Profits Tax Basis Period, Change of Accounting

Chapter 12 Profits Tax: Basis Period, Change of Accounting Date and Losses

1. Learning Objectives

1.1       Determine the basis period for the year of assessment of a continuing business.
1.2       Determine the basis period for the year of commencement of a business.
1.3       Determine the basis period for the year of cessation of a business.
1.4       Explain how provisional profits tax is computed.

2. Basis Periods

2.1       The term basis period is used to refer to the period covered by an assessment.
2.2       The normal basis period for computing assessable profits for a year of assessment is the actual profits of the accounting period ending in the year of assessment (s 18B(2)).
2.3       Where the accounts are made up to 31 March, the basis period is the year of assessment (s 18B(1)).

2.4

EXAMPLE 1

A Ltd has been carrying on business for a number of years and prepares its accounts up to 31 March each year. Its basis period for the year of assessment 2008/09 is from 1 April 2008 to 31 March 2009 (s 18B(1)).

If A Ltd prepares its accounts up to 31 December each year, its basis period for the year of assessment 2008/09 is from 1 January 2008 to 31 December 2009.

(A) Commencement

2.5 The basis period of the year of assessment in which a business commences depends on whether the first accounting date ends in the year of commencement or the following year of assessment.
2.6 If the first accounting date ends in the year of commencement, the basis period is the period from the date of commencement to the first accounting date (s 18C(1)(a)).

2.7	EXAMPLE 2
	B Ltd commenced business on 1 May 2008 and its first accounting date ended on 31 January 2009. Its basis period for the year of assessment 2008/09 is from 1 May 2008 to 31 January 2009. In this case, both the commencement date and first accounting date fell within the year of assessment 2008/09.

2.8       Where the first accounting date ends in the following year of assessment and the first accounting period is not more than 12 months, then:
(a)        there shall be no assessment for the year of commencement;
(b)        the basis period for the following year of assessment is from the date of commencement to the first accounting date (s 18C(2)).

2.9	EXAMPLE 3
	C Ltd commenced business on1 January 2008 and its first accounting date was 31 December 2008. There would be no assessment for the year of assessment 2007/08. The basis period for the year of assessment 2008/09 is from 1 January 2008 to 31 December 2008.

2.10 Where the first accounting date ends in the following year of assessment and the first accounting period is more than 12 months, the assessable profits shall be computed for the first year of assessment on such basis as the CIR thinks fit. Normally, for the year of commencement, the IRD will choose the period from the date of commencement to the corresponding accounting date in the year of assessment.

2.11

EXAMPLE 4

D Ltd commenced business on 1 January 2008 and its first accounting date was 31 March 2009. Its adjusted assessable profit for the 15 months from 1 January 2008 to 31 March 2009 was $15,000. As the first accounting period was over 12 months, it is likely that its first year of assessment is 2007/08 and the corresponding basis period is from 1 January 2008 to 31 March 2008, while its second year of assessment is 2008/09 and the corresponding basis period is from 1 April 2008 to 31 March 2009.

D Ltd
Year of assessment 2007/08
Basis period: 1 January 2008 to 31 March 2008
Assessable profit $15,000 x = $3,000

Year of assessment 2008/09
Basis period: 1 April 2008 to 31 March 2009
Assessable profit $15,000 x = $12,000

2.12

EXERCISE 1

State the basis periods for the first two years of assessment in the following situations:
1.         Mr Lee starts to trade on 1 May 2007. He chooses 30 November as his accounting date and his first accounts end on 30 November 2007.
2.         Mr Po starts to trade on 1 February 2007. He chooses 31 July as his accounting date and his first accounts end on 31 July 2007.
3.         Mr Ping starts to trade on 1 August 2006. He chooses 31 January as his accounting date. His first accounts cover a period of 18 months ending on 31 January 2008.

(B) Cessation

2.13 The basis period for the year of assessment in which the business ceases depends on whether the business commenced on or after 1 April 1974.

2.14

KEY POINT

(a)       For businesses which commenced on or after 1 April 1974 (newly established business), the basis period is the period from the day following the basis period for the preceding year of assessment to the date of cessation (s 18D(1)). (Note: Over 12 months’ profit may be assessed.)
(b)       For businesses which commenced before 1 April 1974 (old established business), there are two sets of rules for determining the last basis period on cessation of business.
(i)        there is no successor to the business; or
(ii)       there is a successor to the business, but the cause of cessation was the death of the proprietor (s 18D(2) proviso).

2.15	EXAMPLE 5 – commenced after 1 April 1974
	E Ltd commenced business on 1 May 1989 and prepared its accounts to 31 December each year. It ceased business on 30 November 2008. Its last year of assessment was 2008/09 and the basis period was from 1 January 2008 to 30 November 2008. Its preceding year of assessment was 2007/08 with the corresponding basis period of 1 January 2007 to 31 December 2007.

2.16

EXAMPLE 6 – commenced before 1 April 1974

G Ltd commenced business on 1 January 1972 and make up its accounts to 31 December each year. It ceased business on 30 November 1978 and had no successor. Its adjusted profit for the period from1 January 1978 to 30 November 1978 was $121,000. It ceased business during the year of assessment 1978/79 and the corresponding basis period was eight months from 1 April 1978 to 30 November 1978.

G Ltd
Year of assessment 1978/79
Basis period: 1 April 1978 to 30 November 1978 (s 18D(2))

Assessable profit before depreciation allowance

2.17 If neither condition in 2.14(b) above is satisfied, the basis period for the last year of assessment will follow the rules for new businesses.

Businesses which ceased or will cease on or after 1 April 1979

2.18     The basis period is also the same as for business which ceased before 1 April 1979.
2.19     However, the excess of ‘relevant profits’ over the ‘transitional amount’ (過渡期款額) will be added to the adjusted profit for the final year of assessment (s 18D(2A)).
2.20     ‘Relevant profits’ means profits for the period from the date following the last accounting date to 31 March of the year of assessment preceding the year of cessation.
2.21     ‘Transitional amount’ means profits from the date following the normal accounting date in the financial year 1974/75 to 31 March 1975. In case a loss was incurred during this period, the transitional amount will be ‘nil’.
2.22     The basis period under s 18D(2A) is the same as that under s 18D(2) (para 9). Only an additional amount, being the difference between ‘relevant profits’ and ‘transitional amount’ is added to the assessable profits.
2.23     Format of computation of basis period for cessation of business for business commencing before 1 April 1974.

	$	$
Profit for the basis period		A
Add: Previous accounting date – 31 March preceding year of cessation	B
Less: End of accounting date for 1974/75 – 31 March 1975	C
		D
Assessable profit		E

If C>B, D is regarded as ‘Nil’
If C is a loss, no deduction is allowed.

2.24

EXAMPLE 7

H Ltd commenced business in 1970 and prepared its accounts to 30 September each year. Its adjusted profits for the following accounting periods are:

Accounting period	Adjusted profits
	$
Year ended 30 September 1973	40,000
Year ended 30 September 1974	42,000
Year ended 30 September 1975	48,000

It ceased business on 30 June 2008 and its tax-adjusted profit for the period from 1 October 2007 to 30 June 2008 was $90,000. There was no successor to the business. The assessment for the year of assessment 2008/09 will be based on the basis period of three months from 1 April 2008 to 30 June 2008 (s 18D(2)).

H Ltd
Year of assessment 2008/09
Basis period: 1 April 2008 to 30 June 2008

	$	$
Profit for the basis period ()		30,000
Add: Relevant profit (s 18D(2A)) for the period from 1 October 2007 to 31 March 2008 ()	60,000
Less: Transitional amount for the period from 1 October 1974 to 31 March 1975 ()	24,000
Excess of relevant profit over transitional amount		36,000
Assessable profit before depreciation allowance		66,000

2.25

EXERCISE 2

An old business commenced trading in the 1960 and used to close its annual accounts on 30 September. The assessable profits for the year of assessment 1974/75 and 1975/1976 are as follows:

Year of assessment	Basis period	Assessable profit
		$
1974/75	Year ended 30.9.74	$15,000
1975/76	Year ended 30.9.75	$18,000

The company ceased business on 30 June 2007 and the assessable profits from 1 October 2006 to 30 June 2007 is $18,000. There was no successor to the trade.

Required:

Calculate the assessable profits for the year of assessment of 2007/08.

3. Change of Accounting Date

3.1	KEY POINT
	The following situations are considered as a change in accounting date: (a) failure to make up an account on the corresponding day in the following year of assessment; (b) accounts are made to more than one day in the following year of assessment (s 18E(1)).

3.2 When there is a change in accounting date, the CIR is empowered to compute the profits for the year of change and the previous year on such basis as he thinks fits (s 18E(1)). The CIR will normally choose a basis which will not unduly prejudice either the taxpayer or the revenue.

(A) New businesses (i.e. businesses which commence on or after 1 April 1974)

3.3 In case of a new business, the CIR is empowered to make an assessment on a basis period of more than 12 months (s 18E(2)(b)).
3.4 In making an apportionment of profits, it is lawful to make apportionment on a daily or monthly basis. (s 18E(3)).

3.5

KEY POINT

(a)       Assessments must be based on at least 12 months’ account.
(b)       The main consideration is that the total profits assessed should be equal to the profits actually made over the lifetime of the business. That is to say, no profits can be dropped out (放棄). However, profit for certain periods can be doubly assessed in certain cases.
(c)       The Commissioner may limit the basis period to a period of less than 12 months if the change of accounting date was for compelling (強制) reasons. For example, a company joining a group and change its accounting date to conform to that of the group would normally be a compelling reason.

3.6

EXAMPLE 8

J Ltd commenced business in 1980 and prepared its accounts to 30 April each year. It changed its accounting date to 31 January 2008. Its adjusted profits are:

Accounting period	Adjusted profits
	$
12 months to 30 April 2006	18,000
12 months to 30 April 2007	12,000
9 months to 31 January 2008	3,600
12 months to 31 January 2009	24,000

The year of change is 2007/08. The basis period for the year of assessment 2007/08 will probably be 21 months from 1 May 2006 to 31 January 2008.

J Ltd
Year of assessment 2007/08
Basis period: 1 May 2006 to 31 January 2008

Adjusted profit ($12,000 + $3,600) $15,600

3.7

EXERCISE 3

L Ltd commenced business in 1985. It prepared its accounts to 30 September each year. It has prepared its accounts to 30 June as of 2007. Its adjusted profits are as follows:

Accounting period	Adjusted profits
	$
12 months to 30 September 2005	18,000
12 months to 30 September 2006	24,000
9 months to 30 June 2007	27,000
12 months to 30 June 2008	30,000

Required:

Calculate the assessable profit for the year of assessment 2007/08.

Solution:

3.8

EXERCISE 4

Global Limited commenced business in Hong Kong in 2001 and prepared its accounts to 31 December each year. As a result of being taken over by an international company, Global Limited changed its accounting date to 30 June 2007. Its adjusted profits (before depreciation allowance) are as follows:

Accounting period	Adjusted profits
	$
12 months to 31 December 2005	1,000,000
12 months to 30 December 2006	1,400,000
6 months to 31 December 2007	1,400,000
6 months to 30 June 2006	600,000
12 months to 30 June 2007	1,800,000

Depreciation allowances for the years of assessment 2005/06 to 2007/08 are as follows:

Year of assessment	Amount
	$
2005/06	150,000
2006/07	180,000
2007/08	120,000

Required:

Compute the assessable profits of Global Limited for the year of assessment 2005/06, 2006/07 and 2007/08 and state the respective basis periods.
(6 marks)
(Adapted HKIAAT Paper 5 Hong Kong Taxation June 2001)

(B) Losses

3.9 Where there are losses involved, the principle is to ensure that the losses available are not given more than once and the losses must be relieved.

3.10

EXAMPLE 9

M Ltd commenced business in 1986 and prepared its accounts to 30 June each year. It changed its accounting date to 31 December as of 2007. Its adjusted profits/losses are:

Accounting period	Adjusted profits
	$
12 months to 30 June 2006	60,000
12 months to 30 June 2007	80,000
6 months to 31 December 2007	(35,000)
12 months to 31 December 2008	100,000

The year of change was 2007/08. It is likely that the CIR will assess M Ltd as follows:

M Ltd
Year of assessment 2006/07
Basis period: 12 months to 30 June 2006

Adjusted profit before depreciation allowance $60,000

Year of assessment 2007/08
Basis period: 18 months to 31 December 2007

Adjusted profit before depreciation allowance ($80,000 – $35,000) = $45,000

The loss of $35,000 is completely utilized and no loss is allowed to be carried forward.

(C) Old businesses (i.e. businesses which commenced before 1 April 1974)

3.11

KEY POINT

(a)       For an old business, all assessments are normally based on exactly a 12-month period. No assessment will be made for a basis period of over or less than 12 months.
(b)       However, if the sole or dominant purpose for changing the accounting date is tax avoidance, the CIR can assess profits of more than 12 months in the year of change or the preceding year (Yick Fung Estates Ltd v CIR (1999) HKLRD 381).
(c)       Profits may be dropped out (gap) or assessed twice (overlap). If a gap or an overlap arises, the IRD’s practice is to choose a gap which is fari to both the taxpayer and the IRD.

3.12

EXAMPLE 10

N Ltd commenced business in 1960 and prepared its accounts up to 30 June each year until 2007. It changed its accounting date to 31 December as of 2007. Its adjusted profits are:

Accounting period	Adjusted profits
	$
12 months to 30 June 2006	180,000
12 months to 30 June 2007	300,000
6 months to 31 December 2007	210,000
12 months to 31 December 2008	160,000

The year of change was 2007/08. According to s 18E(1), the CIR is empowered to compute the profits for the year of assessment 2006/07 and 2007/08 on such basis as he thinks fit.
If the CIR considers the sole or dominant purpose for changing the accounting date is to obtain a tax benefit, it is likely that $180,000 will be assessed in the year of assessment 2006/07 (basis period: 1 July 2005 to 30 June 2006) and $510,000 in the year of assessment 2007/08 (basis period: 18 months to 31 December 2007) (Yick Fung Estate Ltd).
Otherwise, there are three choices available for assessing the profits from 1 July 2005 to 31 December 2007. The total profits in this period of 30 months is $690,000.
The choices available are as follows:

Choice 1: Bring forward the change to 2006/07 (new, new)
Choice 2: Delay the change to 2008/09 (old, old)
Change in 2007/08 (old, new)

Year of assessment	Choice 1	Choice 2	Choice 3
2006/07 basis period Profit	12 months to 31/12/06 $240,000 (1)	12 months to 30/06/06 $180,000	12 months to 30/06/06 $180,000
2007/08 basis period Profit	12 months to 31/12/07 $360,000 (2)	12 months to 31/12/07 $300,000	12 months to 31/12/07 $360,000
Profit dropped out: Period Profit	6 months to 31/12/05 $90,000	6 months to 31/12/07 $210,000	6 months to 31/12/06 $150,000

The CIR can choose one out of the above three options.

Notes:
(1)
(2)

3.13

EXERCISE 5

Florence Ltd commenced business in 1972 and made up its accounts to 30 June annually. As a result of being taken over by an international corporation. Florence Ltd changed its accounting date to 31 December in 2006. The Commissioner of Inland Revenue accepted that the sole or dominant purpose for change of accounting date was not to obtain a tax benefit. You have been supplied with the following adjusted profits for the last four accounting period:

Accounting period	Adjusted profits
	$
12 months to 30 June 2004	950,000
12 months to 30 June 2005	1,200,000
18 months to 31 December 2006	2,520,000
12 months to 31 December 2007	1,320,000

Required:

(a)       What action can be taken by the Commissioner of Inland Revenue when a business changes its accounting date?                                    (2 marks)
(b)       Compute the respective amounts of adjusted profits for the years of assessment 2004/05 to 2007/08. You are required to show all the alternatives that may be adopted by the Commissioner of Inland Revenue in determining the adjusted profits of Florence Ltd. (8 marks)
(c)       If the Assistant Commissioner of Inland Revenue considers that the sole or dominant purpose of Florence Ltd in changing of its accounting date is to obtain a tax benefit and section 61A is to be invoked in making the assessment, compute the respective amount of adjusted profits for the years of assessment 2004/05 to 2007/08.
(2 marks)
(Adapted HKIAAT Paper 5 Hong Kong Taxation December 2002)

3.14 It there is loss involved, the principle is also to ensure that the losses available are not given more than once and the losses must be relieved.

3.15

EXAMPLE 11

M Ltd commenced business in 1970 and prepared its accounts to 30 June each year. It changed its accounting date to 31 December as of 2007. Its adjusted profits/losses are:

Accounting period	Adjusted profits
	$
12 months to 30 June 2006	60,000
12 months to 30 June 2007	80,000
6 months to 31 December 2007	(35,000)
12 months to 31 December 2008	100,000

The year of change was 2007/08. It is likely that the CIR will assess M Ltd as follows:

M Ltd
Year of assessment 2006/07
Basis period: 1 January 2006 to 31 December 2006

Adjusted profit before depreciation allowance
[$60,000 x 6/12 + $80,000 x 6/12] $70,000

Year of assessment 2007/08
Basis period: 1 January 2007 to 31 December 2007

Adjusted profit before depreciation allowance
($80,000 x 6/12 – $35,000) = $5,000

The loss of $35,000 is completely utilized and no loss is allowed to be carried forward.

4. Provisional Profits Tax

4.1 The assessor is empowered to issue a provisional tax return (s 51(1)) to any person for the purpose of collecting information and issuing a demand for provisional profits tax (s 63L).
4.2 In case of a continuing business, the amount of provisional profits for a year of assessment is usually based on the assessable profit (before set-off of loss brought forward) of the preceding year.

4.3	EXAMPLE 12
	P Ltd has been carrying on business for a number of years and prepares its accounts to 31 December each year. It has an assessable profit of $480,000 for the year of assessment 2007/08. The amount of provisional profits for 2008/09 is likely to be estimated at $480,000.

4.4 Any disallowed loss brought forward to the year will be deducted from the estimated amount (s 63H(1) and (2)).

4.5

EXAMPLE 13

Q Ltd commenced business 10 years ago and had losses of $100,000 brought forward to the year of assessment 2006/07. Its assessable profit for the year of assessment 2007/08 was $80,000. The computation of its profit tax liability for the year of assessment 2007/08 (final) and year of assessment 2008/09 (provisional) will be as follows:

2007/08 (Final)

	$	$
Assessable profit	80,000
Less: Loss brought forward	(100,000)
Loss carried forward	(20,000)

Net assessable profit	Nil
Profits tax for year of assessment 2007/08		Nil

2008/09 (Provisional)

	$
Assessable profit of preceding year	80,000
Less: Loss brought forward	(20,000)
Net provisional profit	60,000

Provisional profits tax for year of assessment 2008/09 ($60,000 x 16.5%)		9,900
Total tax payable		9,900

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Profits Tax Basis Period, Change of Accounting

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Profits Tax Basis Period, Change of Accounting

Profits Tax Basis Period, Change of Accounting

EXAMPLE 1

EXAMPLE 2

EXAMPLE 3

EXAMPLE 4

EXERCISE 1

KEY POINT

EXAMPLE 5 – commenced after 1 April 1974

EXAMPLE 6 – commenced before 1 April 1974

EXAMPLE 7

EXERCISE 2

KEY POINT

KEY POINT

EXAMPLE 8

EXERCISE 3

EXERCISE 4

EXAMPLE 9

KEY POINT

EXAMPLE 10

EXERCISE 5

EXAMPLE 11

EXAMPLE 12

EXAMPLE 13

Profits Tax Basis Period, Change of Accounting

Profits Tax Basis Period, Change of Accounting

Profits Tax Basis Period, Change of Accounting