The Federation of Hong Kong Industries has urged the government to revise the tax treatment of Hong Kong processing trade manufacturers operating across the border after 'several hundred' of them were embroiled in tax disputes with the Inland Revenue Department. The department in one case pursued a manufacturer seven years after it switched from one form of processing manufacturing to another over back taxes of tens of millions of dollars. At the heart of the dispute is the different tax treatment of contract processing and import processing, two main types of manufacturing activity in the Pearl River Delta. They have different technical definitions but have more or less the same form of operation. They use imported raw materials to process, assemble or produce goods for export, according to the federation. Many manufacturers shifted their businesses to import processing manufacturing from contract processing, giving them instant access to the mainland consumer market at a time when their overseas markets are in recession. However, this form of processing manufacturing subjects 100 per cent of their offshore profits to taxes, compared with 50 per cent under contract processing manufacturing. In addition, import processing trade does not have tax-free incentives on depreciation of imported machinery, while contract processing trade does. Federation chairman Cliff Sun Kai-lit yesterday said the tax treatment should be the same for both forms of processing. However, a department spokesman said it was wrong to say the operations of the two forms of processing manufacturing were the same. The spokesman said they were different in operations, rights of authorised persons, ownership of goods and settlement in payment and foreign exchange. Sun said the department's tax claim was ill-timed and would encourage Hong Kong manufacturers to further move their operations out of the city to the mainland or low-tax regions such as Singapore. 'The tax claims create great pressure on the cash flow of small and medium-sized enterprises,' Sun said. A tax partner with one of the world's top four accountancy firms said the dispute was about a matter of 'whether substance should override form or the other way round'. 'It is the responsibility of manufacturers to follow the tax arrangement of any specific type of processing manufacturing if they have made changes,' she said. 'Under the principle of self-assessment, it is fair enough the Inland Revenue Department can chase the back taxes it deems fit.' However, she also said it was reasonable the federation urged the department to calculate tax according to a manufacturer's operations rather than the form of processing manufacturing they were classified as.