Consider this: If a taxpayer is unable to settle an objection against an assessment, the case will be referred to the Commissioner of Inland Revenue (CIR) for his determination. I have only a vague recollection of a case ever being overturned by the CIR. The next step is to appeal the CIR’s determination to the Board of Review (BOR). This requires a case stated, which will incur professional fees.

The BOR is an independent tribunal charged with establishing the facts and expressing a legal opinion based on those facts. A taxpayer with a factually sound case has a reasonable chance of success at the BOR, but more professional fees will be incurred and they cannot be reclaimed, even if the taxpayer should ultimately win the appeal.

Assuming the case was won at the BOR, the taxpayer must expect the CIR to appeal the decision to the Court of First Instance or the Court of Appeal. Why? Because the CIR’s costs are met by the HK Government out of taxpayers’ taxes, whereas the taxpayer will be faced with meeting all the costs, including those of the CIR, should the appeal fail. However, that is not the only reason. Consider also the fact that most tax appeals heard by the Court of Appeal, under the Hon Tang Ag, CJHC, fail. Worse still, we have recently seen that even if a taxpayer was inclined to pursue a case to the Court of Final Appeal (“CFA”), the CFA either has no wish to be inundated by tax cases or is just too busy to hear more appeals from lower costs, so there is little chance of having the case heard by the CFA. The result is that the case will get no further than the Court of Appeal, which appears to be very pro the CIR.

So at the end of the day, the taxpayer will have lost his appeal and will be required to pay the tax in dispute, plus possibly interest as well, and will have incurred around HK3-4 million in professional fees. Would you appeal? Probably not, so do not be surprised if the CIR becomes more aggressive in pursuing tax cases.

Corporate groups in Hong Kong may:
• pay tax as a group even though the consolidated group accounts may show a loss
• have a higher effective tax rate
• be disadvantaged from a cashflow standpoint
• feel forced to adopt contrived strategies to utilise stranded tax losses
• have inadequate resources to embark on new business initiatives that would suffer losses in the initial years of operation

In March this year, Professor KC Chan, the Secretary for Financial Services and the Treasury, stated:

“The “group loss relief” suggestion involves a number of complicated issues, such as how to ascertain whether companies are members of the same group, and their loss set-off arrangements with each other. The proposed measure could also be easily abused for tax avoidance. Hence, its implementation must be complemented by complicated legislative provisions to define clearly the scope of application so as to avoid tax abuse. This would inevitably complicate our simple tax regime. Separately, as small and medium enterprises (SMEs) in general do not operate as a group, the “group loss relief” suggestion would not benefit the SMEs at large, which constitute 98% of business establishments in Hong Kong.
As for the “loss carry-back” suggestion, since the proposed measure may result in tax refunds at any time, it may cause drastic and unpredictable fluctuations in tax revenue, rendering the tax revenue more vulnerable to economic cycles. We believe that our current arrangement for enterprises to carry forward their losses without time limit to offset profits in future years should be able to assist enterprises to manage their losses and remains attractive to investors.
Given the above considerations, we are of the view that it is not appropriate to introduce the “group loss relief” and “loss carry-back” arrangements at this juncture.”
This view is not shared by our neighbours, with which Hong Kong competes to be recognised as the favoured location for the establishment of regional headquarters or as a base for Asian business operations. Australia, New Zealand, Singapore, Malaysia and Japan, Hong Kong’s principal competitors, permit group relief, whether on consolidation or in the form of loss transfer.
Personally, I find the reasons advanced by the Government a poor excuse for its failure to undertake a thorough review of this issue. It is also very sad that the Government does not feel it appropriate to issue a consultation paper to the appropriate interested parties for their views and recommendations as to how group relief could be implemented in Hong Kong. Of course doing nothing is the easier option.

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.

The Court of Appeal’s decision, delivered by The Hon Tang Ag CJHC, dismissed the appeal by CG Lighting Limited (“CGL”) against Fok J’s judgment in the Court of First Instance and upheld the position of the Commissioner of Inland Revenue (“CIR”) that 100% of CGL’s profits were sourced in Hong Kong. This came as no surprise, as past experience has indicated that only when cases are heard at the Court of Final Appeal, for which experienced international tax judges are brought in to sit on the bench, can a taxpayer expect a clear interpretation of Hong Kong’s tax laws.

I assume that many people who have read the decision will share my opinion that there was a strong expectation by the Court of Appeal that the case would be appealed to the Court of Final Appeal. Such people will probably not be surprised that the judgment lacks substance in its analysis of the law. However, I was surprised by the comments of the Court of Appeal that were directed at the Board of Review’s findings on fact which, in Tang’s own words, were “not something with which we are required to deal”, yet were expressed anyway, albeit in passing. This is certainly a practice that should be avoided.

Whatever my opinion of the decision, it pales into insignificance when compared with my disgust at the CIR’s refusal to grant consent to CGL’s application to appeal the Court of Appeal’s decision to the Court of Final Appeal. CGL has now applied to an appeal committee of the Court of Final Appeal for leave to appeal to that Court. I suspect that such an appeal has been based on the amount of tax involved, and also on the fact that the issues are of great or general public importance. Certainly for the case to be concluded at this stage would be a huge, if not unexpected, bonus for the Inland Revenue Department.

Personally, I am extremely disappointed that neither the CIR nor the Court of Appeal was able to appreciate the importance of taking this case to its final conclusion. If you were a cynic, you might conclude that the CIR saw this as an easy way to win the case before it could be heard by an experienced revenue judge. In my opinion, such a course of action, whilst to the CIR’s benefit, shows a total lack of interest in seeking an important decision on one of Hong Kong’s more contentious issues. Similarly, it would also be easy to conclude that the Court of Appeal did not wish to have its own decision in this case, and the decision in the earlier case of Datatronics, reviewed and possibly overturned by a court of higher authority.

I sincerely hope that common sense prevails and that leave to appeal to the Court of Final Appeal is forthcoming.

Whilst some Singaporeans may question whether the proposals are sufficient, the normal cry of most taxpayers, the following are a few initiatives introduced by the Singapore Government which would be welcomed in Hong Kong.

A) Marginal Corporate Tax Rate

In Singapore, SME’s enjoy a much lower effective corporate tax rate in that 75% of the first S$10,000 of chargeable income and 50% of the next S$290,000 is exempt from tax. Hence a business with profits of S$300,000 (HK$1.54m) has an effective tax rate of 8.9% and a business with profits of S$1,000,000 (HK$5.130m) will have an effective rate of 15.3%. These rates will be reduced further in 2010, 8.4% and 14.4% respectively, when the standard rate of corporate tax is reduced to 17%. This makes Hong Kong’s current rate of Profits Tax of 16.5% comparatively high.

B) Carry back of tax losses

For a long time tax professionals have campaigned for group relief or a carry-back of tax losses but to no avail. In comparison the Singapore Government has extended the aggregate amount of current year trade losses and capital allowances that can be carried back to S$200,000 and to permit the carry back for up to three years of assessment immediately preceding the year in which the loss was incurred.

C) Jobs Credit Scheme

The Singapore Government has introduced a new Jobs Credit Scheme in order to encourage businesses to preserve jobs during the current downturn. The proposal is that all active employers will receive a 12% cash credit on the first S$2,500 of each month’s wages for each eligible employee on the business CPF payroll.

On behalf of all Hong Kong SME’s I hope the Financial Secretary will announce measures to protect the viability of our businesses, assist with our cash flows, and help us weather the storm.