THE UNIVERSITY OF HONG KONG

SCHOOL OF BUSINESS

ACCT3107 Hong Kong Taxation

Tutorial Questions
Unit 4 Salaries Tax (2)

Answer 10

Relevant provisions in the IRO

The IRO lays down specific rules for ascertaining the taxability of the following fringe
benefits provided by an employer; being free or subsidised accommodation, share options
and travel warrants. In brief, the rules can be set out as follows:

(1) Accommodation s.9(1)(b)&(c), s.9(1A)&(2)

The benefit of rent free or subsidised accommodation provided by an employer or an
associated company is taxed based on a rental value calculated at 10% of the
employee's income from the employment. The 10% may be reduced to 4% or 8% if
the accommodation is hostel or hotel room depending on the number of rooms
provided. If a certain portion of rent is borne by the employee, the portion
borne/suffered is deducted against the rental value calculated, leaving the balance to
be included in the assessable income.

(2) Share options s.9(1)(d)

Special rules also exist for taxing a gain derived by an employee from a share option
scheme set up by an employer. The option is a taxable benefit and tax is imposed on
any gain arising from the exercise or assignment or release of the option. In the case
of exercise, the gain is calculated based on the market value of the shares acquired
under the option as at the time of exercise less the price paid for the shares together
with the cost of the option. Any gain or loss arising from subsequent disposal of the
shares is not taxable under s.9(1)(d). In the case of assignment or release, the gain is
calculated based on the consideration received less the cost paid for the option.

(3) Travel warrants s.9(1)(a)(i)(ii)(iii)

A holiday or travel warrant/passage provided by an employer to an employee was
used to be specifically exempt from tax under the IRO to the extent that it is actually
expended and used for travel. From the year of assessment 2003/04 onwards, this
exemption has been removed (see further discussion below).

General law principles

Under Section 9(1)(a) of the IRO, subject to the exceptions specified, chargeable income
from any office or employment includes any perquisite. The meaning of this term, in the
context of the IRO, was considered by the court in the Glynns case. The majority held that
the term should be given its ordinary meaning and accordingly all benefits derived by an
employee from his employment should be charged to salaries tax.

The decision of the Privy Council in the Glynn's case reflected the Department's pre-Glynn
understanding of what constituted a chargeable perquisite:

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(1) money which can be obtained from property which is capable of being converted into
money; and
(2) money which is paid in discharge of a debt of the employee.

After the Privy Council decision, the IRO has now been amended to accord with the
department's pre-Glynn assessing practice in respect of fringe benefits. A "liability test",
contained in new subparagraph (iv) to s.9(1)(a), has been introduced to exclude from
chargeability any benefit where the relevant payment is one for which the employer has the
sole and primary liability and there is no surety made by any person. The exclusion does not
apply to any payment made by an employer to discharge a liability of an employee. Such a
payment would normally be chargeable to salaries tax as a perquisite.

The exclusion provided by the new sub-paragraph is subject to another new provision,
s.9(2A), which ensures that convertible benefits and education benefits for employees
children remain as chargeable to salaries tax, even if it can be argued that the employer has
the liability for the relevant payment.

With effect from 1 April 2003, the exclusion is extended to any amount paid by the employer
in connection with a holiday journey. All payments by an employer in connection with a
holiday journey are subject to tax, irrespective of whether it is convertible into cash and
whether the primary liability for the benefit is the employees own. The amount to be
assessed is based on the actual amount paid by the employer, instead of the amount to which
the benefit would be converted.

Liability test - Discharge of employer's sole and primary liability with no surety
If a fringe benefit is not convertible into money, and it does not represent an employees
children education benefit, or a holiday journey benefit, it is not taxable provided that
the payment represents a discharge of employers sole and primary liability. This
liability must not be guaranteed by any person. This again confirms the requirement that
the liability must be the employers own liability.

Convertibility into money

If the payment is not in money or cash form but in kind form, and it is convertible,
then the value is the amount of money into which the kind can be converted. For
example, if an employer gives an employee a set of clothes, the employee can sell them
and the sale price which can be received represents the money's worth of the clothes.
Several points should however be noted about this concept of convertibility.

(1) First, the benefit must actually be convertible in order to be assessable. Therefore,
if a benefit cannot be converted into money, it has no money's worth.
(2) In order to prevent an employee from being able to convert a benefit into cash, the
employer can impose conditions on such benefits which prevent such conversion
(for example, by preventing resale to third parties, at least for a limited period).
(3) If, however, a benefit is convertible into cash, the taxable value in the hands of the
employee will only be the second-hand (and not the original) value. This principle
is important in Hong Kong where many second-hand goods appear to have little
value.

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 (4) Finally, it is irrelevant whether the employee actually converts the benefit into cash.
The test is whether he could have converted, not whether he actually did convert.
The date for determining convertibility, and the value of such conversion is the date
when the benefit is received by the employee.

(i) Provision of a domestic helper

If an employer pays the wages of a domestic helper who provides services to an
employee, the payment is tax free if the domestic helper is employed directly by the
employer. But if the employee signs the employment contract with the domestic
helper, it is the employer who discharges the employee's own indebtedness and the
payment is therefore taxable to the employee.

(ii) Low interest loan

If the low interest loan is provided by the employer to the employee and it is the
employer's sole and primary liability to provide such benefit, the benefit should be
exempt under s.9(1)(a)(iv). To ensure such exemption is available, the benefit should
not be convertible into cash.

On the above basis, the benefit i.e. interest differential should not be taxable. To
ensure such exemption is available, the employer should impose restriction on the
application of the loan, for example, the employee is prohibited from sub-lending the
loan fund at an interest rate higher than that charged by the employer, the employee
can only apply the loan on acquiring property for residential purpose and such
property cannot be re-sold within a particular period of time, etc. In doing this, the
benefit would not be regarded as convertible into cash, nor a discharge of employees
liability.

(iii) Club membership

Where an employer makes a payment in respect of an individual membership fee or
other club expense for which an employee is personally liable, the payment will
constitute chargeable income of the employee. However, the cost of acquisition of
corporate membership of a club will produce no chargeable benefit as the IRD
recognises that the entitlement to corporate membership benefits may be transferred
from one employee to another and it is not possible to attribute such expenditure to a
particular employee.

(iv) Education fee of child

Amounts paid by an employer in connection with the education of a child of an
employee are by virtue of s.9(2A) not subject to the liability test, and accordingly
the amount will be treated as chargeable income of the employee irrespective of
whether the employee or the employer is the party liable for the relevant expense.
This would include not only tuition expenses but also payment for incidental expenses
such as boarding fees.

However, in accordance with the decision in an English case (Barclays Bank v

Naylor), the IRD in DIPN 16 states that payment in respect of education expenses
provided by a genuine discretionary trust funded by the employer will not be
regarded as a chargeable benefit.

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Answer 11(a)

(1) Payment for not to resign and to stay in job position is a payment for future services
and is therefore taxable (Cameron v Prendergast). However, if the payment carries
an element that requires Mr. Tam to give up a right, e.g. not allowed to seek for
another job within a certain period, it could be arguable that the payment does not
arise from employment.

(2) The point at issue here is whether the allotment of shares to Mr. Wong upon listing is
a perquisite arising from his employment. Although it could be argued that the basic
requirements for liability to salaries tax do not seem to be satisfied given that similar
shares are also available to the general public, Mr. Wong as an employee is
nevertheless given preferential treatment which is clearly a benefit arising from the
employment. Hence on balance, it is considered that the benefit is taxable. The
taxable value is the market value of the shares at the date of exercising the offer less
the cost of the offer and the shares.

(3) What Mr. Yu got from his employer is the medical insurance coverage which is not a
taxable fringe benefit on the basis that it is the employers sole and primary liability to
pay for the insurance contract and it is not convertible into cash by employee. The
payment of medical expenses by the insurance company is only due to the contractual
entitlement of the employee (as a beneficiary) under the coverage/policy but not an
income arising from employment (Hochstrasser v Mayes).

The insurance premium paid by the employer to insurance company is also not an
income to Mr. Yu given that the payment is a discharge of the employers sole and
primary liability (the employer is the contractor of the insurance policy with the
insurance company, the employees being the beneficiaries only). Therefore, the
insurance premium is not an assessable income to Mr. Yu.

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Answer 11(b)

Peter Pang - Salaries tax assessment for 2015/16

1.4.15 - 1.7.15 -
30.6.15 31.3.16
$ $
Salary 60,000 270,000
Housing allowance (5,000 x 3) 15,000
Rental value (9 months):
270,000 x 10% 27,000
Less: Rent paid (3,000 x 9) 27,000 - 0
75,000 270,000

Total assessable income 345,000

Notes:
1. During the one month when Peter Pang was sent to London on a business trip, the
place of residence was still provided to and was used by Peter Pangs family. Rental
value is therefore calculated.

The hotel accommodation expenses borne by the company is not chargeable to

salaries tax since the payment is made by the company and the stay is for business
purposes. The only principal place of residence is provided in Hong Kong.

2. A reduction of rental value is available in respect of any rental borne or suffered by

the employee for the provision of accommodation, i.e. 9 months at $3,000 per month.

3. Rental value is calculated at 10% (4% or 8%) of that part of the assessable income for
the period during which accommodation is provided.

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