COMMISSIONER OF INLAND REVENUE v. SIN CHUN WAH

Inland Revenue Appeal No. 4 of 1987

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HEADNOTE

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Inland Revenue Ordinance S. 12(l)(a).

One month's salary paid in lieu of notice of termination not deductible from taxpayer's assessable income.

IN THE SUPREME COURT OF HONG KONG

CIVIL JURISDICTION

INLAND REVENUE APPEAL No. 4 OF 1987

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BETWEEN

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JUDGMENT

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1. This is an appeal by the Commissioner of Inland Revenue against the decision of the Board of Review. The facts very shortly are these. The Taxpayer's former employment with the Water Supplies Department ("WSD") terminated on 24th July 1979 when his resignation took effect. Prior to such termination he had commenced his new employment with the Mass Transit Railway Corporation ("MTR") on 5th June 1979. Under his former terms of employment he had to give three months' notice of intention to resign or pay one month's salary in lieu. WSD paid his salary up to 24th July 1979. Subsequently the Taxpayer paid to WSD one month's salary ($3,306) in lieu of the notice he had failed to give.

2. In his 1979/80 salaries tax return, the Taxpayer deducted the $3,306 he had paid, and received an assessment upon that return. Subsequently, however, the assessor raised an additional assessment to include that amount.

3. The Taxpayer appealed to the Board of Review but was not legally represented at that stage. His grounds of appeal were that if he had not paid the $3,306 he would not have been able to take up his new employement as early as 5th June 1979 but would have had to wait until 1st August 1979 under the offer of employment he had received from MTR at the end of April 1979; and that it was his payment that procured his immediate release and enabled him to earn $7,989 for the period 5th June 1979 to 31st July 1979 (his new salary being $4,358 per month) upon the whole of which sum he paid tax. Therefore, he claimed, the payment of $3,306 was wholly, exclusively and necessarily incurred in the production of his assessable income.

4. The Commissioner contended otherwise. On the facts the Board "held that the Taxpayer could not have lawfully obtained employment with the MTR if he did not terminate his contractual obligation with the WSD. He could not lawfully have earned his emoluments from the MTR without paying a sum equal to one month's wages to the WSD. The appeal was allowed and the assessment ordered to be reduced accordingly. "

5. At the request of the Commissioner the Board now states the following question of law for the opinion of this Court:

"Was the Board of Review correct in deciding that the payment made by the Taxpayer to his employer in lieu of notice was wholly, exclusively and necessarily incurred in the production of the Taxpayer's assessable income".

6. The relevant provision of the Inland Revenue Ordinance (Cap 112) is section 12(l):

"12(1) In ascertaining the net assessable income of a person for any year of assessment, there shall be deducted from the assessable income of that person -

7. Mr. Bernard Whaley for the Commissioner submits that even if the expense was incurred in order to place the Taxpayer in a position to earn the extra assessable income (because if he did not pay the month's salary in lieu of notice he could not have taken up the alternative employment with MTR until 1st August 1979), which Mr. Whaley does not concede, the payment of the month's salary was not incurred in the production of the assessable income. He relies primarily upon CIR v Robert P. Burns 1 HKTC 1181, in which the facts in principle are very similar, and which Mr. Dennis Yu for the Taxpayer has not sought to distinguish. In that case the Taxpayer was a race horse trainer who was charged before the Jockey Club's stewards with the contravention of the Rules of Racing and disqualified: for six months. He successfully appealed and subsequently claimed his legal costs of that appeal as an allowable deduction. The claim was disallowed by the Commissioner, but the Board decided that the costs were deductible. The Commissioner appealed against that decision to the Court of Appeal which allowed the appeal. Huggins J.A. (as he then was) with whose judgment Yang J. (as he then was) and Zimmern J. agreed, noted that the substance of the argument on behalf of the Commissioner was that the Board of Review misdirected itself in considering whether the appeal against the Jockey Club's stewards was necessary "for" the production of the assessable income; that having held that the appeal was necessary for the production of the income, the Board proceeded to conclude that the expenditure on legal fees was therefore incurred in the production of that income; that that was a non sequitur and that although the expenses were incurred in order to place the Taxpayer in a position in which he was able to earn part of the assessable income, they were not incurred in the production of it.

8. It is implicit from his judgment that Huggins J.A. accepted that submission. It is helpful to note briefly the facts of the cases upon which he relied. First, Federal Commissioner of Taxation v Hatchett (1971) 125 CLR 494, which Huggins J.A. noted perhaps demonstrated the point made in the submissions on the Commissioner's behalf most clearly. The Taxpayer who was a teacher took two steps to advance himself, (1) he submitted some theses for the purpose of gaining a teacher's higher certificate and (2) he took a course at the university. In connection with each he incurred expenses. Section 51 of The Australian Income Tax Assessment Act 1936 - 1967 provides that all outgoings to the extent to which they are incurred in gaining or producing the assessable income shall be allowable deductions. The High Court of Australia allowed expenses of the theses as deductible because the teacher's certificate automatically entitled the teacher to be paid more for the same work; but the expenses of the university course were held not to be deductible because there was no "perceived connection" between the outgoings and the assessable income.

9. Huggins J.A. next considered Lunney v Commissioner of Taxation (1957) 100 CLR 478 observing that the majority of the Court there thought there was an important distinction between an expense incurred in gaining income and one incurred necessarily for the purpose of gaining it. In that case the question was whether a Taxpayer could deduct the expenses of travelling backwards and forwards to his place of work from his home. Huggins J.A. quoted the following from the majority judgment in that case (at p. 498):

"It is, of course, beyond question that unless an employee attends at his place of employment he will not derive assessable income and, in one sense, he makes the journey to his place of employment in order that he may earn his income.

 

But to say that expenditure on fares is a prerequisite to the earnings of a taxpayer's income is not to say that such expenditure is incurred in or in the course of gaining or producing his income. Whether or not it should be so characterised depends upon considerations which are concerned more with the essential character of the expenditure itself than with the fact that unless it is incurred an employee or a person pursuing a professional practice will not even begin to engage in those activities from which their respective incomes are derived. "

10. That majority judgment also provides some assistance at page 496 where it considers the meaning of the words "in gaining or producing the assessable income" and "incurred in carrying on a business for the purpose of gaining or producing such income", which represented the Austrialian criteria applicable. It observes in several cases expenditure is invested the requisite character if it may properly be regarded as "incidental or relevant" to the derivation of the assessable income but it concludes that "Examination of these cases, however, readily shows chat the expression 'incidental and relevant' was not used in an attempt to formulate an exclusive and exhaustive test for ascertaining the extent of the operation of the section; the words were merely used in stating an attribute without which an item of expenditure cannot be regarded as deductible under the section". The judgment refers also to dicta which construe the words "incurred in gaining or producing the assessable income" as meaning "that it must have been incurred in the course of gaining or producing the assessable income or in the course of gaining or producing such income" and concludes that in the context in which are such expressions have been used they have been intended as a reference, not necessarily to the purpose for which an item of expenditure has been incurred, but, rather to the essential character of the expenditure itself.

11. To return to the judgment of Huggins J.A., he regarded the passage from Lunney which he quoted as being in line with the decision in Hatchett, and observed that the Full Court in Hong Kong came to a similar conclusion in relation to travelling expenses in Commissioner of Inland Revenue v Humphrey (1970) HKTC 451.

12. In that case, in the context of the English criteria ("the performance of the duties of the office or employment") in rule 7 of Schedule E Blair-Kerr J. (at p. 476) noted the judgment of Rowlatt J. in Nolder v Walters 15 TC 380; 387:

"In the performance of the duties' means in doing the work of the office, in doing the things which it is his duty to do while doing the work of the office. A man who holds an office or employment has equally necessarily, to do other things incidentally, and spends money incidentally, because he has the office. He has to get to the place of employment, for one thing. If he had not got the employment he could stay at home. As he has got the employment, he has necessarily got to get there, and it costs him something, if it is only shoe leather, to get there; but that is not in the performance of the office, because in getting there he is not doing the duties, or doing the work of the office. Incidentally, he is obliged to do that, but it is not in doing the work of the office, which begins when he arrives, and sets to work to perform his duties ..."

13. Blair-Kerr J. (at p. 477) also referred to the case of Burton v Rednall 35 TC 435 in which the Taxpayer lived 19 miles from his office at Ipswich. He claimed as deductions the expenses of travelling to Ipswich. Upjohn J. in that case said:

"..... reasonable though Mr. Burton's claim is, he is not performing his duty when he travels between his home and Ipswich. It is reasonable for him to do so - indeed he is bound to do so - but he is not then in the performance of the duties of his office; he is either going to perform his duties or he is going home after performing his duties .... I am ....  reluctantly forced to the conclusion that this appeal must fail".

14. Finally in reaching his conclusion Huggins J.A. also referred to three other cases in which the expenses of a baby-sitter were disallowed (Lodge v Federal Commissioner of Taxation (1972) A.T.R. 251) legal expenses to recover remuneration under a service agreement were disallowed (Eagles v Levy (1934) 19 R.T.C. 23) and legal expenses incurred by a solicitor for the purpose of protecting himself professionally were also disallowed (Knight v Parry (1972) 48 TC 580). In the latter case, as Huggins J.A. pointed out, the judge gave as the first reason for his decision that the expenses were not deductible that:

"even the purpose of protecting himself professionally was not a purpose wholly and exclusively referrable to the carrying on of his practice as a solicitor, but for the purpose of seeing that he was not precluded from doing so".

15. Needless to say, I consider the English and Australian authorities I have referred is of much assistance in construing the Hong Kong criteria in section 12 (1) (a). It is clear from Burns and Humphreys that that was also the view of the Full Court and the Court of Appeal.

16. Mr. Dennis Yu for the Taxpayer stated boldly that he did not propose to rely upon any of the authorities. And true to his word he did not except in one minor context. He disputed Mr. Whaley's contention that the Hong Kong criteria of "wholly, exclusively and necessarily incurred in the production of the assessable income" was not concerned with the purpose of the expenditure, pointing out that in Morgan v Tate & Lyle Ltd. (1955) AC 21, Lord Morton in the House of Lords referred to purpose in the passage reproduced at page 1185 of CIR v Robert P Burns. However it is plain that in that case (and for that matter in Lunney at page 498, and also in Ronpibon Tin No Liability v. Federal Commissioner of Taxation (1949) 78 CLR 47, 49) that while references are made to the purpose of expenditure, they quite clearly refer to irrelevant statutory provisions of the jurisdictions concerned. No such reference appears in section 12(1)(a). And above all, it is clear from the authorities, particularly Burns, that expenditure for the purpose of the production of assessable income is to be distinguished from expenditure in gaining or for production of assessable income. Mr. Yu's submission which relies upon the payment having been made for the purpose of the MTR employment and the income it produced fails in limine.

17. Mr. Yu proceeded to submit on the authority of Edwards v Bairstow (1956) AC 14; 35; 36 that the findings of the Board cannot be said to be unreasonable and that the stated case does not disclose anything which is ex facie bad law. I do not accept that. It is implicit in the case stated that the Board reached its decision on the grounds that the Taxpayer could not have lawfully obtained employment with the MTR and that he could not have lawfully earned his emoluments from the MTR without paying the sum claimed as deductible. That in my judgment is clearly in conflict with the view of the law taken by the Court of Appeal in CIR v Robert P Burns and the other authorities I have referred to. In the light of the guidance afforded by those authorities in my judgment the payment to the WSD was not expenditure incurred in the production of the emoluments the Taxpayer earned from the MTR; a fortiori it was not wholly, exclusively and necessarily incurred in the production of that assessable income.

18. Finally I should mention that Mr. Yu also submitted that the Commissioner was wrong in assessing the Taxpayer's salary for his final month ending on 24th July 1979 to tax because it had been repaid; and that a further question of law arises therefore as to whether or not the Taxpayer's chargeable income had not been overstated by the sum of $3,306. This is a wholly new point, it forms no part of the case stated to this Court. I see no reason to remit the case to the Board as invited by Mr. Yu. Nor do I propose to express any opinion on Mr. Yu's point, which was not fully canvassed in argument. It may be that the Taxpayer will yet be permitted to raise the point despite being out of time. It may be that the set-off upon which Mr. Yu relies, of a month's salary against the sum due in lieu of notice implicitly involves receipt of the month's salary which should be therefore be chargeable to tax. It is not for the Court to speculate upon those matters in the present proceedings which are confined to the case stated.

19. For the reasons I have given the question stated for the opinion of the Court must be answered in the negative. The appeal is accordingly allowed and the decision of the Commissioner restored.

20. Mr. Whaley for the Commissioner has indicated that the Commissioner is not seeking costs; his object is to clarify the application of section 12(l) (a). Accordingly I make no order as to costs.