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Hong Kong Tax News Flash 

Nov 2008, Issue 1 Expand All Collapse All


Reclassification of financial assets - What does it mean for tax?
  
Introduction
 
The recent financial turmoil and deterioration in market conditions has brought about a slash in the value of equity and debt securities investments.  Under HKAS 39 "Financial instruments: Recognition and measurement", Hong Kong companies holding these investments as trading assets have to account for these financial instruments under the classification of "Fair Value through Profit or Loss (FVTPL)" using the "fair value approach".  They also have to report the changes in the values of these investments in their income statements as gains or losses for financial reporting purposes.
 
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Amendments to IAS 39/HKAS 39 - Reclassification of financial assets
      
Background
 
Under HKAS 39, financial instruments are classified as one of the following:
  • Fair Value through Profit or Loss (FVTPL);
  • Loans and Receivables (L&R);
  • Held to Maturity (HTM); or
  • Available for Sale (AFS).
Financial instruments that are classified as FVTPL have to be marked to their fair value on each balance sheet date.  The gain or loss arising from the change in fair value is recognised in the income statement.  On the other hand, financial instruments that are classified as AFS are measured at fair value with the resulting gain or loss taken to equity except for impairment loss.  Any gain or loss previously taken to equity is only transferred to the income statement upon disposal.  Financial instruments classified as HTM or L&R are accounted for at amortised cost using the effective interest rate method, with the amortisation being recognised in the income statement as imputed interest income/expense.
 
Reclassification and the subsequent accounting treatments
 
Prior to the amendments, reclassifications of financial assets under FVTPL into other categories and financial assets under AFS into L&R were generally not allowed.  The amendments permit such reclassifications if certain conditions are met from 1 July 2008.
 
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PwC Observations: Hong Kong profits tax implications arising from and subsequent to the reclassification
 
Since capital gains (losses) are not taxable (deductible) under Hong Kong profits tax, the tax treatment of the gains or losses from change in fair value recognised upon reclassification will depend on the nature (i.e. revenue vs capital) of the assets immediately before the reclassification.  Subsequent to the reclassification, in some situations, the tax treatment will very much depend on whether there is a change of the intention of holding the assets from trading to long-term investment purpose and if yes, the timing of such change.  Both the change of the intention and its timing are a matter of fact.  Depending on the facts of each case, the time of change of the intention may not be the time of accounting reclassification.  Departmental Interpretation and Practice Notes No. 42 on taxation of financial instruments and foreign exchange differences (DIPN 42) states that an accounting treatment, by itself, cannot change the character of an asset from investment to trading and vice versa.  Therefore, taxpayers have to maintain sufficient supporting documentation to substantiate a change of the intention, and its timing, should they wish to claim that the intention of holding the assets has changed from trading to long-term investment.
 
Assets reclassified out of FVTPL: Equity instruments

Assets reclassified out of FVTPL: Debts reclassified as L&R

Assets reclassified from AFS to L&R


Concluding remarks
 
Our observations on the major tax implications are highlighted above.  However, the profits tax implications really depend on the facts of each case.  Please contact our Hong Kong Corporate Tax Team for professional advice specific to your situation.

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Download our Hong Kong Tax News Flash (Nov 2008, Issue 1) (pdf file, 108KB) for your reference.

Contacts
Peter Yu
Hong Kong Tax Leader
Hong Kong
Tel: +[852] 2289 3122 Email
Tim Leung
Partner
Hong Kong
Tel: +[852] 2289 3055 Email
Reynold Hung
Partner
Hong Kong
Tel: +[852] 2289 3604 Email
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