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The owner of Elegance Ltd. (Elegance), one of the premium French fashion manufacturers,

is considering to

directly engage in the wholesales and retailing of this famous fashion

brand in Hong Kong and the Chinese Mainland. The Chairman of Elegance Ltd is

considering to set up a regional headquarter in Hong Kong. He has approached you, being

tax partner of one of the prominent CPA firms, for consultation and advice. He provides

you with the following information:

A. At present the fashion merchants in Hong Kong will place orders to

Elegance in France through some international agents each year. After

these orders were accepted, Elegance will send the fashions directly from

France to the fashion merchants in Hong Kong. At present there is no sales

outlet for this fashion brand in the Chinese Mainland. Elegance will not

interfere if the Hong Kong fashion merchants sell the fashion in Hong Kong

or the Chinese Mainland, and there is no established agreement or covenant

on the retail selling prices of Elegance fashions. On the other hand, the

prices accepted by Elegance from the Hong Kong fashion merchants may

be higher or lower than prices offered by other merchants in other countries

depending on various factors such as the style and pattern of fashions and

the quantity of orders.

B. The Chairman is considering to invest HK$250 million initially to set up a

regional headquarter in Hong Kong, tentatively named Elegance (HK) Ltd.

[Elegance (HK)], and operates sales stores to sell the high-end fashions

exclusively produced by Elegance in France. It is estimated that the annual

demand for Elegance fashions in Hong Kong is more than $350 million per

year in the next five years despite the temporary economic recession in

Hong Kong at the present moment. Moreover, with reference to LVMH

Group which could sell more than $800M in the Chinese Mainland in high

end fashions in 2018, the Chairman expects that the China market could be

even larger than Hong Kong in the next five years. The Chairman plans to

recruit the first CEO of Elegance (HK) through a world-wide search

process. The incoming CEO is planned to be recruited by the French

headquarter and regarded as employee of the parent company assigned to

manage the Hong Kong subsidiary.

C. Elegance (HK) in the initial years does not plan to acquire any property for

selling store or office purpose. Rather it is planned to rent good quality

office and shops for business operation and selling functions. After renting

an office and sales shops, Elegance (HK) plans to decorate the places in a

highly elegant and noble way in alignment with the high-quality, worldrenowned

fashions produced by Elegance. These decorations are expected

to be irrecoverable with zero residual value in case Elegance (HK)

discontinues the rental contracts of these places with the owner.

D. Elegance (HK) will operate as both wholesaler and retailer in Hong Kong.

Initially Elegance (HK) will order fashion products from the parent

company, and the ordered products will be directly imported from France.

Elegance (HK) will also act as agent, receiving customer orders in Hong

Kong and then send the requests to France for production process. It is

considered that the price charged by the parent company for all exported

fashions to the subsidiary will be on open market price basis. Elegance

(HK) will operate several retail outlets in Hong Kong selling Elegance

fashions. From a business perspective, Elegance (HK) considers that the

purpose of operating the retail outlets is not for operational profits but rather

as a marketing effort and promotion of corporate and brand image.

E. Elegance (HK) will plan to directly liaise with existing fashion retailers in

the large cities of the Mainland to promote the brand in China, and conclude

contracts to sell Elegance fashions to these retailers. It is planned to send

various limited authority sales representatives from Hong Kong to the target

cities to identify reputable retailers, and contract to sell high end fashions to

these reputable retailers through liaison and negotiations.

F. The new CEO of Elegance (HK) will also liaise with retailers in the Asian

cities such as Tokyo and Singapore for the Elegance fashions to be sold in

these cities. Once Elegance (HK) is established, it is expected that all

enquiries for purchases of Elegance fashions coming within the Asian

region will only be channelled through Elegance (HK), who will act as the

sole agent and wholesaler in the region until later when other regional

offices might be established as need arises.

G. To facilitate business negotiations within the region, The Chairman of

Elegance plans to recruit staff in Hong Kong and nearby cities and appoint

them as regional sales representatives with limited authority to negotiate the

terms and conditions with the respective local retailers for the sales of the

fashion products. Final agreement will be reviewed and endorsed by the

CEO of Elegance (HK) before the sales contracts will be signed and

concluded by the respective sales agents in those cities.

H. From time to time, the Chairman of Elegance will second senior fashion

consultants and famous designers from France to Hong Kong for 1 - 2

months to share fashion knowledge to the senior officers of the Hong Kong

subsidiary, and to hold fashion shows in Hong Kong and nearby cities to

attract more fashion lovers joining the family of Elegance.

You are required to:

Advise the Chairman of Elegance on the various Hong Kong taxation issues that he has to

bear in mind in the setting up of the Hong Kong regional head office, including any

suggestion you wish to make on particular aspects of tax planning. Ignore overseas

taxation issues, including double tax arrangements. Also ignore other business issues apart

from the tax concerns.

In your answer, you may wish to highlight the following issues (but not necessarily

restricted to these issues only): charges on Hong Kong Profits Tax including sources

(locality) of profits, deductibility of expenses under Profits Tax and Salaries Tax, charges

on Hong Kong Salaries Tax, source of employment for local and overseas employees, etc.

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