BANQUE NATIONAL DE PARIS HONG KONG BRANCH v. COMMISSIONER OF INLAND REVENUE

Revenue law - profits tax - foreign bank doing business in Hong Kong through unincorporated branches - profits falling to be computed on the basis of accounts of the business in Hong Kong prepared by the bank for its own purposes (r.3(2) of Inland Revenue Rules) - the chargeable profits should nevertheless be assessed in accordance with Part IV of the Inland Revenue Ordinance - annual profits of the Hong Kong branches not paid to the Head Office but "lent'' to the Hong Kong branches at "interest" - the person chargeable was the bank, which could not lend to itself - therefore such "interest" was in truth an appropriation of profits and was not deductible as an outgoing or expense incurred by the bank in the production of profits in Hong Kong.

BETWEEN

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JUDGMENT

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Sir Alan Huggins, V.-P.:

1. Banque Nationale de Paris ("the Bank") is a bank whose head office is in Paris.   It has several branches in Hong Kong, and a group account is prepared in respect of the business conducted by those branches. In the years 1977/78 and 1978/79 this business showed a profit, but that profit was not transmitted to Paris: instead, it was retained in Hong Kong and used by the business in Hong Kong in the production of profits for the following years. In the accounts for each of the following years there appears an entry crediting the head office with "interest" on the amount of the retained profits. The Bank thus treated the retained profits as though they were a loan to the Hong Kong branches from the head office and claimed to be entitled to deduct the "interest" from the gross profits of the business in Hong Kong in assessing the profits subject to Hong Kong profits tax. The question before us is whether this was a proper deduction.

2. The matter comes before us on appeal from the decision of Liu, J. upon a Case Stated by the Board of Review. The Commissioner of Inland Revenue, the Board and the judge were all of opinion that the deduction claimed should not be allowed. The basis of that opinion was that, as the Hong Kong branches were not a juridical person separate from the Bank, there could be no loan of the retained profits from their head office to the branches and, therefore, no "interest". If that was the correct view, any payment nominally as interest would in truth bean appropriation of profits, although not shown as such. (The Case Stated does not make it clear whether any money was in fact paid or the "transfer" was nothing more than a book entry.)

3. It is necessary to consider the whole scheme of Part IV of the Inland Revenue Ordinance, which relates to Profits Tax. Section 14 is the charging section. The material words are:

"Subject to the provisions of this Ordinance, profits tax shall be charged .... 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 .... from such trade, profession or business ......".

There is no complete definition of "profits arising in or derived from the Colony", but by s.2(1) they include "all profits from business transacted in the Colony, whether directly or through an agent". They therefore cover what would ordinarily be understood to be the profits of a business - subject to the provisions of the Ordinance. Section 16 then specifies outgoings and expenses which are to be deducted in order to arrive at the chargeable profits, and s.17 expressly excludes others. It is implicit that any deduction is to be made from the income in Hong Kong. The material parts of s.16 are:

I think it is common ground that condition (a) of sub-s.(2) was satisfied, namely that the money was borrowed by a financial institution.

4. Those provisions would present little difficulty in this case were it not that rules have been made under s.85.  By r.3 of the Inland Revenue Rules the "Method of ascertainment and determination of the profits of the Hong Kong branch of a bank whose head office is elsewhere than in the Colony" is prescribed. The rule reads:

It is not in dispute that the Bank is a bank to which the rule applies: nor is it in dispute that para.(2) of the rule applies: the Bank prepared accounts of its Hong Kong business for its own use, and clearly the Assessor was of opinion that those accounts disclosed  the true profits of that business, for he proceeded to compute the assessable profits on the basis of such accounts.

5. Counsel for the Bank advances two main arguments, and perhaps it is more logical to deal first with the second of those arguments, viz. that s.16 has no application to a case where the method of computation is that prescribed by r.3(2). He submits that "all debit items in branch accounts are deductible for tax purposes, unless expressly disallowed under Section 17 of the Ordinance". The whole argument is based upon the assertion that the accounts must be taken to have disclosed "the true profits of the [Hong Kong] branch".  From that it is said that they must disclose "the true receipts and expenses" for the purpose of arriving at the chargeable profits, save in so far as s.17 expressly excludes any expense otherwise deductible - and "[the] interest payable to head office cannot be disallowed under Section 17 because, on the facts found by the Board of Review, the borrowed moneys were expended for the purpose of producing profits chargeable to Hong Kong tax". The answer seems to me to be that accounts may "disclose" true profits without correctly stating them. It is the Ordinance which lays down what is to be charged, and r.3 is concerned only with the method by which the chargeable profit is to be discovered. The rules could not alter the statute, even though they received the express approval of the Legislative Council. Thus, whatever method of ascertainment or determination is employed the profits which are to be ascertained and determined remain those which are chargeable under the Ordinance. Paragraphs (3) and (4) predicate circumstances which make the "ascertainment" of the true profits impossible and therefore prescribe methods for the "determination" of the profits by estimation. What is to be estimated is none the less the chargeable profit computed in accordance with the provisions of Fart IV of the Ordinance.

6. On the assumption that s.16 does apply the issue arises whether the outgoing and expense claimed as a deduction was "incurred by such person", i.e. by a person chargeable. Even sums "payable by way of interest" under para.(a) must, if they are to be allowed, be outgoings and expenses "incurred" within the meaning of the opening words of the sub-section.  The Commissioner argues that the person chargeable was the Bank and that the "interest" paid or credited to the head office could not be incurred by the Bank, because that would involve the Bank in incurring a liability to itself, which is impossible. It matters not whether the payment was in fact made, since it is accepted that an expense may be incurred where a legal liability to pay has arisen: Commissioner of Inland Revenue v Lo & Lo Privy Council Appeal 1982 No.82.

7. The Bank contends in effect that "such person" in s.16 must, in the light of r.3, be construed as referring to the Bank in right of his business in Hong Kong as distinct from the Bank in right of its business in its country of incorporation. The substance of the argument is the suggested injustice and unreasonableness of a situation where profits made in Hong Kong by an unincorporated branch of a foreign bank are more heavily taxed than profits in the same amount made in Hong Kong by a wholly owned subsidiary of a foreign bank. Counsel submits that there is precedent for treating a branch bank as an independent body for some purposes and, indeed, that the scheme of taxation itself requires the Bank's business in Hong Kong to be regarded separately from its business elsewhere. In this connection he relies upon the reference in r.3(a) to "the assets of the Hong Kong branch", a phrase which makes nonsense if strictly construed, even when one takes account of the definition of the Hong Kong branch for the purposes of this rule.

8. Here again I see grave danger in using the rules as an aid to the construction of the Ordinance. The fact that the drafting of the rules may leave something to be desired and requires us to give an unusually liberal construction to the language used cannot justify our approaching the construction of the Ordinance in an equally liberal spirit: and I do not overlook s.19 of the Interpretation and General Clauses Ordinance. The cases cited to us as authority for our supplying words to "bridge the gap" between r.3(2) and s.16 therefore have no application.

9. However, the broad submission based upon general considerations of justice and reasonableness still remains. I recognize that (to use the words of Liu, J.)

"branch banks may be looked upon quite independently for specific purposes, such as in the legal situs of the deposit (See the Henry Prince case), the primary localized obligation to pay cheques at a particular branch where the account is kept (See Woodland v Fear and Richardson v Richardson) and the computation of time for a notice of dishonour (See Clode v Bayley).''

To those cases may be added F.D.C. Co. Ltd. v Chase Manhatten Bank,N.A. Civ. App. 1984 Nos.65 and 131, in which this court recently enjoined the defendant from passing details of the account of a customer of its Hong Kong Branch from that branch to its head office in New York for the sole purpose of putting those details within the jurisdiction of the Internal Revenue Service of the United States of America. Nevertheless, there is no general rule that an unincorporated branch may be looked upon as a separate legal entity where an artificial result would otherwise follow. Counsel suggested that different considerations should apply to profits made by banks from those which apply where the tax-payer is engaged in some other form of commerce: the basic distinction between the two classes of tax-payer is highlighted by the very existence of r.3: the distinction between their businesses is that the former class trades in money. Thus the Commissioner had always allowed "deductions for interest paid in relation to inter-branch transactions". I take it that that means not only transactions between branches within Hong Kong (in relation to which interest earned by one branch would be set off by interest "incurred" by the other branch and would not affect the overall profit of the business in Hong Kong) but also transactions between a branch within Hong Kong and a branch outside Hong Kong. Even on that assumption the interest "incurred" would bean expense resulting from normal day to day banking business and not from the retention of profits at the end of a year's  trading. The retention of profits can be regarded as a capital advance by the head office. However, I appreciate that no point has been taken that the ''interest" is non-deductible because it is interest on capital: rather is it said that it is non-deductible because it has not been "incurred" and does not come within the questionable exception of expenses of normal day to day trading. Such an advance received from another bank would incur interest, and hence it is argued that the retention of profits should be regarded no differently. There may be a measure of illogicality in allowing the deduction of interest on a normal day to day transaction between the branch in Hong Kong and the Paris office and not of interest on group profits retained in Hong Kong, but we are not called upon to consider whether the Commissioner is right to allow the deduction of the former in recognition of "economic realities", and I am not persuaded that we ought to depart from the plain meaning of s.16 in relation to the "interest" on the retained profits. What counsel advances as injustice land unreasonableness is nothing more than a natural consequence of the legal concept enshrined in Salomon v A. Salomon & Co. Ltd.1897 A.C.22, that a corporation has a distinct existence from its shareholders. Whether, as he suggested, the bank here "would have been better off if it had not produced true accounts" is a matter of conjecture. The existence of accounts showing the true profits of the Hong Kong branch merely affected the method of ascertainment or determination of the profits and not the amount of those profits. The Ordinance itself recognizes no distinction between profits made by a bank and profits made by any other business.

10. For these reasons I think that Liu, J. came to the right decision and I would dismiss this appeal.

Cons, J.A.:

11. I agree with the judgment of my Lord.

12. The Appellant's main argument, as it is put, "involves supplying words to 'bridge the gap' between Rule 3(2) and Section 16 of the Ordinance". Such a course was taken by the English Court of Appeal in S.J. Grange Ltd. v. Customs & Excise Commissioners (1979) 1 W.L.R.239, a case which concerned the assessment for value added tax. Lord Denning said at p.242E -

"The judge accepted that argument. I can see the force of it. It is literally correct. But it leads to such impracticable results that it is necessary to do a little adjustment so as to make the section workable. This ban be done by reading in a few words, such as Bridge L.J. suggested in the course of the argument."

13. However I cannot see how it can be said that the legislation, as it stands, is unworkable. The accounts actually presented by the Appellant to the Commissioner can be amended to comply by a simple stroke of the pen. If that is done, they will then no longer comply with normal commercial accounting practice, and it is suggested that that situation would be wholly unreasonable, an additional criterion adopted by Bridge L.J. in the same case and mentioned also by Lord Reid much earlier in the Commissioners of Inland Revenue v. Luke (1963) 40 T.C.630 at 646 and 648. But I am not persuaded that mere divergence from normal accounting practice, even though the Commissioner is willing to accept that practice in relation to other aspects of branch accounting, reaches the height of unreason that their Lordships had in mind.

14. As to the Appellant's alternative argument, I do not read Rule 3(2) as obliging the Commissioner to accept the accounts prepared by the bank just as they stand. If he is satisfied that the accounts are accurate, and thereby "disclose the true profits" he may make use of the figures they contain to compute the assessable profits, but he will do so in the normal way.

Fuad, J.A.:

15. I am fully in agreement with the judgment delivered by my Lord the Vice-President that the Board of Review and Liu, J. came to the right conclusion, and that the answer to the question posed by the stated case must be "Yes". The Vice-President's review of the background and the contentions advanced on behalf of the parties to this appeal makes it possible to make my own observations quite short.

16. I begin with a reference to what Lord Brightman had to say in Commissioner of Inland Revenue v. Lo & Lo [1984] S.T.C.366 when delivering the opinion of the Privy Council on the scope of sections 16 and 17 of the Inland Revenue Ordinance, at pages 369-370. It is now settled law in Hong Kong that those sections "provide exhaustively for the deductions which are permissible to be made" by a person liable to tax under the Ordinance. In that passage, what Lord Brightman was emphasizing, it seems to me, was that in the ascertainment of chargeable profits even if an amount claimed as a deduction does not fall within one or other of the subparagraphs of subsection (1) of section 16, the amount is nevertheless deductible if it is embraced by the words "outgoings and expenses .... in the production of profits ....", and that in deciding what may properly be regarded as "outgoings and expenses", commercial considerations are not to be ignored.  In my judgment any argument based on the proposition that section 16 of the Ordinance has no application in the case before us is not sustainable.

17. I am disposed to think that it is quite plain that the natural and ordinary meaning of the phrases used in what I will call the general part of subsection (1) of section 16, and in para.  (2) of that subsection, do not assist the Bank. By no fair use of language can it be said that the "interest on retained profits" sought to be deducted:-

The use of the words "by such person" in the general part of section 16(1) and the words "by him" in section 16(1)(a) admit to no other conclusion; and they cannot be ignored. When read with section 14 of the Ordinance, there can be no doubt that the legal entity which is chargeable and assessable is B.N.P.; and the profits and expenses which are to be taken into account are those of B.N.P. The device that was adopted (I do not mean to suggest that anything improper was attempted) provides no escape. Put another way, by allowing some of their profits to be retained by their local branches, and by charging interest upon the sum involved, B.N.P. cannot be said themselves to have incurred expenses or to have become liable to pay interest.

18. I have so far confined my remarks to what I have called the natural and ordinary meaning of the provisions we are called upon to construe.  Mr. Pinson for the Appellants pressed very hard upon us a construction of the relevant sections of the Ordinance, read with r.3(2) of the Inland Revenue Rules, that would allow the deduction sought to be made by B.N.P. He asks us, in the context of the overall scheme of the Ordinance and the governing commercial considerations, to read into r.3(2) of the Rules words that would "bridge the gap" between that rule and section 16 of the Ordinance, to accord with the true intention of the legislature discernible from the scheme of the Ordinance read as a whole, thereby avoiding a wholly unreasonable result.

19. I will not rehearse his careful and elaborate arguments which (if I may say so with respect) have been done full justice in the judgment of the Vice-President just delivered.

20. The way Mr. Pinson formulated the words he urged us to read into the governing statutory provisions (and it was helpful of him to have condescended to a formulation) was that the words "as if a branch were a person chargeable to tax under Part IV of the Ordinance" should be added at the end of rule 2(3) of the Rules.

21. In approaching his submissions, it is essential to consider the words of the enabling provisions under which the Board of Inland Revenue made the Rules (section 85). The rule-making power given by section 85(1) is limited - rules may be made (i) "generally for the carrying out of the provisions of this Ordinance" and (ii) "for the ascertainment and determination of any class of income or profits".

22. We are not concerned with the precise form of words that Mr. Pinson has suggested, but their underlying import. But it seems to me that however boldly we approach the task of interpretation, armed with undoubted power to read words into legislative provisions (on principles well accepted but rather difficult accurately to summarise) we cannot give our blessing to the emendation he has proposed, because to do so would, in my judgment, notionally render r.3(2) of the Rules ultra vires. The Rules cannot override the express words of section 16 of the Ordinance, or any other relevant provisions of the Ordinance.

23. The effect of the construction contended for would be that a branch of a bank would be treated in the same way as a subsidiary company (and, indeed, this is what Mr. Pinson's submissions strive for) but that is not what the statute says; as I have earlier indicated, the legal entity chargeable and assessable is clearly B.N.P. and not its branches - the latter cannot be regarded as independent enterprises engaged in business on their own account in this jurisdiction.

24. In relation to the issues which still divide the parties to this appeal, I am bound to say that I find the relevant legislative provisions precise and unambiguous, and to state my opinion that the meaning sought to be attached to them by the Appellants is one that they cannot reasonably bear.

25. I, too, would therefore dismiss this appeal.

26th April 1985