2010 Jun Q1

1 Mr Man, a Canadian resident, holds two Hong Kong incorporated companies carrying on business in Hong Kong, asfollows:On 1 June 2010, Mr Man held a meeting with the senior staff of HK Co2 including the Treasurer, Finance Controller,Legal Advisor and Personnel Director, to discuss a proposal to spin off the Patent B business from HK Co2 to HK Co1.The meeting notes are extracted as follows:(1) The Finance Controller explained that the assets of the Patent B business are to be transferred to HK Co1 at theirnet book value of $12 million, comprising accounts receivables ($8 million), trading stock ($3 million) and plantand machinery ($1 million). The transfer price will be $20 million, giving a profit of $8 million to HK Co2. Noliabilities will be transferred.(2) The Treasurer raised the question as to how HK Co1 should be funded to acquire the Patent B business fromHK Co2. He warned that HK Co1 is currently only an investment holding company and does not have any surpluscash. If an internal source of funding is preferred, it will have to be provided by Mr Man, either as equity or aloan. Alternatively, a bank loan may be sought but Mr Man is likely to be required to provide a guarantee to thebank, either in his personal capacity or by placing some deposits with the bank. The Treasurer also soughtguidance as to how the sale proceeds would be used by HK Co2.(3) The Legal Advisor reminded that Patents A and B are currently owned by Mr Man and registered in his name,and are both only licensed to HK Co2. A royalty is payable at a lump sum of $1 million per annum for eachpatent. After the restructuring, the licensing structure would need to be revised to enable HK Co1 to usePatent B.(4) The Personnel Director stated that the staff are all currently employed by HK Co2 for both businesses. In termsof those staff working for the Patent B business, their employments may need to be transferred to HK Co1 butthis may give rise to provident fund issues. He preferred not to change these employments.(5) Mr Man noted all the issues raised, and agreed to give the proposal more detailed consideration.After the meeting, Mr Man approached you to seek tax advice on his proposed business restructuring, in particularon the issues raised by his staff during the meeting.4HK Co1HK Co2Patent A(loss-making)Patent B(profitable)Mr ManRequired:Prepare a report for Mr Man, giving your advice on the proposed restructuring of the Patent B business. The reportshould address the Hong Kong tax implications arising from the restructuring and cover the issues raised duringthe meeting as follows:(a) Acquisition of the Patent B business by HK Co1 from HK Co2(i) The profits tax implications to HK Co2 as the seller in respect of the assets sold and the profits madefrom the sale. (5 marks)(ii) The profits tax implications to HK Co1 as the buyer of the assets. (6 marks)(b) Funding of the acquisition(i) The profits tax implications to HK Co1 if the acquisition is funded by an external bank loan. (3 marks)(ii) The profits tax implications to both Mr Man and HK Co1 if the acquisition is funded by an internal sourceof funds from Mr Man. (4 marks)(c) Revised licensing structure(i) The profits tax implications, including reporting obligations, to HK Co1, HK Co2 and Mr Man if thecurrent licence of Patent B to HK Co2 is terminated and replaced by a new licence to HK Co1.(5 marks)(ii) The profits tax implications to HK Co1, HK Co2 and Mr Man if the current licensing structure is toremain unchanged. (4 marks)(d) Staff employment(i) The Hong Kong reporting obligations of HK Co1 and HK Co2 if the staff of the Patent B business are tobe transferred to HK Co1. (3 marks)(ii) What alternative you would suggest if all of the staff have to remain under HK Co2’s employment.(6 marks)Note: you should ignore Hong Kong provisional tax and overseas tax throughout this question.Professional marks will be awarded in question 1 for the appropriateness of the format and presentation of thereport and the effectiveness with which its advice is communicated. (2 marks)(38 marks)

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