COMMISSIONER OF INLAND REVENUE v. HK-TVB INTERNATIONAL LTD

[Only where a taxpayer has established the existence of a profit-generating operation carried on by him outside Hong Kong can he escape a charge to profits tax]

Inland Revenue Appeal No. 9 of 1989

IN THE SUPREME COURT OF HONG KONG

HIGH COURT

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BETWEEN

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JUDGMENT

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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 s.69 of the Ordinance. The appellant commissioner ("the commissioner") appeals from a decision of the board, dated 2nd November 1989, and given in favour of the respondent taxpayer ("the taxpayer") on an appeal by the taxpayer to the board against a determination of the commissioner adverse to the taxpayer on a question concerning the taxpayer's liability to profits tax for the years of assessment 1980/81 to 1983/84.

2. The taxpayer is a company incorporated in Hong Kong and carrying on business here. According to the facts found by the board, and recited in the stated case, the taxpayer's ultimate holding company is HK-TVB Limited ("TVB") which is also incorporated in Hong Kong. (Before me, the taxpayer demurred at this designation of its status; but the point is of no importance.)

3. The matter in issue, yet again, is whether the profits of the taxpayer which the commissioner has assessed to profits tax were profits "arising in or derived from Hong Kong". The assessable profits, if the commissioner is right, exceed HK$57M.

4. S.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 ...."

5. S.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, .......".

6. The material facts are as follows.

7. TVB has granted to the taxpayer exclusive rights to broadcast and export TVB's television films and other programmes outside Hong Kong and to grant sub-licences to others to do so. The taxpayer has undertaken diligently to seek such sub-licensees and to contract with them only on the best commercial terms reasonably obtainable. It has agreed to pay to TVB a licence fee equivalent to 40% of the aggregate revenues it receives from so doing. Pursuant to these arrangments the taxpayer has granted appropriate sub-licences to customers in a number of different countries. The standard form it uses provides that Hong Kong law is to be the proper law of the contract thereby created. The negotiations between the taxpayer and its customers were usually (though not always) conducted by employees of the taxpayer who travelled from Hong Kong to the customer's country in order to conduct such negotiations. The rights granted by the taxpayer to its customers by the sub-licenses were, of course, exercised overseas by the broadcasting of the films and other programmes, the subject of the sub-licences, in the customer's country. The contract between the taxpayer and the customer was usually (though not always) concluded by the posting by the customer to the taxpayer in Hong Kong of the form of licence duly signed for and on behalf of the customer. The taxpayer sometimes provided ancillary facilities to the customer on request, the cost of which was usually (though not always) reflected in the licence fee charged to the customer. Virtually the whole of the taxpayer's gross income consisted of the fees it received for the grant of these sub-licences to overseas customers.

8. There is no dispute about these facts. Neither side suggests, in relation to any finding of fact by the board, that the board acted without any evidence, or on a view of the facts which could not reasonably be supported.

9. On these facts, the board determined that the profits accruing to the taxpayer from the fees derived from the sub-licensing were "sourced" in those countries in which the sub-licensees were entitled, by virtue of the sub-licensing contracts, to exercise the rights thereby granted. The board determined that the arrangements made between TVB and the taxpayer vested in the taxpayer rights over intangible property, namely ephemeral visual images projected on a screen, which rights, by the terms of the documents, could only be exercised outside Hong Kong. (It determined that the facilities to which I have referred were simply an incidental adjunct to the taxpayer's core activity of sub-licensing the overseas customers.)

10. The board, having made these determinations, held that the relevant profits did not arise in or derive from Hong Kong from a trade or business carried on by the taxpayer in Hong Kong.

11. The question of law for determination by the court is whether the board was correct in so holding.

12. In my judgment, the board was not correct in so holding; the correct conclusion on the facts found by the board is that the relevant profits did arise in, or were derived from, Hong Kong from the business carried on by the taxpayer in Hong Kong. I arrive at this conclusion by the following route.

13. A taxpayer carrying on business in Hong Kong cannot escape a charge to profits tax on business transacted with his customers merely because those customers are overseas. In the absence of any other facts pointing to a different conclusion, the place at which the operations take place from which the taxpayer's profits in substance arise is, in those circumtances, Hong Kong. And the fact that the business transacted by the taxpayer consists of sales achieved by salesmen, based in Hong Kong, and travelling to the customer's country to negotiate, and (perhaps) even conclude the sales cannot alter the position : compare Sinolink Overseas Ltd. v. Commissioner of Inland Revenue [1985]2 HKTC 127. It may well be otherwise if the taxpayer sets up a separate operation in the oversea country, so that he can be said to be carrying on a business operation there as well as the operation he carries on in Hong Kong; but the mere fact that the taxpayer's salesmen travel from Hong Kong to a number of different overseas countries for the purpose of negotiating with the customers on their own ground does not produce the result that the profits generated by the bargains so struck with the customers are profits which fall outside the statutory words "profits arising in or derived from Hong Kong".  Nor is that result produced by the fact that the customers are only entitled to exercise and utilize the rights granted to them in their own respective countries.

14. The correct analysis is that the taxpayer's operation here which generated the relevant profits was an operation carried on in and from Hong Kong. It was not carried on out of Hong Kong. The profits were generated by the grant, by the taxpayer to the overseas customers, of sub-licences on terms which, after providing for the fees payable to TVB and for all other expenses, created a surplus rather than a deficiency. The grant of these sub-licences, the originating cause of the profits, was business transacted by the taxpayer in and from Hong Kong. The time has come to make it clear that it is only where a taxpayer has established the existence of a profit-generating operation carried on by him outside Hong Kong that he can hope to escape the charge to profits tax imposed by s.14. There may be room for dispute in individual cases as to whether, as a hard practical matter of fact, a taxpayer has succeeded in establishing that he has indeed carried on such an operation outside Hong Kong. But there can be no room for further dispute as to the principle. The question in every case like the present is : Where did the taxpayer carry on the operation which generated the profit?

15. It is, I understand, often considered to be in the best economic interests of Hong Kong that taxpayers conducting from Hong Kong some business abroad should not be subjected to profits tax on that business. If that is thought to be desirable as a matter of policy, there is no reason why the legislature should not intervene and replace the statutory language used in s.14 with some other language which gives effect to that policy. Certainly, however, the language of s.14 as it stands at present is not apt to do so. And this Court is not here to give effect to a policy which may be perceived, rightly or wrongly, to be in the best economic interests of Hong Kong. The Court is here simply to give what is, as a matter of law, the appropriate construction to the words of the Ordinance.

16. A number of authorities were cited to me, most from other jurisdictions upon different statutory language and involving very different facts. I found none of these of much assistance. But Lord Atkin, in Smidth v. Greenwood [1921]3 KB 583, said this in a somewhat similar context (at p.593) :

"I think that the question is, where did the operations take place from which the profits in substance arise?"

17. In a case such as the present, I see no reason to look into the authorities for further guidance than is provided by this observation. However, in deference to the careful argument of Counsel for the taxpayer, I will refer to one further authority, Commissioner of Taxes v. British United Shoe Machinery (SA) (Pty) Ltd. [1964]26 SATC 163, upon which she placed considerable reliance. This was a decision of the Federal Supreme Court from a decision of the High Court of Southern Rhodesia. The respondent company was registered, managed and controlled in the Republic of South Africa, where it had its registered office at Port Elizabeth. The business of the company was that of a dealer in machinery used in the manufacture of footware. It either sold or leased that machinery, the rental of leased machinery bringing in 59% of its income. Leases for the machines, after being signed by the prospective lessees, were all completed by the signature of the respondent company at Port Elizabeth. Under the leases, the lessee undertook to pay a premium, transport charges from Port Elizabeth to his factory, and a monthly rental. The place where the machinery was to be used was specified in the contract of lease and subletting was prohibited. The lessee further undertook to keep the machines in good running order and to redeliver them to Port Elizabeth on the termination of the lease. The respondent company had no branch office in Rhodesia and no canvassing for this business was carried on in that territory. During the years of assessment under review, the respondent company derived income from leases entered into by manufacturers in Southern Rhodesia and was assessed by the Commissioner of Taxes in Rhodesia upon such income as having been derived from sources in the Federation. The company appealed against such assessments to the High Court of Southern Rhodesia. That court allowed the appeal, holding that the source of the company's income was not within the Federation as there was no activity of the company in the Federation which brought about the payment of the income, in as much as all the transactions were controlled in Port Elizabeth. On appeal by the Commissioner to the Federal Supreme Court, it was held, allowing the appeal and confirming the assessment made by the Commissioner, that when income is derived from the use of movable property in a certain place, the source of that income is to be found where that property is used. Clayden CJ said this (p. 167) :

18. In that case, the statutory language was different. The definition of "gross income" in the Federal Income Tax Act, 1954, provided that what was included must be "from any source within the Federation". If the income in issue was from such a source it was taxable; if it was not, it was not.  And, of course, the nature of the property was different, too. The court was there concerned with long term leases of machinery, not short term licences of intangible rights to exploit TV films and other programmes. In my judgment, the resemblance which that case bears to the case with which this Court is now concerned is only slight.  Insofar as it can properly be said that the case lends support to the submissions advanced to me on behalf of the taxpayer here (which I doubt) I would be disposed, with respect, to disagree with it. I accept that, in the present case, the rights granted by the sub-licences were intended to be used, and to be used exclusively, outside Hong Kong.  Indeed, the licences were in terms so limited. But if the question is (as I have held) where do the operations take place from which the profits in substance arise, it can be seen at once that the fact that the rights granted by the sub-licences are to be used by the taxpayer's overseas customers in their own countries is no more to the point than the fact that the terms of the licences were negotiated by the taxpayer's salesmen travelling for the purpose from Hong Kong to the customer's country. And there is, I think, nothing in the case cited which casts any doubt upon the conclusion at which I have arrived, that is to say, that the relevant question to ask here is, indeed : Where did the operations take place from which the profits in substance arise?

19. That is sufficient to dispose of the appeal; but there was some debate before me as to the proper approach of this court, sitting as an appellate tribunal, to findings of fact by the board, and I think I ought to express a view upon the matter.

20. In my judgment, a finding of fact by the board can only be rejected by an appellate tribunal, whose jurisdiction is restricted to matters of law, if it appears that the board has acted without any evidence or on a view of the facts which cannot reasonably be supported. This is so not only in relation to primary facts, but also in relation to inferences drawn from them. Furthermore, if the primary facts as found by the board are capable of supporting two alternative inferences, it is no part of the function of the appellate tribunal to substitute its perferred inference for that legitimately drawn by the board. However, not all decisions by an appellate tribunal reversing a decision of the board involve interference with findings of fact within the board's exclusive competence. It may be that the board's findings of fact can be accepted without qualification, it being only upon the consequences of those findings that the appellate tribunal takes a different view from that formed by the board. The court's finding as to the correct consequence which follows upon the board's findings of fact is then a finding of law, not a finding of fact. (These principles have recently been restated in Beauchamp (Inspector of Taxes) v. FW Woolworth PLC [1989] 3 WLR I and Richfield International Land and Investment Co. Ltd. v. Inland Revenue Commissioner [1989] STC 820, between which two cases I detect no inconsistency.)

21. In the present case, I see no reason for considering, let alone holding, that the board's findings of primary fact were unsupported by the evidence or cannot reasonably be supported. Further, this is not a case in which the board has drawn any inference from the primary facts which I would be disposed to doubt. I part company with the board solely on the conclusion to be drawn from the primary facts as found by the board. This is a conclusion upon a matter of law, i.e., whether the relevant profits did or did not arise in, or were or were not derived from, Hong Kong.

22. For the reasons I have endeavoured to state, I conclude that, on the facts agreed or found, the board was incorrect in law in holding that the relevant profits for the years of assessment 1980/81 to 1983/84 inclusive did not arise in or derive from Hong Kong from a trade or business carried on by the taxpayer in Hong Kong. I answer the question posed in the stated case accordingly.