Global is a group with parent company in Singapore which sells electronic consumer products. Similar to many multi-national companies, the Global group incorporated a company in HK called Local, and also two limited companies in the PRC, each of which operates a production factory. PRC1 operates a factory in Shunde, Guangdong for many years. PRC2 started operation in 2019 in Hebei.

The usual operation is that the Singapore parent company and other associated companies in the Asia Pacific Region decide what consumer goods are to be purchased from Local. Local places order with PRC1 and PRC2 for production, which then sell the finished goods to Local for onward sale by Local to the Singapore and Asia Pacific Region companies.

The normal practice is that Local purchases raw materials and component parts from suppliers in Hong Kong and overseas for onward sale to the PRC factories for production. After production the finished goods are sold to Local. However, gradually most of the purchases of Local are indeed acquired in Mainland China, made in name of Local as buyer, but with actual purchases done by the PRC factories on behalf of Local. Yet for a few supplies that are acquired and shipped from overseas, staff of Local in Mainland China places orders with overseas suppliers, and goods are shipped firstly to Hong Kong and then re-delivered to PRC1 and PRC2.

As certain advanced machines have to be acquired from overseas and it is practically difficult for the PRC factories to acquire machines from overseas, Local bought many machines and placed in the PRC factories premises. They are used by the factories for goods produced and sold to Local. For convenience, Local has not charged machine rental on the factories. Instead a lower price on

goods purchased from the PRC companies is concluded. In Hong Kong, Local claimed depreciation

allowances in tax returns for these machines acquired by it but used only in the Mainland factories.

In 2019 the group was chased by two overseas TV producers [as licensors] on the use of patent rights owned by them. Upon negotiation, licensing agreements were signed between the licensors and PRC1 [as user], and the user was required to pay license fee basing on the quantity of TV sets produced. The Global group arranged that Local paid the license fee on behalf of PRC1. The payment of license fee was therefore charged as part of the cost of purchases by Local.

Local acknowledges that it is treated as a trader with profit earned from purchases from PRC factories for onward sale to overseas customers. The Inland Revenue Department (IRD) treats all the profits of Local are subject to Profits Tax. The Global group considers that it has business activities mainly operating in Mainland China, and should be subject to Hong Kong tax at 50% only. Upon further enquiry, IRD raises that Local is not only subject to Profits Tax, the license fee ultimately paid by it is subject to withholding tax, i.e. payment to licensors should be liable to tax and be paid by Local to IRD on behalf of the licensors. It is also advised that Local is not eligible to claim depreciation allowance on the machines used outside Hong Kong.

Local is alarmed by such claims. Your CPA firm is approached to give advice. In the fact-finding meeting you understand that Local has an office in Hong Kong which functions to maintain the bank accounts in Hong Kong and to handle the goods received from overseas suppliers for onward transport to the PRC factories. All purchase orders for raw materials and component parts are placed direct by staff employed and worked in Mainland China. Also all sales activities including the issue of invoices, arrangement of shipment, the chase for payment etc. are done in Mainland China. The staff in Hong Kong does not manage the bank accounts on the receipt side, but prepares for payment of purchases. All books and records are kept in Mainland and the financial statements are also prepared there.

Explain withholding tax whether it is liable to be paid by Local to IRD.