Employer

HKICPA and FTMS
Module D – Taxation
Module Preparation Seminar
Patrick Ho
LL.B, LL.M, MBA, MCS, FCPA, FCCA, FTIHK, PCLL
Author of “Hong Kong Taxation and Tax Planning”
Principal Lecturer, FTMS Training Systems (HK) Ltd,
13 April 2012
1

Agenda
Major or Difficult Syllabus Topics (Part I)
• Salaries tax:
- Office, employment and pension
- Employment benefits
- Termination payments
• IRD letters
2

• Section 8(1) :
Scope of Charge
• Salaries tax shall be charged on income
arising in or derived from Hong Kong
from the following sources –
Employment
Office
Pension
3

Employment vs Office
• Employment – A legal relationship of
master and servant
• Office – A permanent, subsisting,
substantive position independent from
the person who fills it, and which went
on and was filled by successive holders.
e.g. directors (Great Western Railway
Case v Bater 1922)
4

Employment vs Office
• Employment – income includes salary,
bonus, commission etc.
• Office – major income is direct fee and
includes fringe benefits.
5

Who is an office holder?
• Trade officer
• Marketing director
• Tax director
• Director
• Chief executive officer
• Executive director
• Managing director
6

Arising In or Derived From
• Applies the Territorial Concept
• Need to Determine Hong Kong Sourced
Office, Employment and Pension
• Otherwise, Not Taxable
7

Source of Office
• Place where legal office exists
• Practical concern is where the company
is centrally managed and controlled
(McMillan V Guest, D123/02)
• Place where board of directors holds
meeting for making policy decision
• Irrespective of place of residence and
work
8

Example on Office
• A director of a Hong Kong based
company draws $500,000 in
2009/2010 but never comes to Hong
Kong and performs any duties.
• Is director’s fee assessable to salaries
tax?
9

Pension vs Retirement Lump Sum
• Pension : a periodic payment made after
retirement – with a separate source of
income different from employment and
office.
• Retirement Lump Sum : A lump sum
payment made at the time of retirement – it
is a part of employment income with the
source rule of employment.
10

Source of Pension
• The source of pension is at the place where
the pension fund is managed.
• If a pension fund is managed outside Hong
Kong, the pension is 100% exempt from
salaries tax. If a pension fund is managed in
Hong Kong, only the portion of pension
attributable to Hong Kong service is
taxable.
11

Contract of Service vs Contract for Service
Contract of Service
• A person is under an employment
• Also referred as “being employed”
• Income chargeable under salaries tax
Contract for Service
• A person runs his own business
• Also referred as “self-employed”
• Income chargeable under profits tax
12

Tests for Distinguishing
Contract of Service and Contract for Service
• Control test
• Integration test
• Economic reality test
13

• Two-tier Test :
Source of Employment
3 factors in DIPN 10
Totality of facts approach
14

Source of Employment
• 3 Factors in DIPN 10 :
Where the contract is negotiated /
concluded / enforceable
Place of residence of employer
Where employee’s remuneration is paid
15

Source of Employment : 3 Factors in DIPN 10
• If the contract is negotiated concluded / enforceable
outside Hong Kong, and
• Place of residence of employer outside Hong Kong,
and
• Employee’s remuneration is paid outside Hong
Kong, then
– The employment is generally treated as sourced
outside Hong Kong.
If any one of the three factors is in Hong Kong, the
employment is sourced in Hong Kong.
16

Source of Employment : Totality of Facts
• Totality of Facts Approach :
– Where is the employment contract
enforceable?
– What is the nature of duties?
– Whether hold a post in / has employment
with a HK co.?
– Who pays / bears the remuneration?
– Is remuneration an expense of a HK co.?
– Are overseas duties incidental to HK duties?
17

Board of Review Case – D87/00
Although the three critical factors are outside
Hong Kong, CIR may still treat the employment
sourced in Hong Kong if other factors prove so.
CIR may rely on the “Totality of Facts” approach
in deciding the Source of Employment.
It is the taxpayer’s Burden of Proof to prove that
the employment is sourced outside Hong Kong.
18

Non-Hong Kong Employment
The Extended Charge – Section 8(1A)(a)
• Income arising in or derived from Hong
Kong includes all incomes derived from
services rendered in Hong Kong
[s.8(1A)(a)]
• Effectively imposes charge on income for
services rendered in Hong Kong in respect
to non-Hong Kong sourced employment.
19

Impact of s.8 (1) & (1A)(a)
• Local employment charged on full
salaries income – S.8(1)
• Overseas employment charged only on
services rendered in Hong Kong,
effectively counted on number of days
of services including proportion of
holidays – S.8(1A)(a)
20

Employment : Exemption from Salaries Tax
• when all services are rendered outside
Hong Kong, or
• 60-day rule of visit (i.e. an individual
stays in Hong Kong for 60 days or
less᳈in a year of assessment)
21

Visits
• Normally no permanent base in Hong
Kong
• Not with the intention to stay for work
on a continuous basis
22

Employment : Exemption from Salaries Tax
• Exemption of all services outside Hong
Kong and 60-day rule of visit NOT
APPLIED to:
• Office (i.e. director)
• Government employees
• Sailors, air crew or seafarers
23

60-day Rule of Visit
Apply to both:
– Hong Kong source employment, and
– Non-Hong Kong source employment
24

60-day Rule of Visit
for Hong Kong Source Employment
• All service done in HK 100% taxable
• Some service done in HK 100% taxable
• All service done outside HK 100% exempt
• Service is done in HK during visit:
- for 60 days or less 100% exempt
- for more than 60 days 100% taxable
25

60-day Rule of Visit
for Non-Hong Kong Source Employment
• All service done in HK 100% taxable
• Some service done in HK time-basis taxable
• All service done outside HK 100% exempt
• Service in done in HK during visit:
- for 60 days or less 100% exempt
- for more than 60 days time-basis taxable
26

Relief for Hong Kong source income
taxed in an overseas country
• Income exclusion rule under section
8(1A)(c)
• Tax credit paid in overseas countries set off
against Hong Kong salaries tax payable.
27

Exemption under Section 8(1A)(c)
• Two conditions are required to be
satisfied before the relief under
s.8(1A)(c) is allowed :
– When works in a country with similar tax
rules as those of HK salaries tax; and
– Actually paid tax on that part of income
to that foreign country
28

Dual Capacity
• Holds Office as well as Employment
• Divide remuneration between office
and employment
• Different rules apply
29

183-day Rule of
Anti-Double Tax Arrangement
• 183-day rule with non-residents
coming from countries or places
signed with a double taxation
arrangement with Hong Kong
30

183-day Rule of
Anti-Double Tax Arrangement
• This is different from 60-day rule of visit.
• Mainland Chinese is commonly used in examinations.
• The conditions for exemption are Mainland Chinese :
not employed by a Hong Kong company, and
staying in Hong Kong for 183 days or less in Hong
Kong in any continuous period of 12 months
commencing and ending in the year of assessment,
then, he or she is exempt from Hong Kong salaries tax.
31

183-day Rule of
Anti-Double Tax Arrangement
- Mainland Chinese stays in Hong Kong for 183 days or
less in Hong Kong in a continuous period of 12 months
commencing and ending in the year of assessment, he or
she is exempt from Hong Kong salaries tax if :
- he or she is not employed by a HK company, and
- his or her income is not finally borne by a HK company
32

Crews of Ship & Aircraft – S8(2)(j)
• Income not assessable if physical
presence in HK :
– Not more than 60 days in total in the year
of assessment, and
– Not more than 120 days in total for 2
consecutive years of assessment
33

Employment Income
Chargeable with Salaries Tax
Two Basic Principles:
• The receipt of income is derived from an
employment, and
• The income is in the consideration of
services performed in the past, present and
future.
34

Test of Income from Employment
• Is the receipt customarily expected?
• Is the receipt provided in the contract of
employment?
• Is the payment made for reasons other
than services rendered?
• Is it a gift or compensation?
35

Income Not Related to Employment
• If payment is remuneration for past,
present or future services, it is taxable.
• Voluntary payments for personal
reasons are generally not taxable.
• Compensation for loss of rights is
generally not taxable.
• A payment for agreeing to a restrictive
covenant is generally not taxable.
36

Example on Employer’s Voluntary Payment
• Employer gives an employee a lump
sum of $50,000 voluntarily in
recognition of the employee’s good
performance.
• Is this subject to salaries tax?
37

Example on Employer’s Voluntary Payment
• An employer gives a birthday gift of
$1,000 to the employee on his birthday.
• Is this subject to salaries tax?
38

Section 9(1)(a)
• Income from Office or Employment
– Wages, Salary, Leave Pay
– Fee, Commissions
– Bonus, Gratuity
– Perquisite or Allowance
– Holiday journey actually spent, irrespective of control
– Employee’s child education expenses paid by
employer, irrespective who is liable to pay
– Whether Paid by Employer or Others
39

Other Benefit Items
• Housing benefits : s.9(1)(b) and (c)
• Share options : s.9(1)(d)
• Share award : DIPN 38
• Benefits convertible into cash : s.9(2A)(a)
• Child education allowances : s.9(2A)(b)
• Holiday journey : s.9(2A)(c)
• Withdrawal in excess of proportional benefits
under approved ORSO / MPF schemes : S.8(4)
40

Assessable Income
• That item of income which should be
included in the calculation of total income
for Salaries Tax purpose
• Should be the aggregate amount of income
accruing to a person from all services
41

Summary of Income Chargeable to Salaries Tax
Specific Treatment
Accommodation
Rental refund
Share option
Share award
Holiday journey
Employee child’s
education expenses
Provident fund
Whether
liability borne
by employee
If no, exempt;
If yes, taxable.
General Taxation Principle
Whether
benefit
convertible
into cash
If no, exempt;
If yes, taxable
on second-
hand value.
Whether
enjoying
employer’s
facility
If yes,
exempt.
42

Fringe Benefits (Benefits in Kind)
Principle of Charge of Salaries Tax
• Benefit capable of being converted into money by
the recipient – income taxed at second hand value
• Payment is used to discharge the liability of an
employee, not the liability of an employer
• (Study page 111 of Hong Kong Taxation and Tax
Planning and Learning Pack of QP Module D)
43

Fringe Benefits (Benefits in Kind)
• Fringe Benefits specified in the IRO that
they are taxable at the cash equivalent
– Employer discharges an employee’s liability
– Employer pays school fee of an employee’s
child even though the arrangement is that the
employer discharges his own liability
44

Fringe Benefits : Holiday Journey
• Fringe Benefits specified in the IRO that they are
taxable at the cash equivalent
– Employer provides holiday journey (such as
purchase of air ticket or holiday package, etc., for
an employee) unless
a. the employer does not incur any additional cost in
the provision of such benefit; or
b. an expatriate employee for the first time he came
to Hong Kong to take up his or her post, or
c. his or her departure from Hong Kong after the
employment has been terminated.
45

Section 9(1)(a)(iv)
• Payment by Employer to Third Party in
discharge of Employee’s Primary Liabilities
• Identity of Liabilities is Crucial --
– If employee has no liability, not
assessable
– If employee has liability or obligation to
liability, assessable
46

DIPN 16 : Taxation of Fringe Benefits
For Benefits to be Included as Income
• Receipt of Cash or Cash Equivalent
• Convertible to Cash
• Discharge of Liabilities Committed by
Employee
47

DIPN 16 : Taxation of Fringe Benefits
• Confirm the Liability Test
• Specific Exclusion of Certain Benefits
– Company car provided by employer
– Recreational facilities provided by employer
– Payment of utilities with the bill in the name of
employer
– Interest free or low interest-rate loans provided
by employer
– Club benefits in the name of employer
48

DIPN 16 : Taxation of Fringe Benefits
• Special Tax Treatment on Private Expenses Paid
with Employer’s Credit Card
• Although it is the liability of employer to settle the
monthly statements of the corporate credit card,
the benefit is chargeable to the employee’s salaries
tax liability based on Liability Test.
Reason :
• It is the employee’s primary liability to settle the
private expenses on the spot.
49

Housing Benefits
Three different kinds of housing benefits
• cash allowance / rental allowance
• provision of quarters free or at a
reduced rate
• reimbursement of rent with or without
charge to employee
50

• Section 9(1)(b)
Provision of Residence
• Residence provided rent free - calculated at
rental value as a percentage of income -
– 4% for one room in hotel or hostel
– 8% for two rooms in hotel or hostel
– 10% for other cases
• Must be private and feasible for family
accommodation
51

• Section 9(1)(c)
Excess of Rental Value
• Where residence is provided at a rent
less than the rental value
• Included as income that part of excess
of rental value
52

Reimbursement of Rent (Rental Refund)
• Where residence is provided in terms of
reimbursement of rent -
• General rule of convertibility to cash is
applied
• Sufficient Control must be exercised for
reimbursement amount
• Otherwise treated as cash receipts
53

What is Sufficient Control?
• Duly Stamped Rental Agreement –
Normally no direct relationship
• Rental terms and conditions are reasonable
• Monthly or periodic rental receipts
• Notification of changes required from
employee
• Employees’ integrity is normally assumed
54

CIR v P.L.Page (2003)
• Taxpayer contracted with employer with a term
of housing reimbursement
• Employer paid the maximum amount without
identifying the actual rent paid by employee
• Employee paid actual rents that were more than
the capped maximum amount reimbursed by
employer
55

CIR v P.L.Page (2003) (Con’t.)
• Held: the capped amount “paid back” to Page
was taxable
What did we learn?
• Terms of contract a starting point & a
weighty factor, but not the SOLE test
• Conducts of parties varied the terms of
contract
56

Example on Rental Refund
• David receives salaries of $1,000,000.
• He rented a flat at $40,000 pm, and the employer
refunded $37,000 pm based on production of rental
receipts.
• What amount of rental value will be included as
income?
• $1,000,000 x 10% – 12 x ($40,000 – $37,000)
= $64,000
• Total assessable income=$1,000,000 + $64,000
= $1,064,000
57

Reimbursement (or refund) of Rents
• If IRD accepts the sum of $444,000
($37,000 x 12) relates to reimbursement of
rents, this amount is NOT included as
Assessable Income
• If IRD considers the sum more of a cash
payment without specific purpose (e.g.
because of insufficient control), the whole
amount of $444,000 is assessed
58

• Accept as Rental
Reimbursement:
Impact of Control on
Reimbursement of Rents
• Salaries $1,000,000
• Rent Reimbursement
$444,000
• Total Assessable
Income $1,064,000
• View as Cash
Payment:
• Same data as in the left
hand side
• Total Assessable
Income :
• $1,000,000 + $444,000
• =$1,444,000
59

Different Tax Liabilities
with Same Gross Income
• Thus, it is clear that with the same amount
of cash income ($1,444,000), tax liabilities
can be drastically different because of rental
arrangement.
• This is an example of Salaries Tax Planning
60

Gain on Share Options : DIPN 38
• Granting of share options by the employer or
related corporations does not constitute income
• Benefits deemed received at time employee
could notionally gain the benefits – s.9(1)(d)
and D43/99.
• Benefits recognized even with restrictions to
sell – D120/02.
• Subsequent transactions do not relate to
employment
61

Grant
of Option
Not
Taxable
Procedure of Grant of Share of Option
Exercise
of Option
Taxable
Market value at date of exercise A
– option cost B
– subscription cost C D
Taxable Gain E
Sale
of Shares
Not
Taxable
62

Example on Share Option
• Option granted by employer on 1/2/2011 to
buy 100,000 shares at $5, when market price is
$10 per share
• On 15/2/2012, exercises the option when
market price is $15 per share
• On 15/4/2012, sells the share in the market at
$20 per share
• What if the shares are sold at $12 per share?
63

Gain on Share Options
• In case that an employee does not exercise the
option, but sell the option to another employee
or sell back the option to the employer,
• taxable gain = amount received – cost incurred
64

Reference to :
• Open market value
• Restrictions on sale
• Quoted shares
• “Slump effect”
Valuation of Shares
• Brokerage, stamp duty or other charges
• Unquoted shares
65

Share Option : Restrictions on Sale of Shares
• Share options are sometimes granted on the
condition that restrictions will apply in
relation to the disposal of any shares
acquired under the scheme (e.g. as to when
or to whom the shares can be sold).
• The restriction on disposal of the shares are
relevant in determining the amount “which
a person might reasonably expect to obtain
from a sale in the open market”.
66

Share Option : Restrictions on Sale of Shares
• This is a valuation exercise to be undertaken
in the light of the facts of each particular
case.
• See for example, D120/02, IRBRD vol. 18,
125, where a 25% discount was allowed to
reflect the five year restriction period
against alienation of the shares.
67

Valuation of Quoted Shares
• Where the shares are listed on a stock
exchange,
• the open market value of the shares
acquired can be taken as the closing
quotation value for shares of the same kind
on the date the option is exercised.
68

Valuation of Quoted Shares : Slump Effect
• In practice, the Department will consider a request
for downward adjustment of the quoted value if
there is evidence to suggest that,
• because of the number involved, a sale of the
shares obtained from exercising the option would
only be possible at a reduced price,
• i.e. a “slump effect” would be induced if the shares
in question were to be made available for sale.
• This practice reflects the decision of the Board of
Review in case D46/95, IRBRD, vol. 10, 308.
69

Shares Listed in HK and Overseas
• If the shares are listed in Hong Kong and
overseas at the same time, it is normal
practice for the Department to adopt the
price quoted on the Hong Kong Stock
Exchange.
• If the shares are listed on two non-Hong
Kong exchanges, the taxpayer may select
the more favourable price.
70

Notional Expenses For Quoted Shares
• Once the open market value of the shares is
ascertained, it is accepted that any
brokerage,
stamp duty or
other charges
• that would have been levied if the notional
sale had actually taken place.
71

Unquoted Shares
• For unquoted shares, if it is not possible to
say that for all such companies there is a
single valuation method, e.g. reference to;
• “dividend yield”,
• “earnings yield” or
• “asset backing”.
72

DIPN 38 : Example 1
• The taxpayer had a Hong Kong employment.
He was granted an unconditional right to
subscribe for shares. He ceased employment
and exercised his option after cessation of
employment.
73

Answer to DIPN 38 : Example 1
• Cessation of employment does not prevent
the application of the share option
provisions. As the taxpayer concerned had a
Hong Kong employment at the time of grant
of the right, the relevant income was
derived from Hong Kong and accordingly is
chargeable to Salaries Tax in the year of
assessment in which the right is exercised.
• This approach has been endorsed in CIR v.
Sawhney, Subhash Chander, HCIA 1/2006.
74

DIPN 38 : Example 2
• The taxpayer had a Hong Kong employment.
All services were rendered in Hong Kong
prior to and during the year the unconditional
grant of the right was granted to him.
• During the year of assessment in which the
right was exercised, the taxpayer rendered all
services outside Hong Kong in connection
with the same employment.
75

Answer to DIPN 38 : Example 2
• As the taxpayer had a Hong Kong
employment, the gain would be treated as
having been derived from Hong Kong.
• The gain would only be excluded from the
charge to Salaries Tax by virtue of section
8(1A)(b)(ii), taking into account section
8(1B), if all services were rendered outside
Hong Kong in the year of grant of the right.
76

Answer to DIPN 38 : Example 2 (Con’t.)
• The gain, calculated in accordance with
section 9(4), would fall for assessment in the
year of assessment in which the right was
exercised.
• The fact that the taxpayer did not render any
services in Hong Kong during the year of
exercise would not in itself have any bearing
on whether the gain would be chargeable to
Salaries Tax, see D4/02, IRBRD, vol. 17, 400.
77

DIPN 38 : Example 3
• The taxpayer had a Hong Kong employment.
All services were rendered outside Hong
Kong in the year of assessment in which the
right was unconditionally granted, but
rendered inside Hong Kong during the year
of assessment in which the right was
exercised.
78

Answer to DIPN 38 : Example 3
• As the taxpayer rendered all services outside Hong
Kong during the year of assessment in which the
right was granted, and as it was granted on an
unconditional basis which did not involve services
being rendered in Hong Kong, it would be
accepted that the gain on realization should
qualify for exemption by virtue of section
8(1A)(b)(ii), taking into account section 8(1B),
notwithstanding the fact that the taxpayer was
rendering services in Hong Kong during the year
in which the right was actually exercised.
79

DIPN 38 : Example 4
• The taxpayer had a Hong Kong employment. The right
was conditionally granted, subject to the completion of
a vesting period of 2 years from 1.4.2000. The position
during the vesting period was as follows:
Year ended
31.3.2001
31.3.2002
More than 60 days in Hong Kong
rendering services
No services rendered in Hong Kong
He exercised the option on 1.7.2002. During the year
ended 31.3.2003, he did not render service in Hong Kong.
80

Answer to DIPN 38 : Example 4
• The chargeability of any gain on exercise would
not hinge on where (or if) the taxpayer was
rendering services in the year of assessment in
which the right was exercised.
• For a Hong Kong employment case, income can
only be excluded from the charge to Salaries Tax
if the taxpayer renders outside Hong Kong all the
services in connection with his employment
(taking into account the 60 days allowance
provided under section 8(1B)).
81

Answer to DIPN 38 : Example 4 (Con’t.)
• Accordingly, having regard to the latter point in
the previous paragraph, if during any year of
assessment included in the vesting period, the
taxpayer rendered services in Hong Kong during
visits exceeding 60 days, all of the gain from the
exercise of the option would be chargeable to
Salaries Tax.
• On the other hand, if during each such year the
taxpayer’s visits did not exceed a total of 60 days,
no part of the gain would be treated as chargeable
(section 8(1A)(b)(ii) and (1B) would apply).
82

Non-Hong Kong Employment
• Where a person has a non-Hong Kong employment
at the time of grant, the gain will have a non-Hong
Kong source and will not be chargeable to Salaries
Tax unless it is derived from services rendered in
Hong Kong.
• IRD will generally accept that no liability to
Salaries Tax arises where a right is granted on an
unconditional basis (or on completion of a vesting
period of a conditional grant) prior to a person
rendering any services in Hong Kong,
notwithstanding that the right may be exercised
after the person commences to render such services.
83

Non-Hong Kong Employment (Con’t.)
• Where a person with a non-Hong Kong
employment is granted the right subject to a
vesting period during which services are
rendered both in and outside Hong Kong,
• the gain can be partly attributed to services
in Hong Kong, the benefit should to some
extent be chargeable to Salaries Tax.
84

Calculation of Gain on Share Option
for Non-Hong Kong Employment
In the case of a non-Hong Kong employment,
however, the Department will generally accept
that it is equitable to have regard to
• the number of days in Hong Kong plus leave days
attributable to services in Hong Kong
• during the period from the date of conditional
grant to the date the employee became
unconditionally entitled to exercise the right (i.e.
the vesting period) to the total number of days in
the period,
• notwithstanding that it may only be exercised after
a further period.
85

Taxable
Gain
Calculation of Gain on Share Option
for Non-Hong Kong Employment
=
Days in Hong Kong plus
attributable leave
during vesting period
Total number of days in
the vesting period
x
Chargeable
gain
86

DIPN 38 : Additional Example (para. 48)
• Mr. A is an expatriate working for an overseas
company chargeable on time-basis on employment
income.
• He has a share option with vesting period from
1.1.2001 – 31.12.2002 (730 days).
• He rendered services in Hong Kong as visit:
40 days in year of assessment 2000/2001,
252 days in year of assessment 2001/2002,
0 day in year of assessment 2002/2003.
• He exercised the option in April 2002.
Question: How to assess gain on share option?
87

Answer to Additional Example (para. 48)
• The gain is taxable in year of assessment 2002/2003.
• The taxable gain = Total gain x (days of chargeable
income in 2000/2001 + 2001/2002 + 2002/2003) / 730
= Total gain x (0 + 252 + 0) / 730
• Year of Assessment 2000/2001 : No income is
assessable as Mr. A was less than 60 days in HK.
• Year of Assessment 2002/2003 : No income is
assessable as Mr. A did not carry out service in HK.
• Year of Assessment 2001/2002 : No. of days = 252
88

DIPN 38 : Example 5
• The taxpayer had a non-Hong Kong
employment.
• All services were rendered outside Hong
Kong in the year of assessment in which the
right was unconditionally granted,
• but rendered inside Hong Kong during the
year of assessment in which the right was
exercised.
89

Answer to DIPN 38 : Example 5
• As the taxpayer rendered all services outside
Hong Kong during the year of assessment in
which the right was granted, and
• as it was granted on an unconditional basis that
did not involve services being rendered in Hong
Kong,
• the right would accordingly be recognised as
having been derived from services rendered
outside Hong Kong.
• As such, the gain on exercise of the right would
not be chargeable to Salaries Tax.
90

DIPN 38 : Example 6
• The taxpayer had a non-Hong Kong
employment.
• All services were rendered in Hong Kong
during the year of assessment in which the
right was unconditionally granted,
• but during the year of assessment in which the
right was exercised, the taxpayer rendered all
services in connection with the employment
outside Hong Kong.
91

Answer to DIPN 38 : Example 6
• As the taxpayer rendered all services in
connection with the employment in Hong
Kong during the year of assessment in which
the right was granted, and as it was granted
on an unconditional basis which did not
involve services being rendered outside Hong
Kong,
• the gain on exercise would be fully
chargeable to Salaries Tax in the year of
exercise of share option.
92

DIPN 38 : Example 7
• The taxpayer had a non-Hong Kong
employment.
• Services were rendered inside and outside
Hong Kong :
during the year of assessment in which the
right was unconditionally granted and
during the year in which it was exercised.
93

Answer to DIPN 38 : Example 7
• If the right was unconditionally granted to the
taxpayer after he had commenced to render
services in Hong Kong, part of the gain would be
regarded as having been derived from services
rendered in Hong Kong.
• Accordingly, the assessable portion would be
calculated using “time basis” ratio applied in the
year of assessment of the grant.
• The fact that the taxpayer rendered some services
in Hong Kong during the year of assessment in
which the right was exercised would not in itself
have any bearing on whether the gain on exercise
would be chargeable to Salaries Tax.
94

DIPN 38 : Example 8
• The taxpayer had a non-Hong Kong
employment.
• The right was conditionally granted subject to
the completion of a vesting period during
which services were rendered partly inside
and partly outside Hong Kong.
95

Answer to DIPN 38 : Example 8
• In a case involving a non-Hong Kong
employment, because of the terms of
section 8(1A)(a), it is necessary to ascertain
the extent to which the income (i.e. the gain
on exercise) was derived from services
rendered in Hong Kong.
• The assessable portion would be chargeable
to Salaries Tax in the year of assessment in
which the right was exercised.
96

DIPN 38 : Example 9
• The taxpayer had a non-Hong Kong
employment at the time when the option was
conditionally granted subject to the
completion of a vesting period during which
the taxpayer’s employment was changed to a
Hong Kong employment within the same
group of companies.
• Issue: How to handle changes from Hong
Kong to non-Hong Kong employment or vice
versa during vesting period
97

Answer to DIPN 38 : Example 9
• As the option was derived by the taxpayer from both
the non-Hong Kong employment and the Hong Kong
employment, it is necessary to apportion the share
option gain, which can be done by simple time
apportionment, to ascertain the amount of the gain
attributable to each employment.
The portion attributable to the Hong Kong
employment : fully assessed or fully exempt.
The portion of the gain attributable to the non-Hong
Kong employment : fully exempt or further
apportioned.
98

Share Award
While share or stock award plans vary in
details, the points which need to be
addressed are –
• When does the perquisite accrue to the
employee?
• What value should be attached to the
perquisite when it has accrued to the
employee?
99

When Share Award Taxable?
• The first question can be considered in the light of
section 11D(b) of the Ordinance, which provides
that income accrues to a person when he becomes
entitled to claim payment.
• While this section uses the term “entitled to claim
payment”, in the situation of share award, this
phrase is taken to mean “entitled to ownership of
the shares”.
100

• Upfront approach
Types of Share Award
• Back-end approach
• Phantom share scheme
101

Share Award – Upfront Approach
• Characteristics:
Shares are given at the time of award.
There is a restriction for sale of shares.
• Taxable time: at the time of award of the
shares although there is a restriction for sale of
the shares.
• Taxable amount: Market value at the time of
award at a discount of 5% for each year of
restricted sale period.
102

Share Award – Back-end Approach
• Characteristics:
Shares are not vested in the employees at the
time of award.
Shares are vested when a certain period of time
or certain conditions have been satisfied.
• Taxable time: at the time when shares are
vested in the hand of employees.
• Taxable amount: Market value at the time of
vesting.
103

Share Award – Phantom Share Plan
• Characteristics:
No real shares are vested to employees at any
time.
The shares so allocated to employees are used as
a basis for payment of bonus at a future date.
• Taxable time: at the time when bonus is paid to
employees.
• Taxable amount: Bonus received by employees.
104

Dividend Paid on Share Award
• Upfront Approach
– Dividend paid with upfront approach is NOT
chargeable to salaries tax as the employee is a
shareholder of the company, and dividend is his
investment income which is exempt from salaries tax.
• Back-end Approach
– Dividend paid with back-end approach is chargeable
to salaries tax as the employee is not a shareholder of
the company, and the income is a part of his
remuneration derived from employment.
105

Upfront Approach vs Back End Approach
Upfront approach Back End approach
Vesting period No Yes
Time of
assessment
At the time
of the grant
Valuation Market value
at time of grant
Discount in
valuation
Upon fulfilment
of conditions
Market value
at time of fulfilment
of conditions
Yes No
Distribution Exempt Taxable
106

DIPN 38 : Example 10
• On 1.5.2005, while the taxpayer was an
employee of a group company in Hong Kong,
he was granted 5,000 shares by his employer
subject to a vesting period.
• On 1.7.2006, he resigned from the company.
• On 1.5.2007, the 5,000 shares vested in him.
• The value of the vested shares was $A on
1.5.2007.
107

Answer to DIPN 38 : Example 10
• In this example, the value of the vested
shares, $A, is to be included in the
taxpayer’s assessment for 2006/2007
according to section 11D(b) proviso (ii).
• Reason :
Shares vested after cessation of employment
are deemed to accrue on the last day of
employment.
108

Non-Hong Kong employment
• If shares are subject to a vesting period, they are
perquisite accruing to an employee in the year of
assessment in which vesting takes place. For an
employee who is entitled to time basis apportionment,
the factor is to be determined as follows –
Days in Hong Kong
in the year of assessment that vesting takes place
Days in the year of assessment that vesting takes place
109

DIPN 38 : Example 11
• The taxpayer had a non-Hong Kong employment.
On 1 May 2005, he was granted 10,000 shares by
his employer subject to a vesting period.
• Shares would only be vested on condition that he
remained an employee of his company on the
vesting dates. 5,000 shares vested in him on 1
May 2007 and the remaining 5,000 on 1 May
2008.
• The number of days in Hong Kong and outside
Hong Kong was ascertained as follows -
110

Year ended
DIPN 38 : Example 11 (Con’t.)
(A) (B) (C) %
Days in
HK
Days outside
H K
Total days (A) /(C)
31.3.2006 275 90 365 75
31.3.2007 260 105 365 71
31.3.2008 250 116 366 68
31.3.2009 255 110 365 70
111

Answer to DIPN 38 : Example 11
• In the above example, the assessor and taxpayer
agreed that the “back end” approach is applicable
to assess the vested shares.
• The value of first 5,000 vested shares is included :
– in the year of assessment 2007/08, and
– 250/366 of the value is to be subject to tax.
• The value of remaining 5,000 vested shares is
included :
– in the year of assessment 2008/09, and
– 255/365 of their value is subject to tax.
112

Inbound Employee Cases
• An employee holding a non-Hong Kong employment
may have been granted shares before he takes up his
employment or assignment in Hong Kong and such
shares are subject to a vesting period.
• If shares are vested in him after he takes up such
employment or assignment and the terms of the share
award clearly state that the vesting of the shares will
depend on a period of employment, IRD can agree to
exclude a portion of the gain on time apportionment
referable to the vesting period before the taxpayer’s
transfer to Hong Kong under the “Back End”
approach.
113

DIPN 38 : Example 12 – Inbound Employee
• On 1 September 2006, while the taxpayer was an
employee of a group company outside Hong
Kong, he was granted 10,000 shares by his
employer subject to a vesting period.
• Shares would only be vested on condition that he
remained an employee of the group on the vesting
dates.
• On 1 August 2007, he was transferred to another
company in Hong Kong within the group.
• The Department accepts that the taxpayer had a
non-Hong Kong employment.
114

DIPN 38 : Example 12 – Inbound Employee
• On 31 August 2007, 5,000 of the shares
vested in him.
• The vesting period for these shares totalled
365 days, i.e. 1.9.2006 to 31.8.2007.
• The number of days in the vesting period
after the taxpayer’s transfer to Hong Kong
was 31 days, i.e. 1.8.2007 to 31.8.2007 for
the first 5,000 shares.
115

DIPN 38 : Example 12 – Inbound Employee
• On 31 August 2008, the remaining 5,000
shares vested.
• The vesting period for these shares totalled
731 days, i.e. 1.9.2006 to 31.8.2008.
• The number of days in the vesting period
after the taxpayer’s transfer to Hong Kong
was 397 days, i.e. 1.8.2007 to 31.8.2008, for
these remaining 5,000 shares.
116

Period/
Year ended
1.8.2007 to
31.3.2008
Answer to DIPN 38 : Example 12
(A) (B) (C) %
Days in
HK
Days outside
HK
Total days (A) /(C)
166 78 244 68
31.3.2009 255 110 365 70
117

Answer to DIPN 38 : Example 12
This is a “back end” approach.
• If the vested shares of :
– the value of $A on 31.8.2007, and
– the value of $B on 31.8.2008,
• the amounts to be included in the assessments
would be calculated as :
– 2007/08 : $A x (31/365) x (166/244)
– 2008/09 : $B x (397/731) x (255/365)
118

Outbound Employee Cases
• Shares may have been granted to the employee
holding a non-Hong Kong employment during the
time of his employment or assignment in Hong Kong
but such shares, which are subject to a vesting period,
are vested in him after his transfer outside Hong
Kong to another group company.
• If the “Back End” approach is applicable and if the
terms of the award clearly state that the vesting of the
shares will depend on a period of employment, the
value of the shares attributable to the vesting period
before his transfer outside Hong Kong should be
chargeable to tax.
119

DIPN 38 : Example 13
• The taxpayer had a non-Hong Kong employment.
• On 1 October 2005, while the taxpayer was an
employee of a group company in Hong Kong, he
was granted 5,000 shares by his employer subject to
a vesting period.
• Shares would only be vested on condition that he
remained an employee of the group on the vesting
date.
• On 1 July 2007, he was transferred to another
company outside Hong Kong within the group.
120

DIPN 38 : Example 13
• On 1 October 2007, the 5,000 shares vested
in him.
• The vesting period for these shares totalled
730 days, i.e. 1.10.2005 to 30.9.2007.
• The number of days in the vesting period
before the taxpayer’s transfer outside Hong
Kong was 638 days, i.e. 1.10.2005 to
30.6.2007 for the 5,000 shares.
121

Period
1.4.2007 to
30.6.2007
Answer to DIPN 38 : Example 13
(A) (B) (C) %
Days in
HK
Days outside
HK
Total days (A)/(C)
65 26 91 71
122

Answer to DIPN 38 : Example 13 (Con’t.)
• This is a back end approach.
• Assuming the value of the vested shares on
1 October 2007 was $A,
• the amount to be included in the assessment
for the year 2007/08
• is to be calculated as :
– 2007/08: $A x (638/730) x (65/91)
123

Termination : Lump Sum Receipts
Principle of Charge of Salaries Tax
• Whether the sum is paid for services performed
Types of Lump Sum Receipts
• Payment in accordance with employment contract
• Voluntary payments
• Compensation payment
• Payment in lieu of notice
• Payment in lieu of leave
• Redundancy or severance payment
• Long service award
124

Example on Voluntary Termination Payment
• Mr. Wong, the chief accountant of
Company A, is required to early retirement
by paying a lump sum of $3,000,000 to him.
• If he does not accept the offer, contractually
he can work for 5 years more before the
normal retirement age comes.
• Is the sum of $3,000,000 assessable to
salaries tax? (Ref: D70/01)
125

Example on Termination Payment
Yung Tse-kwong v CIR (2003)
– lump sum received upon termination of
employment
• Sum found to be partly an taxable
inducement for entering into an
employment agreement;
• Partly non-taxable consideration for
entering into a restrictive covenant
126

Walter Alfred Heinz FUCHS v CIR (2011)
• Issue:
• Whether termination payment is chargeable
to salaries tax
127

Walter Alfred Heinz FUCHS v CIR (2011)
Facts:
• By a contract of employment, the Appellant
was seconded to work in the Hong Kong
branch of a German bank for three years.
• The Appellant’s employment was
prematurely terminated after two years. The
bank paid a sum of $18,276,667 to the
Appellant on termination of his
employment. The sum was comprised of
three elements:
128

Walter Alfred Heinz FUCHS v CIR (2011)
Facts (Con’t.):
(a) $3,120,000 being a sum equivalent to the
Appellant’s salary for the remaining term of the
employment contract (12 months) (“Sum A”);
(b) $6,240,000 being “two annual salaries for
duration of service with the bank”(“Sum B”);
and
(c) $8,916,667 being “the average amount of the
bonuses paid in the 3 previous years” (“Sum C”).
129

Walter Alfred Heinz FUCHS v CIR (2011)
Facts (Con’t.)
• A term in the employment contract
• In the event that the employer terminates …
this agreement … the employer shall pay to
the employee (i.e. taxpayer) as agreed
compensation or liquidated damages :
– 2 annual salaries (Sum B)
– an average amount of the bonuses paid in
the 3 previous years of your employment
with the Bank (Sum C).
130

Walter Alfred Heinz FUCHS v CIR (2011)
Facts (Con’t.):
• The assessor conceded that Sum A was nontaxable
but maintained the assessment in
respect of Sums B and C.
• By a determination, the Deputy
Commissioner confirmed the assessment.
131

Walter Alfred Heinz FUCHS v CIR (2011)
Decision of Court of Final Appeal
• Sum A was non-taxable
• Sums B and C taxable
132

Walter Alfred Heinz FUCHS v CIR (2011)
Reasons for the Decision :
• Payments made “in return for acting as or
being an employee” or “as a reward for past
services or as an inducement to enter into
employment and provide future services” are
income chargeable to tax under section 8(1).
• A payment is assessable as income from
employment where the sum is plainly an
entitlement under the contract of employment.
133

Walter Alfred Heinz FUCHS v CIR (2011)
Reasons for the Decision (Con’t.):
• Describing a payment as “compensation for
loss of office”does not displace liability to
tax.
• Where a payment is made in consideration
of the employee agreeing to surrender or
forgo his pre-existing contractual rights, the
payment is not taxable.
134

Walter Alfred Heinz FUCHS v CIR (2011)
Reasons for the Decision (Con’t.):
• Sums B and C were paid in satisfaction of
the rights which had accrued to the
Appellant, rather than in consideration of
the abrogation of his rights, under the
employment contract. Sums B and C
accordingly come within the charge to
salaries tax contained in section 8(1).
135

Payment in Lieu of Notice
• NOT Chargeable to Salaries Tax
• Reason
• It is not paid in consideration for services
rendered, but payment in compliance of the
Employment Ordinance.
136

Redundancy or Severance Payment
• Generally – NOT chargeable to salaries tax if
paid according to the provision of the
Employment Ordinance
• Excess over the requirements of the
Employment Ordinance may be assessable to
salaries tax (Advance Ruling Case No. 25)
137

Long Service Award
• By the general taxation principle, the sum is
paid in consideration for the past services of
an employee, and it is chargeable to salaries
tax.
• However, the method of calculation of long
service award and redundancy payment is
similar under Employment Ordinance. Thus,
as a matter of concession, CIR will charge
salaries tax on the excess payable over the
requirement of the Employment Ordinance.
138

Payment from Approved Provident Fund
Employee’s
contribution
Employer’s
contribution
Retirement Exempt Exempt
Death Exempt Exempt
Incapacity Exempt Exempt
Termination of Service
(Not due to retirement,
Not due to death,
Not due to incapacity)
Not at Termination of
Service
Exempt Assessable on
excess over
proportionate
benefit
Exempt Assessable
139

Payment from Approved Provident Fund
Proportionate
benefit
Accrued benefit
of the employee
(employer’s
= x
contribution)
at the date of
termination
of service
No. of completed
months of service
of the employee
120
140

May be related back
Contract Gratuity
Shorter of
Contract / Employment Period
or
36 months
• A taxpayer has the right to elect or not
to elect for spreading over the gratuity.
141

Types of Correspondence / Letters to IRD
• Replying to an IRD enquiry
• Lodgment of objections against incorrect
assessment
• Lodgment of s.70A claim for correction of
an error or omission in a tax return or
statement
• Application for holdover for provisional
profits tax
142

Replying to an IRD Enquiry
Points to pay attention to :
• Whether the information is relevant and
sufficient
• Tables and appendices with proper indexes
• Present information in a logical and
professional manner
143

Replying to an IRD Enquiry
• As a quality control measure, the draft reply is
reviewed by a senior officer of CPA firm
before the draft is sent to the client for review
• Allow sufficient time for the client’s review
and before the final reply is sent to IRD
• Follow up actions to ensrue that the client’s
tax position is agreed with IRD without delay
144

Objection Letter to IRD
Points to pay attention to :
• Note the time limit for objection and appeal
• Draft the grounds for objection and seek
client’s agreement
• Enclose audited accounts if it is a section
59(3) estimated assessment in the absence
of return
• Any possible grounds for late objection
145

S.70A Claim for Correction of Error / Omission
• Note the time limit for claim of correction
of error or omission under section 70A :
– within 6 years after the end of a year of
assessment, or
– within 6 months after the date on which the
relative notice of assessment was served,
• whichever is the later.
146

Holdover for Provisional Profits Tax
• Note the grounds for holdover of provisional profits
tax – especially the 90% rule of the profits of the
previous year of assessment
• Note the time limit for application of holdover for
provisional profits tax :
– not later than 28 days before the payment due date, or
– not later than 14 days after the date of the issue of the
notice of payment of provisional profits tax
• whichever is the later.
147

Study and Practice for Drafting Letters to IRD
• Chapters 11 of Learning Pack
• Sections 5.1 to 5.4
148

Question and Answer
For further details,
please refer to the book
“Hong Kong Taxation and Tax Planning”
written by Patrick Kin Wai HO
and
Module D Learning Pack (2nd edition)
(and supplement for June 2012)
149

Thank You
150