Proposed amendments to the Inland Revenue Ordinance
Proposed adoption of fair value accounting for financial instruments for tax reporting
Mr CHAN Chun-ying conveyed support of the banking industry for the legislative proposals put forward by the Administration. In relation to the proposals on fair value accounting, he enquired whether the amount of assessable profits arising from financial instruments computed on a fair value basis or a realization basis would have significant difference, and whether the Administration had assessed if the legislative proposals would be subject to judicial review. Mr Christopher CHEUNG was concerned that if a listed company was allowed to account for its financial instruments on a realization basis, it might be able to manipulate its financial results. Mr WU Chi-wai enquired whether a company could elect realization accounting for its tax computation after passage of the Bill.
DS(Tsy)2 pointed out that the Administration had been in contact with the Hong Kong Association of Banks and got its support for the legislative proposal. The Administration would continue to consult relevant stakeholders including the insurance industry and the securities industry on the legislative proposals. Deputy Commissioner (Technical), Inland Revenue Department (“DC(T)”) added that with effect from 1 January 2018, it had been compulsory for companies other than small and medium enterprises to adopt Hong Kong Financial Reporting Standard 9 (“HKFRS 9”) to account for their financial instruments. In accordance with the Court of Final Appeal’s ruling in Nice Cheer Investment Limited v CIR (2013) 16 HKCFAR 813 (“CFA’s ruling”), unrealized profits were not chargeable to tax. Therefore, profits computed on a fair value basis in accordance with HKFRS 9 would have to be recomputed on a realization basis for tax reporting. In order to facilitate companies and save their costs for re-computing their profits on a realization basis, the legislative proposal allowed companies to elect fair value accounting as a basis for tax computation in respect of their financial instruments. The election was optional but once made, it would be irrevocable and would have effect for the year of assessment in respect of which the election was made and all subsequent years of assessment. From the tax perspective, DC(T) explained that as long as both the amount of revenue and expenditure were computed on the same basis, it would not generate taxation problems. In the long run, the overall assessable profits arising from financial instruments computed on a fair value basis or on a realization basis would be the same. Besides, it would be difficult for a listed company to manipulate its financial results because the HKFRS 9 should be applicable to all financial instruments held by the company. According to the existing accounting standards, a company had to restate its balance sheets and profit and loss accounts in the previous financial years if there was a change of adopted accounting standard.
Proposed expansion of the definition of “overseas financial institutions”
Mr CHAN Chun-ying noted that under the legislative proposal to expand the definition of overseas financial institutions, the expanded definition would include an export credit agency, which was owned or established and operated by a foreign state or government (or any sub-division or local authority of a foreign state or government) for the purposes of supporting and developing international trade by providing financing support to its local exporters or investors for international export or overseas investment activities, so that interest expenses payable by the borrowers from such export credit agency could be eligible for interest deduction under IRO. He sought details of the term “overseas investment activities”, including whether it covered investment in overseas real estates.
DC(T) explained that there were foreign companies operating in Hong Kong and chargeable to Hong Kong profits tax. Such foreign companies might borrow money from overseas export credit agencies. While the Administration did not have the information requested by Mr Holden CHOW, it was estimated that the existing amount of loans granted by overseas export credit agencies was relatively small due to the absence of relevant tax deduction measures in Hong Kong. Nevertheless, a number of subsidiaries of foreign companies were planning to participate in infrastructure projects relating to the Belt and Road Initiative and some of them requested the Administration to provide tax deduction for their interest payments made on loans from overseas export credit agencies. Many jurisdictions provided tax deduction for similar interest expenses.
Latest developments on the application of the Convention on Mutual Administrative Assistance in Tax Matters in Hong Kong
Exchange of information under the Convention on Mutual Administrative Assistance in Tax Matters
Mr CHAN Chun-ying sought elaboration on the reservations (including tax recovery and tax examinations abroad) in the Declaration for Extension whereby Hong Kong would not provide certain types of assistance to other jurisdictions under the Convention. He asked whether jurisdictions such as Hong Kong’s AEOI partners would refuse to offer similar assistance to Hong Kong.
DS(Tsy)2 responded that as Hong Kong had been practising a territorial-based tax regime, it was unlikely that Hong Kong would need to ascertain a taxpayer’s liability by conducting tax examinations with other jurisdictions. As set out in item 11 in Annex C to the discussion paper (i.e. the list of reservations and declarations applicable to Hong Kong under the Convention), Hong Kong would not accept requests from other jurisdictions for conducting tax examination in Hong Kong given that tax examinations abroad was an optional provision of the Convention.
Noting that Hong Kong would conduct the first round of AEOI with other jurisdictions in September 2018, and that the Financial Account Information Returns (“AEOI Returns”) from 600 out of some 1600 reporting FIs were still outstanding by 2 June 2018, Mr CHAN Chun-ying enquired about measures the Administration would take to help the 600 FIs to furnish their AEOI Returns in the coming two months, the follow-up actions the Administration would take if FIs failed to furnish the required information to IRD within the prescribed timeframe, and whether IRD would exercise flexibility in handling late AEOI Returns or take enforcement actions against any late returns.
DC(T) advised that IRD had developed a dedicated platform, i.e. the AEOI Portal, for reporting FIs to submit their AEOI Returns electronically. The AEOI Portal had been operating smoothly and FIs had not indicated difficulty in using the system. IRD would adopt a facilitating approach and step up its work in helping FIs to submit AEOI Returns including arranging publicity to enhance FIs’ awareness of their obligations for submitting the returns and ensuring the returns would meet the required format and standard. IRD would conduct analyses on the received AEOI Returns to ensure the information provided (e.g. information on tax residences of account holders) was in order. The checking exercise was still underway and IRD would request the FIs concerned to take appropriate remedial actions if required.