Advance Ruling Case No. 55

1. The provisions of the Ordinance

This ruling applies in respect of sections 14, 16, 19C, 51, 61A and 61B of the Inland Revenue Ordinance (“IRO”).

2. Background

(a)

Company A and Company B are private companies incorporated in Hong Kong. Their ultimate parent company was incorporated in Country C.

(b)

Company A is engaged in manufacturing and sale of electronic components while Company B is engaged in trading of electric and electronic products.

(c)

The Group underwent business and operation restructuring in the Asia Pacific region, including Country C and Hong Kong, to eliminate any unprofitable business. In the restructuring exercise, Company A transferred most of its business to a third party.

(d)

Before the transfer, the directors of Company A stated in the Directors’ Report that the business of the company was subject to disposal to the third party and the directors planned to put Company A into liquidation. The statement of financial position of Company A further revealed that all property, plant and equipment had been disposed of and Company A was in a net liability position.

3. The arrangement

(a)

Company A and Company B will be amalgamated with Company B as the amalgamated company (“the Amalgamation”) under Division 3 of Part 13 of the Companies Ordinance (Cap. 622) (“the CO”).

(b)

Pursuant to the CO, the legal effect of the Amalgamation is that on and after the effective date of the Amalgamation:

(i)

Company A ceases to exist as an entity separate from Company B; and

(ii)

Company B succeeds to all property, rights and privileges, and all liabilities and obligations of Company A.

4. The ruling

(a)

Section 61A of the IRO may be invoked and the un-utilized loss of Company A sustained prior to the Amalgamation will not be allowed for setting off against the assessable profits of Company B, the amalgamated company, under section 19C of the IRO.

(b)

Whether there is any change in the shareholding of Company A and Company B after the Amalgamation requires an analysis of the facts of the case. Section 61B may be invoked if appropriate.

(c)

As no business will be carried on by Company A, the interest expense on loan borrowed to finance Company A’s working capital will not satisfy section 16 of the IRO, and thus will not be deductible under Company B.

(d)

Ruling on other issues is declined.

5. The period for which the ruling applies

This ruling applies for the year of assessment 2014/15, in which the Amalgamation is expected to take place, and all subsequent years of assessment.

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

9 February 2015

8. Commentary

Section 61A of the IRO counteracts transactions entered into for the sole or dominant purpose to obtain a tax benefit.

Section 61B of the IRO counteracts against tax avoidance by empowering the Commissioner to refuse to set off losses brought forward where he is satisfied that the sole or dominant purpose of a change in shareholding was the utilization of those losses to avoid or reduce tax liability.

In the commercial world, it is not uncommon for two or more companies to amalgamate into one company through business restructuring. In general, the main reason for amalgamation is to maximize profits through synergy of cost saving, operational efficiency, market diversification or reduction in competitors, etc.

In the present case, Company A had neither business nor assets after the transfer of its business to the third party. Its directors planned to close it down by way of liquidation. Apparently, there is no commercial justification for the Amalgamation except an attempt to obtain tax benefits through utilizing the unabsorbed loss sustained by Company A to reduce the tax liability of Company B.

(This commentary is not a legally binding statement and it does not form part of the Ruling. For assessment practice, please click here.)