PLC Paper No. CB(1) 1208

Ref: CB1/BC/11/97

Paper for the House Committee meeting on 27 March 1998

Report of the Bills Committee on Inland Revenue (Amendment) (No. 2) Bill 1998

Purpose

This paper reports on the deliberations of the Bills Committee on Inland Revenue (Amendment) (No. 2) Bill 1998 (the Bill).

The Bill

2 The Bill mainly seeks to implement, with effect from the year of assessment commencing on 1 April 1998, the proposals in relation to profits tax in the 1998-99 Budget, which in turn arise from the comprehensive profits tax review conducted by the Administration in 1997. The profits tax proposals to be implemented are summarized as follows:

1. to reduce corporate profits tax rate from 16.5% to 16%;

2. to allow an immediate 100% write-off for new expenditure on plant and machinery specifically related to manufacturing, and on computer hardware and software, which are owned by end-users;

3. to expand the scope of tax reduction for expenditure on scientific research to cover capital expenditure incurred on market research, feasibility studies and other research activities related to business and management sciences;

4. to double the annual depreciation allowance for commercial buildings from 2% to 4%, to align it with that for industrial buildings;

5. to extend the deduction originally allowed only in respect of expenditure on hotel refurbishment to cover capital expenditure incurred on the refurbishment on all non-domestic buildings;

6. to provide a concessionary tax rate at 50% of normal profits tax rate for the offshore business of professional reinsurance companies authorized in Hong Kong;

7. to expand the scope of the exemption allowed in respect of mutual fund corporations, unit trusts and other similar collective investment schemes;

8. to provide for reciprocal exemption of Profits Tax for certain shipowners;

9. to provide an advance ruling service on a full cost recovery basis; and

10. to provide for the adjustment of losses between assessable profits chargeable to tax at normal and concessionary rates of tax.

The Bills Committee

3 At the meeting of the House Committee on 6 March 1998, Members agreed that a Bills Committee should be formed to study the Bill. Under the chairmanship of Hon Eric LI Ka-cheung, the Bills Committee held two meetings with the Administration and met with the Hong Kong Society of Accountants at one of the meetings. The membership list of the Bills Committee is at Appendix I.

Deliberations of the Bills Committee

4 While members of the Bills Committee welcome the proposed tax concessions, they are concerned that these concessions are to some extent offset by the clawback provisions in the Bill. The main concerns of the Bills Committee in this respect and other deliberations are summarized in the following paragraphs.

Clause 7 Expenditure on scientific research

5 This clause implements the proposal to expand the scope of deductions for capital expenditure on scientific research to cover activities carried on for the purposes of any feasibility study or in relation to any market, business or management research. Members are concerned that where a deduction is allowed under this provision, the proceeds of subsequent sale of the assets concerned will be fully taxed as trading receipt although proceeds of capital assets are otherwise not normally taxable. Since the aim of the provision is to encourage tax payers to invest in research and development, the Bills Committee also maintains the view that the plant and machinery used in scientific research and items more akin in nature to "a right" in, or arising out of scientific research should be treated in the same manner under the provision. In response, the Administration accepts the proposition that when the plant and machinery used in scientific research or the rights concerned are sold, only the proceeds to the extent of the deduction allowed, and not the full proceeds, should be taxed as trading receipt and agrees to propose Committee stage amendments (CSAs) accordingly.

6 In response to the Bills Committee’s concern about the appropriate treatment of research expenditure incurred before or after 1 April 1998, the Administration agrees to move a CSA to provide that the trading receipt provision will only apply in respect of expenditure incurred on or after 1 April 1998, where deduction is allowed under the new provision. In respect of continuing expenditure straddling 1 April 1998, the provision would be applied on a pro-rata basis in accordance with the Practices Notes to be issued by the Inland Revenue Department. Members find the proposed arrangements acceptable.

Clause 9 Section added

(16G Capital expenditure on the provision of a prescribed fixed asset)

7 This clause adds the provision to allow an immediate 100% write-off for new expenditure on prescribed assets. The Bills Committee does not agree with the provision under proposed section 16G(3)(a) that proceeds from the subsequent sale of the capital item concerned should be subject to tax at 100% as trading receipt. The Administration accepts the Bills Committee’s view and proposes a CSA to provide that in case of disposal of the plant and machinery concerned, only the proceeds to the extent of the deduction allowed would be regarded as trading receipt.

8 In view of the difficulties pointed out by the Bills Committee to unscramble the written down balance of existing specified fixed assets from the capital allowance pool, the Administration agrees to propose an appropriate CSA to provide for the residual value of prescribed fixed assets which are already in hand before 1 April 1998. Under the CSA, the taxpayer is allowed to elect, on an irrevocable basis, to write off the residual value of such items immediately or, if the residual value cannot be determined, to allow them to remain in the capital allowance pool and be written off in accordance with current depreciation allowances.

Clause 17 Sections added

(33A Annual allowances, commercial buildings and structures)

(33B Balancing allowances and charges, commercial buildings and structures)

9 This clause extends the annual allowance for commercial buildings from 2% to 4%, to bring it in line with the provisions relating to industrial building allowances. However, under the proposed section 33B, a balancing charge is imposed when the property concerned is sold. Since no such charge is levied previously, members are concerned that while the taxpayers will receive a tax benefit in the form of an accelerated tax allowance, the tax will be recaptured from the sales proceed when the building is sold. The Administration’s explanation is that since the annual allowance for capital expenditure on commercial buildings is brought in line with that for industrial buildings, it is reasonable that with the increase in annual allowance, the disposal of commercial buildings should also be subject to balancing allowance/charge as in the case of industrial buildings.

10 While not raising any further objection to the provision, the Bills Committee, however, notes the Hong Kong Society of Accountants’ observation that the increase in the tax allowance for commercial buildings is not a pure concession. With the introduction of the new balancing charge, some taxpayers could end up having to pay more tax in this respect.

Clause 30 Section added

(88A Advance rulings)

11 On the Bills Committee’s suggestion to improve the expanded advance ruling service, the Administration agrees that if the Commissioner of Inland Revenue declines an application for a ruling or withdraws a ruling made, the reasons for the refusal or withdrawal will be given in writing to the applicant. Members find the CSAs proposed in this respect acceptable. Noting that the Commissioner of Inland Revenue’s decision to decline or withdraw a ruling can be subject to judicial review, members accept that the circumstances under which the Commissioner of Inland Revenue may withdraw a ruling will not be specified in the legislation.

12 Members of the Bills Committee do not object to the Administration’s proposed CSA to add a provision to protect the Government against any liability in the provision of the advance ruling service.

Committee stage amendments

13 The draft CSAs proposed by the Administration, including those arising from the deliberations described above and others relating to technical and drafting aspects of the Bill, are in Appendix II.

Recommendation

14 The Bills Committee supports the Bill, subject to the CSAs to be moved by the Administration being in order, and recommends that Second Reading debate on the Bill be resumed.

Advice Sought

15 Members are invited to note the deliberations of the Bills Committee and support the recommendation at paragraph 14 above.

Provisional Legislative Council Secretariat
27 March 1998

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Bills Committee on Inland Revenue (Amendment) (No. 2) Bill 1998