UBIQUITI NETWORKS INTERNATIONAL LTD v. THE COMMISSIONER OF INLAND REVENUE

HCAL 874/2021

[2022] HKCFI 170

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

CONSTITUTIONAL AND ADMINISTRATIVE LAW LIST NO 874 OF 2021

________________________

________________________

________________________

_______________

J U D G M E N T

_______________

A.   Introduction

1.  The applicant, Ubiquiti Networks International Limited (“Company”) files tax returns with the Hong Kong Inland Revenue Department (“IRD”).  On 17 January 2017, the Company submitted its profits tax return (“Return”) for the year of assessment 2014/15 (“Y/A 2014/15”), with a set of Audited Financial Statements and Directors’ Report, which covered the period from 1 July 2013 to 30 June 2014.

2.  In the Return, the Company declared that it had made offshore sales totalling approximately US$151 million which had generated a total profit of about HK$3.18 billion.  The offshore sales of US$151 million included a sum of approximately US$119 million (“Disputed Revenue”) which was said to be net revenue from the Company’s sales to its US-incorporated holding company, Ubiquiti Inc (“Ubiquiti-US”).

3.  On 30 December 2020, based on the figures provided in the Return, the putative respondent Commissioner of Inland Revenue (“Commissioner”) assessed a total tax payable of about HK$524 million for Y/A 2014/15 (“2014/15 Assessment”).  The 2014/15 Assessment included the entire profit made from, and equal to, the Disputed Revenue.

4.  The Company then raised numerous grounds to object to the 2014/15 Assessment (“Objection”), pursuant to section 64 of the Inland Revenue Ordinance Cap 112 (“IRO”).  Only one of grounds raised is relevant for present purposes.  The Company now asserts that no such revenue was generated and the inclusion of the Disputed Revenue was, essentially, an accounting error.  Removing that figure from the Company’s books would reduce its profit tax liability by about HK$153 million (“Disputed Tax”).

5.  Pending the resolution of the Company’s Objection, the Company requested the Commissioner unconditionally to withhold the Disputed Tax.

6.  By decision dated 15 March 2021 (“1^st Decision”), the Commissioner refused to grant an unconditional holdover, but granted a conditional one instead.  The condition was that the Company had to purchase a tax reserve certificate (“TRC”) in the same amount as the Disputed Tax plus another figure, totalling around HK$170 million, as security.  The Company then submitted further information and asked for a reconsideration.  By decision dated 7 June 2021 (“2^nd Decision”), the Commissioner maintained his 1^st Decision.

7.  On 15 June 2021, the Company filed a Form 86 seeking leave to apply for judicial review to challenge both decisions.  On 23 June 2021, I ordered a ‘rolled-up’ hearing for the leave application and the substantive judicial review.

8.  At the rolled-up hearing on 12 January 2022, the Company was represented by Mr Stewart Wong SC and Mr Julian Lam of Counsel.  The Commissioner was represented by Mr William Liu, Senior Assistant Law Officer and Ms Jess Chan, Senior Government Counsel.

9.  This is my Judgment.

B.   The Statutory Framework for Holding Over of Tax

10.  It is helpful first to set out the relevant statutory framework and policy.

11.  The starting point, which is common ground, is that, when resolving an objection raised under section 64 of the IRO, the Commissioner acts as an assessor and is to determine the tax assessment on a de novo basis.

12.  The holding-over of tax pending resolution of objection and appeal is governed by s 71(2) of the IRO, which provides:

Tax shall be paid notwithstanding any notice of objection or appeal, unless the Commissioner orders that payment of tax or any part thereof be held over pending the result of such objection or appeal:

Provided that where the Commissioner so orders he may do so conditionally upon the person who or on whose behalf the objection or appeal is made providing security for the payment of the amount of tax or any part thereof the payment of which is held over either—

(a)  by purchasing a certificate issued under the Tax Reserve Certificates Ordinance (Cap. 289); or

(b)  by furnishing a banker’s undertaking,

as the Commissioner may require.

13.  Simply put, Hong Kong adopts a “pay first, argue later” regime.  Notwithstanding any objection or appeal, the taxpayer has to pay the tax as assessed, unless the Commissioner orders that the payment be held over pending the result of such objection or appeal.  Such holdover could either be unconditional or conditional.

14.  The Commissioner has formulated a policy to guide the exercise of his discretion under section 71(2).  The policy is contained in a published document known as the “Department Interpretation and Practice Notes No. 6” (“DIPN 6”).  §9 of DIPN 6 is pertinent (underlining in original):

9.  The policy with regard to the issue of stand-over orders is as follows:

(a)  Unconditional stand-over – Where, upon receipt of a valid objection and request for holdover, it is immediately apparent to an Assistant Commissioner, or other officer authorized by the Commissioner, that the objection should be allowed forthwith an unconditional stand-over will be ordered pending revision of the assessment. However, interest will be payable if any tax so held-over is finally found payable [see paragraph 14 below].

(b)  No stand-over – Where, upon receipt of a valid objection and request for holdover, it is the opinion of an Assistant Commissioner, or other officer authorized by the Commissioner, that the objection has little chance of success, no stand-over will be ordered and the tax will be payable on the due date(s) contained in the notice of assessment.

(c)  Purchase of tax reserve certificates – Where, upon receipt of a valid objection and request for holdover, it is the opinion of an Assistant Commissioner or other officer authorized by the Commissioner that the objection has some merit but that the balance of probability, based on the facts known to exist at the date of the objection, does not weigh definitely in favour of the taxpayer, a stand-over will be ordered conditional upon the purchase of tax reserve certificates in the amount of the tax stood-over. It is emphasized that, in the generality of cases falling into this category, the purchase of certificates will be required.

15.  It can be readily seen that, under DIPN 6, the grant or not of a holdover and the imposition of any condition for a holdover turn on the view of the Assistant Commissioner, or other officer authorised by the Commissioner, as to whether:

(1)  it is immediately apparent that the objection should be allowed forthwith; or

(2)  the objection has little chance of success; or

(3)  the objection has some merit, but the balance of probability based on the facts known to exist at the date of the objection does not weigh definitely in favour of the taxpayer.

16.  It is only if it is “immediately apparent … that the application should be allowed forthwith” that an unconditional holdover will be ordered.

17.  The discretion conferred upon the Commissioner in deciding whether and if so on what basis to hold over tax is a wide one.  The Court has repeatedly held that DIPN 6 sets out sensible criteria to guide the Commissioner’s exercise of discretion: see, for example, Kinco Investment Holding Ltd v CIR, (unreported, HCAL 91/2009, 20 September 2010) at §§21-22, citing Nam Tai Trading Co Ltd v CIR [2006] 4 HKLRD 51 at 54F.

18.  But, the “hard options” faced by a taxpayer, who wishes to exercise a statutory right to object tax assessment issued by the Commissioner, have previously been recognised: see, for example, Dairyfarm Establishment v CIR [2018] 5 HKLRD 179 at §§1, 35-36.  The potential disparities were recognised as follows:

(1)  Tax demanded under an assessment is payable on the due date specified in the assessment notwithstanding any objection or appeal, unless the Commissioner orders that the payment thereof be held over pending the outcome of the objection or appeal.

(2)  If the Commissioner does not order any holdover and the taxpayer pays the tax as assessed on or before the due date:

(a)  should the taxpayer ultimately succeed in his objection or appeal, he is entitled to be refunded the tax paid, but without any interest;

(b)  on the other hand, should he withdraw, or ultimately fail in, his objection or appeal, no further issue arises as the tax has already been paid.

(3)  Where Commissioner decides to make a holdover order, he may do so unconditionally or conditionally.

(4)  If the Commissioner makes an unconditional holdover order:

(a)  should the taxpayer ultimately succeed in his objection or appeal, no payment will need to be made by him and no further issue arises as there is no tax liability;

(b)  on the other hand, should he withdraw, or ultimately fail in, his objection or appeal, he has to pay the amount of tax that he is liable to pay plus interest on that amount from the original due date or the date of the order (whichever is the later) to the date of the withdrawal or final determination of the objection or appeal at the rate specified in section 71(11), which has stood at 8% per annum since 1 April 2009.

(5)  If the Commissioner makes a holdover order conditional upon the purchase of a TRC:

(a)  should the taxpayer ultimately succeed in his objection or appeal, he is entitled to be refunded the amount paid to purchase the TRC with interest at the rate specified in section 71(7)(ii), which is currently set at 0.05% per annum;

(b)  on the other hand, should he withdraw, or ultimately fail in, his objection or appeal, the TRC shall be accepted by the Commissioner in payment of the tax that the taxpayer is liable to pay and no further payment is required to be made by him.

19.  Hence:

(1)  the interest payable by the taxpayer (who withdraws, or ultimately fails in, his objection or appeal) to the Commissioner in the case of an unconditional hold over is 8% per annum;

(2)  the interest payable by the Commissioner to the taxpayer (who ultimately succeeds in his objection or appeal) in the absence of any holdover is nil; and

(3)  the interest payable by the Commissioner to the taxpayer (who ultimately succeeds in his objection or appeal) in the case of a holdover conditional upon the purchase of a TRC is 0.05% per annum.

20.  Such disparities may be amplified where the time taken to deal with the objection and any further appeal steps until final resolution may be measured in years rather than months or weeks.  In that context, the practical importance and potential financial consequences of the current intended challenge are readily understood.

21.  Lest it be thought otherwise, the time taken is not (or not always) only the result of time/delay on the part of the Commissioner and/or the Board of Review.  For example, in this case, whilst it took the Commissioner around five months to raise requisitions and to require the Company to provide evidence in support of, amongst other things, its claim of offshore profits, it took the Company’s accountants a year to respond with an only partial reply.  Nevertheless, whatever the cause of the passage of likely significant time, its potential impact is obvious.

22.  As to the Court’s role on a challenge by way of judicial review to a holdover decision, the Court’s role is obviously constrained.  The Court is not entitled to look into the substantive merits of the tax objection.  There is no question of balancing whether it would be more or less convenient for a taxpayer who has lodged an objection to pay tax now or later.  In a case such as the present, the Court’s function is limited to seeing whether the Commissioner’s decision to hold over tax conditional upon the purchase of a TRC is so outrageous in its defiance of logic that no sensible person who had applied his mind to the question should have arrived at it: see, for example, Kam Kiu (Hong Kong) Ltd v CIR (2009) HK Tax Cases 249 at §§8-9.

23.  This might properly be described as a high threshold.  Further, the difficulty of crossing that threshold is only multiplied by the fact that what is being tested is whether it was “immediately apparent that the objection should be allowed forthwith”, itself another high threshold.

24.  The high threshold can be satisfied, and the relevant decision quashed, if it is based on a finding of fact or inference from the facts which is perverse or irrational, without evidence to support it, or made by reference to irrelevant factors or without regard to relevant factors.  As it might be more pithily put, a decision may be quashed if it has no reasonable basis: see Building Authority v Appeal Tribunal (Buildings) [2013] 4 HKLRD 52 at §§28-30.

25.  Incidentally, also in the Kam Kiu case (at §§16-17), where the taxpayer had throughout been advised by professional accountants, it was noted that the Commissioner could surely work on the basis that the accountants would know what to put forward and what not to put forward.  Whilst the particular context related to what to put forward if it was desired to obtain an unconditional holdover, it seems to me obvious that the point has wider application.

C.   Background facts

26.  The Company is a Hong Kong incorporated company with a Taiwan Branch, and its principal business is trading of network equipment. It is wholly and immediately owned by a Cayman Islands company (“Ubiquiti-Cayman”), and is ultimately owned by Ubiquiti-US.

27.  The Return for the YA 2014/15 declared nil profits and nil tax liability.  However, there was declaration of offshore profits of approximately HK$3.18 billion (approximately US$410 million, where the adopted conversion rate was 1:7.7513) and profits from sale of capital assets in the sum of approximately HK$2.14 billion (approximately US$276 million).  As stated above, the relevant Directors’ Report and the Audited Financial Statements accompanying the Return were for the year ended 30 June 2014.

28.  The Directors’ Report included the statement that the results of the Company for the year ended 30 June 2014 are as set out in the comprehensive income on page 5.  That page includes reference to ‘Revenue’ in the sum of US$151,765,749 (“US$151 million”) and ‘Cost of sales’ in the sum of US$12,008,609 (“US$12 million”).  The ‘Gross profit’ is therefore US$139,757,140 (“US$139 million”).  The Revenue figure has an explanatory note 6 to identify that it “represents the net amount earned from goods provided to customers”.

29.  Explanatory note 15 to the Financial Statements, headed ‘Related party transactions’, includes a line ‘Sales to the ultimate holding company [Ubiquiti-US]’ with the figure for 2014 shown as US$119,449,995 – where the Hong Kong dollar denomination shown in the note is an obvious typographical error – namely the amount of the Disputed Revenue.

30.  The auditor for the Company’s accounts for YA 2014/15 was PricewaterhouseCoopers Hong Kong (“PwC”).  Ignoring the only qualification, irrelevant for present purposes, that the accounts of the Company’s subsidiaries had not been consolidated, PwC gave its audit opinion that:

… the financial statements give a true and fair view of the state of the Company’s affairs as at 30 June 2014, and its profit and cash flows for the year then ended in accordance with Hong Kong Financial Reporting Standards and have been properly prepared in accordance with the Hong Kong Companies Ordinance.

31.  At this point, though jumping ahead on the chronology, it is worth noting that the Company’s accounts for the following year of assessment 2015/16 were audited by Mazars CPA Ltd (“Mazars”), who took the same approach as did PwC.  In the Y/A 2015/16, the relevant transactions were also booked as “sales to Ubiquiti US” and such entries were also certified as true and correct by Mazars in the 2015 Audited Financial Statements.

32.  The Return bears the taxpayer’s standard declaration, signed by a director of the Company, that “to the best of my knowledge and belief all the particulars contained in this form and the Supporting Documents are true, correct and complete.”

33.  Schedule 3 to the Profits Tax Computation – in summary claiming a nil amount as assessable profit – which accompanied the Return identified the offshore gross profit as calculated by ‘Sales’ of the US$151 million less ‘Cost of sales’ of the US$12 million giving the gross profit figure of the US$139 million, taken into the Return as the converted figure of approximately HK$1.08 billion.

34.  In his submissions, Mr Wong suggested that the figures identifying a revenue of US$151 million as against costs of sale of a mere US$12 million – namely sales of 12.64 times cost – was obviously improbable.  However, it was apparently not so obvious that the directors of the Company or its auditors picked up on it or took any steps upon at the time, January 2017.  As will be seen below, it was only in about July 2019 that the Company claimed that the Return and the Audited Financial Statements were both incorrect – because they had included the Disputed Revenue which was derived from non-existent sales.

35.  The Commissioner raised queries about various profits tax years of assessment, including YA 2014/15, by its letter dated 7 June 2017.  A partial reply was sent by the Company’s accountants, Deloitte, on 6 June 2018.

36.  On 11 July 2018, Deloitte submitted further information and documents in relation to the offshore claim.  By reference to the period after the group restructuring in early 2013, Deloitte offered a diagrammatic transaction flow of purchase and sales of the products as follows:

37.  The diagram appears to identify that the Company sold goods to Ubiquiti-US, albeit that the sale was ‘at cost’, and that there were service fees paid by Ubiquiti-US to the Company.  Some additional detail was provided, but it seems to me that it focused on the relationship between the Company and Ubiquiti-Cayman and the Taiwan Branch.  The information provided about Ubiquiti-US was that the Company received a service revenue from Ubiquiti-US for the provision of procurement services rendered by the staff of the Taiwan Branch in the PRC/Taiwan, where the amount was calculated based on the costs of sourcing incurred by the Company plus a mark-up of 5%.

38.  By letter dated 26 July 2018, Deloitte provided further information.  Appendix 6 to the letter was a detailed income statement which, for the year ended 30 June 2014, identified Revenue of the US$151 million figure, predominantly said to comprise ‘Sale of goods’.

39.  However, in July 2019 – incidentally a year after the correspondence in July 2018, with only one largely immaterial letter in between, in May 2019 – the Company claimed for the first time that the Disputed Revenue was wrongly recorded.  In its letter dated 30 July 2019, Deloitte offered information concerning the Company’s sourcing of goods for the years of assessment 2013/14 to 2015/16.  Deloitte stated – at point (i) – that regarding accounting entries with respect to the Company’s sales of goods to Ubiquiti-US, the Company advised that the relevant sales and costs of sales were offset and hence not reflected in the Company’s income statements considering that the goods were sold by the Company to Ubiquiti-US at cost.  That statement was footnoted as follows – albeit it can be seen to refer to a different year of assessment than relevant for present purposes:

Our client [ie. the Company] would like to clarify that due to the turnover of staff of Ubiquiti group, the Company’s sales of goods to Ubiquiti-US for the year of assessment 2013/14 were erroneously recorded in the Company’s income statement at cost, instead of cost plus 5% mark-up as mentioned in point (ii) of our reply letter submitted to your Department dated 11 July 2018.

40.  The Deloitte letter went on to state at points (ii) and (iii):

Nevertheless, during review of the Company’s gross profit (“GP”) ratios for the years of assessment 2013/14 to 2015/16, it was revealed to our client that different accounting treatments were adopted for specific transactions on the sale of goods to Ubiquiti-US with respect to those US customers who directly arranged for shipment of goods from the warehouses located in the PRC which were owned/operated by various independent logistic companies (“Direct Shipment Transactions”).

Specifically, the costs of shipments of goods fulfilled by the Company from the PRC unrelated suppliers to Ubiquiti-US under the Direct Shipment Transactions were erroneously recorded in the Company’s sales to the Ubiquiti-US and reported in the Company’s income statement for the years of assessment 2013/14 to 2015/16, i.e. … US$119,449,995 for 2014/15 …  These amounts were disclosed as “sales to the ultimate holding company” in Note 15 to the Company’s audited financial statements for … 2014/15 … (i.e. related party transactions).  This is because of the limitation of Ubiquiti group’s accounting system which resulted in inventory in and out had to be recorded at cost in the Company’s balance sheets.

However, the corresponding cost of sales under the Direct Shipment Transactions for the aforesaid years of assessment were not recorded in the Company’s income statements.  From Ubiquiti’s group perspective, the reporting of sales by the Company was done in error – as the related sales were also reported in Ubiquiti-US’s income statements.

Our client is of the view that the said error in recording the Company’s revenue is primarily due to the change of auditors before and after the group restructuring of the Ubiquiti Group.  When the said error was initially revealed, our client has discussed with the Company’s existing auditor for rectification of the said error in the Company’s income statements in the subsequent years.

As a result, there was an inaccurate profit margin being reflected on the Company’s financial statements for the aforesaid years of assessment.

41.  Appendix 1A to the letter is an analysis on the Company’s revenue and costs of sales.  It identifies a nil cost of sales against the revenue of the US$190 million.  That revenue figure is footnoted – fn3 and fn9:

3.  Per sales to the ultimate holding company disclosed in Note 15 to the Company’s audited financial statements for the year ended 30 June 2015 (i.e. related party transactions).

9.  As mentioned in point (ii) of our cover letter, the amount represented the Ubiquiti Cayman’s sales to Ubiquiti US via the Company with respect to those Ubiquiti US’s customers in the US for collection of goods in the PRC.  However, the corresponding cost of sales was erroneously not recorded in the Company’s income statement for the corresponding year of assessment.

42.  On 7 April 2020, the Commissioner wrote to the Company stating that there were missing documents and inconsistent facts, and requested the Company to provide further information and evidence.  Of the 76 questions raised, 10 of them related to the alleged accounting error.  After other partial replies, by letter dated 29 October 2020, Deloitte addressed the relevant questions and stated that for the year of assessment 2013/14, the Company sold goods to Ubiquiti-US with a 5% mark-up, but it was erroneously recorded at cost in its accounts.  It also provided the Reports and Financial Statements for the year ended 30 June 2018, which were audited by RSM Hong Kong (“RSM”) (who had been appointed as the auditor of the Company for the year ended 30 June 2018 to fill the casual vacancy arising on the resignation of Mazars).

43.  Part of the Financial Statements for the year ended 30 June 2018 contained a retrospective restatement of financial statements for the earlier periods.  This is explained as follows:

The Company’s financial statements for the year ended 30 June 2017 have been restated to correct prior periods errors relating to certain sales transactions made by Ubiquiti Inc. to its customers in the United States, who had directly arranged for shipment of goods to the United States from manufacturers located in the People’s Republic of China (“Direct Shipment Transactions”).  It is revealed to the management of the Company that the Company erroneously recorded the Direct Shipment Transactions as the Company’s sales to Ubiquiti Inc. and recognised revenue of US$68,947,458, US$119,449,995 and US$163,055,039 for the year ended 30 June 2013, 2014 and 2015 respectively.  As a result, the revenue and profit for the above-mentioned financial years were overstated by the corresponding amount; and the amount due from ultimate holding company and the retained profits as at 30 June 2013, 2014 and 2015 (and accordingly 30 June 2016 and 2017) were overstated by US$68,947,458, US$188,397,453 and US$351,452,492 respectively.  The prior periods errors are corrected retrospectively and the effect of the retrospective restatement on the statement of financial as at 1 July 2016 is summarised below [in a table].

44.  The revised income statement of the Company is identified in an attachment to the Deloitte letter, including showing the removal of the US$119 million as revenue for the period 2014/15.

45.  Notwithstanding this letter, on 30 December 2020, the 2014/15 Assessment was raised consisting, in part, of profits tax chargeable on the offshore profits claimed, in the sum of HK$170,490,265.

46.  On 12 January 2021, Deloitte sent the notice of objection against the 2014/15 Assessment, and requested the tax in dispute to be held over unconditionally.

47.  On 15 March 2021, the Commissioner issued the 1^st Decision, making the holdover of that part of the tax conditional (albeit that an unconditional holdover was ordered regarding a different part of the assessment).

48.  On 12 April 2021, the TRC was purchased.

49.  In letters dated 31 May 2021 and 2 June 2021, Deloitte and DLA Piper respectively provided further information to the Commissioner and asked for the reduction of the sum for TRC.  It was argued that the accounting error should not be taken into account when assessing the profits tax payable.  It was stated that: (1) because of the limitation of its accounting software system, the cost for the purchase in respect of Direct Shipment Transactions had to be recorded as “sales to Ubiquiti US” and it was for the finance team to manually reverse the entries at each quarter and, but that was not done for the three financial years ended June 2013, 2014 and 2015; (2) because there were no corresponding matching costs in the Company’s books, this supported that the “sales to Ubiquiti US” did not take place; and (3) the Company worked with RSM to correct the error, and RSM agreed that the retrospective restatement made was reasonable and acceptable.

50.  In its own letter dated 2 June 2021, RSM wrote to provide an overview of the audit procedures performed and evidence obtained relating to the Retrospective Restatement, and enumerating the particular procedures carried out.  The letter states that the procedures performed in documentary evidence obtained was part of the work performed for the FY 2018 Audit, and were not exhaustive.  The penultimate paragraph of the letter stated that the content of the letter was intended for general information only and therefore did not constitute, in whole or in part, an expression of an opinion on the Retrospective Restatement and the DLA Piper letter.

51.  On 7 June 2021, the Commissioner made the 2^nd Decision, rejecting the request and maintaining the conditional holdover order.  Though I shall refer to subsequent events, strictly that comes from material which was not available to the Commissioner at the time that he made either the 1^st Decision or the 2^nd Decision (and so is not able to be taken into account when considering the decisions of the Commissioner as at the time they were made).

52.  On 15 June 2021, the Form 86 was filed in these proceedings.

53.  By letter dated 22 July 2021, DLA Piper informed the Commissioner, amongst other things, that the “sales to Ubiquiti US” entries had in fact been reversed in the accounting software system, but were reinstated pursuant to advice given by the previous auditor PwC.  It was not explained why PwC gave such an advice or why the Company adopted it.  The Company said that, back then, its finance team did not appreciate the implication of reinstating sales revenues in the sum of US$119 million to its accounts.  Also provided was a PwC working paper which identified the “need to add back the related party sales that have been eliminated” in the sum, amongst others, of the US$119 million for FY14.

54.  On 2 December 2021, and in response to a request made by DLA Piper the previous day asking for confirmation that the overstatements were mistakes, which request had been prompted by the Commissioner stating that RSM was “yet to provide an explicit confirmation that the Errors were mistakes”, RSM replied, pointing out in addition to the explanation that the Retrospective Restatement had been made pursuant to the audit procedures set out in the 2 June 2021 letter:

2.  We are not in a position to conclude that by including the Overstatements in the previous audited financial statements, the former auditors of the Company must have made mistakes because we do not know what information was provided and/or not provided by the Company and Ubiquiti US to the former auditors at the time when the relevant audits were carried out.

3.  However, based upon the information we gathered from the Company and Ubiquiti US in accordance with the audit procedures set out in the [2 June 2021 letter] and the information set out in [DLA Piper’s 1 December 2021 letter] (including your letter to the Commissioner of Inland Revenue dated 22 July 2021), we are of the firm view that it was entirely appropriate for the Company to carry out the Retrospective Restatement because (a) the previous audited financial statements of the Company included revenues which were not in fact earned by the Company; and (b) the Retrospective Restatement was necessary for the Company’s financial statements to give a true and fair view of the financial positions of the Company.

55.  Mr Liu places emphasis on paragraph 2, and Mr Wong places emphasis on paragraph 3. But, as already indicated, neither paragraph was before the Commissioner at the time of the relevant decisions under challenge (though he will no doubt take both paragraphs into consideration when determining the actual Objection).

D.   The Decisions

56.  The 1^st Decision was contained in a standard format letter dated 15 March 2021.  No reasons were given in that letter itself but reasons were given by the Commissioner by way of affidavit evidence.  The Commissioner said that at the time of the 1^st Decision, he considered that the objection raised by the Company had some merits but did not weigh definitely in favour of the Company based on all the facts known to exist as at the date of the objection.

57.  The Commissioner had taken into consideration the following:

(1)  The inclusion of the Disputed Revenue was unlikely to be a pure error.  The Disputed Revenue stood at US$119 million.  It was substantial.  It represented about 80% of the total annual revenue as stated.  Yet, it was only discovered about 6 years after the error is said to have occurred.

(2)  Had it been an error, it should have been identified by professional auditors.  Yet, PwC certified the YA 2014/15 financial statements as true and correct.  Likewise, PwC’s successor, Mazars, also certified such “sales to Ubiquiti US” in YA 2015/16 as true as correct.  No explanation had been provided by PwC or Mazars so far.

(3)  Correction of tax return in prior years which were audited by professionals must be coherently explained and substantiated with documentary evidence.  The Company had yet to provide sufficient documentary evidence in support of the true nature of the alleged accounting error.  Some documents concerning the Direct Shipment Transactions requested by the Commissioner on 9 February 2021 were still outstanding.  Those documents were only provided on 22 July 2021, i.e. after the 1^st and the 2^nd Decisions had been made.  At that the time of the objection/decisions, the Commissioner had to make further investigation into the facts.

58.  The 2^nd Decision was contained in a letter dated 7 June 2021.  The Commissioner reiterated that the objection had some merits but was not considered to weigh definitely in the Company’s favour.  The Commissioner further elaborated his reasons by way of affidavit evidence:

(1)  By then, a further version of how the alleged error came about was provided.  The Commissioner observed that inconsistent versions had been provided over time to explain the alleged errors.  All along the Company engaged auditors and was represented by tax professionals.  This cast serious doubt and made it not immediately apparent that the objection should be allowed forthwith.

(2)  RSM has yet to provide a confirmation that the inclusion of the Disputed Revenue was a mistake.  Their letter dated 2 June 2021 issued to the Company (and provided to the Commissioner by the Company presumably for such a purpose) did not contain statements to this effect.

(3)  The requested documents were still outstanding.

E.   Grounds of Review

59.  The Company says the Decisions not to grant unconditional holdover are Wednesbury unreasonable.  The argument flows from the established principle that the Commissioner has to determine an objection by acting as an assessor de novo.  It follows that to tax the Company, the Commissioner must be able to identify at least one positive basis upon which tax is said to be payable.  If no positive basis could be identified, it must be immediately apparent that the objection should be allowed.

60.  The Company submits that in the circumstances, the only reasonable conclusion is that there is no basis to charge the Company with any profit tax.  The Commissioner could only have concluded that the inclusion of the Disputed Revenue was a mistake and, thus, the Company could not have profited from it.  Since the Company could not have profited, there could be no positive basis for tax.

61.  The Company heavily relies on the fact that the Disputed Revenue was included in the income statement without any costs of goods sold being deducted.  Along the same line, as I have already noted, it also relied on the fact that the total offshore sales of US$151 million was generated by a costs of sales at only US$12 million, a sum which is said to be self-evidently too small to generate total sales of US$151 million.

62.  In his submissions, Mr Wong submits that it does not matter whether the position is that (a) there were in fact no sales or (b) there were sales, but they were ‘at cost’, and the cost must be (but was not) deducted.  On either basis, he says, there was no profit.  He submits – as he must, if the challenge is to succeed – that, on the basis of the materials before the Commissioner, to have decided otherwise was Wednesbury unreasonable, perverse or irrational.  Mr Wong submits that there was no possible positive basis on which to have assessed a liability to profits tax, and that the only conclusion that was (and is) that it was (and is) immediately apparent that the Objection should be allowed.

63.  As to the explanations given by the Commissioner for making the 1^st Decision and the 2^nd Decision, Mr Wong makes various observations, summarised in the submission that none of the reasons identify a possible positive basis for an assessment to profits tax.

F.   My View

64.  Counsel for the Commissioner, Mr Liu, says that the Company has introduced a fundamental change to the policy in DIPN 6 when it says that the Commissioner must be able to identify at least one positive basis to say that tax is payable. The test laid down by DIPN 6 for ordering unconditional holdover is that it is “immediately apparent” that the objection should be allowed “forthwith”. Mr Liu submits that the “no possible positive basis” test would lower the threshold for ordering an unconditional holdover.  Alternatively, and in any event, if a possible positive basis is indeed needed, Mr Liu points to the assessment being made under the IRO according to the Return filed by the Company.

65.  I do not think Mr Wong has really sought to introduce a different test or threshold applicable to the policy under DIPN 6, though perhaps the use of the particular label – which Mr Wong even capitalised as the “Possible Positive Basis” – is not altogether helpful.  The wording of DIPN 6 seems to me to be clear enough without having to rephrase it.  But, logically, an assessor must have some basis upon which he makes his assessment and, in the face of an objection and request for holding over of tax, he must apply his mind properly to the relevant question posed in making a decision whether to hold over tax, and if so on what basis.  He could not randomly make up figures in his own mind and then proceed based on those made-up figures.  If he orders a conditional holdover, he must be able to explain why he thinks it is not immediately apparent that the Company has not made assessable profit in the assessed amount, to which a liability to profit tax would attach.

66.  In the instant case, the Commissioner must be able to explain why he thinks it is not immediately apparent that an objection to the assessment of profits tax by reference to the revenue in the sum of the US$119 million should be allowed forthwith.  In this sense, it is not wrong to say that an assessor must be able to identity a possible positive basis on which tax might, properly arguably, be assessed – or at least that it is not immediately apparent that the prior assessment should be set aside forthwith.

67.  However, I have no doubt that there is a positive basis – if one gives it that label – perfectly reasonably open to the Commissioner to reach and hold the view that it is not immediately apparent that the Company had not made the Disputed Revenue or the corresponding profit, so that the objection to the assessment made should be allowed forthwith.  That basis is the Return which was submitted by the Company itself, with the declaration that the information stated therein is true and correct, based on accounts verified by a director, and supported by a set of Audited Financial Statements which a prominent accounting firm had confirmed gave a true and fair view of the Company’s affairs.

68.  The Hong Kong taxation system places great importance on the filing of correct tax returns.  The IRO has conferred on the Commissioner wide and substantial powers for this purpose: see sections 51 and 52. Failure to file tax returns, or filing returns with incorrect information, are also punishable as a criminal offence: see section 80.  It is antithetical to say that the revenue and profit stated by a taxpayer in his tax return could not be relied on by the Commissioner as a positive basis to make tax assessment.

69.  The Company submits that it has “disavowed” the Disputed Revenue (and by extension the Return).  It has told the Commissioner that it got its figures wrong in the Return, based upon financial statements which were wrong, so that the Commissioner should have allowed it to correct the Return and the financial statements.  It says that it is wrong for the Commissioner to insist that the Return might have been correct.

70.  The Commissioner is entitled to place appropriate reliance on the taxpayer’s own return, though the Commissioner is of course not bound by the tax return filed by the taxpayer when making his assessment.  Filing a return and making an assessment are two distinct procedures.  The Commissioner is entitled to make use of other information which he may consider to be a better reflection of the correct situation.  It must follow that, even if the taxpayer has disavowed a previous return and submitted a new one, the Commissioner is still entitled to prefer the figures in the old return, if there are valid reasons to do so.

71.  In this case, Commissioner has clearly given substantial weight to the fact that the Return disavowed by the Company was based on the accompanying financial statements which were audited and certified as true and correct by the directors and by professional auditors.  As at the dates of the two Decisions, (1) the Company was yet to procure an opinion from another professional auditor to say that PwC must have made a mistake or that the inclusion of the Disputed Revenue must have been a mistake, and (2) the Company was yet to procure any material from PwC or Mazars identifying precisely what the mistake was, and how it was made, and why it should be rectified.

72.  I acknowledge that the Company’s deponent has explained in his third affidavit filed in these proceedings why RSM was engaged to review the accounting error, rather than go back to PwC and Mazars – for the twin reasons of (a) efficiency and cost-effectiveness and (b) greater independence and impartiality.  But, first that explanation postdates the relevant Decisions, and secondly it seems to me that it remains properly open for the Commissioner to see in addition whether there is any further material which might be forthcoming from PwC or Mazars.

73.  I also note that between and since the date of the Decisions, RSM has provided its opinion in the two letters of 2 June 2021 and 2 December 2021 respectively.  Obviously, the clearer letter as regards its own opinion is the latter (which was not available to the Commissioner at the time of either Decision).  But even if it had been, the Commissioner would in effect have been faced with competing professional audit opinions – and where RSM is unable to state that the competing opinion must have been a mistake.  On that basis, it is difficult to see why it must have been immediately apparent that the earlier opinions and approach (PwC and Mazars) must be wrong and the subsequent opinion (RSM) must be right.

74.  The Company’s submission that very little weight should be given to the fact that the 2014 financial statements were audited because the current auditor has confirmed that the Retrospective Restatement to exclude the Disputed Revenue was appropriate takes the matter further.  The relative weights fall to be considered by the Commissioner in determining the Objection – unless it is immediately apparent to the authorised officer considering the holdover that absolutely no weight can be given to the prior auditor’s view.

75.  As an aside, the latest version regarding why the Disputed Revenue was included or reinstated in the Financial Statements and Return is telling, namely that it was based on the advice of PwC, which was accepted.  But, for the avoidance of doubt, since that information was not before the Commissioner at the relevant time, it strictly does not come into the present consideration.

76.  The Company complains that the Commissioner’s reliance on PwC’s audit opinion on the 2014 Audited Financial Statements (and Mazar’s for the following year) had never been raised with the Company before is a reason made up ex post facto by the Commissioner. I do not agree.  Companies of the Company’s scale are required to submit audited financial statements as supporting documents for their tax return. Obviously, the Commissioner would consider the opinion of then auditor – just as, when determining the Objection, the Commissioner will have to consider the opinion of the subsequent auditor.

77.  The Commissioner has also placed reliance on the fact that the Company, with the assistance of tax professionals, has offered inconsistent versions about the true nature of the Direct Shipment Transactions and how the alleged error came about.  At the dates of the two Decisions, requested documents which might shed light on the nature of the Direct Shipment Transactions were still outstanding.

78.  It is all very well to say that the arithmetical result when calculating liability to profits tax would be the same whether there were in fact sales or were in fact no sales.  But it seems to me that prior to reaching a firm conclusion on the Objection, it is properly open to the Commissioner to consider that further investigation of those mutually inconsistent facts is something that may be of value in the overall correct assessment to tax.  Mr Wong submits that it is only the details which have changed in the explanation put forward, for the reason that the Company was still investigating matters.  But, even assuming that to be so, it is difficult to see why the Commissioner should not have a similar opportunity to investigate matters in those circumstances.

79.  Indeed, Mr Wong’s submissions effectively require me not just to consider the merits of the Objection, but in practical terms to rule on it. Whilst he may be correct that when a Wednesbury challenge is mounted, some view of the underlying merits may be required, the focus nevertheless remains on the decision-making process.  In this case, notwithstanding that the Objection is yet to be resolved, if I were to find in favour of the Company, it would effectively be a decision which would require the Objection also to be determined in favour of the Company (and would likely bind any Board of Review, and perhaps subsequent tiers of potential appeal to the courts).

80.  But, if focus is kept on the correct decision, what the Court is currently concerned with on this challenge is obviously a decision pending the resolution of the actual Objection, where the person statutorily required to determine the Objection is the Commissioner, acting as an assessor on the de novo basis.

81.  On analysis, the holdover decision is one which might properly be described as interim, and it is one which is to be made expeditiously.  If a holdover is to be unconditional, the decision-maker must be able to see “immediately” – that is without further investigation or consideration – that the objection should be allowed “forthwith”.

82.  Further, if one reads DIPN 6 §9(a) and §9(c) together, the other side of the equation is seen.  To avoid an order requiring the taxpayer to purchase a TRC pending an objection, the Commissioner must be of the opinion that the objection not only has some merit, but that on the facts already known the balance weighs “definitely” in favour of the taxpayer.

83.  Indeed, where the holdover decision is one made pending the determination of an objection, the necessary opinion as to the merits of the objection is of its nature provisional, to the extent that it does not dictate or mandate the outcome of the determination of the objection.  Unconditional holdover has been identified under DIPN 6 as appropriate only where it is appropriate for the holdover decision in effect to dictate or mandate the outcome of the determination of the objection.  Alternatively, it might be seen the other way round: if the objection is immediately apparently one which should be allowed forthwith, there is no need to hold over any tax, conditionally or otherwise.  It has already been determined that no (or a different) tax liability arises, and that is what the determination of the objection will state.

84.  It is probably unnecessary, and may be unhelpful, to seek to describe the number of cases which might fall into this category; but it might be thought that the number of such cases would be in a small minority of the total number of cases in which an objection to an assessment is raised.  By way of example only, the type of case in which it might be immediately apparent that the objection should be allowed forthwith might include an assessment in which there has been an obvious merely arithmetical or calculation error, or an obvious typographical mistake.  But, of course, there will be other cases where the balance might weigh definitely in favour of the taxpayer, so that it is immediately apparent that the objection should be allowed forthwith.

85.  It is also important to remember that, when ordering a conditional holdover, the Commissioner has not rejected the Company’s arguments based on its explanations, its restated accounts and the new auditor’s opinion.  Rather, the ordering of a conditional holdover specifically recognises that there is weight to be given to those arguments.  It is just that, although the Objection has some merit, on the facts known to exist at the date of the Objection, the opinion is held that the balance of probability does not weigh definitely in favour of the Company.  Mr Wong submits that the Commissioner cannot ignore calculations which leave no doubt, even if previously there was doubt.  But how to deal with the doubt is precisely the question on determination of the Objection itself.  That there is doubt that the Objection will definitely be decided in favour of the Company means simply that it is open to the Commissioner to have made a conditional holdover.

86.  Mr Wong’s submission that the Company’s confidence in the Objection is demonstrated by its willingness to face interest of 8% on the tax it might later be ordered to pay if there is an unconditional holdover pending the Objection, adds nothing to the analysis.

G.   Conclusion

87.  The Company’s intended grounds of review are not reasonably arguable.  The application for leave to apply for judicial review is dismissed.

88.  In any event, even if the intended grounds of review are thought to be reasonably arguable, I would dismiss the substantive application for the reasons given above.

89.  As to costs, I see no reason why they should not follow the event.  The Company shall pay the Commissioner’s costs, to be taxed if not agreed.