Tax Planning and Management

Case

Charming Fashion Limited was incorporated in Hong Kong in December 2018 by the Charming Group. Its principal activity was the manufacture of garments for sale. Calvin Chan was at all material times the Managing Director of Charming Fashion Limited.

In 2019, Charming Group set up another Hong Kong company in the name of Charming Garments Limited. In the same year Charming Garments Limited set up a Guangzhou Factory of which it was the sole shareholder.

Operations of Charming Fashion Limited commenced with the taking of sales orders from its United States customers. After the receipt of sales orders, the sales department would work out the costing for Calvin to make a decision whether to accept the order. The sales department (which comprised seven staff) was located in Hong Kong.

After the sales orders have been confirmed, the production department would arrange for production by the Guangzhou Factory. A production order, which was the responsibility of a team of three in Hong Kong, would be generated for each sales order. This production order sets out all the details including measurements, style, type of materials and quantity.

The purchase of raw materials was the responsibility of the purchasing department. This department has four staff situated in Hong Kong. They also make arrangements for transportation of materials and semi-finished goods between Hong Kong and Guangzhou.

At the time, there were about 60 workers in the Hong Kong factory, who would carry out part of the production procedures. Calvin explained that in order to meet the requirements for a Hong Kong Certificate of Origin for the goods, certain procedures must be carried out in Hong Kong.

By means of a Processing Agreement dated 1 January 2020 between the Guangzhou Factory and Charming Fashion Limited, the Guangzhou Factory agreed to undertake Charming Fashion Limiteds manufacturing process for the period from 1 January 2020 to 31 December 2021. Clause 4 of that agreement provided that the processing fee shall be agreed for each order according to the style of the goods.

On the same date, Charming Fashion Limited entered into a Procurement Agreement with Charming Garments Limited, whereby Charming Fashion Limited purported to appoint Charming Garments Limited as its PRC agent to secure exclusive production of the Guangzhou Factory for a term of three years from 1 January 2020.

Under Clause 2 of the Procurement Agreement, Charming Garments Limited undertook to ensure that the processing charges to be levied by the Guangzhou Factory shall be at normal market rate on usual commercial terms.

Clause 4 provided that Charming Garments Limited shall develop a Monitoring Programme to ensure that the Guangzhou Factory will comply with all applicable state and local laws and regulations pertaining to wages, overtime compensation, benefits, workplace conditions and safety.

Clause 9 of the Procurement Agreement provided that Charming Fashion Limited shall, in consideration of the covenants of Charming Garments Limited therein, pay Charming Garments Limited a consultancy fee of HK$400,000 per annum.

Two staff members have been transferred to Charming Garments Limited to perform the services which it was obliged to perform under the Procurement Agreement. They were then assigned by Charming Garments Limited to station in the Guangzhou Factory to supervise and monitor the production activities.

This included a plant manager who stayed in the mainland from 1 January 2020 to 31 May 2020; as well as another production supervisor who was shown to have stayed in the mainland from 1 September 2020 to 31 March 2021. The monthly salary of these two employees amounted to HK$30,000 and HK$17,000 respectively.

An extract of Charming Fashion Limiteds profit and loss statement for the year ended 31 March 2021 shows the following results:

	HK$	HK$
Sales		3,000,000
Less: Processing fee	800,000
Other costs of sales	700,000	(1,500,000)
Gross Profit		1,500,000
Less: Consultancy fee	400,000
Other operating expenses	700,000	(1,100,000)
Net Profit		400,000
Assessable profit (50:50)		200,000

The Assessor has raised a Profits Tax assessment for the Year of Assessment 2020/21 which disallowed deduction of the HK$400,000 consultancy fee and also assessed the net profit of HK$400,000 in full. An objection was raised by Charming Fashion Limited against the aforesaid Profits Tax assessment.

Requirements as a (TAX PAYER)

• Statement of facts and statement of issues
  • TP presents a factual statement explaining the reason for their appeal
  • TP presents a clear statement of issues which should be agreed with IRD in advance
• TP arguments - TP presents their legal and factual argument.
• TP summary