Raymond Yeung Tax Consultant former Assessor of Inland Revenue Department 前稅局評稅主任楊輝洪

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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 belong.

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 deductible again.

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 CIR's contention.


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