one and the same person (This is done because company and employee are considered as different persons so person does fraud behind the veil of the company's name). So, through this tax evaded by the person can be easily find out and those who have evaded tax are liable for serious liablity. Persons who commits fraud or tax evasions are covered under Section 82 of the Chapter 112 of Inland Revenue Ordinance.

Section 82 of the Chapter 112 of the Inland Revenue Ordinance states that:

Any person who wilfully with intent to evade or to assist any other person to evade tax-

• (a) omits from a return made under this Ordinance any sum which should be included; or (Amended 30 of 1950 Schedule)
  (b) makes any false statement or entry in any return made under this Ordinance; or
  (c) makes any false statement in connection with a claim for any deduction or allowance under this Ordinance; or
  (d) signs any statement or return furnished under this Ordinance without reasonable grounds for believing the same to be true; or
  (e) gives any false answer whether verbally or in writing to any question or request for information asked or made in accordance with the provisions of this Ordinance; or
  (f) prepares or maintains or authorizes the preparation or maintenance of any false books of account or other records or falsifies or authorizes the falsification of any books of account or records; or
  (g) makes use of any fraud, art, or contrivance, whatsoever or authorizes the use of any such fraud, art, or contrivance,

commits an offence. (Amended 49 of 1956 s. 63; 40 of 1972 s. 12; L.N. 411 of 1984; 50 of 1991 s. 4; L.N. 338 of 1995; 4 of 2010 s. 15)
(1A) A person who commits an offence under subsection (1) is liable-

• (a) on summary conviction to-
  • (i) a fine at level 3;
    (ii) a further fine of treble the amount of tax which has been undercharged in consequence of the offence or which would have been undercharged if the offence has not been detected; and
    (iii) imprisonment for 6 months; and
  (b) on indictment to-
  • (i) a fine at level 5;
    (ii) a further fine of treble the amount of tax which has been undercharged in consequence of the offence or which would have been undercharged if the offence has not been detected; and
    (iii) imprisonment for 3 years. (Added 4 of 2010 s. 15)

Therefore, as Mr Leung is covered by the Section 82 of the Chapter 112 of the Inland Revenue Ordinance, he is in danger to get the above specified penalties or imprisonment as metioned above if recognized by the commissioner.

Furthermore, Mr. Leung is suggested to follow the provisions of the law to minimise or remove the penalty that could be levied as stated in the law.