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The Vexed Question of Source of Profits from Cross border Processing Arrangements

Following the earlier Court of Appeal decision in the Datatronic case,1 on 3 May 2010, the Court of First Instance (“CFI”) held that in the case of C G Lighting Limited (“the C G Lighting case”),2 the profits of the taxpayer arising from its sales of goods acquired by way of a sub-contracting arrangement with its wholly owned subsidiary in the mainland were fully chargeable to Hong Kong profits tax. The C G Lighting case was an appeal by the Commissioner of Inland Revenue (“CIR”) against the decision of the Board of Review (“BoR”) in which the BoR allowed the taxpayer’s claim for 50:50 apportionment and remitted the case back to the Inland Revenue Department (“IRD”) to decide the appropriate apportionment. The 50:50 apportionment is a concession granted by the IRD by virtue of its Departmental Interpretation and Practice Notes No. 21 – Locality of Profits (“DIPN No. 21”) for contract processing arrangements whereby a Hong Kong entity provides raw materials, technical know-how, management, production skills, design, skilled labour, and training and supervision for local labour employed by the mainland Chinese entity in the manufacturing process. Together, the Datatronic case, the C G Lighting case, and a recent BoR case3 indicate that the vexed question of the source of profits from cross-border processing arrangements will continue. In this article, we discuss the background to the C G Lighting case and the rationale of the CFI’s decision. We then provide a critical commentary on the decision and its implications for the controversial issue of the source of profits from cross-border processing arrangements in the Hong Kong profits tax regime.