Lion Limited (Lion Ltd) is an investment holding company incorporated in the British Virgin Islands (BVI). Its board of directors comprises members belonging to a Chan family residing in Hong Kong. Most of the top-level policies and the implementation of decisions are discussed between the board members and top management in Hong Kong.

Currently, Lion Ltd has a wholly owned Hong Kong subsidiary named Tiger Limited (Tiger Ltd), which was acquired by Lion Ltd in April 1996. It is managed and operating in Hong Kong and its principal business activity is trading of shoes and apparel. Tiger Ltd also holds 100% equity interest in another Hong Kong-incorporated company called CatLimited (Cat Ltd), and 20% equity interest in a company registered in Guangzhou called Mao Limited ("Mao Ltd).

Cat Ltd, which is centrally managed in Hong Kong, was set up by Tiger Ltd in early 2000s, at which time Cat Ltd directly acquired an office building in Shanghai. Such building is still owned by Cat Ltd as of today and used by the group. Mao Ltd is a limited function manufacturing enterprise in Guangzhou, and owns a factory building located in Guangzhou which is its major asset.

The management of Lion Ltd was recently approached by an unrelated Cayman Island company, Fish Limited (Fish Ltd). Fish Ltd proposed to acquire 100% equity interest in Tiger Ltd together with the 20% equity interest in Mao Ltd, but not any equity interest in Cat Ltd. The proposed acquisition was approved by the board in principle, except that an internal restructuring exercise would need to be conducted to spin off Cat Ltd prior to the acquisition. The following two steps illustrate the process of the acquisition:

Step 1: Tiger Ltd would transfer its 100% equity interest in Cat Ltd to Lion Ltd. The consideration would be determined based on an independent valuation report and would be settled by Lion Ltd by cash.

Step 2: Lion Ltd would then dispose of its 100% equity interest in Tiger Ltd to Fish Ltd. This deal is expected to be completed before the Lunar New Year in 2023.

Apart from the aforesaid information, the acquisition meeting was held between Lion Ltd and Fish Ltd. Lion Ltd was requested to provide additional information relating to Tiger Ltd as follows:

On 25 November 2020, the Inland Revenue Department of Hong Kong (IRD) issued a query letter to Tiger Ltd enquiring the purchase and sale mechanism with Mao Ltd in order to justify the offshore claim (i.e. profit derived was offshore in nature) made by Tiger Ltd for Hong Kong Profits Tax purposes. The total assessable profits in dispute between Tiger Ltd and the IRD is HKD1,000 million.

In respect of the disputed profits under investigation by the IRD, Tiger Ltd and Mao Ltd have entered a subcontracting agreement. Under the terms of the agreement Tiger Ltd sources raw materials from overseas suppliers using independent overseas agent. The overseas agents solicit and negotiate with the suppliers based on instructions from Tiger Ltd. Tiger Ltd then places orders with the suppliers to confirm the purchases, and sells the raw materials on to Mao Ltd at an arms length price (i.e. market price). Mao Ltd then produces products in China and sells the finish goods back to Tiger Ltd at an arms length price, before Tiger Ltd resell the products to customers in mainland China.

Beside the subcontracting agreement, Tiger Ltd has also signed a separate agency agreement with Mao Ltd, whereby Mao Ltd will assist Tiger Ltd in soliciting, negotiating and concluding sales orders in mainland China with full authority on Tiger Ltds behalf.

Upon completion of the acquisition of Tiger Ltd in the first quarter of 2023, Cat Ltd would acquire 100% equity interest in a company incorporated in Indonesia called Ox Limited (Ox Ltd) for long term investment purposes. It is planned that Ox Ltd will declare a special dividend to Cat Ltd and Cat Ltd will also declare a special dividend to Lion Ltd prior to the end of 2023.

Required

1) Pertaining to the proposed acquisition by Fish Ltd and the current holding structure

of Lion Ltd as well as the mode of operations of its group companies, discuss the relevant Hong Kong Profits Tax and Stamp Duty implications arising from each step of the acquisition, in particular:

a) the transfer of Cat Ltd from Tiger Ltd to Lion Ltd (Step 1); and

b) the transfer of Tiger Ltd from Lion Ltd to Fish Ltd (Step 2).

2) Critically analyse the Hong Kong Profits Tax implications on the offshore claim enquired by the IRD.

3) Discuss whether, and if so to what extent, the Hong Kong Profits Tax implications in relation to special dividends declaration prior to the end of 2023, in particular:

1. 1. a) the special dividend to be paid by Ox Ltd to Cat Ltd; and

   2. b) the special dividend to be paid by Cat Ltd to Lion Ltd.