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Advance Ruling Case No. 21

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 is incorporated in Country X and is a member of an international group. It has registered a branch in Hong Kong (the Branch).
(b) In Country X, the Company imported goods from affiliated companies in Hong Kong and Country Z.
(c) The Branch is set up to fulfill requirements of the Company's customers in Country X so that they can manage by themselves the import related logistics in a more efficient manner.
(d) Other than the registered address, the Company does not maintain any office in Hong Kong. Neither does it employ any employees nor agents here. All the sales transactions are carried out by the Company's staff in Country X while the purchase transactions are also made by them with the affiliated companies. These are assisted by the computer ordering system.
(e) By using the Branch, the Company benefits from shorter payment terms from the customers under the said arrangement as compared with the local payment terms which are usually 2 to 3 times longer.

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3. The arrangement 

(a) Goods are purchased internally within the Group and prices are set by a product division using the resale price (or market minus) method under the transfer pricing guidelines as developed by the Organization of Economic Cooperation and Development.
(b) After the Company's introduction of the product sample with demonstration to potential customers in Country X, its key account managers and sales people in Country X will negotiate the price and quantity per product type with the customers. Price confirmation is made by e-mail or fax. Sales contracts will be prepared and signed by the key account managers of the Company in Country X on behalf of the Branch.
(c) For large volume customers, subsequent to the conclusion of price and volume of products, the Company's field application staff will assist customers in the product evaluation until customers agree to the final version and send their purchaser orders to the Company in Country X. The sales people will then pass the order information to customer service staff of the Company for inputting into the computer ordering system. Upon the input, a purchase order in the name of the Branch will automatically be generated and sent to the supplier.
(d) When the suppliers accept the orders, they will confirm the delivery schedule and input to the ordering system. Customer service staff of the Company will then send the confirmed delivery schedule list to the customers in Country X by e-mails.
(e) When orders are completed and goods are delivered, the suppliers in Country Z and Hong Kong will change the order status sign in the computer ordering system to confirm the delivery. Delivery of the products is normally by air directly to customers in Country X or their designated factories outside Hong Kong.
(f) Except storing certain goods in Country X for some important customers, the Branch usually will not keep stock of inventory.
(g) The Company's financial control team in Country X will decide on the credit limit extended. For those sales under letter of credit terms, the letter of credit will be negotiated with the banks in Hong Kong by the Company's Shared Service Centre (SCT) in Country Z on behalf of the Branch. A service fee will be charged by SCT to the Branch.
(h) Apart from the duties of financial control, reporting, transaction posting and inter-company and bank reconciliation, the financial controller of the Company in Country X as well as the accounting manager of SCT in Country Z will be authorized to operate the Branch's bank account in Hong Kong for receiving customers' money and making payments.
(i) The Hong Kong Branch books the profit derived from the sales and purchase transactions invoiced in its name. The financial accounts and records of the Branch are entered into and kept by SCT on its behalf.

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4. The ruling

  The profits booked in the accounts of the Company's Hong Kong branch are not arising in nor derived from Hong Kong, and thus are not chargeable to Hong Kong Profits Tax under Section 14(1) of the IRO.

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5. The period for which the ruling applies

  This ruling will apply for the year of assessment 2005/06 and subsequent years of assessment.

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6. The material assumptions in respect of a future event or any other matter made by the Commissioner

  No assumptions are made by the Commissioner.

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7 . Date of ruling issued 

  8 February 2005.