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Lewis Lu |
Curtis Ng |
Many readers will be familiar with the famous conclusion of Justice Rowlatt in Cape Brandy Syndicate v IRC, [1921] 12 TC 358 that: "In a taxing act, one merely has to look at what is clearly said. There is no room for any intendment. There is no equity about a tax." And Lord Tomlin's statement in the Duke of Westminster case (Duke of Westminster v IRC, 19 TC 490) that: "This so-called doctrine of "the substance" seems to me to be nothing more than an attempt to make a man pay notwithstanding that he has so ordered his affairs that the amount of tax sought from him is not legally claimable." This approach to interpreting tax law has recently been under threat from the 'tax fairness' agenda.
So it was refreshing to the see Hong Kong courts uphold the Inland Revenue Department's (IRD's) request to charge HK$26.8 million ($3.4 million) of tax when it is not clear from the stated facts that any commercial profit arose to the taxpayer group (Commissioner of Inland Revenue v Perfekta Enterprises Limited (HCIA 1/2016)). The taxpayer (Perfekta) was a manufacturer who had acquired land for industrial use in the 1960s and 1970s. In 1994, it ceased its manufacturing activities. In preparation for this it sought permission to vary the terms of the lease and entered into an agreement with a developer in respect of which it received an initial payment of HK$165 million. The Hong Kong Court of First Instance found that this marked a change of intention and that the income received should be taxable as trading profit. The court also denied any deduction for the value of the land on the grounds that deductions were only allowed "to the extent to which they are incurred during the basis period". This appears to cast further doubt on the applicability of the Sharkey v Werner, 36 TC 275, principle in Hong Kong.
The court placed heavy emphasis on the legal documents surrounding the transaction. Although the development activity had taken place in a subsidiary, a reference in the board minutes to this being "for internal purposes" and a clause voiding the transfer of land if the subsidiary and the developer did not sign a new development agreement allowed the courts to find that the taxpayer retained an interest in the development. The board minutes and the witness statements conflated the activities of the company and the group, which has allowed the court to follow suit.
The board of review had held that the land was re-invested into the subsidiary and that the initial payment was an equalisation payment. The court refused to endorse this view in the absence of any explicit statement of this intent in the documents.
So, despite all the talk of 'tax fairness', precision in the drafting of legal documents and the ordering of transactions remains critical. It seems clear that the taxpayer could have ordered its affairs to ensure that no tax was payable. It has sought leave to appeal, but for now it remains the case that there is no equity about a tax.
Lewis Lu (lewis.lu@kpmg.com) and Curtis Ng (curtis.ng@kpmg.com)
KPMG China
Tel: +86 (21) 2212 3421
Website: www.kpmg.com/cn
