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Profits Tax - When is an
expenditure incurred?
Section
16(1) allows expenses “incurred” during the basis period. The word “incurred” is not defined in the Inland Revenue Ordinance.
From case
law, “incurred” does not completely mean "paid". In general, an expenditure is
incurred when the claimant has committed a definite or absolute
liability and that the amount has been ascertained on an accurate
basis, even though the amount of liability may not yet be
determined.
In the case of So
Kai-tong Stanley trading as Stanley So & Company v CIR the judge
said: "the appellant relies on Lo & Lo v. CIR, in which it was
stated that deductions are not confined to a disbursement, but
included an obligation to pay. What the appellant has overlooked is
that the obligation to pay must be an accrued liability, which is
undischarged .... It is therefore imperative to identify the legal
basis for giving rise to the liability to pay. The appellant says
that his firm will be obliged to pay up if Yam & So brings a claim
against it in a court of law. This is a circular argument because it
does not address the core issue of why the appellant's firm will be
adjudged to be liable to Yam & So's claim. It is not the appellant's
case that the parties had entered into a legally binding agreement
on the matter. Indeed no such material had ever been adduced to
explain the nature of the obligation. The appellant has throughout
not identified the basis upon which the alleged obligation is
founded. The Board is entitled to reject the contention that the
appellant's firm was under an obligation to pay make good the loss
or liability incurred by Yam & So. There is no basis for challenging
the Board's conclusion that the retrospective fixation of the amount
of office facilities charges was not related to a commercial
agreement…”
Click here for more
about the case. In short, in order that an expenditure paid after
the end of the basis period to be "incurred" during the year of
assessment, there must be a "legal liability" to pay the amount by
the end of the basis period.
Click here to see the court comments on
"incurred" in the case Lo & Lo v CIR.
Accruals
for rent, interest, insurance, lighting and heating, … etc. in
respect of the accounting period are acceptable.
A mere commitment, without an established and
definite legal liability, to pay a future debt does not
satisfy the requirement of "incurred". A provision
for contingent liability is not deductible either. Neither is a transfer to a general
reserve against possible future expenditure or loss a deductible
expenditure.
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