LAM SOON TRADEMARK LTD v. THE COMMISSIONER OF INLAND REVENUE

CACV 279/2004

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO. 279 OF 2004

(ON APPEAL FROM HCIA NO. 2 OF 2004)

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JUDGMENT

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Hon Stock JA:

Introduction

1. The issue in this appeal is one of construction of sections 14, 15(1)(b) and 60 of the Inland Revenue Ordinance Cap. 112.  It comes before us on appeal from the decision of Tang J (as he then was) dated 6 August 2004 before whom a Case was stated by the appellant against the Board of Review’s confirmation of the respondent’s additional tax assessments for the years of assessment 1990/1991 to 1993/1994 inclusive.  Those additional assessments were in respect of royalty income derived by the appellant from licensing the use of trademarks to its related companies.

2. For the purposes of this appeal, we can conveniently take the essential facts from the introductory paragraphs of the judgment below:

“	2.	The appellant is part of the well-known Lam Soon Group of Companies. It was incorporated in December 1987 in the Cook Islands with an issued and paid up capital of US$2. Between December 1987 and October 1990, the appellant was a subsidiary of Lam Soon Hong Kong Limited (“LSHK”). In October 1990, it became a subsidiary of Lam Soon Food Industries (BVI) Limited (“LSF-BVI”). LSF-BVI was in turn wholly-owned by Lam Soon Food Industries Limited (“LSFI”). LSFI became a listed company in Hong Kong in July 1991.  LSFI was incorporated in Bermuda and in turn was a subsidiary of LSHK. LSHK was incorporated on 13 May 1961 and is also listed in Hong Kong. Some of its brand names, such as “Knife” and “Axe” are well-known in Hong Kong.
	3.	As the Board has held and it is uncontroversial ‘At all relevant times, the principal activities of the Appellant were the acquisition of trademarks and the granting of licences to use the trademarks in return for royalty income.’”

3. We are in this appeal concerned with only one aspect of the learned judge’s judgment, namely, that which related to the power of the Commissioner to make a reassessment under section 14(1) of the Ordinance when a final assessment had already been made by invocation of the provisions of section 15(1) of the Ordinance.

The statutory provisions

4. Section 15(1)(b) provides as follows:

“	(1)	For the purposes of this Ordinance, the sums described in the following paragraphs shall be deemed to be receipts arising in or derived from Hong Kong from a trade, profession or business carried on in Hong Kong -
		(a)	….
		(b)	sums, not otherwise chargeable to tax under this Part, received by or accrued to a person for the use of or right to use in Hong Kong any patent, design, trademark, copyright material, secret process or formula or other property of a similar nature, or for imparting or undertaking to impart knowledge directly or indirectly connected with the use in Hong Kong of any such patent, design, trademark, copyright material, secret process or formula or other property;
		… .”

5. Section 21A of the Ordinance, as it stood at the years of assessment with which we are concerned – it has since been amended – then read as follows:

“The assessable profits of a person arising in or derived from Hong Kong in respect of a sum deemed by section 15(1)(a) or (b) to be a receipt arising in or derived from Hong Kong from a trade, profession or business carried on in Hong Kong shall, for the purposes of this Ordinance and notwithstanding any other provisions of this Part, be taken to be 10 per cent of such sum.”

6. Section 60(1) of the Ordinance provides that:

“	Where it appears to an assessor that for any year of assessment any person chargeable with tax has not been assessed or has been assessed at less than the proper amount, the assessor may, within the year of assessment or within 6 years after the expiration thereof, assess such person at the amount or additional amount at which according to his judgment such person ought to have been assessed, and the provisions of this Ordinance as to notice of assessment, appeal and other proceedings shall apply to such assessment or additional assessment and to the tax charged thereunder:
	Provided that-
	(a)	(Repealed 2 of 1971 s. 39)
	(b)	where the non-assessment or under-assessment of any person for any year of assessment is due to fraud or wilful evasion, such assessment or additional assessment may be made at any time within 10 years after the expiration of that year of assessment.”

7. Section 14 stipulates that:

“	(1)	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 (excluding profits arising from the sale of capital assets) as ascertained in accordance with this Part.
	(2)	In the case of-
		(a)	a corporation; and
		(b)	a corporation ("relevant corporation") to which a share of the assessable profits of a partnership is apportioned under section 22A and is charged in the partnership name under section 22,
	profits tax shall be charged on the assessable profits of that corporation, or on that share of the assessable profits of that relevant corporation, as the case may be, at the rate specified in Schedule 8.”

The assessments and the objection

8. The appellant company was established in the Cook Islands to hold trademarks, and its business was the licensing for use in Hong Kong of intellectual property owned by the appellant.  The income with which we are concerned is the royalty income that was derived from that licensing.  By invocation of the provisions of sections 15(1)(b) and 21A, a series of assessments were raised in the name of Hong Kong resident companies on the appellant’s behalf (see section 20B).  No objection was taken to any of those assessments and accordingly, under section 70 of the Ordinance, they became “final and conclusive.”  Subsequently, however, the assessor concluded that the appellant had been carrying on business in Hong Kong and should be the subject of an additional assessment under sections 14 and 60 of the Ordinance and, accordingly, in March 1997 raised additional profits tax assessments. 

9. The appellant objected against those additional assessments, but the Commissioner confirmed them and there was an appeal to the Board of Review against the determination to confirm.  When the matter came before the Board, it heard testimony and concluded that the appellant had in fact carried on a business in Hong Kong; and that the royalty receipts in respect of the years of assessment constituted profits arising in or derived from Hong Kong.  That aspect of the determination, canvassed again before Tang J, is not part of this appeal.  It is the legality of the re-assessment that is the subject of this appeal. 

10. The question in the Case stated was put thus:

“

51.

Whether upon the evidence before the Board and in all the circumstances of the case the Board erred in law by holding that the royalties having already been charged to Profits Tax under section 15(1)(b) of the Ordinance could further be charged with Profits Tax under section 14 of the Ordinance:”.

The judge at first instance held that the additional assessment was lawfully raised.

The argument

11. The appellant’s argument, broadly put, is that:

1)	The amounts charged to profits tax by application of the deeming provision of section 15(1)(b) on receipt of sums paid for the use of intellectual property in Hong Kong is calculated in accordance with the provisions of section 21A; which, according to its terms at the relevant time, was at the rate of 10% of the sums thus deemed to be a receipt arising or derived from Hong Kong from a trade, profession or business carried on in Hong Kong.
2)	The assessments became, in the absence of objection, final and conclusive (section 70).
3)	Section 60 only permits an additional assessment where either the taxpayer has not previously been assessed or where the taxpayer “has been assessed at less than the proper amount”.
4)	Inasmuch as the taxpayer in this case had been previously assessed, section 60 could not be invoked.
5)	There had been no assessment at less than the proper amount, for that amount was the full amount assessable under the provisions which the assessor chose to invoke in making his original assessments. The statute conferred no power upon the assessor to cancel or withdraw the original assessments, nor any power to issue substitute assessments. Upon the original assessments, the taxpayer stood assessed upon the basis that the royalty receipts were not otherwise chargeable to tax; that is to say, on the footing that the royalty receipts were not in fact profits arising in or derived from Hong Kong.

Analysis

12. I do not agree with this argument.  It seems to me that the effect of section 60 is clear, in that the question to be asked by the Commissioner is whether or not the taxpayer has been assessed for less than the proper amount.  What is that proper amount?  If a person carries on a trade profession or business in Hong Kong, then the proper amount of profits tax chargeable in each year of assessment in respect of assessable profits arising in or derived from Hong Kong for that year from such trade profession or business is the amount chargeable under section 14.  The deeming provision of section 15 of the Ordinance is just that.  It is not conclusive of the place of trade or business in respect of which the trading receipts arise.  When an assessment is made by application of section 15(1)(b) (and section 21A) the amount assessed has been assessed on the footing that the taxpayer, whilst not in fact carrying on a trade or profession or business in Hong Kong, is nonetheless, by reason of a deeming provision, deemed so to be, or to have been, carrying on that trade or business in Hong Kong; and in such circumstances was, under section 21A as it stood at the material time, liable to pay 10% of the sums referred to in section 15(1)(b).  If that transpires to be an incorrect premise, and if the person liable to profits tax has paid less than the proper amount, section 60 is available to the Commissioner.  The second assessment then made is made in respect of the same taxpayer conducting the same business in respect of the same receipts (subject to deduction of expenses, if any), and that new assessment is the amount at which “such a person ought to have been assessed” (section 60).

13. In that section 70 is prayed in aid of this appeal, it does not in fact avail the appellant.  Section 70 provides:

“	Where no valid objection or appeal has been lodged within the time limited by this Part against an assessment as regards the amount of the assessable income or profits or net assessable value assessed thereby, or where an appeal against an assessment has been withdrawn under section 68(1A)(a) or dismissed under subsection (2B) of that section, or where the amount of the assessable income or profits or net assessable value has been agreed to under section 64(3), or where the amount of such assessable income or profits or net assessable value has been determined on objection or appeal, the assessment as made or agreed to or determined on objection or appeal, as the case may be, shall be final and conclusive for all purposes of this Ordinance as regards the amount of such assessable income or profits or net assessable value:
	Provided that nothing in this Part shall prevent an assessor from making an assessment or additional assessment for any year of assessment which does not involve re-opening any matter which has been determined on objection or appeal for the year.”

14. It is said that the proviso to the section does not permit the assessor to withdraw or amend an assessment or make a substituted assessment after the assessment becomes final and conclusive.  This argument is difficult to follow.  The proviso, so it seems to me, clearly applies to the situation under consideration.  There has been no objection or appeal for the tax years in question, wherefore it follows that there has been no determination in relation to any objection or appeal, wherefore it further follows that the assessments made under section 14 cannot involve “reopening any matter which has been determined on objection or appeal for the year[s]”.  

15. There then follow a number of ancillary points, which are points proffered, it seems, to buttress the suggested illogicality of the Commissioner’s reading of the effect of sections 14 and 15.  In raising the further assessments, the assessments were made upon 90% of the royalty receipts, in other words on the balance of the royalty receipts left after the application of section 15.  It is said on behalf of the taxpayer that the assessor had no power to assess at less than the full amount charged to profits tax by section 14 and that that follows from the peremptory terms of the section which provides that “profits tax shall be charged in respect of assessable profits”. (Emphasis added).  Furthermore, our attention is drawn to the fact that section 14 requires tax to be charged for each year of assessment “at the standard rate”; so that there is no provision for a partial assessment which, it is said, was constituted by the assessment in this case on 90% only of the gross royalty receipts. 

16. I fail to see where there has been a breach of the requirement of section 14.  That charging section requires profits tax to be charged in respect of assessable profits which arise in the circumstances there described, and that is what has happened in this case.  Section 15 is not itself a charging provision.  It is an aid to section 14, and the charges raised at both stages with which we have been concerned were raised under section 14.  It is the failure to recognize this fact that seems to me to lie at the heart of the appellant’s difficulty in these appeals.  The combination of sections 14, 15 and 60 can only mean that if an assumption has been made by reason of the provisions of section 15 which result in an original assessment which does not present the proper amount chargeable to tax, activation of the powers under section 60 will necessarily result in a further assessment which gives credit for the amounts that have been assessed chargeable to profits tax by operation of section 15.

17. Finally it is argued that the assessor acted outwith his power by “raising a s. 14 assessment for the first time” whilst not fulfilling the requirement of the Ordinance under section 51 to require the provision of a profits tax return.  For reasons that I have already provided, I do not view the assessment issued by the application of the provisions of section 60 as constituting an “assessment under s. 14 for the first time.”

18. There is nothing in section 60 that requires an invitation for a profits tax return for the making of an additional assessment.  The power to make assessments is constituted by section 59 of the Ordinance:

“	(1)	Every person who is in the opinion of an assessor chargeable with tax under this Ordinance shall be assessed by him as soon as may be after the expiration of the time limited by the notice requiring him to furnish a return under section 51(1)…
		…
	(2)	Where a person has furnished a return in accordance with the provisions of section 51 the assessor may either –
		(a)	accept the return and make an assessment accordingly; or
		(b)	if he does not accept the return, estimate the sum in respect of which such person is chargeable to tax and make an assessment accordingly.”

19. The relationship between section 59 and section 60 was considered by Mills–Owens J in Mok Tsze Fung v The Commissioner of Inland Revenue [1962] HKLR 258.  He said, at page 270, and I respectfully agree, that:

“Section 59 deals with returns or lack thereof, whereas section 60 envisages a case where a return has been made but subsequently it comes to light that it may very well not be reliable.  …  Section 60, when it uses the words ‘ought to have been assessed’ does, no doubt, in a sense operate retrospectively, but it is submitted, in presently enabling terms.  The words ‘according to his judgment’ are inconsistent with the suggestion that a fresh return is to be required under section 51 with a view to re-applying section 59.”

And he added, at page 276, that:

“I see no reason to consider that section 60 may only be implemented by resort to section 59 as the appellants contend.  In my opinion, section 60 stands on its own feet, being aimed at the case, amongst others, where following a first assessment under section 59 (whether on acceptance or rejection of a return) information comes to light justifying the assessor in inferring that the taxpayer has not disclosed the whole of his profits.”

That analysis applies equally, in my judgment, where information comes to light justifying the assessor in inferring that the computation of assessable profits has been made upon the basis of a deeming provision resulting in an assessment that is less than the proper amount because the true factual position, had it been disclosed at the time of the original assessment, would have rendered that deeming provision otiose.

20. Le Pichon JA, in the judgment that follows, addresses a vires point raised by Mr Barlow.  I have had the advantage of reading that judgment in draft and I agree with it. 

21. For these reasons, I would dismiss the appeal.

Hon Le Pichon JA:

22. I agree with the judgment of Stock JA which I have read in draft.  This judgment addresses Mr Barlow’s submission that in the event that this court were to agree with the Commissioner that section 60 was not subordinate to sections 15(1)(b) and 21A, the additional assessments issued by the Commissioner should, nonetheless, be set aside as being ultra vires the assessor’s statutory powers. 

23. Mr Barlow’s argument, in summary, was that Part IV of the Ordinance was a mandatory regime of assessment for the ascertainment of assessable profits represented by the formula: chargeable profits (i.e. receipts) less deductible expenditure = assessable profits.  In order to ascertain the ‘assessable profits’ chargeable to profits tax, it was said that the assessor was required to make the deductions allowed under section 16 from the receipts.  In the present case, the assessor failed to carry out the process mandated by section 16 et seq. for ascertaining assessable profits by not making any deductions, thereby rendering the assessments ultra vires.

24. Mr Barlow placed considerable reliance on the decision of the Privy Council in Commissioner of Inland Revenue v Mutual Investment Co. Ltd [1967] 1 AC 587 for the proposition advanced.  But it is to be noted that the Mutual Investment case was not about the meaning of section 60 of the Ordinance.  The issue in that case was the deductibility of certain expenses incurred in the production of dividends in respect of the receipt of which the taxpayer was not liable to pay profits tax under the Ordinance.  It is not authority for the proposition that an additional assessment raised under section 60 in respect of profits tax is ultra vires if the assessment is made by reference to total receipts without first making deductions in respect of expenses incurred in the production of that income.  Nor is it authority for the proposition that any assessment raised under section 14(1) on total receipts is necessarily ultra vires.  For my part, I do not find that case to be of assistance in construing section 60. 

25. Mr Barlow also prayed in aid the Privy Council decision in de Maroussem and others v Commissioner of Income Tax [2004] 1 WLR 2865 as confirming the ‘approach’ adopted in the Mutual Investment case.  Since I do not accept the premise for his citation of the Mutual Investment case, the de Maroussem case does not advance matters further.  In that case, the taxpayer who was the leaseholder of land had entered into an arrangement with a developer who carried out works on the land to enable it to be sold off in plots.  The consideration received for each plot was divided between the taxpayer and the developer.  The assessments were made on the basis that the totality of the receipts by the taxpayer represented taxable income in the hands of the taxpayer when it was clear that the land had a substantial value prior to the implementation of the arrangement with the developer.  That, the Privy Council held, was wrong in law.  Whilst the statute required the Commissioner to make an assessment “according to the best of his judgment”, the assessments fell to be set aside because not only had the Commissioner misdirected himself in law, such misdirection had a material effect on the quantum.  Again, I derive little assistance from that case which involves facts far removed from the present.  It does not support the proposition advanced by Mr Barlow and has nothing to do with the construction of section 60.

26. Turning to section 60 itself, it confers power on an assessor to raise, inter alia, additional assessments within a specified period “where it appears to an assessor” that for any year of assessment the person chargeable with tax “has been assessed at less than the proper amount”.  The assessor is empowered to assess such person at the additional amount at which “according to his judgment” such person ought to have been assessed.  It is to be noted that section 60 makes no specific reference to profits tax, to any of the provisions contained in Part IV of the Ordinance or to section 59 which precedes it.  Subsection (1) of section 59 enables the assessor to make an assessment as soon as the time limited by the notice requiring the taxpayer to furnish a return under section 51(1) expires.  Subsection (2) deals with the situation where a return is furnished by the taxpayer and subsection (3) when he does not.  Where subsection (3) applies, if the assessor is of opinion that such a person is chargeable to tax, he may estimate the sum chargeable to tax and make an assessment accordingly.

27. In Mok Tsze Fung v The Commissioner of Inland Revenue [1962] HKLR 258, Mills-Owens J considered the relationship between sections 59 and 60.  At page 276 he stated:

“I see no reason to consider that section 60 may only be implemented by resort to section 59 as the appellant contends.  In my opinion, section 60 stands on its own feet, being aimed at the case, amongst others, where following a first assessment under section 59 (whether on acceptance or rejection of a return) information comes to light justifying the assessor in inferring that the taxpayer has not disclosed the whole of his profits.”  (emphasis added)

I respectfully agree.  It should also be noted that section 60 is not limited to cases where there had been a first assessment under section 59.  That is made clear by the use of the phrase “amongst others” in the passage cited.

28. Mills-Owens J also considered the meaning of the words “according to his judgment”, in conjunction with the opening words of section 60, namely, “where it appears to an assessor”.  At page 279 he made these observations:

“There is no requirement that the assessor shall first form a judgment and then translate it into an additional assessment.  The formation of his judgment is an integral part of the making of his additional assessment.  Nor is there any implication that the “judgment” will be one based upon precise, demonstrable facts.  The inference is to the contrary by reason of the very use of the words “according to his judgment” and the words “Where it appears to an assessor”, and, as I have previously indicated, by reason of the necessities of the case.  If the assessor may estimate under section 59 why not under section 60 when faced with the same situation, that is to say circumstances giving rise to doubt whether the taxpayer has made full disclosure?  One cannot escape the fact that the words “according to his judgment” are time-honoured words in income tax legislation.  …  The policy of the law is to force the taxpayer’s hand.  So long as the assessor, or Commissioner, does not act capriciously or dishonestly, his assessment, being made according to his judgment, cannot be disturbed except upon the taxpayer bearing and discharging the onus of proof.”

29. In the present case, the assessor and the Commissioner considered that the taxpayer was chargeable to profits tax under section 14 of the Ordinance.  The assessments raised represented the difference between the total receipts for the years in question and the amounts charged to tax under sections 15 and 21A for those years.  The objection based simply on the failure to comply with the mandatory procedure contained in Part IV cannot, it seems to me, of itself and without more invalidate the raising of the additional assessments.  The assessor or the Commissioner clearly had the power to raise such additional assessments. 

30. For the additional assessments to be set aside, the taxpayer bears the burden of showing that the assessor or Commissioner had acted “capriciously or dishonestly”.  The failure to make deductions allowed under section 16 could hardly be characterised as capricious or dishonest conduct in a case where no tax returns had been filed by the taxpayer furnishing the assessor with information concerning the deductions claimed.  Nor was the taxpayer disadvantaged in any way: it was open to him to object to the assessments on the basis that he is entitled to certain deductions.  The Commissioner would then be in a position to form a view as to whether the claimed deductions should be allowed.  If the Commissioner were to disallow all or any part of the deductions, any grievance could be addressed on appeal.  But to require the assessor or the Commissioner to speculate on the amount of the deductions when the taxpayer has not furnished him with the information would not be a profitable exercise.  If Mr Barlow’s argument is correct, on what material is the assessor or Commissioner to base any decision as to possible deductions?  And what if he had no material before him to form a view?  It would be absurd to suggest that so long as some deduction was made he would be acting within his statutory powers.  For these reasons, I am not persuaded that there is any substance in the ultra vires point.

Hon Yuen JA:

31. I have had the benefit of reading in draft form the judgments of Stock JA and Le Pichon JA, and I respectfully agree with them.

Hon Stock JA:

32. Accordingly, this appeal is dismissed.  There will be a costs order nisi that the costs of this appeal be to the respondent.