The recent decision by the Court of Appeal in the case of Commissioner of Inland Revenue and Datatronic Limited, handed down on 15th July 2009, in favour of the Commissioner of Inland Revenue may not have come as a surprise to some but will undoubtedly be a cause of concern to others. (The facts of the case can be found here)
There are two basic issues that immediately concern me, the first being that the Court of Appeal appears to have chosen to overrule certain findings of fact by the Board of Review whilst accepting others. The second being the acknowledgement by the Court of Appeal that the Inland Revenue Departmental Interpretation and Practice Notes have no legal standing.
Section 69(i) Inland Revenue Ordinance specifically provides that an appeal from the Board of Review to the Court of First Instance should only be on a point of law, as the Board of Review is the final determinant of questions of fact. An appeal from the Court of First Instance to the Court of Appeal also being on a point of law.
That said, in the case of the Commissioner of Inland Revenue v Datatronic, the Board of Review concluded, based on the facts before it, that;
(A) The agreement between Datatronic and its wholly owned foreign subsidiary DSC, located in Guangzhou, was in the nature of an import processing agreement.
(B) Through necessity (i.e. under an import license) the transfer of raw materials to DSC and the corresponding transfer to Datatronic of the finished products were structured as sales and purchase agreements.
(C) The price at which DSC sold products to Datatronic was not at arms length, being little more than the cost of the raw material plus further disbursements incurred.
(D) Datatronic, “was carrying on a manufacturing business and the profit was sourced in the PRC.”
(E) “In line with paragraphs 21 and 22 of DIPN 21 (Inland Revenue Departmental Interpretation and Practice Note 21) we consider that in the present case the apportionment of profits on a 50/50 basis is appropriate under the circumstances. We take this view because a high percentage of Datatronic’s profits did come from the sale of the finished goods from DSC, while a large part of their operations which contributed to the profit is question did take place in Hong Kong, thus rendering the apportionment at 50/50 basis appropriate”.
The Court of Appeal agreed with the finding that the agreement between Datatronic and DSC was in the nature of an import processing agreement. However, despite the Board of Review’s findings the Court of Appeal did not agree with (B), (C), (D) and (E) above.
Most taxpayers and their representatives who have been involved with manufacturing in Mainland China during the 1980’s/1990’s will acknowledge that the form of many agreements are structured to satisfy tax or customs requirements but the true substance may be substantially different. In my mind it is clear that the pricing of finished product was structured to provide DSC with little more than a processing fee. No doubt the acceptance of the form of the transaction as opposed to its substance will raise eyebrows in some quarters.
However, while the decision of the Court of Appeal to overrule some but not all of the Board of Review’s findings are disturbing, my concern for the future is whether the Court of Appeal will continue to interfere with the Board of Review’s findings of fact.
Lastly, but not least, is that the Inland Revenue Department failed to follow the wording of its own Practice Notes which taxpayers use as guidance and follow as a matter of principle.
Interesting times ahead?
