Profits Tax - Prepaid expenditure
In short, prepaid expenditure is payment in
advance for purchase of goods or services or for use of a property.
Letting alone the nature of expenditure, the timing of expenditure
may sometimes gives rise to dispute as to which basis period they
It is well established that generally accepted accounting
principles apply unless there are specific provisions in the Inland
Revenue Ordinance. The "accrual" accounting practice for
payments in arrear has all long been accepted by the Revenue.
As for payments in advance, before the "Secan" case (see below), the
Revenue accepted full deduction even though such expenditure should be carried
forward to match future related income / period under the "accrual"
practice. However, since the Secan case, in DIPN40 the IRD
says that prepaid expenditure which has
been carried forward in accordance with generally accepted
accounting practice to the following year of assessment is not
deductible. Since then, no full deduction will be allowed in case the accounts has adopted
"accrual concept" for prepaid expenditure.
|Commissioner of Inland Revenue v Secan Limited & Ranon Limited 5
HKTC 266 (the“Secan”case).
The taxpayers were engaged in the development
of property for sale. The financed the developments by borrowings.
The development took years to complete. Rather than expensing the
interest on the loans in the year in which it was incurred, the
taxpayers capitalized the interest as part of the cost of
developments. When the property was sold four years later, the
taxpayers claimed deduction for the total interest expenses although
a major portion of the interest expenses were capitalized to stock
or work-in-progress at the year end. CIR disallowed the claim on the
grounds that upon capitalization the interest charges had been
deducted in calculating profits and therefore could not be
The taxpayer contended that by failing to deduct interest
charges for the earlier years, its tax computations
understated the loss in these years. In other words, the taxpayer claimed
back deductions for all the prior-years interest expenditures
CIR's contention was that the
taxpayer's computations and financial statements for the first three years, which were
agreed to show a true and fair view of the taxpayer's affairs, were correct; the Ordinance did
not prohibit the capitalization of interest; and furthermore, because
of the capitalization the interest could not give rise to
any losses brought forward. The Board upheld CIR's
determination and ruled that the expenses had been deducted in the
“value of trading stock”. The Court also agreed to the