EXXON CHEMICAL INTERNATIOINAL SUPPLY SA v. COMMISSIONER OF INLAND REVENUE

[Business transacted in Hong Kong in the course of a business carried on in Hong Kong is subject to profits tax, even though performance is effected outside Hong Kong]

Inland Revenue Appeal No. 2 of 1989

IN THE SUPREME COURT OF HONG KONG

HIGH COURT

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J U D G M E N T

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1. This is an appeal from a Board of Review constituted under the Inland Revenue Ordinance, Cap. 112 ("the Ordinance") by way of a case stated by the Board under section 69 of the Ordinance.

2. The appellant (to which I shall refer as "ECIS") carries on business in the Bahamas, and in Hong Kong. It appeals from a decision of the Board, dated 20th June, 1988, and given in favour of the respondent (to whom I shall refer as "the Commissioner"), on an appeal by ECIS to the Board against a determination of the Commissioner adverse to ECIS.

3. ECIS is the creature of the multi-national group the parent of which is incorporated under the laws of the State of New Jersey and is known as Exxon Corporation (USA). In the course of its business carried on in Hong Kong, ECIS effected a number of transactions whereby it purchased goods from one affiliate within the Exxon group and sold them to another affiliate within the group. Common features of all the transactions with which this appeal is concerned are that (1) these affiliates, the seller to ECIS and the buyer from ECIS, are not incorporated, and do not carry on business, in Hong Kong; (2) ECIS received, in Hong Kong, the order from the buyer and placed, from Hong Kong, the order with the seller; and (3) on the order of ECIS, the seller to ECIS forwarded the goods directly to the buyer from ECIS; the goods thus did not pass through Hong Kong, but ECIS became, on its purchase of the goods, the owner of the goods, and remained as such at risk until its performance of its contract for the sale of the goods by their delivery, in good order and condition, to the buyer.

4. The facts on which the Board arrived at its decision in the matter, and some further facts, were proved or agreed and are set out in detail in the stated case; I shall not here reproduce them (those material for present purposes are those which I have already mentioned). The parties are agreed that the facts of one transaction, particulars of which were detailed before the Board (and which followed the "sequence of steps" set out in Exhibit C to the stated case) are typical. If I analyse this transaction in the manner urged on me by ECIS, the appeal succeeds. If I analyse it in the manner urged on me by the Commissioner, the appeal fails.

5. The facts relating to this transaction are as follows.

6. ECIS in Hong Kong received from Exxon Chemical Singapore pte. Limited (an Exxon affiliate company) an order for lube oil additive for delivery in Singapore. An ECIS order handler in Hong Kong checked the order. He retransmitted it from Hong Kong by telex to Exxon Chemical Supply Company ("ECSC") in the USA (and sent a copy of the retransmission telex to the buyer). The telex initiated a computer print out for an ECSC operations co-ordinator. He established that the goods were available from another Exxon affiliate company in the USA ("the seller"). He sent a telex confirming receipt of the order to ECIS or to the buyer (or perhaps both; but nothing turns on it). He reserved space for the goods to be loaded on board ship at Houston, Texas, USA. He calculated the selling price between the seller and ECIS by reference to price guidelines given to him for inter-affiliate transfers and inserted them in the order. He sent a booking telex to the buyer and ECIS advising them of the name of the ship and its estimated times of departure and arrival. He transmitted the order to the seller and to an (unrelated) freight forwarder instructed by the seller. The freight forwarder handled transit of the goods to the wharf, prepared the bill of lading and other shipping documents (excluding ECIS's invoice to the buyer) and delivered the bill of lading to the carrier. The carrier loaded the goods and returned the bill of lading with freight expense details. The freight forwarder entered the shipment data (including the quantity loaded, freight expense, insurance cost and full value of the invoice) into the ECSC computer by telex. The ECSC computer generated ECIS's invoice at the freight forwarder's office (a duplicate copy was printed at and retained by the ECSC computer centre). The freight forwarder sent ECIS's invoice, bill of lading, and other shipping documents to the buyer. The carrier delivered the goods to the buyer. The seller generated an invoice addressed to ECIS and forwarded it to ECSC. The freight forwarder generated an invoice addressed to ECSC and forwarded it to ECSC. ECSC paid the freight forwarder's invoice; settled the seller's invoice to ECIS through an inter-company accounting system; and posted entries in ECIS's inter-company account through Exxon's Central Clearing House in New Jersey (it (1) credited to ECIS the amount of ECIS's invoice to the buyer; and (2) debited the amount of all invoices addressed to ECIS or to ECSC and its own charges for services provided to ECIS in relation to the order).

7. This transaction threw up a profit for ECIS, in that the price which ECIS achieved from the buyer exceeded the sum of (1) the price for which ECIS had to account to the seller and (2) the costs, charges and expense incurred by ECIS in relation to the transaction.

8. In these circumstances, the parties are at issue over the application to this transaction (and other similar transactions) of the charge to profits tax imposed by section 14 of the Ordinance. The amount at stake exceeds HK$53,000,000.

9. Section 14 of the Ordinance provides (so far as material) as follows :

"Subject to the provisions of this Ordinance, profits tax shall be charged for each year of assessment at the standard rate on every person carrying on a trade, profession or business in Hong Kong in respect of his assessable profits arising in or derived from Hong Kong for that year from such trade, profession or business ...."

10. Section 2 of the Ordinance (a definition section) provides (among other things) as follows:

"Profits arising in or derived from Hong Kong ....shall, without in any way limiting the meaning of the term, include all profits from business transacted in Hong Kong, whether directly or through an agent."

    (I should state that although I drew the attention of counsel in the course of the argument to this definition, no point was taken on it.)

11. The parties are agreed that if the profit from the transaction in question arose in, or is derived from, Hong Kong, ECIS must bring it into account for the purpose of computing its assessable profits for the relevant year of assessment. If the profit did not arise in, or is not derived from, Hong Kong, then ECIS is entitled to have it excluded from that computation.

12. ECIS submits that before deciding where a profit is derived (or, I suppose, where it arises) it is necessary first to determine how the profit is derived and then (and then only) secondly to determine where it is derived. I am content for the purposes of the present case to accept this; having already demonstrated how the profit on the transaction in question was derived I can satisfy myself that it was derived from a "mark-up" on sales (as ECIS itself submitted) and I can go on to consider where it was derived. I ask myself : Where did ECIS obtain the buyer's order for the goods? The answer is that it obtained that order in Hong Kong. I ask myself : Where did ECIS place its order with the seller for the goods to meet the buyer's requirements? The answer is that it placed that order from Hong Kong. These acts, the obtaining of the buyer's order in Hong Kong and the placing of the order with the seller from Hong Kong, are the foundations of the transaction; for it is the differential between the selling price and the buying price ("the mark-up") which generates, indeed represents, the profit.

13. Having decided that the obtaining of the order from the buyer, and the placing of the order with the seller, took place respectively in and from Hong Kong, I conclude that the profit made by ECIS on this transaction arose in, or is derived from, Hong Kong. That is where ECIS transacted this piece of business; and the profit it earned from it was earned by what it did here. It may not be much that ECIS did to earn its profit; but as a hard, practical matter of fact, it was here that it did it.

14. The Board arrived at the same conclusion, although by a longer route. The case stated by the Board raises only one question which I have to decide (it raises another question as well but the parties are agreed that I do not have to decide it).

15. The question posed in the stated case is whether on the true construction of the ordinance and in particular section 14, the Board was correct in holding that the relevant profits arose in or were derived from a trade or business carried on by ECIS in Hong Kong"?

16. In my judgment the Board was correct in so holding, and the question must accordingly be decided in the affirmative. ECIS has failed to show that the Board made an error of law; or that no person, properly instructed in the law and acting judicially, could have come to the Board's conclusion (cp Reed v. Nova Securities Ltd [1985] 1 WLR 193, per Lord Templeman at p. 200).

17. That is sufficient to dispose of the matter.

18. ECIS, however, presented a formidable argument with which I must deal to the effect that the transaction which I have analysed (and the other similar transactions) produced "off-shore" income which, on the true construction of the Ordinance, cannot be said to have arisen in or to have been derived from Hong Kong. I shall first set out the principal contentions advanced on behalf on ECIS and I shall then mention briefly the authority cited in support of its argument.

19. The principal contentions of ECIS may be summarised as follows.

1.    Two conditions (" (1)" and "(2)") have to be satisfied before profits can fall within the charge to profits tax imposed by section 14; (1) the tax-payer must carry on a trade, profession or business in Hong Kong; and (2) the profits from such trade, profession or business must "arise in", or "derive from", Hong Kong.

2.    Condition (1) looks to the location of the business as an on-going entity, usually its "centre of operations". Condition (2) looks to the profit (or loss) generated by individual business transactions.

3.    Some of the transactions of a Hong Kong business ("on-shore" transactions) may give rise to chargeable relievable profits (or relievable losses) and some ("off-shore" transactions) may give rise to non-chargeable profits (or non-relievable losses).

4.    The meaning and effect of section 14 is a question of statutory interpretation. The phrase "profits arising in or derived from Hong Kong" is found in a section imposing a charge to tax; and it is for the court to interpret the meaning of the phrase, having regard to the context in which it occurs.

5.    Condition (2) admits of three possibilities:

(a) Derivation of income wholly outside Hong Kong ("off-shore" income).

(b) Derivation of income wholly within Hong Kong ("on-shore" income).

(c) Derivation of income partly outside and partly within Hong Kong ("multiple-source" income).

6.    For a Hong Kong business to have "off-shore" income or "multiple-source" income it must use the services of others (in the case of ECIS, it used agents and contractors) in the off-shore territory or territories.

7.    Since the Ordinance does not provide for apportionment between territories in the case of "multiple source" income, the court has to plump for one derivation as the source.

8.    Before deciding where a profit is derived, it is necessary first to determine how it is derived.

20. I am prepared, for present purposes, to accept that all these contentions advanced on behalf of ECIS are correct. The next contention is another matter. ECIS contends next:

9.    On the facts, ECIS derived its profit by buying the goods outside Hong Kong and selling and delivering them outside Hong Kong. Therefore (the contention is) the profit was derived solely from outside Hong Kong. If that is wrong, and part of the profit was derived from Hong Kong (that is to say, if this is a case of "multiple-soruce" income) then the profit arose in substance outside Hong Kong (alternatively, the acts more immediately, or most, responsible for the receipt of the profit took place outside Hong Kong; or in the further alternative, the dominant factor or factors contributing to the production of the profit puts the case on the "off-shore" side of the line).

21. In my judgment (and on this I agree with the Board), on the facts ECIS derived its profit from what it did in Hong Kong. The income which arose from the "mark-up" taken by ECIS arose where the mark-up was taken; that is to say, in Hong Kong. No doubt, income arose on the sale by the seller to ECIS; but that was income of the seller. No doubt, income arose on the delivery of the goods to the buyer; but that was the income of those responsible for getting the goods from Houston to Singapore. The only income of ECIS was its "turn" between the selling and buying prices. ECIS does not operate, outside Hong Kong, any activity with a view of profit. It is in my view immaterial that the subject of the transaction, effected in this case by the acceptance by ECIS of the order frog the buyer, and matched (at a profit) by its own order placed with the seller, was a load of lube oil additive destined for transhipment from the USA to Singapore. The business was transacted in Hong Kong.

22. For these reasons, I reject this last contention of ECIS. If I am wrong, and the transaction is one which should be held to have taken place partly within Hong Kong and partly outside Hong Kong, I would still reject the contention, on the ground that the dominant factors in the transaction (which I have identified above) put the profit on the Hong Kong side of the line; in otherwise words, that the profit arose, in substance, in Hong Kong.

23. I propose now to refer to the case which was cited to me on behalf of ECIS and placed at the fore-front of its argument. This is C.I.R. v. Hang Seng Bank, 3rd May 1989 (unreported). The decision is a decision of the Court of Appeal in Hong Kong (Cons v.-p., Clough J.A. and O'Connor J.). The bank traded certificates of deposit on the markets for such instruments operated in Singapore and London. This trade was profitable. The sole question at issue was whether the profits of the trade arose in or were derived from Hong Kong. The Court held that the profits were derived from Singapore or London. This conclusion was (if I may respectfully say so) obviously correct. It was in Singapore and London, where, financially speaking, the real action took place, where the bank's money was put to work, as Cons V.-P. analysed it. And the relevant profits of the bank were attributable to three basic stages, two of these indicating an off-shore derivation, as Clough J.A. analysed it. (These two were the investment of the bank's money outside Hong Kong and the sale of the investments so made outside Hong Kong; and, in substance, Clough J.A. treated these as the dominant factors which put the profits on the "off-shore" side of the line.) O'Connor J. held that if a single territorial source had to be plumped for as the source of the profit, that place could only be where the funds were invested, and later realized at a profit, outside Hong Kong.

24. In the Hang Seng Bank case, the Court of Appeal gave full consideration to all (or nearly all) the relevant authority on questions of source of profit, including cases arising in or derived from India, Australia and South Africa, as well as from the United Kingdom. I consider it would be a work of supererogation for a judge of first instance to go through the authorities yet again, when they have so recently been reviewed by the Court of Appeal. (There are three local cases at first instance not noticed by the Court of Appeal. The first is C.I.R. v. International Wood Products Limited [1971] HKTC 551. The second is Sinolink Overseas Limited v. C.I.R. [1985] HKLR 431. The third is Bank of India v. C.I.R., 15th December 1988 (unreported). No doubt the Court of Appeal, in arriving as its decision in the Hang Seng Bank case, did not regard any of these three cases as assisting them in their deliberations. For my part, I see no reason, in the present case, now that the decision in the Hang Seng Bank case is available as a guide for the future, for this court to go behind it to earlier decisions of lower courts, or to decisions in other jurisdictions. I mention these three cases only to show that I have not overlooked them. Each of them turned on its own facts.)

25. As it seems to me, the construction which the Board placed on section 14 is entirely consonant with the Hang Seng Bank case. Once one reaches the conclusion that the profit, in substance, arose from a piece of business transacted in Hong Kong rather than outside it, that is the end of the matter. Of course, the source from which income is derived is not necessarily identical with the place where the business is carried on; the income may perfectly possibly be derived from an operation in a quite different place. I do not propose here to make the mistake of confusing the place where the business is carried on with the place (or places) where it operates. But it is hardly a matter of surprise to find that the place where a company carries on business is the place (or one of the places) where, as part of that business, it conducts a profitable operation. If a piece of business is transacted in Hong Kong, should the fact that, in order to carry out the transaction the tax-payer has by way of performance to do certain acts outside Hong Kong, be treated as displacing, for present purposes, the fact that the business was indeed transacted in Hong Kong? I think not. I would regard the fact that the business was transacted in Hong Kong as the dominant fact, indicating that the profits were earned in Hong Kong.

26. A number of earlier decisions of the Board of Review were mentioned to me, with the suggestion that they are inconsistent with this reasoning. If that is so, I must, with respect, conclude that those decisions were wrong, except in so far as they can be justified on their own special facts.

27. As I have said, I propose to answer in the affirmative the question, posed by the stated case and mentioned above, which I have to decide; but I cannot part from the case without mentioning one point which has troubled me throughout and in order to consider which I felt it necessary to reserve my judgment.

28. The transaction I have analysed and the other, similar, transactions with which the case is concerned are described in the stated case as "simulated arms length transactions" (this is one of the facts said to have been proved or agreed). The facts certainly are that the seller, the buyer and ECIS itself were all creatures of Exxon Corporation (USA). The "mark-up" taken by ECIS represented part of Exxon's profit in supplying the goods to the ultimate consumer. Exxon has arranged its affairs so as to take that part of its profit through ECIS, its Panamanian in-house middleman in Hong Kong. ECIS performed none (or hardly any) of the ordinary functions of a trader, one who uses his skill and judgment in the purchase and sale of goods from and to third parties. In these circumstances, were these transactions of ECIS undertaken for some genuine commercial purpose or were they undertaken solely to obtain some tax advantage for Exxon in the USA (cp. Overseas Containers Ltd v. Stoker [1989] 1WLR 606)?

29. This is the point which has troubled me. But the case has proceeded from first to last on the assumption of the parties (and of the Board) that these transactions were genuine (if not ordinary) trading transactions; and, upon reflection, I have concluded that I should not and cannot go behind this for the purpose of deciding the present case. The point which has troubled me was not in any way developed in argument and, if there is anything significant in it, it must be considered in some other case, should one ever arise again, where one party or the other puts forward the sort of transaction I have had to consider here as a genuine trading transaction.

30. ECIS having failed in this appeal must pay the Commissioner's costs.