Moon Hong Kong Limited ("Moon HK") carries on a business in Hong Kong, the shares of which are listed on the Hong Kong Stock Exchange. Moon HK was a manufacturer of cutlery. To take advantage of lower labour and other costs in the Mainland of China ("the Mainland"), Moon HK has set up a wholly owned subsidiary, Moon Manufacturing Limited ("Moon Manufacturing") in the Mainland for the manufacture of the cutlery. Moon Manufacturing was registered as a wholly foreign owned enterprise in the Mainland in the year 2015. Moon Manufacturing was granted a licence to carry on manufacturing and trading in the Mainland.
Moon Manufacturing Limited
The business licence of Moon Manufacturing is an import processing licence. It was so arranged that Moon HK would sell raw materials to Moon Manufacturing and, after processing, buy finished goods from Moon Manufacturing. Customs reporting documents show that Moon Manufacturing takes up the title of raw materials upon import and transfers the title of finished goods upon export. The sale and purchase contracts were prepared by the sale and purchasing department of Moon HK in HK office. The pricing of the raw materials and finished goods to/from Moon Manufacturing was determined on an arm's length basis. To fac ilitate the manufacturing process, moulds owned by Moon HK were transferred to Moon Manufacturing for its use, at no cost. However, the moulds are only used to manufacture finished goods supplied to Moon HK. In addition, a number of senior management staff employed by Moon HK are stationed in Moon Manufacturing to monitor and manage its operations.
Moon Overseas Limited
Moon Overseas Limited ("Moon Overseas"), incorporated and carrying on business in Country X, is a wholly owned subsidiary of Moon HK. From June 2019, Moon HK sells the finished goods to Moon Overseas at a price 20% below the market price. After that, finished goods are said to be sold by Moon Overseas to end customers in Hong Kong at a market price. Profits from sale of finished goods in the Hong Kong market are taken up by Moon Overseas. Moon Overseas is a tax resident in Country X and is taxed in Country X. Moon Overseas asserts that it does not have a permanent establishment in Hong Kong.
2
Required:
As the tax adviser for Moon HK, prepare a report for the board of directors addressing the following issues, from a Hong Kong tax perspective:
(a) The management of Moon HK has heard of the 50:50 offshore profits claim for Hong Kong tax reporting. With supporting references from tax authorities (e.g. DIPN, tax legislation or tax cases), explain the qualifying conditions for offshore profits claim and evaluate whether Moon HK could be entitled to such a claim.
(13 marks)
(b) The opinion of the assessor of Inland Revenue Department is that the arrangement between Moon HK and Moon Overseas was entered into for the purposes of shifting the profits from the former to the latter. Explain to the management of Moon HK, with reference to the transfer pricing principles and relevant tax rules, how the transaction between Moon HK and Moon Overseas can be chargeable and how the profits so shifted are to be brought back into charge in the context of the relevant provisions of the Inland Revenue Ordinance.
(11 marks)
Professional marks will be awarded in Question 1 for the appropriateness of the format and presentation of the report and the effectiveness with which the advice is communicated.