4. Honesty and accountability

During the past decades, our firm has also encountered some tax payers who have positive and responsible attitude towards their accounting and tax affairs. Some of them, once found out that there were discrepancies in tax reporting, would take quick steps to seek advices from professional accountants with the aim to remedy the errors as soon as possible.

There was an established garment manufacturing company having its head-quarters in Hong Kong. More than 10 years ago, the firm set up its production arm in Dongguan, the PRC. It was common at that time to enter into a “contract processing” agreement with the local government to run the production base. However, about 5 years ago, the company changed the agreement mode to “import processing” which meant that the manufacturing was operated under a self-owned enterprise in the PRC. Business had been very smooth and rewarding.

Under the policies of the Inland Revenue Department’s DIPN21, the company had applied for 50/50 apportionment of profits to distinguish the on-shore trading and offshore manufacturing profits. The latter income, which was manufacturing in nature, was not assessable within the tax jurisdiction of Hong Kong.

The company was not aware of the facts and reasons why the then tax representative (also auditors) did not change the accounting and the correlated tax treatments for the two modes of processing contracts as mentioned above. These treatments had been continued and the 50/50 apportionment of profits had been done year by year. However, when the Inland Revenue requested for a latest production contract for review, the tax representative then realized that the treatments had been done mistakenly over the past 5 years.

The directors of the company were told of such serious mistakes and they immediately took steps to appoint another firm of certified public accountants to act as their tax representative. The company through the new tax representative made voluntary disclosure to the tax authority about the issue and promised to amend the financial statements so as to re-submit correct profit returns.

The financial statements were re-stated by the new accounting firm within 3 months of the initial identification of the problem. On behalf of the client, the firm had made sincere, frank and full disclosure of the income situations. In view of the cooperative manner of the tax payer, the Inland Revenue Department finally accepted that the mis-adoption of the accounting and tax treatments after the new “import processing” agreement was entered into because of negligence. The company was eventually fined 30% of the additional taxes.

Because the directors of this company held responsible attitude and took appropriate actions, the case was expeditiously resolved which resultantly reduced more negative impacts on the company within a relatively short period.