BUSI 0085 Advanced Topics in Taxation Discussion Questions Unit 4 Anti-avoidance Provisions

Answer 7 (a) Matters taken into account in deciding whether any transaction is entered into with a purpose of enabling a person to obtain a tax benefit: s.S.61 s.61 is to attack transactions which are "artificial or fictitious" and the effect of which is to reduce the amount of tax payable by any person. What is "artificial or fictitious" is not defined in the Ordinance. "Artificial" is not a mere synonym for 'fictitious' and it means something which is not natural, not normal, or ordinary. Fictitious means counterfeit, not genuine and unreal. A fictitious transaction is one which those who are ostensibly the parties to it never intended should be carried out. It may be a sham transaction which never legally takes place and where the parties never intend to give any effect to the apparent disposition they have given. Where a transaction is at arm's length, it will be very difficult for the assessor to invoke Section 61. In order to determine whether a transaction is "artificial", or "fictitious", the circumstances in which it was made and carried out should be examined. In this respect it is necessary to refer to case law. In Kum Hing Land Investment Co. Ltd. v C.I.R. the taxpayer paid a commission to a company partly owned by its senior director and claimed that it was a negotiating commission paid on successfully securing a lease agreement on behalf of the taxpayer company. It was held by the court that with regard to s.61 of the IRO, the word transaction includes the whole of any particular transaction, not merely part of it. The payment and receipt of the commission is only part of the whole transaction (from the inception of the idea to pay commission to the final completion of the deal). When an assessor is considering whether or not a transaction is artificial or fictitious, there is nothing in the IRO preventing him from taking into consideration all the surrounding circumstances. Although a part of the transaction (i.e. payment and receipt of commission) might be real, the transaction as a whole could be held as both artificial and fictitious. The Supreme Court supported the views of the Commissioner and disregarded the payment of the commission, as being both artificial and fictitious under s.61 of the IRO. In C.I.R. v Rico Internationale Ltd., the court held that with regard to the commission paid by the taxpayer to associated companies, this was a "sham" and not "bona fide" arm's length commercial transaction. Therefore only that part of expenses incurred in the production of assessable income was allowed.

TA_U4_Anti-avoidanceProvisions

s.61A s.61A applies to a transaction which has the effect of conferring a tax benefit upon a taxpayer, and it can be concluded that the taxpayer entered into or carried out the transaction for the sole or dominant purpose of obtaining that benefit. As per DIPN 15 (revised), s.61A is to be used to strike down blatant or contrived tax avoidance arrangements. It should not cast unnecessary inhibitions on normal commercial transactions by which taxpayers legitimately take advantage of opportunities available for the arrangement of their affairs. However, s.61A only applies when the non-tax purposes of a taxpayers transactions (even if they are legitimate) are clearly outweighed by the tax purposes. Transaction for the purpose of s.61A, means a transaction, operation or scheme, whether or not enforceable or intended to be enforceable by legal proceedings (s.61A(3)). When considering whether a transaction has been entered into for the sole or dominant purpose of obtaining a tax benefit, the whole transaction, operation or scheme must be considered. Tax benefit for the purpose of s.61A means the avoidance or postponement of the liability to pay tax or the reduction of a tax amount (s.61A(3)). To determine whether the sole or dominant purpose of a transaction entered into by a taxpayer was to obtain a tax benefit, s.61A clearly spells out seven matters that are to be taken into account. The IRD considers that the ultimate conclusion on the sole or dominant purpose of a transaction is an objective one to be drawn on the basis of that transactions external features viewed in their proper context. The seven matters are: Matter 1 The manner in which the transaction was entered into or carried out - the background and alternative purposes attributed to the parties entering the transaction. Matter 2 The form and substance of the transaction - it is necessary to compare the legal effect of the transaction with its commercial end result. Matter 3 The result which would be achieved by the transaction - it involves a comparison of the result which would arise out of the operation of the IRO with the result which would arise if the transaction had not been entered into. Matter 4 Any change in the financial position of the relevant person that has resulted, will result, or may reasonably be expected to result, from the transaction; Matter 5 Any change in the financial position of a person who has any connection with the relevant taxpayer arising out of the transaction.

TA_U4_Anti-avoidanceProvisions

Matter 6 Whether the transaction has created rights or obligations which would not normally be created between persons dealing with each other at arm's length under a transaction of the kind in question - in making this comparison due regard must be given to the surrounding circumstances. Matter 7 The participation in the transaction of a corporation resident or carrying on business outside Hong Kong. Matters 1 and 2 look at the manner and background in which the transaction was entered into. Both form (legal obligations and effects) and substance (commercial end) are considered and compared. Matters 3 to 5 examine the amount of tax saving (or financial implications) of any person connected with the transactions. Matters 6 and 7 are matters which if present can be relevant indicators of a purpose of obtaining a tax benefit, although they are not conclusive. The introduction of s.61A helps clarify the considerations based on which the tax authority makes the determination whether a transaction amounts to a tax avoidance scheme or arrangement. In fact, many of these considerations are already applied in case law and followed by the Inland Revenue in applying s.61 to determine if a transaction is artificial or fictitious. (b) Powers conferred upon either the assessor or the assistance commissioner under s.61 and s.61A of the IRO: S.61 empowers an assessor to disregard any transaction or disposition where he is of the opinion that such transaction is artificial or fictitious and would reduce the amount of tax payable by any person. That is to say the person concerned shall be assessed accordingly as if the transaction or disposition has not taken place. Where a transaction is found to be entered into with the sole or dominant purpose of enabling a person to obtain a tax benefit in accordance with s.61A(1), s.61A(2) empowers the Assistant Commissioner to raise an assessment by either of the following methods: (a) (b) as if the transaction or any part thereof had not been entered into or carried out, in such manner as the assistant commissioner considers appropriate to counteract the tax benefit which would otherwise be obtained.

In other words, he will make an assessment on the basis that the transaction did take place but was entered into in the manner normally employed in carrying out such a transaction by parties at arm's length. A manner appropriate to counteract a tax benefit may involve via making adjustments to assessments for years subsequent to the year of assessment in which the transaction is entered into or to assessments of other persons affected by the transactions.

TA_U4_Anti-avoidanceProvisions

Answer 8 (a) Section 61B is used to restrict the trafficking of loss companies for purpose of tax avoidance. It disallows losses set-off if the CIR is satisfied that the SOLE or DOMINANT purpose of any change in shareholding in a company was for the purpose of utilising such losses to obtain a tax benefit. s.61B applies if 1. A change in shareholding has been "effected" after 13.3.1986, and 2. CIR is satisfied that as a direct or indirect result of the changes, profits have been received by or accrued to the company during ANY year of assessment (i.e. not necessarily in the year subsequent to the change); and 3. Utilisation of the loss is the "sole or dominant" purpose of the change in shareholding. "Effected" means shares transferred from one person to another. The transferee may or may not be an existing shareholder, and the transferor may or may not continue to be a shareholder. In deciding whether profits have been received, the flow of profits before or after the change will be examined in particular with reference to (a) (b) (c) (d) nature and conduct of the company's business, income and expenditure patterns, management and control. background of the party to whom shares were transferred.

"Dominant purpose" means the purpose, which outweighs all other purposes combined. Based on the facts provided, the acquisition of the shares in Brown Ltd by Cheer Ltd may have risk under anti-avoidance provisions depending on: (I) (II) whether or not profit arises in Brown Ltd as a result of the change in shareholding; and whether or not the sole or dominant purpose of the acquisition is for utilising the loss of Brown Ltd.

If it can be proved that the acquisition of the 2/3 of shares in Brown Ltd is intended to continue and improve the existing business of Brown Ltd, and there is no profit arising as a result of the acquisition; it can be argued that the sole or dominant purpose of the acquisition is not to utilise the tax loss of Brown Ltd. Any profit attributable to the change in management and control or business strategy or even financial assistance from Cheer Ltd after the acquisition will be considered as commercial reward, not as a result of the share transfer. In the circumstances, losses sustained in the assessments of Brown Ltd in the previous years could be used to set off against the future profits, if any, accrued to Brown Ltd. Nevertheless, Cheer Ltd should be aware of the possible challenge by the Inland Revenue on the basis of Section 61A. It is advisable for Cheer Ltd to obtain an advance ruling on the acquisition proposal in respect of the treatment of the losses brought forward, if it is going to take over the shares of Brown Ltd.

TA_U4_Anti-avoidanceProvisions

To Cheer Ltd, the benefit is only limited to the investment in Brown Ltd. earning dividend income which is non-taxable. The accumulated loss is attached to Brown Ltd. By acquiring the shares of Brown Ltd would not render Cheer Ltd to enjoy the tax loss benefit since HK does not operate on a group loss relief basis.

(b) Main Points: Explain s.61A and the seven matters; The threshold question is whether the taxation advisers suggestion would withstand challenge under the anti-avoidance provisions of s.61A. Objectively, on the basis of the criteria listed in that section, it would seem that the leases to the loss company at 1% of fair market rent were entered into for the sole or dominant purpose of obtaining a tax benefit, namely, the utilization of the loss incurred by Small to offset the rental profits effectively transferred to it by Big. In this event, the tax plan would not be effective. Explain s.61B; s.61B: not applicable because there is no change in the shareholding of Small Explain s.15(1)(m) & s.15A; s.15(1)(m) and s.15A: applicable but not effective because tax on the monthly income of $1,000 only (i.e. 1% of the total sum) Therefore, IRD will most likely apply s. 61A

TA_U4_Anti-avoidanceProvisions