Advance Ruling Case No. 48

1. The provisions of the Ordinance

This ruling applies in respect of sections 14 and 16 of the Inland Revenue Ordinance ("IRO").

2. Background

(a)

The Company, a Hong Kong incorporated company, is a wholly owned subsidiary of Group A. Group A, with its headquarters located outside Hong Kong, is principally engaged in the development, manufacturing, distribution and retailing of various products, including Product P.

(b)

The Company is engaged in retailing activities in Hong Kong and is designated as Group A's distribution hub for most of the products in the Asia Pacific region.

(c)

Company B is a wholly owned subsidiary of Group A. The distribution and retailing of Product P in Sub-region S was handled and housed under the Sub-region S branch of Company B ("B-branch"). Sub-region S is located outside Hong Kong.

(d)

According to Group A's plan in streamlining its structures, the business of distribution and retailing of Product P in Sub-region S is integrated into the Sub-region S branch of the Company ("the Branch"). The Branch is managed and operated by a team of staff in Sub-region S who work independently from the Company's office in Hong Kong.

3. The arrangement

(a)

All the business and employees of B-branch are transferred to the Branch. All these employees are local people living and working in Sub-region S and they are not required to perform their duties in Hong Kong.

(b)

The Company has entered into non-exclusive distribution agreements with its overseas associated companies ("the Suppliers"). Under the distribution agreements, the Company is granted the right to distribute Product P in Asia Pacific region. The Company purchases Product P from the Suppliers for its further distribution and for its own retailing in Hong Kong.

(c)

The Company is required to adhere to all Group A's business policies. The product retail/wholesale suggested prices, product categories, terms of delivery and payment conditions etc. are all pre-determined and centrally governed by Group A. The transfer prices of Group A for all related party transactions are determined and coordinated internally by Group A's headquarters outside Hong Kong in a manner which meets the arm's length standard such that Group A's distribution companies earn an arm's length return.

(d)

Every year, the Branch will attend meetings with the Suppliers outside Hong Kong. The Suppliers will provide the product price list to the Branch. The purchase plans and annual sales budget prepared by the Branch, and all the sales terms (including the product prices) are negotiated and concluded between the Branch and the Suppliers directly outside Hong Kong. The approved annual sales budget is then uploaded by the Branch to Group A's internal ordering system. The Company's Hong Kong office is not involved in the discussions and negotiations between the Branch and the Suppliers.

(e)

Purchase order is placed by the Branch directly with the Suppliers via Group A's internal ordering system. Order confirmation is sent directly from the Suppliers to the Branch. The Company's Hong Kong office does not have any authority to accept, reject or amend any details in the order confirmation.

(f)

The staff of the Branch contact and liaise directly with unrelated wholesalers in Sub-region S. The wholesalers place orders with the Branch. The wholesale managers of the sales team in the Branch have the ultimate authority to conclude the sales terms with the wholesalers and to approve the purchase orders from wholesalers.

(g)

The goods are shipped directly from the Suppliers outside Hong Kong to the Branch in Sub-region S. The Suppliers inform the Branch directly on the shipment details.

(h)

The Suppliers issue invoices to the Branch. The staff of the Branch also issue invoices to its (wholesale) customers.

(i)

The Branch settles its accounts with the Suppliers through Group A's netting system. The customers of the Branch settle their accounts with the Branch by cheque deposited into the Branch's bank accounts in Sub-region S.

(j)

The after-sales services are handled by the local service team of the Branch in Sub-region S.

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

There are no assumptions made by the Commissioner.

5. The ruling

(a)

The Company will not be chargeable to Profits Tax under section 14 of the IRO in respect of the profits derived by the Branch from its sales of Product P to the unrelated customers in the Sub-region S market, as described in the arrangement.

(b)

All the associated expenses to be incurred by the Company for the generation of the profits mentioned in 5(a) above will not be deductible under section 16 of the IRO.

6. The period for which the ruling applies

This ruling will apply for the year of assessment 2010/11 and subsequent years of assessment.

7 . Date of ruling issued

7 November 2011.

8. Commentary

(a)

Under section 14 of the IRO, every person who carries on a trade, business or profession in Hong Kong is chargeable to profits tax on the profits arising in or derived from Hong Kong. In the present case, the contracts of purchase and sale of Product P by the Branch would be effected outside Hong Kong. Therefore, section 14 does not apply to the profits to be derived by the Branch from its sales of Product P in Sub-region S.

(b)

The Company's associated expenses, not incurred in the production of assessable profits, are not deductible under section 16 of the IRO.

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