SINOLINK OVERSEAS LIMITED v. COMMISSIONER OF ISLAND REVENUE

I.R.A. No. 1 of 1985

                Appellant appealed additional profits tax assessment upon the basis that the relevant profits arose in China and did not arise in nor were derived from a business conducted in Hong Kong.

Held:-

                The issue raised was purely one of fact namely: "Where do the operations take place from which the profits in substance arise" following Smidth v. Greenwood [1921] 3 K.B.583 and Hong Kong and Whampoa Dock Co. (No.2) v. Commissioner of Inland Revenue [1960] H.K.L.R.166.

                On the facts, the relevant profits arose in Hong Kong.

I.R.A. No 1 of 1985

IN THE SUPREME COURT OF HONG KONG

HIGH COURT

APPELLATE JURISDICTION

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BETWEEN

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JUDGMENT

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1. This appeal is brought by the appellants, Sinolink Overseas Limited (the company) against a determination of the Respondent under section 64 of the Inland Revenue Ordinance (Cap.112) dated 3rd December 1984 to confirm an additional profits tax assessment raised against the company in respect of what are called its profits on "off-shore sales" for the year 1981/1982.

2. The facts upon which the respondent based his decision are set out in his determination. The following summary suffices. The company was incorporated in Hong Kong on 4th January 1980 and commenced business on 16th June 1980. It described its business as "importer and exporter of plywood". For profits tax purposes the company in its material accounts for the period 4th January 1980 to 30th April 1981 differentiated between local and off-shore sales. In round figures its turnover was $32.912m. $7.499m of this was attributed to local sales: the balance of $25.412m to off-shore sales. After deduction of the respective costs figures, the gross profit total of $1.636m was split as to $0.433m to local and as to $1.203m to off-shore. Net profit figures are then derived by apportioning other "expenses" totalling $1.046m in the same ratio i.e. $0.226m to local and $0.819m to off-shore. Apart from travelling expenses, which may well have been incurred substantially abroad, these expenses seem to be the administration and overhead costs arising in respect of the company's Hong Kong premises in Lockhart Road.

3. It is therefore not without significance to note that the net profits on overseas sales, the subject matter of this appeal, stem from:-

4. The information placed by the company before the respondent about off-shore sales was as follows:-

5. The company also submitted what was called a "full set of documents relating to a representative transaction". This transaction was based upon:-

6. By section 14 of the Inland Revenue Ordinance profits tax is chargeable "on every person carrying on a trade profession or business in the Colony in respect of his assessable profits arising in or derived from the Colony for that year from such trade, profession or business".

7. Both here and below the company made what is substantially the same point in two different ways. First it was said that the company was carrying on two businesses one domestic and one off-shore and that the relevant profits arose from the latter. Alternatively it was said that these off-shore profits, computed as aforesaid, arose out of contracts of sale like (B), and accordingly arose in or were derived from China not Hong Kong. Particular reliance was placed upon the location of the sales contract in China: the source of supply from abroad: and direct shipment via but not to Hong Kong.

8. In his determination the respondent rejected this argument in the following terms:-

"(3)    In the present case, the Company operates from its sole establishment in Hong Kong. Sales personnel are despatched from Hong Kong for sales negotiation outside Hong Kong. Upon conclusion of a sale contract, they would return to Hong Kong to arrange for supplies either from local sources or by contacting prospective suppliers overseas. All the rest of the sale operations, so far as the Company as the selling party to the sale contract is concerned, appear to take place in Hong Kong. In these circumstances, I am of the view that the sale profits attributable to the shipments to China have arisen in or are derived from Hong Kong from the trade or business it carries on here. I should add that in reaching this view I have had due regard to the functions of  the Company's personnel who carried out various duties overseas. I am satisfied, however, that they were no more than peripatetic agents of the company and their activities and authority were not such as to constitute a permanent establishment overseas to which any part of the profits now brought to charge could be said to be attributable."

9. The company's particular criticism of those conclusions are that the respondent paid insufficient regard to the location of the contract of sale and too much regard to the company's administration centre in Hong Kong.

10. There was no issue between counsel as to the proper tests to be applied in the construction of section 14. In Hong Kong and Whampoa Dock Co. (No.2) v. Commissioner of Inland Revenue (1960) H.K.L.R.166 the Full Bench adopted as appropriate to the construction of this section two tests particularly associated with Lord Atkin. First in Smidth v. Greenwood (1921) 3 K.B.583, 593, Atkin L.J. formulated the question arising in these terms: "where do the operations take place from which the profits in substance arise". Later when giving the advice of the Privy Council in Rhodesia Metals Limited v. Taxes Commissioner (1940) 3 All E.R.422, 426, he quoted with approval a test in fact first formulated by Isaacs J. in Nathan v. Federal Commissioner of Taxation (1918) 25 C.L.R.183 as follows:-

"Source means not a legal concept but something which a practical man would regard as a real source of income ..... The ascertaining of the actual source is a practical hard matter of fact."

11. I readily accept that these tests, which raise a pure question of fact, are those which I must seek to apply. The company's operations have to be identified and located. I must first try to identify the various activities which collectively have produced these profits. Then I must seek to deduce one governing location since apportionment is not permissible in law or possible on these facts.

12. I cannot however accept the further use counsel sought to make of these earlier authorities. They sought either to argue from or to criticise factual deduction made in these cases. I do not regard this as right or helpful. One of the problems of the authorities in this field to my mind, is that on occasions what were initially formulated as explanations of factual determinations had a tendency to harden into apparent presumptions of law. For example there are many cases in which the location of a contract of sale was said to be "crucial" and was apparently regarded as almost decisive. MacLaine v. Escott (1926) A.C.424, and the cases collected there are examples of this: whereas Commissioner of Taxation v. Kirk (1900) A.C. 588 appears to be an example to the contrary.

13. But in Smidth v. Greenwood Atkin L.J. expressly rejected the suggestion that this one feature was decisive as did Lord Radcliffe in Firestone Tyre v. Lewellin (1957) 1 All E.R.561, 568. Lord Radcliffe pointed out that "under the conditions of international trade and modern facilities of communication" the place of sales "test is capable of proving a somewhat ingenuous one". Advances in the technology of communication. and the increased use of telex have emphasised the validity of this point. In my judgment all these authorities are consistent in treating this question as one of fact. The location of the contract of sale is a relevant, and possibly a very relevant factor in such determination, but its importance will vary according to circumstances.

14. I am also not impressed by Mr. Barlow's argument that because the Full Bench in the Hong Kong Dock case gave much less weight to the company's administrative base in Hong Kong then did the trial judge, I was bound to or should down grade the significance here of the company's Hong Kong H.Q. In the context of these profits it was submitted that I should in effect treat its existence as a cause sine qua non and not a causa causans. I do not regard the factual weight which one court may give to a particular factor in the case before it, as of any guide to any subsequent court, except possibly where the facts as a whole are indistinguishable.  Blair Kerr J., who was a member of the Court in the Dock's case, was, I think, right to treat it as a decision on its own facts in Commissioner of Inland Revenue v. International Wood Products Limited Hong Kong Text Cases 551, 565. Equally it seemed to me unnecessary for Mr. Feenstra to reserve his right to argue before a higher court that the Dock's case was wrongly decided on its facts.

15. I therefore regard this appeal as turning purely upon fact. I cannot readily regard it as a test case, as was suggested. Nor can I commend the appellate procedures chosen. Two avenues of appeal are now open: one to the Board of Review under section 66: the other to this court under section 67. Although it is open to an appellant choosing the latter course to open up and re-argue questions of fact this appellant did not do so. The company chose to found upon the statements and documents presented to the Commissioner below, without further elucidation and without calling any evidence. This to my mind is most unsatisfactory. The specimen documentation is almost certainly not complete. I should, for example, be surprised if the "negotiations" with the sellers were all oral, and included for example no telex communications. I can only regard the description of the salesman in paragraphs (c), (d) and (e) as superficial, and of the part played by the company's Hong Kong office in paragraphs (f) and (h) as partial and incomplete.  As none of the questions presented to my mind by these paragraphs have been answered I can only do my best on the tenuous available material and draw such inferences as I think proper.

16. In my judgment the company's operations, the activities which collectively produced these profits, can be said to fall under four broad heads namely:-

Heads (2), (3) and (4) speak for themselves. Head (1) is to my mind equally important but hardly noticed in the documents. It is obvious that the gross profit is the difference between the costs of head (2) and the return from head (3). But I apprehend the crucial skill in this trade is to ensure that such differential in the company's favour sufficiently exists. This means knowing, before any offer is made, that whatever is offered for sale can be brought in on identical terms, but at a substantially more favourable price. Thus I cannot believe that the negotiations referred to in the letter to the sellers of 23rd February started after 20th February. I cannot believe that the man who signed the contract of 20th February on behalf of the company did so without knowing that goods, precisely answering the contract descriptions and terms, except the price, were then available to the company. I do not know the precise mechanisms used because the company has revealed nothing. I do not know for example whether something akin to open offers were obtained from Oslo; whether such information was transmitted to the salesman before he left for China; or whether it was communicated to him in China. But I am quite sure that the profits of this nature could never have been earned unless some mechanisms for the pre-contract management of the terms discussed with both buyers and sellers existed.

17. It is also I think apparent that this vital function could only be controlled and conducted from and through the company's administrative centre in Hong Kong. This together with Hong Kong's location, its shipping, communications and banking systems may well explain why the company was incorporated in Hong Kong in the first instance.

18. Turning to the location of these four heads of activity the position is:-

19. In these circumstances I have no hesitation whatever in concluding that the company carries on one business in Hong Kong; and that the profits arising from these so-called off-shore sales arose in and were derived from this Hong Kong business. This appeal is accordingly dismissed.