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HCIA000003/1986
IN THE HIGH COURT OF JUSTICE
APPELLATE JURISDICTION
I.R. APPEAL No. 3 OF 1986
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BETWEEN
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Central Enterprises Ltd.
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Appellant
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Commissioner of Inland Revenue |
Respondent |
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Coram: Hon. Jones J. in Court
Dates of hearing: 13th and 14th November 1986
Date of delivery of judgment: 25th November 1986
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JUDGMENT
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1. This is an appeal by case stated from a decision of the Board of Review (the Board) given on the 8th July 1985 which upheld assessments to profits tax for the years 1974/75 and 1975/76 made by the Commissioner of Inland Revenue (the Commissioner) under section 14 of the Inland Revenue Ordinance.
2. The appeal concerns the treatment of three mainly domestic properties as trading stock as determined by the Commissioner or whether they were for long term investment as claimed by Central Enterprises Limited (the appellant). The properties covered by the assessments are Monticello Mansion and Central Mansion which were acquired by the appellant in 1961 and properties in Sai Wan Ho Street treated as one property which were acquired in 1973.
3. The appellant has at all material times been owned by the Wu family through various companies over the past 20 years. The Wu family are wellknown in the property market in Hong Kong for they have been concerned with both large and small property transactions. They were described by the Board as developers, investors and traders.
4. Prior to their entry into property, the Wu family had operated a very large scale taxi business. However, as a result of the riots in 1967, many of the taxis were sold to their employee drivers.
5. In 1973 the appellant intended to go public, but the floatation was eventually abandoned as the stock market was in decline. A draft prospectus was prepared for this purpose which included a number of properties owned by the group.
6. It appears from the accounts of the taxpayer that from 1961 until the 31st March 1973, Monticello Mansion and Central Mansion, with the exception of the ground floor and basement of Central Mansion which were not mentioned, were shown in the accounts as trading stock. Other properties were described in the accounts as fixed assets.
7. The Board gave a detailed consideration of each of the properties under separate headings in the case stated which I now set out:
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7.1 Central Mansion
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(a)
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The redevelopment of the Central Mansion site was finished in January 1964. However two years prior to that the tax representatives of the Taxpayer, Messrs. F.S. Li & Co., had confirmed by letter dated 30.3.62 (see para (3) of Determination) that "the land and buildings to be erected thereon are intended for trading purposes.......". This comment was made in order to justify the Taxpayer's claim to charge interest payments against its taxable income; a set-off that is not, of course, available if the property is to be treated as a long term investment.
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(b)
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As redeveloped Central Mansion was composed of 162 units, the ground floor and basement were however initially used mainly as a garage and workshop for taxis of the Taxpayer and of two associated companies.
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(c)
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Within one month of the occupation permit 116 units were sold. Mr John Wu said it was the Taxpayer's intention to sell all the domestic units, save for 26 to be kept as quarters for drivers and the basement and ground floor for the taxi business ("retained units"). In effect therefore the Taxpayer conceded that for this block at any rate it was a trader with regard to the bulk of the units; the burden upon it to show that the retained units were not ultimately to be sold was therefore a heavy one, the more so as they continued to be shown as "current assets" in the account.
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(d)
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Mr Wu maintained that the accounts wrongly represented the Taxpayer's original intention. However - at least so far as all units other than the retained units were concerned - the accounts were a correct representation. Mr Wu explained that until 1973, in anticipation of the public issue, the taxpayer did not employ a proper accountant, relying upon book-keepers. He claimed he was ignorant of the distinction between fixed assets and current assets, the Taxpayer simply depended upon guidance from Messrs. F.S. Li & Co. and subsequently Messrs. M.W. Kwan & Co. In cross-examination he conceded that the tax representatives and auditors would rely upon instructions given to them by the Directors but he said it was in the former's interpretation of those instructions that they went astray.
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(e)
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We formed the view that Mr Wu's explanation was unacceptable because we felt that if it meant that the accountants had taken an objective view of the facts and concluded therefrom that those properties were for trading then it was reasonable to assume that this Board given the same facts would have reached the same conclusion. Certainly until 1973 both sets of auditors were consistent in their treatment of trading and fixed assets: Mr Wu was not prepared to say they were negligent in this respect.
Mr Wu had been involved in the Taxpayer's affairs since 1964 and those of other companies within the Wu family group and, in our view, must therefore have seen a great number of accounts and been involved in their audits. The excuse of ignorance (impliedly for the other directors) was not in our view convincing: both he and his brother Gordon, another director, were professional men quite unlikely to be incapable of grasping the distinctions concerned.
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(f)
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As for the ground floor and basement of Central Mansion, Mr Wu said that they were purpose-built as garage and workshop for taxis. However following the 1967 riots, the Taxpayer sold its taxis and some of the retained domestic units to its former drivers. Thence, for two years, the ground floor was let to the drivers and the basement was let to the building's occupants. Then the ground floor was converted into a ballroom and later converted into a shopping centre. We considered the claim that the area was exclusively purpose-built did not hold up.
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Monticello Mansion
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(a)
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The F.S. Li letter of 36.1.62 (para 7.1 (a) above) applied to Monticello as do our foregoing remarks concerning the accounts. Although this property was originally only partially developed due to lack of funds, the original approved plans allowed for a second phase of development.
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(b) |
As regards the Phase I development, we did not in our Decision go into details concerning the sales because there was no suggestion in Mr Wu's testimony that there was any original intention to hold these for investments and despite the 1967 riots many sales were achieved.
We did not believe that the riots altered that intention; it merely postponed carrying it into effect indeed sales were made in 1968 & 1969.
In the pertinent accounts all of the remaining Phase I units, plus the Phase II units, completed in 1968 and let to the Navy pursuant to negotiations in 1967-1968, were shown as "stock of completed flats at cost".
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(c)
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Mr Iles argued that the 1973 draft prospectus evidenced a firm intention to hold long term because that is how they were categorised. That in our view was debatable as the prospectus was only a draft, nevertheless if we had accepted that proposition, the intention (if indeed sincere) in our opinion was predicated on the floatation going through. But the floatation did not proceed and all the units concerned were sold to a company, in which some but not all of the Taxpayer's shareholders were interested.
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(d)
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It was put to us that this last mentioned transaction was not a sale, merely a distribution amongst the family. We considered this argument specious not only because the shareholders were not the same but also because the Agreement for sale produced to us has all the hallmarks of an arm's length transaction. We were not unmindful that this transaction took place the day following the sale of the ground floor and basement, of Central Mansion to another company of which members of the Wu family were shareholders, but the totality of the shareholders in the buying companies did not match those of the Taxpayer.
To our mind these transactions do not dilute the view we had formed that both phases of Monticello were never intended as long term investments.
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Sai Wan Ho Property
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(a)
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This property, comprising six distinct properties, was acquired in 1973/74 and all the components are stated in the balance sheet for that year to be fixed assets.
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(b)
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Before acquisition these properties were owned either wholly or partially by a member of the Wu family. We viewed the purchase as an exercise in anticipation of the then contemplated 1973 floatation.
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(c) |
In the draft prospectus however the properties are classified as "properties held for development in the future". Mr Wu himself said the property was bought for rental not for development. Yet another inconsisteney occurs in that title to shop 3 of 12A was never transferred to the Taxpayer. We did not view Mr Wu as a credible witness in this regard."
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8. Having considered the, evidence, the Board made the following conclusions which resulted in the appeal from the Commissioner being rejected.
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"8 1.
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Having regard to the background of the shareholders of the Taxpayer, the Taxpayer's business activities were varied, its attitude towards properties ambivalent and, with possible one notable exception (Wu Sang House, an office block), open-minded and pragmatic.
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2.
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Whoever drew up the annual accounts referred to at 6.4 above was, we think it reasonable to assume, aware that the purpose for which properties were held had a bearing on their characterization in the accounts. Without first hand testimony from the person or persons concerned we could not accept that he did not appreciate what he was about, especially so since the characterizations were not related to an isolated year. The accounts were successively audited by Messrs. F.S. Li & Co. and Messrs. M.W. Kwan & Co.
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3.
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We accepted that the development of Phase II of Monticello was indeed prompted by the willingness of the British Forces to take a lease of 60 flats (which in fact eventuated in 56 flats) to be built in an extension about four blocks of the then existing structures for a period of three years and that the advance payment of rents enabled this Phase II to be financed. Nonetheless we did not consider what there was sufficient evidence to justify these flats being treated collectively as specifically ear-marked for long term investment. As we have said with regard to all the other properties, Wu Sang House excepted, we formed the view, for the reasons stated, that the Taxpayer was never firmly committed to long term investment. We believe that so long as the Navy were prepared to maintain leasing (by exercising its option for a further 2 years) at a satisfactory rent the flats would be retained, thereafter however the Taxpayer would feel free to sell them with vacant possession. Moreover the Taxpayer's accounts did not classify Phase II as a long term investment. The Taxpayer evidently paid tax on the rent received, but that is not per se evidence of long term investment. Mr Iles submitted that should we find that the undeveloped Phase II was not ab initio a long term investment, then it became so by reason of a change of intention i.e. to build to lease to the Navy. We do not accept this interpretation; as we see it those leases enabled the Taxpayer to undertake a development it would not otherwise have been able to afford. When the lettings ceased the Taxpayer could then sell when the time was ripe. Mr Halkyard referred us to the case of JamesHobson & Sons Ltd. v. Newall which factually bore some resemblance to the circumstances of both Central Mansions, and both phases of Monticello Mansions.
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4.
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The failure of the Taxpayer to claim rebuilding allowances was hot in our opinion an oversight by its professional advisors: we believed that it was intentional and consistent with the view they had formed and advice given to them by Directors or officers of the Taxpayer that it did not intend to retain the properties as capital assets - unlike Wu Sang House."
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9. The questions of law that have been prepared for determination by the Court are as follows:-
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"(1) |
Whether as a matter of law there was any evidence upon which a tribunal properly directed as to the law, both substantive and procedural, could properly conclude that the following properties or any of them, and if so which, were trading stock:-
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(i)
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the basement of Central Mansion;
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(ii) |
the ground floor of Central Mansion;
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(iii) |
the 26 domestic units in Central Mansion referred to (7.1 (c) above);
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(iv) |
he 60 domestic units in Monticello Mansion let to the Secretary of State of Defence under the Agreement dated 21st November1968 (Appendix H to the Deputy Commissioner's Determination);
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the 6 properties collectively referred to as the 'Sai Wan Ho Property' (at 7.3(a) above).
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(2) |
Whether the Board of Review would be correct in law in deciding (if, which is denied, it did decide) that a taxi operator's garage and workshop for its taxis were trading stock.
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(3) |
Whether, if such garage and workshop were not trading stock, they would, as a matter of law, become trading stock upon the cessation of such taxi business and their being let, first, in their existing state, secondly, as converted into a ballroom and, finally, as converted into a shopping centre.
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(4) |
Whether it was correct in law for the Board of Review to approach the question of whether property was trading stock by first forming a view on the accounting treatment given to them and then and only then considering all the transactions relating to them to see if such transactions diluted the view formed on such accounting treatment - rather than to consider the evidence as a whole and form its view thereon."
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10. Mr Bokhary, counsel for the appellant submitted that a very important finding made by the Board was that the appellant was both an investor as well as a trader. He therefore sought to distinguish this fact from the case of James Hobson son & Sons Ltd. v.Newall(1). In that case no finding had been made that the taxpayer was an investor with the result that a heavy burden was placed upon him as a trader to rebut the presumption that properties were held for trading rather than for investment. He therefore contended that as the appellant in the instant case has been held to have been an investor, that burden has been satisfied. Accordingly whether the properties were trading stock or investments fell to be decided without a presumption that they were trading stock.
11. Although Mr Bokhary has placed emphasis upon the finding by the Board that the appellant is an investor, there was also a finding that the appellant is a trader. Therefore the burden of proof on a land dealer who also claims to be an investor remains a heavy one see Harvey v. Caulcott(2) which was followed in Cadwallader v. Wheeler (3). I therefore reject this submission.
12. Mr Bokhary went on to criticise the Board on the grounds that they had adopted a wrong approach to the evidence by looking first at the accounting treatment and thereafter considering the remainder of the evidence to decide whether their initial view had been diluted. It is agreed that if the Board approached the evidence in this way it was obviously wrong. Mr Bokhary also submitted that the Board had wrongly assumed that the accounts produced were in fact correct. I find no merit in either of these submissions. It is clear from a reading of the case stated that the Board considered all the evidence placed before them and did not approach their task by dealing first with the accounts in isolation before looking at the other evidence. Upon the evidence the Board was entitled to find that the accounts were correct.
13. By section 68(4) of the Inland Revenue Ordinance, the onus of proof to establish that an assessment is incorrect is upon the appellant. Essentially the case argued for the appellant was that there was no evidence upon which, the Board if properly directed could have come to their decision that the properties were trading stock.
14. By section 69(1) of the Inland Revenue Ordinance, an appeal by way of case stated may only be made on a question of law. If the Board acted without any evidence or on facts upon which no one could have reasonably come to their decision, the Court may intervene on the grounds that there has been a mistake in law, see Edwards (Inspector of Taxes) v. Bairstow & Anr. (4).
15. The evidence with regard to Central Mansion reveals that two years before the completion of the redevelopment the land and buildings to be erected thereon were intended for trading purposes. Subsequent evidence showed that deposits were received for the sale of flats that were under construction and in April 1963 that an eleven storey building was being developed for the sale of flats. Within one month of the issue of the occupation permit on the 28th January 1964, 116 units out of 162 were sold. Another 20 were sold during the next three years. The appellant conceded that it was a trader with regard to the bulk of the units. Those retained as residential units were shown in the accounts as current assets. There was no evidence to support the appellant's contention that they were retained for investment and it was therefore open to the Board to drawn an inference that the 26 flats which were not sold were builder's remainders. The accounts until 1973 also set out details of trading and fixed assets. Subsequently the basement, ground floor and the 26 remaining units had been sold or leased. It was quite reasonable for the Board to treat Central Mansion as one development. It is clear that the Board were not impressed with the explanation given by Mr Wu that the account did not represent the appellant's original intention. His evidence drew a considerable degree of adverse criticism.
16. With regard to Monticello, the same evidence was given that the land and buildings to be erected thereon were intended for trading purposes. There was clearly no intention to hold Phase I of the development for investment purposes whilst in respect of Phase II, there were negotiations between the appellant and the Ministry of Defence for the rental of 60 flats to be built on top of the lower four blocks of Phase I. In respect of this development, a tenancy agreement was entered into for three years from the 1st September 1969 which agreement was later renewed for two further periods of two years each. These properties were included in the draft prospectus in 1973. However, when the floatation did not proceed, all the units were sold to a company in which some but not all of the taxpayer's shareholders were interested. The evidence supported the Board's finding that the appellant had no intention to use the property for long term investment.
17. The properties comprised in Sai Wan Ho Street were included in the draft prospectus in 1973 and classified as "properties held for development in future". Mr Wu had claimed that the property was bought for rental and not for development, although the title of one shop was never transferred to the appellant. The properties were sold by the 31st March 1975. The evidence given by Mr Wu with regard to the Sai Wan Ho properties was not accepted by the Board.
18. In my judgment, having read the case stated and the decision of the Board, I am of the opinion that the evidence irresistibly led to the conclusion to be drawn from the evidence that the various transactions carried out by the taxpayer amounted to trading operations. The Board, as I have said, looked at the whole of the evidence in coming to their decision and did not, as was contended by the appellant, consider the accounts first in isolation before looking at the other evidence to see whether their initial view had been diluted.
19. The evidence to support the Board's decision was plain and obvious. The heavy burden placed upon the appellant as a trader was not discharged.
20. I answer the questions that have been put to the court, as follows:-
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i) Yes.
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ii) Yes.
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iii) Yes.
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iv) Yes.
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v) Yes.
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2.
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This is a hypothetical question which does not require to be answered.
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3.
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This is a hypothetical question which does not require to be answered.
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4.
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The approach to this matter has been dealt with in my judgment. The answer would be no if the Board had approached their determination in this manner. |
21. There was abundant evidence before the Board to enable them to make their determination. Accordingly the appeal is dismissed.
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( B.L. Jones )
Judge of the High Court
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(1) [1957] 37 TC 609
(2) [1952] 33 TC 159
(3) [1955] TR 265
(4) [1956] AC 14
Representation:
Mr K. Bokhary, Q.C. and Mr Denis Yu (Woo, Kwan, Lee & Lo) for the Appellant
Mr N. Kat and Miss A. Au for Commissioner of Inland Revenue
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