The facts of the case are that Li and Fung (“L&F”) assisted its customers in connection with the manufacture, sale and purchase of goods, for which it received a commission of 6% of the total FOB value of the customer’s export sales. L&F had entered into contracts with its offshore affiliates to perform certain of the services in return for a commission equal to 4% of the FOB value of total export sales by L&F’s customers.
At the Board of Review, the Commissioner of Inland Revenue (“the CIR”) suggested that L&F operated a “supply chain management business” and that the 4% commission paid to the affiliates was for the offshore services, whilst the 2% retained by L&F was for the management of the services undertaken in Hong Kong, and was therefore taxable. The Board of Review applied the principles enunciated by the Court of Final Appeal’s judgment in ING Baring Securities (Hong Kong) Ltd v CIR (2007) to HKCFAR 417, namely that section 14 of the Inland Revenue Ordinance required the identification of those activities that directly gave rise to the earning of the commission profits as opposed to those activities that, whilst important, were incidental or antecedent. Having ascertained the relevant activities, it was then essential to determine where they were performed.
The Board of Review held that L&F was a commission agent and that the services for which it received a commission were undertaken offshore. Accordingly, the Board held that L&F’s profits from this source had been correctly filed as offshore and were not taxable.
On appeal to the Court of First Instance, Mr Benjamin Yu, SC on behalf of the CIR, suggested that the commission income was derived from both a Hong Kong source and an offshore source and hence should be apportioned. This opinion was based on the “brain analogy”, in that the knowledge of the business rested with the senior management, to whom junior staff frequently referred. Reyes J rejected the “brain analogy”, previously cited in ING Barings, on the basis that the administrative and oversight functions undertaken in Hong Kong were not relevant criteria for ascertaining the geographical location of the commission profit.
Reyes J concluded that the Board of Review had directed itself correctly in the analysis of the facts, in that “it was not the Board’s function to investigate every facet of L&F’s operations and then decide which matters were qualitatively the most important towards making a profit. What instead had to be done was what the Board actually did. That was to discern in a practical manner those activities of L&F which directly (as opposed to indirectly) led to the production of profits”.
Inevitably Reyes J, having decided in favour of the taxpayer, has had his judgment appealed by the CIR to the Court of Appeal, which, as we have seen, has a track record of finding in favour of the CIR. I await the decision with interest, and am also curious to see which judges are chosen to sit on this case.
