Question 4

X-mas Ltd (X-mas) carries on business in Hong Kong as a manufacturer and trader of toys. During the year ended 31 March 2019, X-mas incurred a royalty expense of $400,000 in respect of the trademark TnMe. TnMe is owned by a US incorporated company, Toys-n-Me Inc, and has been developed by its in-house research team.

Under the trademark license agreement, X-mas is granted the right to use TnMe in its manufacturing process in Mainland China. All of these manufactured products are then sold by X-mas in Hong Kong, and all the profits arising from their sale are returned as taxable profits by X-mas for Hong Kong tax purposes. The royalty cost for the use of the trademark is payable to Toys-n-Me at the rate of 1% of the gross sales of the products bearing the trademark. Toys-n-Me Inc does not carry on a business in Hong Kong and has no relationship to X-mas, except for the trademark licence agreement.

Required:

(a) Discuss whether or not Toys-n-Me Inc will be subject to tax in Hong Kong in respect of the income received from X-mas Ltd.

(b) Assuming that Toys-n-Me Inc is subject to tax in Hong Kong, calculate its estimated profits tax liability for the year of assessment 2018/19.