QINHE ENERGY HOLDINGS LTD v. PENG FEI INVESTMENT INTERNATIONAL LTD

HCA 1579/2021

[2023] HKCFI 1872

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 1579 OF 2021

________________________

________________________

________________________

D E C I S I O N

________________________

INTRODUCTION

1.  This is the plaintiff’s appeal against two orders made by Master Gary CC Lam on 28 September 2022:

(1)  the order dismissing the plaintiff’s summons dated 3 May 2022 for summary judgment and/or interim payment; and

(2)  the order allowing the defendant’s summons dated 12 May 2022 for security for costs in the sum of $2,500,000 up to and including the completion of discovery.

2.  The subject-matter of the action is a share transfer agreement dated 15 December 2017 entered into between the plaintiff and the defendant, which was varied about eight months later by a supplemental agreement dated 29 August 2018. I shall call the former, as varied, “the Share Transfer Agreement” and the latter “the Supplemental Agreement” below.

3.  Under the Share Transfer Agreement, the plaintiff agreed to sell its shares in Direct Power International Ltd (“Direct Power”), a BVI company holding assets in coal mining in mainland China, to the defendant for RMB 4,000,000,000. Some of the consideration was then paid and some shares in Direct Power were transferred pursuant to the original agreement. Then, on the same day when the Supplemental Agreement was executed, the parties entered into a share charge (“the Share Charge”) under which the defendant charged shares in Direct Power as security for its payment obligations under the Share Transfer Agreement.

4.  The plaintiff says that the defendant has failed to pay the consideration under the Share Transfer Agreement in full. It brings the present action claiming, among other things, the unpaid balance. The balance together with interest calculated up to 19 October 2021 amount to RMB 1,049,348,396.46.

5.  On the other hand, the defendant says, among other things, that it is entitled to withhold the outstanding balance under the express terms of the Share Transfer Agreement because the plaintiff had failed to disclose various liabilities of Direct Power and its subsidiaries, as was required under the agreement. Furthermore, this failure amounts to breach of representations and warranties on the part of the plaintiff. The defendant thus makes a counterclaim for damages and other reliefs. It contends that it is in any event entitled to wholly set off the plaintiff’s claim by its counterclaim.

6.  By the time the plaintiff took out its summons for summary judgment and/or interim payment, pleadings had been served. They had since been amended. Before the master were the amended versions. I note that after the master’s hearing, they have been further amended. At the hearing before me, parties have been referring to the latest set of pleadings.

FACTUAL BACKGROUND

7.  The dispute primarily turns on the rights and obligations of the parties under the Share Transfer Agreement. The following matters are either common ground or not in serious dispute for the purposes of the appeal.

8.  Under the Share Transfer Agreement, the assets to be sold comprised the following:

(1)  all the shares in Direct Power, which were directly held by the plaintiff;

(2)  all the shares in Winner Deluxe Ltd (“Winner Deluxe”), which were directly held by Direct Power; and

(3)  80% of the shares in Qinhe Energy Group Co, Ltd (“Qinhe Energy Group”), which were owned by Winner Deluxe. Qinhe Energy Group is a mainland entity engaged in the business of mining, delivery and sale of coal.

9.  Direct Power, Winner Deluxe and Qinhe Energy Group are referred to as “the target companies” in the Share Transfer Agreement.

10.  The material clauses are clauses 7(2)1(2), 7(2)1(3), 7(2)4(1) and 11(4). The defendant relies on them to contend that it is entitled to deduct amounts from the consideration payable under the Share Transfer Agreement. Clause 7(2)4(2) is also relevant for construction purposes. I shall reproduce the original Chinese text below. The accompanying English translations are agreed by the parties for use in this appeal. “Party A” is the plaintiff, “Party B” the defendant, and “Party C” Direct Power.

11.  Clauses 7(2)1(2) and (3) read:

“(2) 截止本協議簽署日, 目標公司不存在任何違反中國的強制性法律、法規以及部門規章規定的情形;

(3) 截止到本協議簽訂時, 丙方無任何債務也未對外提供過任何擔保。”

“(2) Up to the date of signing this Agreement, the target companies shall not have violated any mandatory laws and regulations of China and any departmental regulations.

(3) Up to the date of signing this Agreement, Party C is not liable for any debt and has not yet provided any guarantee to a third party.”

12.  Clauses 7(2)4(1) and (2) read:

“(1) 除甲方已經向乙方披露的情形外 (披露債務明細詳見附件二)，目標公司不存在任何其他未披露的債務、責任及或有負債，包括但不限於任何擔保、表外負債、已經或潛在的法律糾紛、行政處罰、法律責任；如存在該等情形或由於甲方未披露或未提供目標公司的任何材料造成目標公司和 / 或乙方承擔責任或產生損失，則甲方應承擔上述責任並對目標公司和 / 或乙方因此受到的任何損失承擔連帶賠償責任，並可直接從應付甲方股權轉讓對價中扣除；

(2) 任何因本次交易完成前存在於目標公司的違法、違規或違約等行為 (如有) 而導致的或有債務和責任，包括但不限於目標公司應承擔的稅務責任、員工社會保險和住房公積金責任欠繳、員工工資欠付責任等，均與乙方無關，應甲方承擔責任”

“(1) Apart from the conditions which have already been disclosed by Party A to Party B (refer to Annex 2 for the particulars of debts disclosure), the target companies shall not owe any undisclosed debt, liabilities and contingency debt, including but not limited to any guarantee, off-balance sheet liability, pre-existing or potential legal dispute, administrative penalty and legal liability; where the said situation happens or could be attributed to any reason(s) that Party A fails to disclose or provide any materials of the target companies, leading to liability borne by or losses suffered by the target companies and/or Party B, then Party A shall be responsible for the liability above-mentioned and bear an obligation to compensate the target companies and/or Party B for loss which could be directly deducted from the consideration of share transfer to Party A.

(2) Party A shall be responsible for any contingent debt and liability arisen from the violation of laws and regulations or breach of contract (if any) by the target companies prior to the completion of transaction, including but not limited to the tax liability of the target companies, liability due to default in payment of social insurance, housing provident fund and wages of employees which have nothing to do with Party B and should be borne by Party A.”

13.  Clause 11(4) read:

“如因甲方違反本協議致使乙方承擔或可能承擔任何費用、責任或蒙受任何損失，則乙方有權在應向甲方支付的轉讓價款中預先扣除相關金額。”

“Where Party B has to bear or potentially bear any expenses, liabilities or suffer from any losses due to the breach of contract by Party A, Party B is entitled to deduct the respective amount from the payment for share transfer in advance before it is made to Party A.”

14.  Pursuant to the Share Transfer Agreement, the plaintiff transferred a total of 100 shares out of 104 shares in Direct Power to the defendant on 15 December 2017 and 21 April 2020. The remaining four shares were held by the plaintiff on trust for the defendant pursuant to a declaration of trust dated 22 December 2017. (There is a dispute as to how the four shares came to be held in this manner. But it is not presently relevant.)

15.  Furthermore, between December 2017 and April 2021, the defendant made a series of payments to the plaintiff. The defendant pleads that they amounted to RMB 3,720,099,779.10 in total. The plaintiff’s case is that only RMB 3,700,099,779.10 had been paid towards the consideration payable under the Share Transfer Agreement. The difference of RMB 20,000,000 does not need to be resolved in this appeal.

THE PLAINTIFF’S CLAIMS

16.  The plaintiff’s case is that by reason of the defendant’s failure to pay the outstanding balance, it exercised its rights under the Share Charge between September and November 2021. It re-registered the 100 shares of Direct Power in its own name and removed the directors nominated by the defendant from Direct Power and Winner Deluxe.

17.  The plaintiff commenced the present action in October 2021, claiming a number of reliefs, including declarations in relation to the Share Transfer Agreement, the Supplemental Agreement and the Share Charge.

18.  In its summary judgment application, however, it only seeks to enter judgment for the outstanding balance in the sum of RMB 279,900,221, together with interest. (The balance is calculated based on the defendant’s figure, ie RMB 4,000,000,000 minus RMB 3,720,099,779.10.) At the same time, it reserves the right to pursue the remainder of the reliefs at trial.

THE DEFENCES

19.  The defence consists of four limbs.

The first limb

20.  First, unknown to the defendant at the time of the Share Transfer Agreement, Direct Power and/or Winner Deluxe were burdened with two groups of undisclosed liabilities and/or debts – first, tax liabilities arising from a transaction referred to as “Transaction 1” in the pleadings; second, the internal debt owed by Direct Power and/or Winner Deluxe to Qinhe Energy Group totalling not less than RMB 190,250,000. The defendant only discovered the tax liabilities in about 2018 or 2019 and the internal debt in the second half of 2021.

21.  The defendant’s case on the undisclosed tax liabilities arising from Transaction 1 is as follows.

22.  In around 2011, it was Direct Power who directly held the 80% shareholding in Qinhe Energy Group. In Transaction 1, Direct Power transferred that shareholding to Winner Deluxe for a consideration of $1,000,000. This resulted in the corporate shareholding structure as described in para 8 above.

23.  According to the consolidated balance sheet of Qinhe Energy Group for the year 2011, the company had a net asset value of just over RMB 4.7 billion at the time. Accordingly, 80% of its shareholding would have been worth about RMB 3.8 billion. Hence the transfer in Transaction 1 was carried out at a considerable undervalue.

24.  On 8 January 2014, the Qinshui County Taxation Bureau (“the Tax Office”) issued a special tax investigatory adjustment notice to Direct Power (“the Tax Notice”), stating that after investigation it was found to have violated the relevant tax regulations, including the PRC Law on Enterprise Income Tax, and demanding it to pay enterprise income tax (企業所得稅) (“EIT”) in the sum of RMB 206,474,200, together with interest. Failure to pay would attract a late surcharge of 0.05% per day.

25.  The original Chinese text is reproduced below:

“特別納稅調查調整通知書

沁稅調 (2014) 1號

恒能國際有限責任公司：

  經調查，你企業自2011年至2011年納稅年度，違反《中華人民共和國企業所得稅法》及其實施條例和《中華人民共和國稅收徵收管理法》及其實施細則關於特別納稅調整的有關規定，決定 … 調增你企業應納稅所得額206474.2萬元，應補企業所得稅20647.42萬元，並按有關規定加收利息。

  限你企業自收到本通知書之日起15天內，向沁水縣國家稅務局負責稅款徵收部門繳納上述稅款及利息，逾期未繳納稅款的，從滯納稅款之日起，按日加收滯納稅款萬分之五的滯納金。”

26.  On the evidence, the plaintiff appears to have caused a total sum of RMB 178,500,000 to be paid to the Tax Office. On that basis, the defendant says that at least RMB 27,974,200 of the EIT still remains overdue and the interest demanded in the Tax Notice, which amounted to RMB 22,047,800, has remained unpaid.

27.  The defendant has adduced expert evidence to show that there are tax liabilities arising from Transaction 1 under the law of the mainland. They comprise (1) the outstanding EIT against Direct Power, (2) late surcharges on the outstanding EIT, and (3) penalties for “non-payment” or “non-withholding” of the EIT against Direct Power and/or Winner Deluxe.

28.  The defendant relies on an expert report compiled by Mr Wong Shun On Caesar of RSM Tax Advisory (Hong Kong) Ltd dated 17 August 2022 (“the RSM Report”). The report, together with the appendices, is 206 pages long. According to his resume, Mr Wong has extensive experiences in handling mainland China tax matters.

29.  According to the RSM Report, by virtue of Transaction 1, Direct Power became, and is, subject to EIT. Under mainland tax law:

(1)  A non-resident enterprise without a business establishment in the mainland will be charged EIT at a rate of 10% on mainland-sourced income.

(2)  A non-resident enterprise with a business establishment in the mainland will be charged EIT at a rate of 25% on mainland-sourced income.

(3)  A resident enterprise will be charged EIT at a rate of 25% on worldwide income.

30.  It is Mr Wong’s opinion that gains derived by Direct Power from its transfer of the equity ownership in Qinhe Energy Group is clearly mainland-sourced income and subject to EIT. The taxable income is equal to the transfer consideration minus the tax cost basis. The latter would broadly be the purchase price previously paid by Direct Power to acquire the stake in Qinhe Energy Group and further capital injected into the company. The transfer consideration in Transaction 1 of $1,000,000 is just around 0.02% of 80% of the net asset value of Qinhe Energy Group at the time.

31.  Mr Wong observes that the Tax Office issued the Tax Notice against Transaction 1 with the unreasonable transaction price and adjusted the taxable income upwards, imposed interest and stipulated a late payment surcharge rate.

32.  While some of the EIT charged under the Tax Notice has been paid, Mr Wong observes that (1) most of the payments were made after the stipulated deadline of 23 January 2014, (2) Direct Power’s name did not appear on the tax payment certificates, and (3) no part of the interest has been paid.

33.  It is Mr Wong’s opinion that since Direct Power has not in a timely manner properly and completely performed the requirements under the Tax Notice, the tax authorities can recover the overdue taxes until they have been settled. The time bar stated in the relevant laws does not apply as the tax liability under Transaction 1 was already investigated by the Tax Office.

34.  It is Mr Wong’s further opinion that since the plaintiff refused to make any further payment under the Tax Notice, this can also trigger the tax authorities to revisit the case by the tax audit department. During further review, if any information or documents provided by the taxpayer in the last investigation is found to be incomplete or untrue, the case can be reclassified into tax evasion. The tax authorities are then empowered to re-assess the taxable amount, and proceed with further action to recover the tax and related liabilities without any time bar.

35.  Mr Wong concludes as follows:

“Since the tax and interests have been overdue for years and the taxpayer refuses to pay any more, it is more likely than not that the Tax Office or its supervisory offices will tighten up the tax recovery actions, and will revisit the case by independent tax audit department, and revise the taxable amounts and tax payable upwards where necessary.”

36.  When that happens, in addition to the EIT actually overdue under the Tax Notice, further EIT may be imposed by the Tax Office. The authorities may make adjustments to the transfer price, the tax cost basis in Transaction 1 and/or the applicable EIT rate. In the RSM Report, Mr Wong comes up with 12 possible scenarios to estimate such potential EIT and related liabilities (ie interest and late payment surcharges). The scenarios cover the situation where Direct Power is treated as a non-mainland resident, which would attract a tax rate of 10%, and other scenarios cover the situation where it is not, which would attract a tax rate of 25%. Some of the variables in the different scenarios are unknown to the defendant, eg, the tax cost basis. The defendant has no information on, for instance, the costs incurred by Direct Power to acquire the 80% shareholding in Qinhe Energy Group in the first place.

37.  In summary, the EIT may range from RMB 27,974,200 to RMB 383,407,070 (where EIT is charged at 10%) or RMB 337,685,500 to RMB 958,517,614 (where EIT is charged at 25%). Together with interest and continually accruing late payment surcharges, the tax liabilities may range from RMB 132,560,405 to RMB 2,442,304,928.

38.  Apart from the above tax liabilities, Mr Wong further opines that Direct Power is at risk of being penalised up to five times the amount of unpaid or underpaid tax. In addition, Winner Deluxe is under a potential obligation to act as a tax withholding agent if Direct Power is deemed to be a non-resident enterprise for tax purpose and may be liable to pay a penalty for failing to perform its withholding obligation.

The second limb

39.  The existence of the above undisclosed tax liabilities and undisclosed internal debt amounts to breaches of the undertakings and guarantees given by the plaintiff to the defendant under clauses 7(2)1(2), 1(3), 4(1) and (2). It also falsified certain pre-contractual representations allegedly made by the plaintiff which the defendant relied on in entering into the Share Transfer Agreement. All these resulted in actual and potential loss and damage, including but not limited to expectation loss as the value of Direct Power and its subsidiaries would necessarily be lower than if none of the liabilities and debts had been present.

The third limb

40.  By reason of the matters stated in the first limb, the defendant is contractually entitled to withhold further payments of consideration under the Share Transfer Agreement pursuant to clauses 7(2)4(1) and 11(4). Alternatively, the plaintiff’s claim is wholly set off by the defendant’s counterclaim.

The fourth limb

41.  If Direct Power is deemed to be a non-resident enterprise for EIT purposes, the defendant is under a potential duty under mainland law to act as a tax withholding agent for the EIT which the plaintiff is liable for under the Share Transfer Agreement. This is referred to as “Transaction 2” in the pleadings.

42.  To conclude, the defendant contends that the above four limbs of defences raise triable issues and summary judgment ought not to be granted.

Inconsistent remedies

43.  In addition, the defendant submits that the plaintiff’s summons for summary judgment is inherently defective and should be dismissed in limine as the plaintiff has chosen not to make a definite election to pursue a monetary claim. While a party may plead alternative inconsistent remedies, he must make an election at a time when it applies for summary judgment: Tang Man Sit v Capacious Investments Ltd [1996] 1 AC 514.

44.  In the prayer for relief in the statement of claim, the plaintiff simultaneously seeks both the unpaid balance of the consideration (together with interest) and a declaration that the plaintiff has rightfully and lawfully taken back all the shares of Direct Power in accordance with the Share Charge.

45.  The defendant points out that the plaintiff arguably made the election when it re-registered the shares in its own name and removed the directors nominated by the defendant from Direct Power and Winner Deluxe. Hence it can no longer pursue the monetary relief in the sum of the unpaid balance of the consideration.

46.  In any event, as the plaintiff has specifically reserved its right to pursue the remainder of the reliefs set out in the prayer, it has not made any effective election in favour of the monetary relief which it now seeks in its summary judgment application.

LEGAL PRINCIPLES

47.  An appeal from a master to a judge under Order 58, rule 1 of the Rules of the High Court is by way of re-hearing. I should treat the summonses as though they came before me for the first time: Hong Kong Civil Procedure 2023 at 58/1/2.

48.  The principles on summary judgment are well-known. The burden is on the defendant to show a real or bona fide defence or some other reason for a trial. The defendant must satisfy the court that his evidence is capable of being believed and that on the basis of such evidence, there is a fair or reasonable probability of the defendant having a real or bona fide defence: see, eg, recently, Guanghua SS Holdings Limited v Lim Yew Cheng [2022] HKCFI 1052 at para 13.

49.  The principles governing interim payment are not in dispute. The court first considers whether the plaintiff would obtain judgment for a substantial sum of money at trial. The test is essentially the same as for granting conditional leave to defend. The court must be satisfied that the defendant either has no arguable defence or that there are sufficient doubts regarding the genuineness of the defence, ie it is shadowy. If so satisfied, the court will then decide whether to exercise its discretion to make an order and, if so, for what amount: Hong Kong Civil Procedure 2023 at 29/11/1, 29/11/4 and 29/11/5. Where the defendant establishes an arguable defence such that unconditional leave to defend should be granted, the plaintiff necessarily will fail in showing that it would obtain judgment for a substantial sum of money: Chiu Ricky Tong v Eagle Bright Property Development Co Ltd [2022] HKCFI 872 at paras 23 to 24.

DISCUSSION – SUMMARY JUDGMENT

50.  On the evidence before me, I am satisfied that whether there are tax liabilities arising out of Transaction 1 as alleged by the defendant (ie the first part of the first limb of defence) is an issue which ought to be tried, and that if such liabilities are established, it is arguable that the defendant is entitled to deduct from the consideration such alleged liabilities pursuant to clauses 7(2)4(1) and 11(4) of the Share Transfer Agreement. Alternatively, it is arguable that the existence of such liabilities amounted to breaches of the Share Transfer Agreement such that the defendant is entitled to set off its loss and damage from the plaintiff’s claim (ie the second and third limbs of defences).

51.  For that reason, the defendant should be allowed to defend the action unconditionally. Summary judgment ought not to be entered. It is therefore unnecessary for me to deal with the defence based on the alleged undisclosed internal debt and the other parts of the four limbs of the defences or the alleged inconsistent remedies.

The first limb – the undisclosed tax liabilities

52.  The plaintiff has also adduced expert evidence on tax law and practice in the mainland. It has filed two short affirmations made by Mr Li Xuechao, who is a practising lawyer with the law firm Guangdong Shangda (Dongguan) Law Firm.

53.  Insofar as Transaction 1 is concerned, Mr Li makes the point that sums amounting to RMB 178,500,000 in total were paid to the Tax Office and that the tax payment certificates issued by the Tax Office state that there is no surcharge or late fees payable in relation to the tax payments. Furthermore, in his experience, the tax authorities will not generally impose any late fees on any payment of tax that have already been made. As such, it is unlikely that any late fees would be imposed in relation to the tax payments, as they have already been paid and received by the tax authorities without any indication from the latter that late fees are payable.

54.  Furthermore, it is Mr Li’s opinion that given that the Tax Notice made it clear that overdue payment of taxes will be subject to a daily late surcharge of 0.05% and did not say that any fines would be imposed, and given that the relevant tax circulars did not say that any fines or penalties would be imposed on any withholding agent, there is no basis for there to be a penalty risk against Winner Deluxe, as alleged by the defendant’s expert.

55.  In the RSM Report, Mr Wong disagrees with Mr Li’s conclusions. Mr Wong says that the tax payment certificate is just an official evidence of tax payment made and should not and cannot be used as evidence to support the contention that no interest or late payment surcharges should be paid. Furthermore, Mr Wong highlights that the taxation of Transaction 1 has been outstanding for more than a decade and the tax amount is very significant and the outstanding liabilities remain sizable. The penalty provisions are contained in the tax law and rules. They are comprehensive, well-defined and ready for use. There is therefore a risk that a penalty will be imposed.

56.  There is therefore a conflict of expert evidence on whether the tax liabilities arising out of Transaction 1 as alleged by the defendant exist or not.

57.  In this regard, it is notable that Mr Victor Dawes, SC, appearing with Mr Jonathan Fung for the plaintiff, has not placed much reliance on the contents of Mr Li’s affirmations, whether in his written or oral submissions. Instead, the focus of his submissions is to make criticisms of the defendant’s case. He argues that the alleged potential tax liabilities are wholly fanciful risks which the defendant has conjured up to avoid fulfilling its payment obligations. He points out that the defendant never raised the alleged EIT or the alleged penalty risk in any communication with the plaintiff prior to the present action. Nor did it raise the existence of the alleged EIT when it first filed its defence and counterclaim. It was only after the plaintiff took out its application for summary judgment that the defendant raised the point.

58.  Mr Dawes comments that the defendant’s case on quantum is imprecise and that is further proof of the spurious nature of the alleged potential liabilities. The defendant’s case refers to “unknown factors” which would affect any further assessment by the Tax Office and comes up with 12 possible scenarios. But, importantly, the defendant, Mr Dawes contends, has made no attempt to flesh out its case by adducing evidence as to the likelihood of any given scenario eventuating. There is no evidence adduced by the defendant at all on the likelihood of the Tax Office imposing the alleged EIT and/or any penalties on Direct Power and Winner Deluxe. As such, the allegation of tax liabilities is no more than pure speculation on the defendant’s part and must be rejected as being wholly incredible. Furthermore, in his oral submissions, Mr Dawes stresses that no further demand has in fact been made by the tax authorities over the years.

59.  The issue before me at this interlocutory stage is whether the allegation of tax liabilities arising out of Transaction 1 is arguable. Or is the risk of such liabilities fanciful such that they can be dismissed outright without a trial of the conflicting expert evidence?

60.  In my judgment, I do not agree with the plaintiff that the risk of the mainland tax authorities imposing the alleged EIT and/or penalties can be rejected summarily as fanciful or purely speculative.

61.  The matter turns on the tax law and practice of the mainland. Foreign law issues are matters of fact. There is presently a clear factual dispute.

62.  It is plain that the RSM Report seeks to address the issue of tax liabilities in a comprehensive manner. Mr Wong has made extensive references to the mainland tax laws and regulations and given detailed citations. It would not be appropriate or necessary for me to go into any in-depth analysis of his opinion at this interlocutory stage. The question for me now is to see whether I can reject his opinion outright as being untenable, or incapable of belief, without it being tested in a trial.

63.  I do not consider that I can do that.

64.  Mr Wong’s opinion has been arrived at against a number of objective facts:

(1)  The consideration of $1,000,000 was on its face much less than 80% of the net asset value of Qinhe Group Energy at the time – in fact, as little as 0.02%.

(2)  The Tax Notice was issued, in which a demand for a substantial sum of EIT was made.

(3)  Up to this day, the demand made in the Tax Notice has not been met in full – the EIT specified in it has not been fully settled and the interest has not been paid at all.

(4)  There is therefore an actual liability of Direct Power to pay the overdue EIT and interest.

(5)  There is no explanation so far offered by the plaintiff for the continuing default.

(6)  According to the Tax Notice, late payment surcharges would accrue on a daily basis.

65.  Against the above context, Mr Wong opines that it is “more likely than not” that the Tax Office will tighten up its tax recovery actions and direct an upward adjustment of the taxable amounts under Transaction 1, together with interest and penalties.

66.  In my view, this opinion is arguably plausible, especially when viewed against the above objective facts. Mr Wong has come up with various estimates of the potential (ie further) EIT which may be imposed in the event of a re-assessment. The plaintiff criticises such estimates to be speculative. However, on the face of the RSM Report, Mr Wong has reached his conclusions based on the prevailing tax law and rules in the mainland, his own practical experiences in handling mainland tax matters and his analysis of the facts pertaining to Transaction 1. As such, his opinions are at least capable of belief.

67.  As for the plaintiff’s expert evidence, Mr Rimsky Yuen, SC, appearing with Mr Adrian Kwan for the defendant, contends that the Mr Li’s affirmations does not provide anything close to an adequate rebuttal of the RSM Report. My own observation is that the opinions arrived at in the affirmations do not appear to be supported with full reasoning. I also note that while Mr Li opines in his affirmations that the tax authorities may be time-barred from issuing demands to Winner Deluxe, Mr Dawes in his oral submissions confirms that he would no longer rely on this part of the opinion.

68.  This is not the occasion to discuss the quality of the rival expert evidence. For the reasons stated above, I am of the view that the defendant’s expert evidence cannot be rejected summarily.

69.  To complete the analysis, I should also add that I have taken note of Mr Dawes’ submission that as a matter of fact, no demand has actually been made by the tax authorities since 2014. That fact itself may be indicative of the risk of a tax re-assessment but is in no way conclusive. It is perhaps a matter which may become relevant in the trial. But at this stage this factor alone does not help advance the plaintiff’s case that the re-assessment risk is fanciful or purely speculative.

70.  To conclude, the defence based on the RSM Report in relation to the tax liabilities arising out of Transaction 1 ought to be tried.

The third limb – contractual entitlement to deduct

71.  The next question is whether the defendant is entitled to deduct any such tax liabilities from the consideration payable under the Share Transfer Agreement.

72.  In this regard, Mr Dawes highlights that the only present obligation on the part of Direct Power and/or Winner Deluxe is the obligation to pay the EIT (and interest) actually specified in the Tax Notice. However, in its latest pleading, the defendant does not rely on this actual present obligation. Instead, it relies on further EIT and penalty which may be imposed in the event of a re-assessment. These are merely potential liabilities. Mr Dawes submits that they do not come within clauses 7(2)4(1) or 11(4) and hence the defendant has no contractual entitlement to deduct.

73.  This is because:

(1)  Clause 7(2)4(1) only entitles the defendant to deduct sums where the target companies or the defendant has “borne” a liability or “suffered” a loss. The wording makes it plain that for the clause to be triggered, there must be some actual liability of an ascertained amount or some actual loss suffered. This would happen where the Tax Office actually makes a demand for a certain sum.

(2)  The clause does not apply to any potential liability which may crystallise only in the future.

(3)  Clause 11(4) only covers deductions for the defendant’s losses and liabilities. It does not cover any further EIT and penalties which may be imposed since these are potential liabilities of Direct Power and/or Winner Deluxe, not of the defendant.

(4)  Here, it is not open to the defendant to argue that it has itself suffered a loss in terms of a diminution in value of its shares in Direct Power because it has so far not adduced any evidence as to how the value would be so affected.

74.  On the issue of pleading, insofar as the plaintiff is saying that the defendant no longer relies on the actual overdue EIT and interest as specified in the Tax Notice, that interpretation of the pleading is incorrect. Those two sums have been expressly incorporated into the table containing the 12 scenarios.

75.  Separately, there is no need for me to come to any definitive view on the construction of the two clauses at this stage – more specifically, whether I agree that the clauses are only triggered by “actual loss”.

76.  Even adopting the plaintiff’s construction, Mr Yuen submits, and I agree, that it is plainly arguable that the presence of potential tax liabilities of Direct Power of the magnitude suggested by the defendant’s expert are a form of actual loss suffered by the defendant and hence would come within the contractual clauses. As a matter of common sense and commercial sense, it is plausible to argue that the values of the companies would be much less than if they had not been burdened with the potential substantial tax liabilities and this amounts to an actual loss to the defendant as the companies would arguably be worth less than what it had agreed to pay for.

77.  I therefore conclude that it is arguable that the defendant is entitled under the terms of the Share Transfer Agreement to deduct the potential tax liabilities from the consideration.

78.  There is no need for me to deal with the plaintiff’s argument that the defence of undisclosed tax liabilities was raised at a very late stage. I have undertaken the above analysis based on the substance of the parties’ expert evidence. Ultimately, their rights and obligations are governed by the contractual documents. In the circumstances, the alleged lateness does not, in my view, have any material bearing on the analysis as a whole.

The third limb – set-off

79.  In any event, the defendant would have an arguable defence of set-off based on the breach of undertakings or guarantees arising from the potential tax liabilities.

80.  To conclude, the defendant should be allowed to defend the action unconditionally. In his oral submissions, Mr Dawes accepts that in the event that I find that there is an arguable defence based on the undisclosed tax liabilities arising from Transaction 1, the plaintiff’s summons for summary judgment ought to be dismissed. The master’s order should therefore be upheld.

DISCUSSION – INTERIM PAYMENT

81.  In light of my ruling above, there is no basis for the court to grant interim payment. The application should likewise be dismissed.

DISCUSSION – SECURITY FOR COSTS

82.  The defendant applies for security for costs pursuant to both Order 23, rule 1(1)(a) and section 905 of the Companies Ordinance, Cap 622.

83.  There is no dispute that the court has jurisdiction under both of the above provisions to grant security in favour of the defendant. The issue is whether it should exercise its discretion to do so.

84.  Having reviewed the materials before me, I would decline to grant the security for costs. In arriving at this conclusion, I have taken into account the following factors which I consider to be material and relevant.

85.  First, the plaintiff is incorporated in the Cayman Islands. The evidence shows that it has no place of business in Hong Kong.

86.  Generally speaking, a plaintiff ordinarily resident out of the jurisdiction should provide security for costs. The rationale is that if the defendant were to be successful in his defence, he may find himself seriously out of pocket by not being able to enforce any costs order in his favour against a plaintiff who is out of the jurisdiction and who has no assets here. It is therefore generally fair and just to order security in this kind of situation to ensure that the defendant is not forced to defend himself against allegations without protection in costs: see, eg, Lai Jianping v ABN Amro Bank NV [2013] 3 HKC 571 at paras 5 to 6. This is a factor in favour of the defendant.

87.  Second, the evidence suggests that the plaintiff is a merely an offshore holding company with no substantive business activities or operating assets of its own. This factor is in favour of ordering security as it is prima facie unfair and unjust for the plaintiff to commence proceedings against the defendant with immunity over any costs order which it may be required to pay.

88.  Third, on the other hand, the plaintiff’s claim and the defendant’s counterclaim raise essentially the same issues. In my view, the counterclaim does not operate as a mere defence to the plaintiff’s claim. In fact, this is a case where even if the plaintiff did not commence or continue with the action, the defendant would have to prosecute the counterclaim in any event. This is a factor which weighs against granting the security. I say so for the following reasons.

89.  Here, the objective facts are that the defendant had paid substantial sums of money to acquire the shares of Direct Power. However, the plaintiff has taken back the shares by re-registering them in its own name and removing the directors nominated by the defendant from the boards of Direct Power and Winner Deluxe. The plaintiff says that it is entitled to do so under the Share Charge.

90.  The status quo is therefore that the shares are now in the name of the plaintiff. This is plainly not a status quo which the defendant would be content to live with, when its case is that it has already fully performed its side of the bargain under the Share Transfer Agreement. In fact, as part of the reliefs sought in its counterclaim, the defendant seeks an order that the plaintiff do transfer back to it any shares in Direct Power registered in its name.

91.  The defendant now says that it is not obliged to pay up the outstanding balance of the consideration based on its contractual entitlement to withhold and/or its right of set-off. It is true that these matters raise issues which need to be resolved in the adjudication of the plaintiff’s claim. However, in order to get back the shares of Direct Power of which the defendant says it is the rightful owner, these are matters which the defendant will need to raise in any event.

92.  Hence it is fair to say that the defences are not a mere response to the plaintiff’s claim. They are cross-claims which have to be litigated in any event. As things presently stand, if the defendant gives up its counterclaim now, the plaintiff would continue to hold the shares. I agree with the plaintiff’s submission that it is inconceivable that the defendant would be content with the present state of affairs.

93.  Analysed that way, the defendant can properly be described as the real attacker. It would be unjust for it to be able to obtain security for bringing its own claim when it is effectively in the position of a plaintiff: see, eg, Winko Foundation Ltd v Ho Chi Hung Terence [2015] 5 HKC 497 at para 32; Pannam Ltd v Gheorghe Nicolaescu HCMP 339/2015, 9 June 2015 at para 15.

94.  I bear in mind that the mere existence of a counterclaim arising out of the same matters as that in a plaintiff’s claim per se does not disentitle a defendant to security for costs.

95.  However, in the present case, given the status quo, the defendant would have to prosecute its counterclaim in any event in order to get back the shares in Direct Power. This is a prominent fact and a significant factor which weighs against granting it security for its costs.

96.  Mr Yuen makes the submission that the plaintiff’s claim and the defendant’s counterclaim are mirror images of each other and as such no additional costs will likely be incurred in dealing with the counterclaim. He further submits that once the defence is established and the plaintiff’s claim fails, there is nothing else to litigate. The reliefs which the defendant seeks in its counterclaim would follow as a matter of course.

97.  The submission is not in itself incorrect. However, it fails to address the proper question in the present context, namely whether the counterclaim would have to be litigated in any event, ie whether or not the plaintiff continues with its claim.

98.  In an application for security for costs, the ultimate question is whether having regard to all the circumstances of the case, it is just and fair to grant security for the defendant’s costs: see, eg, Delco Participation BV v HWH Holdings Ltd [2021] HKCFI 250 at para 17; Pannam Ltd at para 15.

99.  On the special facts of the present case, I would answer the question with a “No”, even though the plaintiff is a company out of the jurisdiction and apparently has no assets here.

ORDERS

100.  For the above reasons, I make the following orders.

101.  I dismiss the plaintiff’s appeal against the master’s decision on summary judgment and interim payment.

102.  I allow the plaintiff’s appeal against the master’s decision on security for costs. I set aside the order and dismiss the defendant’s summons. The security paid into court by the plaintiff pursuant to the master’s order be paid out to the plaintiff’s solicitors.

103.  I make the following costs orders nisi.

104.  The defendant do have costs of the appeal on summary judgment and interim payment.

105.  The plaintiff do have costs of the appeal on the security for costs and costs of the defendant’s summons, including the relevant part of the hearing before the master.

106.  All costs are inclusive of any reserved costs and are to be taxed if not agreed. I grant a certificate for two counsel.