A very successful OBM toy manufacturing company used to have three shareholders, one of them was called Mr. A. He held 10% equity. About 20 years ago, the company set up its production base in Baoan District, Shenzhen. After certain years of hardworking, this company had been able to earn an annual net profit in excess of HK$10 million in the recent few years.
Since Mr. A was merely a minority shareholder and was not that familiar with production, he was only assigned to handle some sales activities. And because of this, he had spent pretty much time in leisure and entertaining on golf courses, night clubs, etc. It was unfortunate that his indulgence in such enjoyment had cost him more than his total handsome income of HK$2 million a year, being director’s emoluments and dividends received from the company. Mr. A could save up no monies but even had to borrow. Thus, he made himself a ‘negative liability’.
The other two partners had noticed Mr. A’s problems and urged him to quit those avoidable “hobbies”. However, Mr. A was reluctant to change and ultimately asked to sell his 10% stake in the company to the majority partners. Though the other two shareholders were somewhat unwilling to acquire the 10% stake, they finally offered a net asset base method to calculate the share value. Mr. A was not agreeable to the offer and suggested to use the past three year’s aggregate profits to form the valuation. No compromise was made then. However, Mr. A had been pressed by his loan creditors to repay debts. He finally reached an agreement with his two counterparts to dispose of his 10% shares at a price agreed among themselves.
Despite the share transfer had been completed, Mr. A felt oppressed by his previous partners because he considered he was not paid at the right price. With revenge in mind, he reported to the tax authorities in Hong Kong and Shenzhen that the company had under-stated taxable income. These informant actions had caught the attention of the tax authorities, initiating them to start conducting investigation process in the company’s affairs.
In the past decades, the directors of this company had ‘ignored’ the importance of account preparation and tax reporting and had casually delegated these functions to a loyal accounting supervisor. The directors had not even met their auditors for years. The accounting supervisor, with good loyalty to and caring for the business, had adopted a similar level of profit performance like long time ago before the removal of the production base. Management accounts using inappropriate policies were prepared for audit propose. Thus, a substantial portion of operating profits had been omitted in the company’s financial statements and tax returns during the past seven years.
The tax investigation process in Hong Kong had lasted for over ten months, resulting in an aggregate sum of additional taxes and penalties amounted to HK$9 millions. On the PRC’s side, the ‘price’ was much more costly. This was really a big blow on the company’s financial survival. This case presented a somewhat embarrassing picture of a taxpayer with Mr. A could escape any burden even though he was one of the shareholders and actually, the informant. The category of informants’ intelligence represents the most occurring cases in tax investigation instituted by the Inland Revenue Department.