Chapter 10 Profits Tax: Expenditure

1.       Learning Objectives

1.1       Understand when expense is deductible under profits tax.
1.2       Understand how to distinguish capital expenditure and revenue expenditure.
1.3       Understand when various types of expenses are deductible or not deductible under profits tax.
1.4       Understand when a gratuity paid upon retirement or termination of employment is deductible under profits tax.
1.5       Understand what payments in respect of retirement scheme are deductible under profits tax.
1.6       Understand what expenses are specifically not deductible under profits tax.
1.7       Understand the general principles governing the specific deductions under Sections 16A to 16G.

2.       General Principle

2.1

KEY POINT

(a)       Statute law governing deductions in general is set out in Section 16(1) which allows deduction of all outgoings and expenses to the extent to which they are incurred during the basis period for the year of assessment in the production of profits chargeable to profits tax for any period. (b)        The expenses must not be capital in nature or for domestic or private purposes (Section 17(1)).

 

 

3.       Specific Deductions under Section 16(1)

3.1       Section 16(1) sets out the general rule for deduction of expenses and then goes on to specify that a number of expense are allowable. These expenses are listed out in Section 16(1)(a-h).
3.2       Expenses falling outside Section 16(1)(a-h) should be considered for deduction by reference to the general rule in 2.1 above.
3.3       Other than Section 16(1)(a-h), the IRO also grants deduction to certain expenses under Section 16A to Section 16G.
3.4       The expenses deductible under Section 16 may be summarized in the following table.

Section	Description
16(1)	Expense must be, to the extent, incurred in the production of assessable profits
16(1)(a)	Interest expense in connection with borrowing
16(1)(b)	Rent paid for land or building occupied
16(1)(c)	Overseas income tax on interest income etc.
16(1)(d)	Bad debts and provision for doubtful debts
16(1)(e)	Expenditure on repair
16(1)(f)	Expenditure on replacement of implement, utensil or article
16(1)(g)	Expense for registration of trademark or design or patent
16(1)(ga)	Expenditure for Sections 16AA, 16B, 16C, 16E, 16F and 16G
16(1)(h)	Such other deductions as may be prescribed by any rule made under IRO.
16(2)(a)	Interest paid by a financial institution
16(2)(b)	Interest paid by a public utility company
16(2)(c)	Interest paid to an entity not a financial institution
16(2)(d)	Interest paid to a financial institution
16(2)(e)	Interest paid for the purchase of inventory or machinery
16(2)(f)	Interest paid on listed debentures or marketable instruments
16(2A)	Interest paid on loan secured by a deposit or another loan
16(2B)	Interest paid back to an associate of the borrower
16(2C)	Interest paid back through the purchase-back of listed debentures or marketable instruments

 

(A)       Interest Expenses

3.5	KEY POINT
	Subject to further conditions in Section 16(2) and Section 16(2A) to Section 16(2G), sums payable by a taxpayer by way of: (a)        interest on any money borrowed by him for the purpose of producing chargeable profits; and (b)        legal fees, procuration (獲得) fees, stamp duties and other expenses in connection with such borrowing are deductible under profits tax (Section 16(1)(a)).

3.6       Even if Section 16(1)(a) is satisfied, deduction will not be allowed unless one of the following conditions is fulfilled:
(a)        the money has been borrowed by a financial institution (s 16(2)(a));
(b)        the money has been borrowed by a public utility company (s 16(2)(b));
(c)        the money has been borrowed from a person other than a financial institution or an overseas financial institution and the sums payable by way of interest are chargeable to profits tax (s 16(2)(c));
(d)        the money has been borrowed from a financial institution or an overseas financial institution (s 16(2)(d));
(e)        the money has been borrowed wholly and exclusively to finance:
(i)         capital expenditure on the provision of machinery or plant incurred by the borrower, where such expenditure qualifies for depreciation allowance; or
(ii)        the purchase of trading stock by the borrower, where the trading stock purchased is used by the borrower in the production of profits chargeable to profits tax; and
(iii)       the lender is not an associate of the borrower; and
(iv)       where the lender is a trustee of a trust estate or a corporation controlled by such a trustee, neither the trustee nor the corporation nor any beneficiary under the trust is the borrower or an associate of the borrower (s 16(2)(e)).

3.7       In case s 16(2A) or s 16(2B) or s 16(2C) is not satisfied, the interest deduction will be partially reduced on a reasonable basis provided that the interest is incurred for the production of the taxpayer’s chargeable profits.
3.8       s 16(2A) secured loan test – restriction applies when the borrowing is secured by a deposit or loan made by the borrower or a person associated with the borrower with or to
(i)         the lender, a financial institution, an overseas financial institution, or an associate of any of the above, and
(ii)        interest generated by such deposit or loan is not taxable.
The amount of interest expenses allowable for deduction will be reduced by the amount of the tax-free interest earned.

3.9

EXERCISE 1

State whether interest paid on the following loans will qualify as a deduction for profits tax purposes. 1.         Mr Wing is a manufacturer of electronic components in Hong Kong. In order to finance additional working capital he borrows from a local bank. The loan is secured by a mortgage over Mr Wing’s factory premises. 2.         Mr Yam carries on a business in Hong Kong as a travel agent. In order to finance additional working capital he borrows from a local bank. The loan is secured by a fixed deposit at the same bank in the name of Mr Yam’s brother, who does not carry on a business in Hong Kong. 3.         Tiwo Ltd is the wholly owned subsidiary of Watoo Ltd. Both companies were incorporated in Hong Kong and carry on a business in the territory. In order to finance expansion of the group’s factory premises Watoo Ltd takes out a loan with a local bank. The loan is secured by a fixed deposit with the same bank in the name of Tiwo Ltd. 4.         Mr Choi is the major shareholder and managing director of Choi Investment Ltd, a company carrying on a business in Hong Kong. To finance working capital for the company Mr Choi takes out a loan with a local bank. The loan is secured by a fixed deposit in the name of Mr Choi with a bank in Guernsey.

 

(B)       Rent paid for the purpose of producing assessable profits – Section 16(1)(b)

3.10     Section 16(1)(b) governs the deduction of rent paid by a taxpayer. If rent is paid to the spouse or partners or the spouses of the partners, the position is summarized as follows:

(a)     Rent paid by a sole proprietorship business
Rent paid to the proprietor	Not deductible
Rent paid to the spouse of proprietor	Deductible
(b)     Rent paid by a partnership
Rent paid to a partnership	Deductible
Rent paid to the spouse of a partner	Deductible
(c)     Rent paid by a corporation
There is no restriction imposed on the amount of rent paid by a corporation to its directors or shareholders. As long as the payment of rent satisfies the conditions provided in Section 16(1), the rent is deductible under profits tax.

3.11     A premium is a lump sum paid at the grant of lease. It is not deductible as being capital in nature even though it may be paid by instalments (Henriksen v Grafton Hotel Limited (1942) 24 TC 453, Stick v Regent Oil Company Limited (1966) 43 TC 1).

(C)       Overseas income tax on interest income etc. – Section 16(1)(c)

3.12     In principle, overseas income tax is not an expense incurred in the production of chargeable profit, and it should not be deductible under profits tax (e.g. sales tax, VAT, etc.).
3.13     However, Section 16(1)(c) provides that if the overseas income tax is deducted or paid for income derived from interest, bill of exchange or certificate of deposit earned outside HK but taxable in HK under Section 15(1)(f), (g), (i), (j), (k) and (l), such overseas tax is deductible unless the taxpayer is legible for double tax relief under Section 49.

(D)       Bad debts and provision for doubtful debts – Section 16(1)(d)

3.14     The deduction of bad debts and provision for doubtful debts is governed by section 16(1)(d) which may be summarized into the following scenario:
(a)        Only specific trade debts which have been included as trading receipts previously, and proved to be bad to the satisfaction of the assessor are deductible.
(b)        Bad debt derived from a loan is not usually deductible because the loan is not part of trading receipt of the lender unless the lender is a financial institution or carries on a money-lending business.
(c)        Loan made to staff and suppliers written off are not deductible because they are not trading receipts.
(d)        General provisions for doubtful debt is not deductible.
(e)        Trade debts which are found becoming bad after cessation of business are not allowable.
(f)        Recovery of bad debt which has been allowed previously is assessable in the year of assessment when the bad debt is collection – Section 16(1)(d)(ii).

(E)       Repair – Section 16(1)(e)

3.15     Section 16(1)(e) provides that repairing expenditure is deductible as it is revenue in nature. Repair is to reinstall an asset back to its original status. However, it should have to distinguish repair from improvement. Section 17(1)(d) provides that the cost of any improvement is not deductible.
3.16     The distinction between repair and improvement is
(a)        whether any new asset or enduring benefit is created as a result of the expenditure incurred; or
(b)        whether the asset can be readily used after having been purchased without incurring the so-called “repairing” expenditure.

3.17	EXAMPLE 1
	A person purchases an office and incurs expenditure to decorate that office, such expenditure is for improvement. Another example is that a business has been using its office for some years, and incurs expenditure to redecorate the office, such expenditure is for repair which is a deductible expense under profits tax.

(F)       Replacement – Section 16(1)(f)

3.18     Section 16(1)(f) provides that expenditure incurred in the replacement of any implement, utensil or article employed is fully deductible under profits tax, but replacement for other assets is treated as acquisition of plant and machinery and the owner is entitled to depreciation allowances only.
3.19     Inland Revenue Rule 2 (IRR 2) defines implement, utensil or article to include the following items:
(a)        Belting (帶類),
(b)        Crockery (瓦器) and cutlery (餐具),
(c)        Kitchen utensils,
(d)        Linen (麻布),
(e)        Loose (散裝的) tools,
(f)        Soft furnishings (including curtains and carpets),
(g)        Surgical and dental instruments, and
(h)        Tubes for X-ray and infra-red machines.
3.20     If an items falls into the category of IRR 2 above, the tax treatment is as follows:
(a)        the cost incurred in the initial purchase of such items is not entitled to any deduction and no depreciation allowance is granted on such expenditure, and
(b)        the cost incurred for the subsequent purchases of those items is fully deductible in the year in which the expenditure was incurred.

(G)       Expense for registration of trademark or design or patent – Section 16(1)(g)

3.21     Payment for registration of trademarks, patents or designs, e.g. legal fees, if used for producing assessable profits is allowable. Without such a provision, such payment will be disallowable as being capital in nature.

4.       Miscellaneous Payments not Specifically Covered in Section 16(1)

(A)       Legal expenses

4.1       The nature of legal expenses is neutral for tax purposes. The rule for the deduction of legal expenses under profits tax is to look at the nature of the transaction under which the legal expenses were incurred. Common transactions leading to the payment of legal expenses are listed as follows:
(a)        Collection of trade debts – deductible.
(b)        Breach of contract / dispute over a contract – deductible if the contract relates to taxable trading activities.
(c)        Leases – legal expenses and stamp duty incurred by a tenant in connection with the first letting of an immovable property are not deductible because the tenant obtains a right to occupy a property for a period and this right is a capital asset of the tenant. However, legal expenses and stamp duty incurred for the renewal of lease is deductible.
(d)        Leases – legal expenses and stamp duty incurred by a landlord in connection with the first or subsequent letting of an immovable property are deductible under profits tax.

(B)       Removal expenses

4.2       If the removal expenses is involuntary, such as the demand of the return of the property by the landlord, the removal expenses are deductible.
4.3       If the removal is voluntary, e.g. the company moves to a better or bigger site or premises which implies an expansion of the business activities, the removal expenses are treated as capital expenditure and not deductible.

(C)       Tax paid

4.4       Property tax and profits tax (including both provisional and final payments) paid or payable are not deductible – Section 17(1)(g).
4.5       Salaries tax paid or payable for sole proprietor or partners of their spouses are not deductible – Section 17(1)(g).
4.6       Salaries tax paid for the remuneration of an employee or a director is deductible – Section 17(1)(g).

5.       Other Specific Deductions under Section 16A to 16K

5.1       The expenses deductible under Section 16A to 16K may be summarized in the following table.

Section	Description	Characteristics
16A	Lump sum contribution to approved retirement fund	Deductible in 5 equal annual instalments
16AA	Annual contribution to MPF by proprietor and partners	Maximum $12,000 p.a. each person
16B	Research and development	Cost of purchase of machinery fully deductible in the year of purchase
16C	Technical education	Fully deductible if paid to approved institutions
16D	Charitable donations	Max. 25% of income for 2007/08 – deductible
16E	Purchase of patents	Fully deductible if used in industrial process and not purchased from associate
16F	Refurbishment (建築物翻修開支)	Deductible in 5 equal annual instalments
16G	Prescribed fixed assets (訂明固定資產方面的資本開支)	Cost of purchase of computer hardware and software and manufacturing machinery fully deductible in the year of purchase
16H – 16K	Environment protection facility (環保設施)	Cost of machinery fully deductible in the year of purchase Cost of installation deductible in 5 equal annual instalments

(A)       Contribution to approved retirement scheme – Section 16A

5.2       Initial and special contributions made to a recognized retirement scheme or an approved retirement scheme are of a capital nature and not deductible under profits tax by the restriction imposed in Section 17(1)(c).
5.3       However, Section 16A allows the expenditure to be deductible in five equal annual instalments.

5.4	EXAMPLE 2
	X Ltd incurred $5,000,000 for the initial contribution to set up a recognized occupational retirement scheme in the year ended 31 March 2008. The amount of deduction available in each year is as follows: Year of assessment Amount 2007/08 $1,000,000 2008/09 $1,000,000 2009/10 $1,000,000 2010/11 $1,000,000 2011/12 $1,000,000

 

(B)       Contributions to MPF in self-employment cases – Section 16AA

5.5       Contributions made for sole proprietor and partners to mandatory provident fund are not expenses incurred in the production of assessable profits. They are prohibited from deduction under profits tax under Section 17(1)(b).
5.6       However, Section 16AA allows a deduction of mandatory contributions to mandatory provident fund in self-employment cases under profits tax. The maximum amount deductible is $12,000.

(C)       Expenditure on research and development – Section 16B

5.7       The deduction relates to research and development in science, technology, marketing, business or management, production, etc. (see DIPN 5 (Revised August 2007), paras 2 to 21).
5.8       The deduction is not applicable to expenditure incurred in the acquisition of rights in research and development.
5.9       Capital expenditure on plant and machinery can be deducted in full in the year of assessment in which it was incurred.
5.10     Capital expenditure on land or buildings cannot be fully deducted in the year in which it was incurred, but industrial building allowance is granted to the cost of construction of the building or building structure used for research and development purposes.

 

5.11

EXAMPLE 3

A Ltd is carrying on business in HK and prepares its accounts to 31 March each year. In the year ended 31 March 2008, it paid the following expenditure relating to its business: (a)       $500,000 on purchase of plant and machinery for carrying out scientific research; and (b)       $15 million on construction of a laboratory for carrying out scientific research (land cost = $10 million; construction cost = $5 million). A Ltd can claim a deduction of $500,000 under s 16B in respect of the plant and machinery used for carrying out scientific research under s 16B. It can only claim an industrial building allowance in respect of the cost of construction of the laboratory. It cannot get a deduction for the cost of land.

5.12     Section 16B(3A) provides that proceeds for the sale of rights in, arising out of, research and development the expenditure which has been allowed as a deduction under Section 16B is taxable notwithstanding the exclusion relating to the sale of capital assets contained in Section 14. However, the taxable amount is restricted to the amount of the deduction allowed under this section.

(D)       Payment for technical education (工業教育) – Section 16C

5.13     Where a taxpayer carrying on a trade or business in HK pays any sum for the purpose of technical education related to that trade, business or profession at any university, university college, technical college or other educational institutions which has been approved in writing by the director of education, a deduction can be granted.

(E)       Charitable donations – Section 16D

5.14     The payment must be a donation of money, not less than $100 in total to an approved charitable institution or trust of a public character or to the government, for charitable purposes.
5.15     The payment must be pure donation. The donor cannot obtain any benefit from the donation.
5.16     A deduction is limited to 35% for the year of assessment 2008/09 (25% for the years of assessment 2003/04 to 2007/08) of the assessable profits after depreciation allowance but before charitable donations.
5.17     Because of the 35% limit, charitable donations should be added back to the adjusted profits first. The approved donations are then deducted against the adjusted profits after deducting the depreciation allowances.

5.18

EXAMPLE 4

A taxpayer has adjusted profits of $100,000 after the deduction of charitable donations of $16,000 for the year of assessment 2008/09. He is entitled to a depreciation allowance of $80,000. Profits tax computation   $ Adjusted profits 100,000 Add: Charitable donation 16,000   116,000 Less: Depreciation allowance 80,000   36,000 Less: Approved charitable donations 35% 12,600 Assessable profits 23,400 If, after disallowance of charitable donations and deduction of the depreciation allowance, the computation yields an adjusted loss, any approved charitable donations will not be allowable.

5.19     If a donation does not qualify as an approved charitable donation under Section 16D, consideration may be given to whether the expense qualifies for deduction under the general rule of Section 16(1) (e.g. it is incurred for the purpose of promoting or advertising the taxpayer’s product).

(F)       Purchase and sale of patent rights – Section 16E

5.20     Expenditure incurred in the purchase of patent rights or the right to any know-how (實際知識) for use in HK in the trade for the production of chargeable profits is allowable.
5.21     Where a deduction has been allowed, the proceeds from sale of such a right will be taxable.
5.22     Know-how means any industrial information or techniques likely to assist in the manufacture or processing of goods or materials.
5.23     Patent rights means the right to do or authorize the doing of anything, which would, but for that right, be an infringement of a patent.
5.24     No deduction is allowed if the patent or know-how is wholly or partly acquired from an associate.

(G)       Expenditure on building refurbishment – Section 16F

5.25     Capital expenditure incurred on the renovation or refurbishment of a building or structure (other than a domestic building or structure) can be deductible in five equal instalments over five years of assessment, beginning with the basis period in which the payment was actually made.
5.26     A domestic building or structure means any building or structure used for habitation (住所), but does not include any building or structure used as a hotel or guesthouse, or any part of a hotel or guesthouse (s 16F(5)).
5.27     Section 16F relief does not apply to:
(a)        domestic building or structure;
(b)        building or structure to be first used substantially by the person for the production of profits;
(c)        building or structure to be used for a purpose different from that for which it was used immediately before the capital expenditure was incurred (e.g. expenditure incurred to convert an office into a showroom) (s 16F(4)).

5.28	EXAMPLE 5
	E Ltd is carrying on business in HK and prepares its account to 31 March each year. During the year ended 31 March 2008, it incurred $600,000 on the renovation of its office premises. E Ltd is entitled to claim refurbishment allowance of $120,000 (i.e. $600,000 / 5) in each of the five years of assessment 2007/08, 2008/09, 2009/10, 2010/11 and 2011/12.

5.29     A person who is granted a refurbishment allowance under Section 16F is not eligible to claim commercial building allowance in respect of the same expenditure.

 

(H)       Capital expenditure on the provision of a prescribed fixed asset – Section 16G

5.30     Full deduction is allowed to the capital expenditure on the provision of a prescribed fixed asset in the year of purchase. Prescribed fixed asset means:
(a)        plant and machinery which is used specifically and directly for any manufacturing process, e.g. electronic manufacturing plant and machinery, plastic manufacturing plant and machinery (see IRR 2);
(b)        computer hardware, other than that which is an integral part of any machinery or plant; and
(c)        computer hardware and computer systems.
5.31     Prescribed fixed asset does not include a fixed asset in which any person holds rights as a lessee under a lease.
5.32     No deduction may be allowed under Section 16G for:
(a)        capital expenditure that may be deducted under any other sections; and
(b)        capital expenditure incurred under a hire-purchase agreement.
5.33     Where a prescribed fixed asset is partly used in the production of chargeable profit, the deduction shall be limited to the extent of the use of the asset so used.
5.34     The proceeds received from the sale of the prescribed assets is subject to profits tax, but the amount taxable is limited to the deduction already granted under this section. However, the Commissioner may determine the true market value of the assets disposed if the buyer and seller are related.
5.35     If the asset is destroyed, the insurance moneys or other compensation shall be treated as if they were sales proceeds.

6.       Deductions Not Allowable under Section 17

6.1       The following is a summary of deductions not allowed under Section 17:

Section	Description
17(1)(a)	Domestic or private expenses
17(1)(b)	Expenses not for the purpose of producing chargeable profits
17(1)(c)	Expenditure of a capital nature
17(1)(d	Expenditure on improvement
17(1)(e)	Sums recoverable under an insurance contract
17(1)(f)	Rent of premises not occupied for the purposes of producing chargeable profits
17(1)(g)	Any tax paid or payable under the IRO other than salaries tax paid in respect of employee’s remuneration
17(1)(h)	Ordinary or annual contributions made for the payment in respect of a recognized occupational retirement scheme which exceed 15% of the total emoluments of an employee
17(1)(i)	Provision made for the ordinary or annual contributions in respect of a recognized occupational retirement scheme which exceeds 15% of the total emoluments of an employee
17(1)(j)	Provision made in respect of an unrecognized occupational retirement scheme
17(1)(k)	Sum paid by an employer being either a contribution under an occupational retirement scheme or a premium in respect of a contract of insurance under an occupational retirement scheme, where: (a)       provision for the payment of such sum has been made in any prior year of assessment; and (b)       a deduction has been allowed for such provision in any prior year of assessment
17(1)(l)	(a)       Contribution made by an employer to the funds of; or (b)       Payment made by an employer for the purposes of the operation of, an occupational retirement scheme other than a recognized occupational scheme
17(2)	Payment made to a sole proprietor, partners and their spouses

(A)       Domestic or private expenses – Section 17(1)(a)

6.2       Domestic or private expenses include the cost of traveling between the person’s residence and place of business and excess of the statutory limit of contribution to the MPF of $12,000 each year.
6.3       Section 17(1)(a) applies to sole proprietor and partnership business. As a corporation is not a human being, Section 17(1)(a) does not apply to a corporation. The private or domestic expenses of a director does not mean that it is a private or domestic expense of a corporation. Although the private or domestic expense of a director satisfies Section 17(1)(a), an assessor may disallow such expense under Section 16(1) if he or she of the opinion that the expense is not incurred in the production of assessable profits.

 

(B)       Payments made to sole proprietor, partners and their spouses

6.4       Section 17(2) prohibits the deduction of any sum in respect of remuneration or interest on capital or loans payable to members of a partnership or their spouses, and spouse of a proprietor.
6.5       The following table summarises the deduction not allowable in a sole proprietorship business under Section 17 and payments deductible under Sections 16(1)(b) and 16AA.

	Paid to Proprietor	Paid to the Spouse
Salaries or other remuneration	Not deductible	Not deductible
Interest on capital or loans	Not deductible	Not deductible
Contribution made to a MPF scheme	Deductible up to $12,000 each year	Not deductible
Rent paid for business use	Not deductible	Deductible

6.6       The following table summarises the deduction not allowable in a partnership business under Section 17 and payments deductible under Sections 16(1)(b) and 16AA.

	Paid to Partner	Paid to the Spouse
Salaries or other remuneration	Not deductible	Not deductible
Interest on capital or loans	Not deductible	Not deductible
Contribution made to a MPF scheme	Deductible up to $12,000 each year	Not deductible
Rent paid for business use	Deductible	Deductible

7.       Others Non-deductible Expenses

(A)       Capital expenditure

7.1       Section 17(1)(c) provides that any expenditure of capital nature is not deductible under profits tax. The two tests commonly used to decide whether an expense is of capital or revenue nature are as follows:
(a)        whether the payment is an once-and-for-all payment, or
(b)        whether an asset or enduring benefit is created via the payment.
Although the two factors are both important, each case has to be considered on its own merit (按事情的是非曲直，按實質說).
7.2       If the payment is of recurring nature, i.e. it is a periodic payment such as rent, it is most likely that it is of revenue nature, and the payment is deductible under profits tax.
7.3       If the payment is a lump sum payment as in the case of premium for the use of an immovable property, the payment is of capital nature and it is not deductible under profits tax.
7.4       If an asset or enduring benefit is created via the payment, it is most likely that the payment is of capital nature, and not deductible under profits tax.
7.5       Following table shows the example of capital expenditure:

Descriptions	Characteristics
Cancellation of agreements	(a)    The cost of acquiring or getting rid of contracts which are capital in nature is capital expenditure. E.g. A lease is a fixed asset to a tenant thus compensation paid to cancel a lease is capital expenditure (Mallett v Staveley Coal and Iron Co Ltd (1928) 13 TC 772.) (b)    Payment to get rid of an unprofitable normal trading contract is revenue in nature.
Acquisition of business	In John Smith and Son v Moore (1921) 12 TC 266, the House of Lords held that they were part of the fixed capital and the cost was not allowable.
Dismissal of employee	(a)    A payment to get rid of an unsatisfactory director is a normal revenue expense (Mitchell v Noble (BW) Ltd (1926) 11 TC 372). No new asset was created; goodwill was not enhanced. (b)    Payments to retiring directors for agreeing not to compete with the company was held to be capital expenditure because this increased the company’s goodwill (Associated Portland Cement Manufacturers Ltd v Kerr (1946) 27 TC 103).
Franchise fee	Capital expenditure and not deductible. Note that Section 16E does not apply for franchise fee.
Permanent quota	Capital in nature, not deductible.

7.6	EXERCISE 2
	A Co, a firm of accountants, entered into what has turned out to be an onerous leases of office premises. In order to break this lease, it paid $100,000 to the landlord. At the time the lease was surrendered, two years remained of a five year lease. Required: Explain whether the following payment are deductible under the IRO.

 

(B)       Other expenses

7.7       Following table shows the examples:

Descriptions	Characteristics
Payments to employees upon cessation of business	(a)    Severance payment – deductible (CIR v Cosmotron Manufacturing Co Ltd (1995) HKRC 90-081)). (b)    Voluntary payment to employees for the purpose of closing down the business may not be allowable. (c)    Payments made to employees at the time of merging two ship repairing business were held to be allowable because the employer did not cease business at the time the payments were incurred.
Pre-commencement expenses	Not deductible in a strict sense, but, by concession, allows expenses of a revenue nature (e.g. wages of employees, rent of shop premises) incurred before starting a business.
Books	The cost of books by professionals is capital expenditure but may qualify for depreciation allowance (Munby v Furlong (1977) 50 TC 491).
Loss due to embezzlement (盜用) or misappropriation	(a)    By a servant or employee may be allowable as being an expense arising out of, and incidental to, the carrying on of the trade. (b)    By a partner or director of a private company, the loss is not allowable.
Entertainment expenses	The entertainment cannot be of a private or domestic nature, or capital expenditure. A deduction can be granted if the entertainment is predominantly in connection with business transactions and the persons entertained are existing or potential clients.
Commission	Commission paid to an undisclosed person is not deductible (DIPN 12).
Removal expenses	The cost of removal of plant and machinery can qualify for depreciation allowances and the cost of removal of trading stock can be deductible.
Fines and penalties	A fine or penalty for breaking the law is not allowable, e.g. traffic fines are not deductible.
Professional accounting and tax fees	Expenses of submission of tax returns and answering routine enquiries are allowable. However, the expense of disputing an assessment is not allowable.
Private use of cars and other private expenses	(a)    Expenses attributable to the private use of cars are not allowable. (b)    If the car is partly used for business purposes and partly for private purposes, apportionment of the running expenses and depreciation allowances is necessary. (c)    In case of a corporation, private use of cars by directors or senior staff may be part of the employee’s remuneration package. As such, the whole of the running expenses and depreciation allowances may be allowable (BR 3/72).
Remuneration to relatives	A deduction can be granted if the relatives performed services in the production of chargeable profits.
Clothing	A female barrister claimed the cost of replacement and laundering of her court dress. The House of Lords disallowed the cost on the ground that the dress served the dual purpose of meeting her professional requirements and enabling her to be warmly and properly clad (被覆蓋的) (Mallalieu v Drummond (1983) 57 TC 330).
Expenses of a jockey	In D46/02, a jockey claimed expenses for sauna, gymnasium and physical training. The jockey needed to keep his weight below a certain limit in order to ride a horse and at the same time to maintain fitness. The BoR accepted that the expenses were incurred for both business and personal purposes and allowed 80:20 apportionment of the expenses of the fitness centre incurred.
Compensation for breach of contracts upon cessation of business	In Overseas Textiles Ltd v CIR (1990) HKRC 90-042, the taxpayer company ceased business. It had to pay compensation for its failure to complete certain spinning (紡紗) and weaving (編織) contracts. A sum paid to get rid of a possible law suit after discontinuation of a business was not made for the purpose of the trade.

7.8	EXERCISE 3
	Mr Lo set up his own accounting practice in April 2008. During that month, he paid $30,000 for a set of accounting and taxation textbooks and reports. He paid an additional $2,000 for the annual update to Willougby’s “Hong Kong Revenue Law”. Required: What, if any, tax relief is Mr Lo entitled to for these payments in the year of assessment 2008/09? Explain your answer.