WING ON CHEONG INVESTMENT CO. LTD v. COMMISSIONER OF INLAND REVENUE

HEADNOTE

                Where it was alleged that a taxpayer, having originally acquired a property for investment purposes, subsequently changed his intention and utilized the property as trading stock, a charge to profits tax would arise only if the evidence established the change of intention with the precision necessary to demonstrate the change of character of the property for tax purposes: Simmonds v. IRC [1980] 1 WLR 1196 applied.

Inland Revenue Appeal
No. 1 of 1987

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 a case stated on 6th January 1987 for the opinion of the court pursuant to section 69 of the Inland Revenue Ordinance (Cap. 112). The case is stated on the application of Wing On Cheong Investment Co. Ltd. ("the Appellant"). The Appellant is dissatisfied with the decision of the Board of Review ("the Board") given on 16th July 1985, confirming a determination by the Revenue that the Appellant was liable to profits tax on assessable profits of $1,570,728and $13,002,129 for the years of assessment 1976/77 and 1977/78 respectively. The profits arose on sales of units in properties known as the Sui Yip Building, 183 - 189 Fa Yuen Street ("the first property") and the Sui Yee Building, 590-596 Queen's Road West ("the second property"). The first sale of a unit in the first property was effected in September 1976. Further units were sold in 1976 and 1977.  The first sale of a unit in the second property was effected in January 1977. Further units were sold in 1977.

2. Profits tax is exigible on profits made from trafficking in property but not on profits made from investment in property. A profit arising on the sale of property acquired for investment purposes and retained as a capital asset until the sale is not a taxable profit. A profit rising on the sale of property acquired for trading purposes and retained as a current asset until the sale is a taxable profit. A profit arising on the sale of a property originally acquired for investment purposes but which by the date of the sale has been dedicated by the owner to trading purposes is also a taxable profit; and that, claims the Revenue, is what has happened here. The Board agreed. Its critical conclusion, in effect, was that on 1st May 1976 the Appellant ''launched, itself on a trading activity" (cp. per Lord Denning MR in Pilkington v. Randall (1966) 42 T.C. 662 at p. 672.)

3. The Revenue do not dispute that the first property and the second property were acquired by the Appellant for investment purposes. But the Revenue says that the Appellant subsequently changed its mind; by the date of the sales which threw up the profits sought to be taxed it had decided to turn the first property and the second property to account by way of trade. The Appellant disputes this. The question thus raised is a question of fact: a change in the state of a man's mind is as much a fact as a change in the state of his digestion.

4. The Board decided this question of fact in favour of the Revenue. The proper approach of the court to the matter is indicated in the speech of Lord Wilberforce in Simmonds v. IRC [1980] 1 WLR 1196, at pp. 1198, 1199. The court should be disposed to uphold any decision of the Board on factual matters if it can possibly do so. But where what is in issue is a change of intention on the part of the taxpayer, the court must consider precisely what the Board has found as to the taxpayer's intention, and if the court discovers that the findings of the Board are inconsistent, unintelligbile, illogical or illfounded, then it should be prepared to differ from the Board. In this connection one must ask first: What were the Board required or entitled to find? The question is posed and the answer is provided by Lord Wilberforce (see the case cited, at pp.1199) in the following passage:

"One must ask, first, what the commissioners were required or entitled to find. Trading requires an intention to trade: normally the question to be asked is whether this intention existed at the time of the acquisition of the asset. Was it acquired with the intention of disposing of it at a profit, or was it acquired as a permanent investment? Often it is necessary to ask further questions: a permanent investment may be sold in order to acquire another investment thought to be more satisfactory; that does not involve an operation of trade, whether the first investment is sold at a profit or at a loss. Intentions may be changed. What was first an investment may be put into the trading stock - and, I suppose, vice versa. If findings of this kind are to be made precision is required, since a shift of an asset from one category to another will involve changes in the company's accounts, and, possibly, a liability to tax: see Sharkey v. Wernher [1956] A.C. 58. What I think is not possible is for an asset to be both trading stock and permanent investment at the same time, nor to possess an indeterminate status - neither trading stock nor permanent asset. It must be one or other, even though, and this seems to me legitimate and intelligible, the company, in whatever character it acquires the asset, may reserve an intention to change its character. To do so would, in fact, amount to little more than making explicit what is necessarily implicit in all commercial operations, namely that situations are open to review.''

 

5. The Board founded itself on the agreed "Facts" set out in the determination of the Acting Commissioner which (with an immaterial exception) were agreed. These were as follows:

6. The Board also found the following circumstances to be relevant and correct:

"4.1    The Appellant, one of many companies forming a familial group, engaged in a variety of businesses including property development, financing, supermarkets and camera retail agencies. It was incorporated in 1957, according to Mr. Li Ting Chung, its managing director who gave evidence, to invest surplus funds of an associated company in quoted shares as a hedge against inflation : later in his testimony it transpired that for the initial seven years it acted as a front for the sale of cameras on behalf of another group company which held an agency for a competitive brand camera. In 1964 however $1 million worth of quoted shares were acquired, a further $700,000 were bought up to 1970. It was not until 1970 that any of the quoted shares were sold whereupon most of the proceeds were channelled back by way of increased capital or loans to help fund property purchases for investment.

 

4.2       The chronology of the properties purchases and activities are as follows :-

 

1968 June

185 Fa Yuen Street was purchased at an auction at $28,532. A minute was produced in evidence authorizing Mr. Li to bid for the property for rental income purpose', a phrase which re-occurs in subsequent Minutes. This purchase appeared in the 1968 balance sheet as 'Land and Buildings'. The Company's share capital then was $1.5 million.

1971

183, 187 & 189 Fa Yuen Street were bought for a total of $844,000. The Minute au-thorizing this stated that the plan was to redevelop them with 185 Fa Yuen Street into a 14 storey building thereby increasing 'rental income'.

594, 592, 596 and 590 Queen's Road West were bought separately in that order between May and November for a total of $1.7 million. In each case there was a supporting Minute indicating that the purpose was to rent out.

6 Jordan Road : Bought for $922,467. The supporting Minute was silent as to the purpose of the acquisition.

Flat 2B Kingston Building : Bought at $144,507 - no supporting Minute tendered.

The 1971 balance sheet groups all of fore-going under the heading 'Land and Buildings' not under 'current assets'. The issued capital was by then $4 million having been increased by $2.5 in 1970. It was in 1971 that those quoted shares previously shown as 'Investments' (as distinct from other shares shown as 'Trading Portfolio') were sold and evidently fetched $2,437,290 (i.e. $1,767,714 at which they stood in the 1970 balance sheet plus the $669,576 gain shown in the 1971 accounts).

1972

22 & 24 Kin Wah Street : Bought for $1,670,000 with a deposit of $250,500, completion scheduled for March 1973 - no supporting Minute was produced and apparently no mortgage was raised. 22 & 24 Kin Wah Street were shown in the balance sheet as 'Land and Buildings'.

183 - 189 Fa Yuen Street were demolished. On the 11.9.72 they were mortgaged to Middle Investments. Ltd. (a company controlled by Mr. Li's father) for $1.1 million.

In this year the issued capital was raised from $4 million to $6 million.

1973

20 Kin Wah Street : Purchased for $990,000. No supporting Minute was tendered in evidences .

183 - 189 Fa Yuen Street were further mortgaged to Middle Investments for an extra $700,000 for the redevelopment then underway.

The balance of $1,419.500 due on 22 & 24 Kin Wah Street was paid and a mortgage of $800,000 was raised.

The Company was further capitalized to the extent of $9 million giving a total of $9 million at which it remained throughout the period which concerns us.

1974

18 Kin Wah Street was purchased at $957,212 again there is no supporting Minute. A mortgage of for $400,000 was raised.

The balance sheet included 18 Kin Wah Street under 'Land & Buildings'.

590-596 Queen's Road West was demolished.

The development of 183-189 Fa Yuen Street property into a 14 storeys block of re-sidences with shops etc. was completed, the occupation permit being issued on the 14th February 1974. The block was call 'SIU YIP BUILING' and the units therein were advertised for rent. Advertising of the units for rental began in December 1973 in the three main Chinese newspapers in Hong Kong and continued fulsomely up to March 1976 when the advertising campaign was not continued on the same scale but, nevertheless, there was still some advertising carried out up to July 1976. During the period from October 1973 to March 1974 the Appellant took the initiative in so far as the commercial units of this building were concerned by writing to such companies as The Hongkong and Shanghai Banking Corporation, The Post Master General, Hang Seng Bank Limited, and Algemene Bank Nederland N.V. and other business organisations in an effort to find tenants for the commercial units.

In 1974 the property market was in a poor state in consequence partly of the economic effect of the massive increases in oil prices beginning at the end of 1973 and partly of the free fall of the stock market in the spring of that yearl. The 1973 Profit & Loss Account showed a small write down of the share investment portfolio and the 1974 Profit & Loss shows a large write down in the share trading portfolio ($673,286) and in the share investment portfolio ($402,792). No write downs were made under 'Land and Buildings'.

1975

A building mortgage over 590-596 Queen's Road West was given to ASEAM to secure $4.3 million.

The stock market having improved the share trading portfolio was revalued.

1976

On the 1st May 1976 there is a Minute of a proposal to sell some of the Siu Yip flats to redeem the Middle Investments mortgages totalling $1.8 million - in fact no sale was made until September 1976.

26 Kin Wah Street was purchased at $1,000,000, the supporting Minute of the 2nd May 1976 indicating that the purpose was to develop this in conjunction with 18-24 Kin Wah Street into 2 residential towers of 25 storeys for 'Long Term Investment purposes'.

On the 1st September 1976 the first sale of a unit in Siu Yip Building, Fa Yuen Street, occurred and a further 19 units were sold by the end of the year. No sales advertisement was placed in the newspapers until 1977; and advertising sign board was put up at the building when it was first decided to sell to satisfy the mortgage i.e. May 1976. Letting advertisements continued but, as we have said, fell off appreciably from March of 1976.

1977

The new 22 storey block (named 'SIU YEE BUILDING') at 590-596 Queen's Road West was completed, the occupation permit being dated 12.1.77. The Appellant immediately began selling and by year's end 60 per cent in area had been sold.

In this year a further 27 units of Siu Yip Building were sold.

1978

The Kin Wah Street properties were redeveloped as 'Universal Tower'. No sales of any units took place until 1984. The reason for the sale of this property was that the Appellant was facing a liquidity problem which could only be solved by selling some of the flats in the development. The Appellant to this day still owns some units in this development."

7. Although the Board did not expressly say so in its findings, it also had before it a letter dated 23rd March 1979 from the Appellant's auditors, Price Waterhouse & Co., to the Revenue, which referred to the Appellant's intentions in relation to the second property in the following terms:

"f) & g) The company changed its intention on the property on 13th January, 1977 (refer to minutes dated 13/1/77 & 12/2/77) and a valuation report was available to value the property as at 17/1/77. We consider that the property has been transferred from fixed asset to current asset on 13/1/77 and as the value of the property as at 13/1/77 and that as at 17/1/77 made no material difference, we take the market value as at 17/1/77 as the cost of the building (current asset) and the difference between this cost and sales proceed was considered to be trading receipt and be subject to profits tax."

8. This letter refers to minutes of meetings held on 13th January 1977 and 12th March 1977.

9. The minutes of 13th January 1977 read as follows:

10. It was resolved:-

11. The minutes of 12th March 1977 read as follows:

"At a Meeting of the Board of Directors of the Company held at its registered office at Ting Cheong Bldg., 13th floor, 166-168 Des Voeux Road Central, Hong kong at 11 a.m. on the 12th day of March, 1977.

12. Resolution:

13. I must say at once that, in my judgment, these two sets of minutes lend no support to the suggestion in the Price Waterhouse letter that the Appellant had changed its intention as therein indicated. On the contrary, the minutes, in my judgment, lead to the opposite conclusion. Certainly they lend no support to the contention that any change of intention, if change there was, took place on 1st May 1976, as the Board found. It does not however appear that the Board attached any weight to the Price Waterhouse letter of 23rd March 1979. In my judgment, no reasonable Board could have done so. The letter contained an unfounded expression of opinion. It did not constitute evidence.

14. On all the material before them the Board made the following findings concerning the first property and the second property respectively:

              "FINDINGS REGARDING SIU YIP BUILDING

15. I have read and re-read the stated case and attempted to follow the reasoning of the Board. Disposed though I am to uphold its decision, I regret that I find myself unable to do so. In my judgment, the evidence went no further than establishing that conditions on 1st May 1976 were such that a decision by the Appellant on that date to turn the properties to account by way of trade would have been an eminently reasonable decision and that the conduct of the Appellant after that date, if such a decision had been taken, would have been consistent with it. There is, as it seems to me, no evidence to support the conclusion that the Appellant did in fact take a decision on 1st May 1976 (or for that matter on any other date before the sales in question) to turn the properties to account by way of trade. It is not enough to say (true as it is) that the purchase, development and sale of property is characteristic of property trading. The error of law lies in the application of this generalization to the facts of the instant case, in which the properties in question were acquired as investments. Certainly there were sales of the properties ; but as Lord Salmon succinctly pointed out in the case cited (at p. 1203):

"An investment does not turn into trading stock because it is sold."

The Board's speculation as to what was in the 'collective mind" of the Appellant's directors is not evidence. The minutes of the meetings of 1st May 1976 and 3rd August 1976 (which were before the Board) read as follows:

"        Minutes of Meeting of the Board of Directors of Wing On Cheong Investment Co. Ltd. held at its registered office at Ting Cheong Building, 13th f1., 166-168 Des Voeux Road C., Hong Kong on lst May, 1976 at 10 a.m.

 

          Present: Mr. Li Ting Chung

               Mr. Li Ting Mo

               Mr. Stephen D. S. Li

16. It was resolved:-

"         At a meeting of the Board of Directors of the company held at its registered office at Ting Cheong Building 13/F., 166-168 Des Voeux Road, C., Hong Kong on the 3rd day of August, 1976 at 11.30 a.m.

 

Present  :  Mr. Li Ting Chung

            Mr. Li Ting Mo

                    Mr. Stephen Ding Sing Li

17. It was resolved:-

18. In my judgment these minutes point to the forced realization of investments, not to trading; the opposite conclusion from that reached by the Board.

19. That conclusion was based on speculation, not evidence. I remind myself of the indication given by Lord Wilberforce that, for a finding of an intention to change the character of an asset from a fixed to a current asset, precision (especially, it seems to me, as to the date of the change) is required. I regret to say that in my judgment the findings of the Board wholly lack that precision, and I find its conclusion that the Appellant changed its intention on 1st May 1976 illfounded. The true and only reasonable conclusion contradicts the determination: see Edwards v. Bairstow [1956] A.C. 14, per Lord Radcliffe at p. 36.

20. What the Board has done is to reason that if a man's stomach rumbles you are entitled to conclude that there has been a change in the state of his digestion. You are entitled to speculate that that may be the case: but not to find as a fact that it is.

21. The questions raised in the stated case are as follows:

              "The questions of law for the opinion of the Court are:-

22. For the reasons I have endeavoured to state I answer all these questions in favour of the Appellant and I propose to discharge the assessments of which the Appellant complains accordingly.