Hong Kong: No refund of tax paid due to fraudulent conduct of directors
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Hong Kong: No refund of tax paid due to fraudulent conduct of directors

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Ayesha Lau


Darren Bowdern

The Hong Kong Court of Final Appeal (CFA) recently delivered judgment in Moulin Global Eyecare Trading (in Liquidation) v The Commissioner of Inland Revenue (FACV No 5 of 2013). The Court considered the position where profits tax payable by a company was overpaid because the directors had fraudulently misstated financial accounts and tax returns. In reality, there was no profit for a number of years but the directors were content to pay substantial amounts of tax to perpetuate continuing fraud on a grand scale on creditors and investors. The liquidators sought to recover this tax for the benefit of creditors on the grounds that the tax had been paid in error. The legal issue before the CFA was whether the knowledge of the fraudulent directors (in the preparation of fraudulent financial accounts and tax returns) could be attributed to the company.

The CFA, placing great reliance on the attribution of fraudulent knowledge to Moulin as well as issues of public policy, dismissed the appeal.

Having reviewed the facts and the language and legislative purpose of the statutory provisions contained in the Inland Revenue Ordinance ("the ordinance"), the Court held that the knowledge of the fraudulent directors should be attributed to Moulin. The leading judgment of Lord Walker of Gestingthorpe included a detailed restatement of the law of attribution of the fraud of directors of a company to the company itself and defined the limits and scope of the fraud exception to the attribution rules.

The Court, in acknowledging the importance of having a fair and efficient tax system which can be expected to produce public revenue to a more-or-less predictable level, held that prompt payment and finality within a reasonably short time were important policy aims and reflected in the ordinance. It is an essential part of the scheme of the ordinance that the Commissioner is able to make assessments on the basis of the taxpayer's returns and it would frustrate this statutory purpose if the fraud exception were to intrude into this scheme. Lord Walker therefore concluded that the fraud exception must be limited to its proper, limited role of barring unmeritorious defences in claims by corporate employers against dishonest directors or employees and their accomplices.

Consequently, the CFA held that the fraud exception should not apply to the claim against the Commissioner and the fraudulent knowledge of the directors would be attributed to the taxpayer. The liquidators could not rely on "error" to seek the refund of overpaid tax because Moulin, knowing that the return was false, had not made an "error" in the return but had instead told a deliberate lie in it.

The decision of the CFA is significant for two reasons: Firstly, it clarifies the legal principles governing the attribution of directors' knowledge to a company while adopting a narrow interpretation of the fraud exception to such attribution of knowledge. Secondly, the Court has taken a broad public policy approach to ensure the finality of assessments within the statutorily intended timeframe, even if creditors may lose substantially through overpaid tax on falsified profits.

Ayesha Lau (ayesha.lau@kpmg.com) and Darren Bowdern (darren.bowdern@kpmg.com)

KPMG

Tel: +852 2826 8028 & +852 2826 7166

Website: www.kpmg.com

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