Advance Ruling Case No. 54

1. The provisions of the Ordinance

This ruling applies in respect of section 14 of the Inland Revenue Ordinance ("IRO").

2. Background

(a)

The Company is a private limited company incorporated in Hong Kong. It is jointly owned by Family A based in Country A and Family B based in Country B. All the Company’s directors are non-Hong Kong residents.

(b)

Family A and Family B are partners in garment industry. Each owns 50% of Company C, a company incorporated in Hong Kong.

(c)

Companies D1 and D2 based in Country D and Company E based in Country E (collectively “the Overseas Manufacturers”) are the garment subsidiaries of Company C.

(d)

Company F in Country F, which is wholly owned by Family A, coordinates all the marketing activities. Family A directors and key executives of Group A based in Countries A, D and E contact customers, negotiate sales and purchase, initiate purchase orders from customers, route purchase and sales orders to the Overseas Manufacturers.

(e)

Shipments are arranged by the Overseas Manufacturers to customers directly. The goods will not pass through Hong Kong.

(f)

Company C pays a fee to Company F based on 5% of turnover introduced by Group A (“the Marketing Fee”).

3. The arrangement

(a)

The Company is set up as an intermediary between unrelated overseas customers and the Overseas Manufacturers. It purchases garments from the Overseas Manufacturers and resells them to the customers.

(b)

The Company shares an office with Company C and maintains a registered office in Hong Kong through an accounting firm.

(c)

The Company has established a branch outside Hong Kong (“the Overseas Branch”).

(d)

The Company maintains a liaison office in Country D and is in the process of establishing a similar office in Country E (collectively “the Overseas Offices”).

(e)

Some employees presently working for the Overseas Manufacturers will be re-deployed to the Overseas Branch and the Overseas Offices.

(f)

Family A directors will represent Company F to negotiate the terms of sales with customers. Customers will be introduced by Company F which will not have authority to conclude sales agreements with customers. All inquiries and contacts will be passed to the Overseas Branch.

(g)

The Marketing Fee to Company F will be paid by the Company.

(h)

The Overseas Branch is in charge of collecting purchase orders and initiating sales confirmation. The offer and acceptance of sales transactions will be concluded and centralized by executives in the Overseas Branch.

(i)

The Overseas Branch will initiate purchase orders to the Overseas Manufacturers.

(j)

The Overseas Offices will monitor production of goods and follow up shipment schedules with the Overseas Manufacturers.

(k)

The Overseas Branch will generate sales invoices, showing that Hong Kong is the port of loading and country of origin of goods, to customers and prepare full set of export documents. Copies of these documents will be passed to the Company’s Hong Kong office for negotiation and factoring.

(l)

The Company maintains bank accounts in Hong Kong for payments to the Overseas Manufacturers and collection of receipts from customers. It has obtained receivable finance from a bank in Hong Kong secured by a guarantee from Company C.

(m)

The Company will employ an accountant and an administrative clerk in Hong Kong to handle letters of credit (“LC”), present documents to the bank, operate bank accounts and keep records.

(n)

All the banking documents will be signed by the directors of Company C stationed in Hong Kong.

4. The ruling

The Company will be chargeable to Hong Kong Profits Tax under section 14 of the IRO in respect of its profits derived from transactions described in the arrangement.

5. The period for which the ruling applies

The ruling will apply for the years of assessment 2013/14 to 2015/16.

6. The material assumptions in respect of a future event or any other matter made by the Commissioner

The Commissioner has not made any assumption.

7 . Date of ruling issued

11 October 2013.

8. Commentary

(a)

Under section 14 of the IRO, every person who carries on a trade, profession or business in Hong Kong is chargeable to profits tax on the profits arising in or derived from Hong Kong.

(b)

The business of a trading company is recognised as involving the effecting of the contracts of purchase and sale. The concept “effecting” should involve more than the decision to accept an offer. It should be comprehended that obtaining trade facilities from banks is to give effect to the terms and conditions of the contracts of purchase and sale.

(c)

The issuing of LC and the negotiation and settlement of trade debts are an integral part of a trading company’s business. They cannot be ignored for all practical purposes within a commercial context.

(d)

If all parties involved have been attributed an arm’s length rate of profit having regard to their functions, assets and risks, it will be hard to conclude the profits attributed to the Company in Hong Kong should have a source outside Hong Kong.

(e)

In the present case, the Company’s involvement during the initiation, negotiation or conclusion stage of the trading transactions is not apparent. It is not clear whether the Company can have the right to reject any particular purchase order initiated by Company F, or the directors of Company C can transact business on behalf of the Company.

(f)

The goods may pass through Hong Kong since they can be loaded in Hong Kong with Hong Kong as its country of origin of the goods.

(g)

The Company’s Hong Kong office operates bank accounts in Hong Kong and negotiates trading documents with the bank for receivable finance. It handles all banking documents endorsed by Company C’s directors in Hong Kong to give effect to the settlement of the trading transactions. The operations of the Company enable the group to obtain trade finance with lower cost. It is the operations performed in Hong Kong that enable the Company to earn the profits in question.

(This commentary is not a legally binding statement and it does not form part of the Ruling.)