DR. THE HONOURABLE LEUNG KA-LAU v. THE COMMISSIONER OF INLAND REVENUE

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FACV NO. 5 OF 2023

[2023] HKCFA 36

IN THE COURT OF FINAL APPEAL OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

FINAL APPEAL NO. 5 OF 2023 (CIVIL)

(ON APPEAL FROM CACV NO. 278 OF 2021)

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JUDGMENT

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Chief Justice Cheung:

1.  I agree with the judgment of Madam Justice McLachlin NPJ.

Mr Justice Ribeiro PJ:

2.  I agree with the judgment of Madam Justice McLachlin NPJ.

Mr Justice Fok PJ:

3.  I agree with the judgment of Madam Justice McLachlin NPJ.

Mr Justice Lam PJ:

4.  I agree with the judgment of Madam Justice McLachlin NPJ.

Madam Justice McLachlin NPJ:

A.  Introduction

5.  The issue in this case is whether a sum of HK$1,765,821 (“Sum”) paid as damages by the Hospital Authority (“HA”) to the Taxpayer (“Taxpayer”) for standing by for work on rest days, statutory and public holidays, is taxable as salaries tax.

6.  The Sum arose in this way. The Taxpayer argued that he (and other doctors in the same position) were entitled to rest days, statutory and public holidays pursuant to sections 17 and 39 of the Employment Ordinance, Cap 57 (“EO”), and by being on call they were deprived of this entitlement. This Court agreed in the judgment rendered on 20 October 2009 (“CFA Judgment”) and damages were assessed by Reyes J for the Taxpayer’s loss of rest days, statutory and public holidays from 17 March 1996 to 1 October 2005.

7.  The history of these proceedings is as follows. The Commissioner of Inland Revenue (“CIR”) assessed salaries tax on the Sum under section 8 of the Inland Revenue Ordinance, Cap 112 (“IRO”). The Taxpayer filed an objection. The Deputy Commissioner of Inland Revenue affirmed the salaries tax assessment on 5 December 2018. The Taxpayer appealed to the Board of Review, which by its decision on 24 June 2020 upheld the determination of the Deputy Commissioner. On 27 April 2021, Anthony Chan J of the Court of First Instance granted leave to appeal against the decision of the Board of Review and allowed the Taxpayer’s appeal (“HCIA Judgment”). The CIR appealed this decision. By judgment issued on 22 February 2023, the Court of Appeal dismissed the CIR’s Appeal (per Kwan VP and Cheung JA, G Lam JA dissenting). On 11 May 2023, the Court of Appeal granted leave to appeal to this Court.

8.  The following undisputed facts were set out in the HCIA judgment:

“(i) Since 1 December 1990, the HA has become a statutory body under the Hospital Authority Ordinance (Cap. 113) taking over management of public hospitals and public hospital doctors.

(ii) As a result, the Employment Ordinance (‘EO’) is applicable to the HA.

(iii) On 26 June 1995, the Taxpayer was employed as Senior Medical & Health Officer (‘SMO’) by the HA.

(iv) Up to January 2011, the Taxpayer was a SMO. From 3 February 2012, the Taxpayer was employed as part-time Consultant by the HA.

(v) The Taxpayer, like his peers, was required to operate on an ‘on call system’, whereby he would be rostered on call after normal working hours (including Sundays and public holidays).

(vi) The ‘on-call system’ included ‘resident call’ (i.e. to be on-call while remaining within the hospital’s precincts) and ‘non-resident call’ (i.e. to be on-call while away from the hospital).

(vii) It was one of the terms of employment that the Taxpayer’s hours of work would be over normal working hours of 44 hours per week on operational needs and he was not eligible for overtime allowance because of his seniority.

(viii) ‘Rest day’ (1 rest day in every period of 7 days) is a right conferred by s. 17 of the EO.

(ix) ‘Resident call’ was clearly ‘work’ required of the Taxpayer.

(x) ‘Non-resident call’ entailed the Taxpayer staying within 30-minute distance of the hospital; not drinking alcohol; remaining mentally ready to respond to calls for his services. In other words, he was not entitled to abstain from working for the HA. Thus, a day rostered on-call could not qualify as a ‘rest-day’ under the EO.

(xi) Such right takes effect as contractual terms implied into the Taxpayer’s contract of employment with the HA.

(xii) On the other hand, ‘public holidays’ are rights conferred under the Taxpayer’s contract of employment with the HA, read together with s. 39 of the EO.

(xiii) Deprival of ‘public holidays’ from the Taxpayer would be treated in the same way as deprival of ‘rest days’.

(xiv) Over the material periods, the Taxpayer was subject to ‘resident call’ and ‘non-resident call’ on rest days and public holidays.

(xv) As a result of the CFA Judgment, the Taxpayer’s compensation (i.e. the Sum awarded) was calculated by actual reference to his daily wages. In its quantification, the components of such daily wages included his basic salary, cash allowance, fixed allowance, flexi-allowance and monthly allowance (as the case may be), but excluded fixed rate honorarium, subsidy pursuant to the Home Loan Interest Subsidy Scheme or a payment in lieu, equivalent to 5% of basic salary (as the case may be). Moreover, the daily wage was calculated by dividing the monthly remuneration by the actual number of days for the month concerned.”

9.  The relevant statutory provisions are as follows:

(1)  The IRO section 8(1)(a) provides that “salaries tax shall … be charged for each year of assessment on every person in respect of his income arising in or derived from Hong Kong from ... any office or employment of profit…”.

(2)  The IRO section 9(1)(a) gives examples of income from office or employment as including wages, salary, leave pay, fee, commission, bonus, gratuity, perquisite, or allowance, whether derived from the employer or others.

(3)  The EO section 17 Grant of rest days:-

“(1) Subject to the provisions of this Part, every employee who has been employed by the same employer under a continuous contract shall be granted not less than 1 rest day in every period of 7 days.

(2) Rest days shall be in addition to any statutory holiday, or alternative holiday or substituted holiday, to which an employee is entitled under section 39.”

(4)  The EO section 39 Grant of holidays:-

“(1) Subject to subsections (1A), (2) and (3), an employee shall be granted a statutory holiday by his employer on each of the following days*—

(a) Lunar New Year’s Day or, if that day falls on a Sunday, then the fourth day of Lunar New Year;

(b) the second day of Lunar New Year or, if that day falls on a Sunday, then the fourth day of Lunar New Year;

(c) the third day of Lunar New Year or, if that day falls on a Sunday, then the fourth day of Lunar New Year;

(d) Ching Ming (清明) Festival;

(da) Labour Day, being the first day of May;

(e) Tuen Ng (端午) Festival;

(f) the day following the Chinese Mid-Autumn (中秋) Festival or, if that day falls on a Sunday, then the second day following that Festival;

(g) the Chung Yeung (重陽) Festival;

(h) the Chinese Winter Solstice Festival (冬節) or Christmas Day, at the option of the employer;

(i) the first day of January;

(j) Hong Kong Special Administrative Region Establishment Day, being the first day of July;

(k) National Day, being the first day of October;

(l) the Birthday of the Buddha, being the eighth day of the fourth lunar month.

(1A) The operation of subsection (1)(da) shall be suspended for the year 1998.

(2) An employer may, instead of granting an employee a holiday on a statutory holiday, grant the employee an alternative holiday on another day (which is not a statutory holiday or a substituted holiday) within the period of 60 days immediately preceding or next following the statutory holiday, if the employer has notified the employee, either orally or in writing or by notice posted in a conspicuous place in the place of employment, of the day on which he will be granted the alternative holiday—

(a) where the alternative holiday is to be taken on a day within the period of 60 days immediately preceding the statutory holiday, not less than 48 hours before that day; or

(b) where the alternative holiday is to be taken on a day within the period of 60 days next following the statutory holiday, not less than 48 hours before the statutory holiday.

(2A) Subsection (2) shall apply to and in relation to a holiday under subsection (4) as it applies to and in relation to a statutory holiday.

(3) An employer and his employee may agree that another day shall be substituted for a statutory holiday or an alternative holiday or a holiday under subsection (4), if such substituted holiday falls within the period of 30 days of such statutory holiday, alternative holiday or holiday under subsection (4).

(4) Where—

(a) a statutory holiday falls on a rest day, or in the case of an employee who is a young person, on a day on which, by virtue of the Employment of Young Persons (Industry) Regulations (Cap. 57 sub. leg. C), the employment of the employee in an industrial undertaking is not allowed, the employee shall be granted a holiday on the next day thereafter which is not a statutory holiday or an alternative holiday or a substituted holiday or a rest day; or

(b) a statutory holiday falls on the same day as that of another statutory holiday, an employee shall be granted a holiday on the next day thereafter which is not a statutory holiday or an alternative holiday or a substituted holiday or a rest day.

(5)-(9) (Repealed 137 of 1997 s. 3)”

B.  The Question of Law

10.  Appeals from the Board of Review to the courts lie only on questions of law: Kwong Mile Services Ltd v Commissioner of Inland Revenue (2004) 7 HKCFAR 275 at §31. Therefore, the analysis must begin with a statement of the question of law.

11.  The question of law, as formulated by Anthony Chan J, is whether the Board erred in law in finding that the Sum was income from employment within the meaning of section 8(1) of the IRO.[1]

12.  The standard of review is one of “decent respect” or deference for the tribunal appealed from, in this case the Board of Review. In an appeal on law only, the duty of an appellate court is “no more than to examine those facts with a decent respect for the tribunal appealed from and if they think that the only reasonable conclusion on the facts found is inconsistent with the determination come to, to say so without more ado”: Edwards (Inspector of Taxes) v Bairstow [1956] AC 14 at 39. See also Kwong Mile Services at § 37.

C.  The Issues

13.  The ultimate issue is whether the Sum is income from employment. It is agreed that the test for income from employment is set out in Fuchs v Commissioner of Inland Revenue (2011) 14 HKCFAR 74 at §§ 16 to 18. The only issue is how Fuchs, properly understood, applies to the facts in this case.

14.  In applying Fuchs, the majority of the Court of Appeal relied on the following propositions:

(1)  The question is whether the entitlement was “in respect of services given by [the Taxpayer].”

(2)  The payment of the Sum was not a matter provided for in the contract of employment.

(3)  Rather, the Sum was consideration for depriving the Taxpayer of his right to a day of absence from work – for abrogation of his right under the EO and the contract. While the distinction between a payment pursuant to a contract provision and a payment made as consideration for abrogating rights under the contract may be a fine one in some situations, it must be drawn.

(4)  The Sum was damages paid in consideration for depriving the Taxpayer of his right to be absent from work on rest days and holidays contrary to the EO, and not pursuant to the contract provisions. The fact that damages were calculated based on a full day’s wages does not change the character of the payment.

(5)  The Sum was not a reward for past services rendered by the Taxpayer; there was no request and consent between the doctors and the HA for rostering them on-call on rest days and in fact there is a statutory prohibition for paying employees in lieu of working on statutory holidays.

(6)  Taxation of the Sum would result in double taxation because the Taxpayer has already paid tax on the salary earned for the rest day.

(7)  The Taxpayer’s contractual entitlements are not the immediate cause for the payment of the Sum.

15.  In applying Fuchs, Counsel for the CIR made the following submissions:

(1)  The Sum was paid to compensate for rest days and holidays not given to the Taxpayer and was therefore taxable under Fuchs as payment for “being or acting as an employee.” A broad and common-sense approach should be taken to determine whether the Sum was income from employment under section 8 of the IRO.

(2)  The Sum was paid for the Taxpayer standing by to render services and the fact that he was not called on to treat patients is irrelevant.

(3)  The Sum may be considered as a payment for past services.

(4)  The Sum replaced the contractual benefits the Taxpayer was entitled to under his employment contract and is taxable as a substitute for them. Sections 20 and 40A(2) of the EO provide for compensation for working on holiday and rest days by agreement or after termination; the same damages to compensate for days off should be treated in the same way.

(5)  The entitlement to holidays and rest days is an inducement to enter into the contract of employment, making the Sum taxable under Fuchs.

(6)  The distinction between payments made under contract and payments made to abrogate rights (relied on by the CA majority) is false.

(7)  The distinction between immediate cause (causa causans) and indirect cause (relied on by the CA majority) is unhelpful.

(8)  Taxing the sum will not result in double taxation, as the CA majority suggested.

16.  In his oral submissions, Counsel for the Taxpayer, Mr Ng, stated that he was not relying on the substitution argument, and was not pressing the double taxation argument. This removes from consideration these two points.

17.  It emerges from the above that the central issue that divides the parties is how the Sum should be characterized, applying Fuchs.

D.  Analysis

18.  The starting point of the analysis is the test for taxation from employment set out by this Court, per Ribeiro PJ, in Fuchs v Commissioner of Inland Revenue, which relies on the speeches of Lord Radcliffe and Viscount Simonds in Hochstrasser (Inspector of Taxes) v Mayes [1960] AC 376, and Lord Templeman in Shilton v Wilmshurst (Inspector of Taxes) [1991] 1 AC 684. I set out the relevant portions of Fuchs below:

“16. The test which has evolved in that jurisprudence for determining whether income is ‘from the taxpayer's employment’ and therefore assessable rests largely on the three House of Lords decisions just mentioned. It is clear that not every payment which an employee receives from his employer is necessarily income ‘from his employment’. It is not sufficient to qualify a payment as such income simply to say that the employee would not have received the sum in question if he had not been an employee. The test, formulated in positive terms as to when the sum is assessable, has been expressed as follows:

(a) In Hochstrasser (Inspector of Taxes) v Mayes Lord Radcliffe stated:

The test to be applied is … contained in the statutory requirement that the payment, if it is to be the subject of assessment, must arise ‘from’ the office or employment. … I think that their meaning is adequately conveyed by saying that, while it is not sufficient to render a payment assessable that an employee would not have received it unless he had been an employee, it is assessable if it has been paid to him in return for acting as or being an employee.

(b) In the same case, Viscount Simonds approved Upjohn J’s statement in the lower court as follows:

… the authorities show that to be a profit arising from the employment the payment must be made in reference to the services the employee renders by virtue of his office, and it must be something in the nature of a reward for services past, present or future.

(c) In Shilton v Wilmshurst (Inspector of Taxes), Lord Templeman expanded on the test:

Section 181 is not limited to emoluments provided in the course of employment; the section must therefore apply first to an emolument which is paid as a reward for past services and as an inducement to continue to perform services and, secondly, to an emolument which is paid as an inducement to enter into a contract of employment and to perform services in the future. The result is that an emolument ‘from employment’ means an emolument ‘from being or becoming an employee.’ The authorities are consistent with this analysis and are concerned to distinguish in each case between an emolument which is derived ‘from being or becoming an employee’ on the one hand, and an emolument which is attributable to something else on the other hand, for example, to a desire on the part of the provider of the emolument to relieve distress or to provide assistance to a home buyer. If an emolument is not paid as a reward for past services or as an inducement to enter into employment and provide future services but is paid for some other reason, then the emolument is not received ‘from the employment’.

(d) In Mairs (Inspector of Taxes) v Haughey, while stressing that each case ultimately involves applying the statutory language to the facts, Lord Woolf stated that general assistance is provided by the speeches in the two decisions cited above as to the applicable test.

(e) In the English Court of Appeal decision in EMI Group Electronics Ltd v Coldicott (Inspector of Taxes), after an extensive review of the authorities, Chadwick LJ noted Lord Woolf’s acknowledgment of the guidance provided by Hochstrasser (Inspector of Taxes) v Mayes and Shilton v Wilmshurst (Inspector of Taxes) and applied the test as formulated by Lord Radcliffe and Lord Templeman to conclude that a payment in lieu of notice, contractually agreed from the outset of the employment relationship, fell squarely within it.

17. In my view, the same approach should be adopted in the construction of s.8(1) of the Ordinance. Income chargeable under that section is likewise not confined to income earned in the course of employment but embraces payments made (in Lord Radcliffe’s terms) ‘in return for acting as or being an employee’, or (in Lord Templeman’s terms) ‘as a reward for past services or as an inducement to enter into employment and provide future services’. If a payment, viewed as a matter of substance and not merely of form and without being ‘blinded by some formulae which the parties may have used’, is found to be derived from the taxpayer’s employment in the abovementioned sense, it is assessable. This approach properly gives effect to the language of s.8(1).

18. It is worth emphasising that a payment which one concludes is ‘for something else’ and thus not assessable, must be a payment which does not come within the test. As Lord Templeman pointed out, it is only where ‘an emolument is not paid as a reward for past services or as an inducement to enter into employment and provide future services but is paid for some other reason, [that] the emolument is not received “from the employment”.’ (Emphasis supplied.) Thus, where a payment falls within the test, it is assessable and the fact that, as a matter of language, it may also be possible to describe the purpose of that payment in some other terms, eg, as ‘compensation for loss of office’, does not displace liability to tax. The applicable test gives effect to the statutory language and other possible characterisations of the payment are beside the point if, applying the test, the payment is ‘from employment’.”

19.  Of particular relevance are the following phrases defining the test from the preceding paragraphs. To be taxable, the Sum must “arise from the office or employment”; the Sum is assessable “if it has been paid to [the Taxpayer] in return for acting as or being an employee”; the Sum “must be something in the nature of a reward for services past, present or future”; and the Sum is taxable if it is “a reward for past services” or “an inducement” to continue providing services or to enter into a contract to perform services in the future.

20.  Ribeiro PJ, accepting the above, emphasized that taxability must be “viewed as a matter of substance and not merely of form and without being ‘blinded by some formulae which the parties may have used’.” Nor is it enough to be able to say that the payment can be characterised as being for “something else”; “where a payment falls within the test, it is assessable and the fact that, as a matter of language, it may also be possible to describe the purpose of that payment in some other terms … does not displace liability to tax.”

21.  The next question is whether, viewing the Sum as a matter of substance rather than form, it is income from employment. As Fuchs makes clear, income from employment is broadly defined. It must arise “from” the “office or employment.” In other words, it extends to any payment made to the Taxpayer as a result of his “acting as or being an employee.”

22.  The facts of this case reveal that the Sum was paid to the Taxpayer as compensation for the failure of the HA to accord him the holidays and statutory rest days to which he was entitled under the EO. The question, applying Fuchs, is whether that purpose falls within the phrase “acting as or being an employee”, rendering past services, or as an inducement to enter into or remain in the contract for future services.

23.  Viewing the issue as a matter of substance, the answer to the question is clearly yes. First, the purpose for which the Sum was paid arises from the Taxpayer acting as or being an employee. The Taxpayer was required to be on standby at the request of the HA. He had to hold himself ready to go to the hospital at any time. This was what the Sum was aimed at compensating. The Taxpayer stood by on his holiday and rest days because he was an employee of the HA. In doing so, the Taxpayer was “acting as or being an employee.”

24.  Second, the Sum may be viewed as a payment for past services. The Taxpayer provided the HA a service by being on stand-by, even if he was not called on to go to the hospital. The HA had a responsibility to properly staff its hospitals on holidays and statutory rest days. It fulfilled that obligation, in part, by requiring the Taxpayer to stand by on call on those days. That was a past service to the HA.

25.  Third, the terms of the contract that provided for holidays and rest days, of which the Taxpayer was deprived, may be viewed as an inducement to prospective employees to enter into a contract for services with the HA. Hence it is related to employment, under the Fuchs test.

26.  For all these reasons, it seems clear that the Sum arose out of employment, as discussed in Fuchs.

27.  The arguments put against this conclusion fall within the category of fine distinctions and formalities which Fuchs warns against.

28.  The Taxpayer’s first argument is that the Sum was not paid pursuant to the of contract of employment, but rather to abrogate the Taxpayer’s rights. While conceding that this distinction could be fine in some cases, the Court of Appeal saw it as pivotal in this case. It is therefore worth examining in detail.

29.  In Fuchs, Ribeiro PJ referred to “abrogation of rights” to explain why a payment received where a contract of employment is prematurely terminated (or abrogated) was not taxable, referring to Henley v Murray (Inspector of Taxes) (1950) 31 TC 351. It is true that where a contract of employment is entirely set aside, or abrogated, it has been held that compensation for this is not taxable: see Henley, supra; Comptroller-General of Inland Revenue v Knight [1973] AC 428; Mairs (Inspector of Taxes) v Haughey [1994] 1 AC 303. But it does not follow that applying the label “abrogation of rights” means that the sum so described is not taxable.

30.  One must apply the proper test, as described in Fuchs. As Yuen JA stated in Poon Cho-Ming, John v Commissioner of Inland Revenue [2018] HKCA 297, at §27.2, “‘abrogation of contractual rights’ is not itself the test of chargeability in every termination situation. The test is not whether the employer had acted in breach in terminating the contract. In every case, the test remains that of the purpose of the payment at the relevant time.” (emphasis added)

31.  It may also be noted that the “abrogation cases” are all distinguishable from this case, being concerned with situations where the employment of the taxpayer with the existing employer had been brought to an end. The word describes the total abrogation of the contract, which terminates it. Wrongful dismissal can also be viewed as akin to the abrogation cases, since such situations connote that the employment contract of the taxpayer is no longer subsisting. The two are both distinguishable from the present case.

32.  The employment contract in this case was never terminated, whether in whole or in part. The HA never terminated the contract or any of its terms, nor were they set aside by agreement or any other mechanism. The contract remained fully in force at all times. The Taxpayer’s right to be paid for the days he was on stand-by did not negate or “abrogate” those terms. The Taxpayer relied on the terms of the contract and his rights and asked that he be given compensation for the failure to fulfill them. This is not abrogation of the contractual rights, but a demand that they be fulfilled.

33.  The majority of the Court of Appeal, with respect, appears to have equated failure to perform a contractual term with abrogation of that term. These are two different concepts.

34.  A second distinction relied on by the majority of the Court of Appeal lies in the contention that the Sum was damages – not for the failure of the HA to pay the Taxpayer for standing by on holidays and rest days – but for the HA’s breach of the EO. Thus, the Sum, rather than arising from the contract of employment, arose from the HA’s infraction of the EO.

35.  Again, the distinction fails to convince. While the HA may have arguably violated the EO, the principal reason the payment was ordered was the entitlement to payment for the Taxpayer’s standing by on holidays and rest days.

36.  As noted, the Taxpayer no longer presses the distinctions between immediate and secondary causation. If pressed, this would be yet another fine distinction – the sort of distinction Ribeiro PJ stressed cannot override the test, viewed substantively. The Taxpayer’s contract was as much the source of the contract as the HA’s primary obligations breached.

37.  While no longer pressed, the Taxpayer’s double taxation argument is misguided. The Taxpayer’s Letter of Appointment provided for a basic monthly salary. The Taxpayer has received this salary and has paid tax on it.

38.  However, this basic monthly salary does not include compensation for denial of rest days or holidays by the HA. Section 8 of the IRO expresses tax to be chargeable in respect of an employee’s income from employment, not on discreet days worked. As G Lam JA, dissenting, pointed out, tax is paid on the amounts paid by the employer, regardless of when or whether they are paid pursuant to a court order rather than of the employer’s own volition. The employer paid the Taxpayer basic salary. This did not include compensation for being on call on holidays and rest days. The Sum as ordered in the CFA Judgment is paid to the Taxpayer as compensation for his loss of rest days and holidays, and is thus over and above the basic monthly salary of the Taxpayer.

39.  While it is not necessary to consider it, I find the CIR’s argument on substitution unconvincing. The CIR argues that because the Sum was paid in substitution for lost holidays and rest days under the contract, the Sum should be considered as contractual, quoting Lord Woolf in Mairs (Inspector of Taxes) v Haughey: “It is inevitable that if a payment is made in substitution for a payment … [t]here will usually be no legitimate reason for treating the two payments in a different way.” It also argues that because the contract provides for payment of money where holidays and rest days are denied by consent or on termination under sections 20 and 40A(1) of the EO respectively, compensation for denial of holidays and rest days generally should be treated as payment for employment. We are not dealing with one payment being substituted for another in this case. Substitution arguments must be used with care to ensure both matters compared are identical.

E.  Conclusion

40.  I would therefore allow the appeal.

Chief Justice Cheung:

41.  Accordingly, the Court unanimously allows the appeal and determines the question of law, namely whether the Board of Review erred in law in finding that the Sum was income from employment with the meaning of section 8(1) of the IRO in the CIR’s favour. The Court further makes an order nisi that the costs here and below be paid by the Taxpayer to the CIR, and the parties be at liberty to lodge written submissions on costs within 14 days of the date of this judgment, such submissions to be dealt with on the papers.