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Advance Ruling Case No. 33

1. The provisions of the Ordinance

  This ruling applies in respect of sections 8, 9, and 16(1) of the Inland Revenue Ordinance ("IRO").


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2. Background

(a) Company Y was incorporated in Country A. Its shares are listed on the Stock Exchange of Country A.
(b) Company Y has established a deferred employee share plan ("the Plan") to motivate and reward employees. Companies within the group may participate in the Plan.
(c) Company X, a Hong Kong subsidiary of Company Y, is prepared to participate in the Plan.

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3. The arrangement 

(a) Eligible employees of Company X participating in the Plan ("Participant(s)") will contribute an agreed amount from their salaries. Company X will make matching contribution for each Participant, subject to a ceiling. The contributions will be held by a trustee ("the Plan Trustee").
(b) The Plan Trustee will acquire Company Y shares with the contributions, either through purchase in the stock exchange or subscribing to new issue of shares. Shares acquired with Company X's contribution are referred to as the "Matching Shares".
(c) Shares acquired, whether with contributions from Participants or Company X, will be registered in the name of the Plan Trustee for Participants' benefit. The Plan Trustee will keep separate accounts for individual Participant to identify shares held on account of that Participant.
(d) There is a restriction period during which shares acquired cannot be sold, transferred or otherwise dealt with by Participants. However, Participants will receive dividends / bonus issues, take up rights issues and have voting rights in respect of shares held on their behalf as if they were owners. Participants can only deal with the shares freely upon expiry of the restriction period.
(e) Bonus issues attributable to the Matching Shares are subject to the same restriction period as the Matching Shares.
(f) If there are rights issues attributable to the Matching Shares during the restriction period, Participants may at their own discretion contribute additional funds to acquire rights shares. Company X will not make additional contributions in this respect. There is no restriction regarding shares acquired through rights issues.
(g) Should a Participant cease employment with Company X during the restriction period, Matching Shares held by the Plan Trustee for his benefit would be forfeited. If cessation is due to death, retirement, redundancy or permanent disability, Matching Shares would be allocated to him based on the proportion of the restriction period that has elapsed.

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4. The ruling

(a) The Matching Shares, together with the relevant bonus issues, are the Participants' taxable income from employment in the year of assessment when the restriction period expires. The taxable amount shall be the average of the opening and closing price quoted on the Stock Exchange of Country A on the first trading day following the expiration of the restriction period.
(b) Dividends attributable to the Matching Shares during the restriction period are perquisites from employment under section 9(1) of the IRO and chargeable to tax in the year of assessment that they are received by Participants.
(c) The rights issues attributable to the Matching Shares subscribed during the restriction period are assessable under sections 9(1)(d) and 9(4) of the IRO in the year of assessment that the shares are subscribed. The amount of the taxable benefit shall be the excess of market price of the shares over the subscription price and related expenses paid by the Participant. There is no taxable benefit to the Participants if the rights issues are not acted upon.
(d) The amount charged to the Profit and Loss Account of Company X in respect of its contribution to the Plan for acquiring the Matching Shares is an outgoing or expense for purposes of section 16(1) of the IRO and deductible to the extent that it is incurred in the production of assessable profits. Company X is, however, taxable on the amount, by way of cash or otherwise, directly or indirectly, received or receivable from the Plan or its parent company to the extent that the amount has previously been allowed as deduction.

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5. The period for which the ruling applies

  The ruling, subject to any future legislative changes, applies from the year of assessment in which the Plan is introduced to employees of Company X.

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

(a) The arrangement will be implemented as stated in the application for the ruling.
(b) Company X will recognise its contributions to the Plan as an expense in its Profit and Loss Account.

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7 . Date of ruling issued 

  11 May 2007.


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8. Commentary 

(a) Share awards to employees are perquisites chargeable to Salaries Tax. The time and what amount that the perquisite will be taxed will generally depend on the terms of the award.
(b) During the restriction period, Participants are not regarded as legal owners of the Matching Shares and bonus shares, if any. Taxable benefit has therefore not yet accrued to the employees. Dividends and rights issues received during the restriction period are however, extra benefits not subject to any restriction. Dividends are chargeable when they are received. Rights issues are treated as share options and taxable when they are exercised.
(c) When Company X makes cash contribution to the Plan for acquiring Matching Shares for the benefit of its employees and charges such to its profit and loss account, an expense has been incurred for purposes of section 16 of the IRO. However, any subsequent amounts received or receivable will be taxable.
  (This commentary is not a legally binding statement and it does not form part of the Ruling.)