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Advance Ruling Case No. 10

1. The provisions of the Ordinance

  This ruling applies in respect of section 14 of the Inland Revenue Ordinance ("IRO").


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2. Background

(a) The Company was incorporated in Hong Kong in 1989.
(b) Its business is the trading of bedding products and the related raw materials. It maintains offices and showrooms in Hong Kong. The products are manufactured by its affiliate (the Affiliate) in the Mainland of China (the Mainland).
(c) The Affiliate is a wholly foreign owned enterprise incorporated in the Mainland in 1993. It is licensed to import raw materials and manufacture bedding products for export and local sale. It operates an import processing trade. It owns its factory premises, plant and machineries. It also undertakes some processing work for Mainland customers. Its profits are subject to tax in the Mainland.
(d) The Company purchases raw materials in Hong Kong and sells them at cost to the Affiliate.
(e) The Affiliate processes the raw materials to produce products specified by the Company. The Company sends some supervisors to monitor the manufacturing process in the Mainland so as to ensure production quality.
(f) The finished goods are sold at a profit by the Affiliate to the Company, which sells the same to customers in Hong Kong.
(g) Invoices are issued to effect the transactions between the Company and the Affiliate. They make declarations in the import/export forms presented to their customs bureaus.
(h) The Company's trading profits are fully subject to Hong Kong Profits Tax up to year of assessment 2001/2002.

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3. The arrangement

(a) The Company's operations in relation to sourcing, purchase of raw materials and sale of finished products remain to be taken place in Hong Kong.
(b) The Company intends to manufacture its products in the Mainland.
(c) The Company intends to execute a Processing and Assembly Agreement (the Agreement) with the Affiliate in January 2003.
(d) The major terms in the Agreement are as follows :
  (i) the Affiliate will provide facilities and services to assist and facilitate the Company to manufacture the bedding products in the Mainland;
  (ii) the facilities include use of factory premises, plant and machineries, local labour and factory utilities;
  (iii) the Company will pay and reimburse the Affiliate all the manufacturing costs plus a general service fee.
(e) The Agreement is not to be furnished to any Mainland authority for registration.
(f) The delivery of raw materials to the Affiliate and finished goods back to the Company will no longer be effected as trading transactions. They will be recorded on an internal transfer basis. No invoice will be prepared. However, the Company and the Affiliate will continue to make customs declarations in the import/export forms. Both Mainland and HKSAR Customs Bureau will recognize that there is import/export of raw materials/finished goods.
(g) The Affiliate continues to operate its trade in form of import processing. It will continue to undertake the processing work for other Mainland customers.

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4. The ruling

(a) The Agreement does not license the Company to manufacture or carry on business in the Mainland. The manufacturer is the Affiliate, not the Company.
(b) The Company derives its profits from trading in Hong Kong. They are fully subject to Hong Kong Profits Tax under section 14 of the IRO. The 50% apportionment detailed in paragraphs 15 and 16 in Departmental Interpretation & Practice Notes No. 21 (Revised 1998) will not apply to trading profits.

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5. The period for which the ruling applies

  This ruling will apply for the year of assessment 2002/2003 and subsequent years of assessment.

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6. Date of ruling issued

  5 March 2003.