10. One tree in two houses

A successful advertising production house in Hong Kong was owned by Mr. A who was absolutely a talent in the industry. A few years ago, his company had been transformed from an unlimited firm to a limited corporation. The awesome growth in turnover of the business in recent years had generated annual revenue of millions of dollars.

On certain day, Mr. A was surprised to receive a letter from the Field Audit Section of the Inland Revenue Department (“IRD”) notifying him that tax officers would pay a visit to his office to conduct examination of books and records. Since the examination would cover 7 years, it was surely the IRD’s intention to cover both unlimited and limited companies owned by Mr. A. After the first meeting at the field, the IRD issued some Profits Tax protective assessments to each of Mr. A’s companies.

Through the introduction by friends, Mr. A had approached a tax accountant hoping that the tax issue could be resolved properly. The new accountant conducted review of the companies’ books and records and had found some irregularities. When closing the books of every financial year, there were many unevidenced journal vouchers, suspense accounts and exceptionally large and frequent transactions in the director’s current account. The fact was actually that the accounting supervisor of the business wished to save tax for his boss and had manipulated the entering of transactions in both old and new entities during the past 2-3 years transitional period. He had made up some journal adjustments which were without supportings to build the ledgers of the two companies. Consequently, there was substantial expenditure entered in duplicate in the profit and loss accounts of the two companies in the past few years.

The IRD had also found many other anomalies in the books and records, thus had continuously issued demand letters to ask for explanations on the job production invoices, costs, gross margins, etc. The investigation had gone to a more serious stage – Mr. A’s private bank accounts, properties, investments, bank transfers and remittances were asked as to their sources, nature, purposes and even certain related parties were under examination.

In the last 7 years, Mr. A had only reported an average annual profit of around a few hundred thousand dollars which should be far below the actual. Under such circumstances, the tax accountant had urged Mr. A to honestly and voluntarily revise the companies’ annual accounts for tax review. Mr. A was also warned that there would be substantial taxes and penalties. When the tax officers reviewed certain personal bank accounts of Mr. A, they had noticed that there were many large in/out transactions during the past few years. However, due to the high volume of bank, property and investment transactions, some even involved overseas deals, Mr. A was only able to provide part of the information required. He said some other income was not in concern and asked the accountant to leave such transactions. The case had been stayed unsettled for quite a time.

Not until 30+ months of investigation, the accountant and IRD had jointly drafted an asset betterment statement for Mr. A to identify the net worth of him and his two companies. The full analysis of the statement had finally unveiled a possible understatement of profit by Mr. A. Additional taxes and heavy penalties had been levied against the taxpayer costing him a big fortune of over HK$5 million.

This case tells that if someone is being tax investigated, it is better for the him/her to make full disclosure frankly and honestly. Any willful default or delay will surely bring much more serious fines than good responses.