THE COMMISSIONER OF INLAND REVENUE v. COSMOTRON MANUFACTURING CO LTD

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Headnote

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Revenue Law ---- Deductible expenses under ss. 16(1) and 17(1)(b) of the Inland Revenue Ordinance (Cap. 112). Whether and when severance payments under s.31B of the Employment Ordinance (Cap. 57) are incurred in the production of profits.

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JUDGMENT

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Bokhary JA:

The question

1. Are all severance payments, including those made upon the cessation of the employer's business, to be regarded as having been incurred in the production of profits and therefore deductible for the purpose of ascertaining taxable profits? That is the question of law which arises in this revenue appeal. The statutory context and factual circumstances in which it arises are as follows.

Statutory context

2. Section 16(1) of the Inland Revenue Ordinance, Cap. 112, provides that

"In ascertaining the profits in respect of which a person is chargeable to tax under this Part for any year of assessment there shall be deducted all outgoings and expenses to the extent to which they are incurred during the basis period for that year of assessment by such person in the production of profits in respect of which he is chargeable to tax under this Part for any period ..."

3. That is coupled with section 17(1)(b) of the same Ordinance which provides that

"For the purpose of ascertaining profits in respect of which a person is chargeable to tax under this Part no deduction shall be allowed in respect of ... any disbursements or expenses not being money expended for the purpose of producing such profits."

4. It will be noted from the terms of section 16(1) that provided that the outgoing or expense was incurred during the basis period of the year of assessment concerned, it matters not whether the profits in the production of which the outgoing or expense was incurred were for that basis period or some other basis period.

5. Turning to the Employment Ordinance, Cap. 57, one finds it providing by section 31B thereof that an employer is bound to make a severance payment to any employee who has been employed under a continuous contract for a period of not less than 24 months and is dismissed by reason of redundancy or is laid off.

6. Subsection (2) of the same section provides that an employee who is dismissed shall be taken to dismissed by reason of redundancy if the dismissal is attributable wholly or mainly to the fact that:

7. As to when an employee is to be taken to be laid off, one turns to section 31E(1) which provides that:

"Where an employee is employed under a contract on such terms and conditions that his remuneration thereunder depends on his being provided by the employer with work of the kind he is employed to do, he shall for the purposes of section 31B(1) be taken to be laid off where the total number of days on each of which such work is not provided for him by the employer exceeds---

and he is not paid a sum equivalent to the wages which he would have earned if work had been provided on the days on which no work was provided."

8. The amount of severance payment is dealt with in section 31G, subsection (1) of which provides that

"Subject to this Part, the amount of a severance payment to which an employee is entitled in any case shall be calculated by allowing---

for every year (and pro rata as respects an incomplete year) of employment under a continuous contract by his employer subject in all cases to a maximum payment not exceeding, where the relevant date occurs in a period specified in column I of Table A in the Seventh Schedule, the amount specified in column 2 of that table opposite to the period."

9. So much for the statutory context. As for the factual circumstances, they are these.

Factual circumstances

10. The Taxpayer is a company which had carried on business as a manufacturer of metal products. As such, it had operated a factory.

11. It had commenced business in 1968. And it remained in business for about 20 years.

12. Then, during the basis period for the year of assessment 1990/91, it ceased business, closed its factory, dismissed for redundancy its workforce of some 123 persons most of whom had been employed by it for more than 10 years, and made severance payments to them as required by law.

13. In its 1990/91 profits tax return, the Taxpayer declared a loss of $1,908,708.

14. It had, in computing that loss, deducted from its gross profits severance payments totalling $2,937,981 which it had made during the 1990/91 basis period.

15. The Assessor took the view, however, that severance payments made upon cessation are not to be regarded as having been incurred in the production of profits. Accordingly, he wholly disallowed the deduction of $2,937,981, assessed the Taxpayer's chargeable profits at $1,121,673 and assessed it to profits tax at $185,076.

16. When the matter came to him upon the Taxpayer's objection, the Commissioner upheld the Assessor's view that severance payments made upon cessation are not to be regarded as having been incurred in the production of profits.

17. But he considered some of the amounts making up the total of $2,937,981 to have been paid other than by way of severance payment. And he considered those amounts deductible. So he reduced the chargeable profits to $957,055 and the tax thereon to $164,618.

18. The Taxpayer appealed to the Board of Review against the Commissioner's determination.

19. Taking the view that all severance payments are to be regarded as having been incurred in the production of profits, the Board of Review allowed the Taxpayer's appeal and remitted the assessment to the Commissioner for him to deduct the severance payments in the present case.

20. The Commissioner then appealed to the High Court against the Board of Review's decision.

21. That appeal was heard by Mr Justice Findlay on November 16 last year and dismissed by him on the 21st of that month: he agreeing with the Board of Review that all severance payments are to be regarded as having been incurred in the production of profits.

22. Still disputing that view of the law, the Commissioner now appeals to this Court against Findlay J's decision.

The answer

23. That is how the question stated at the beginning of this judgment comes to us. And it is now for us to answer it.

24. Miss Shine for the Commissioner, to whom I am indebted for her assistance throughout this appeal in which the Taxpayer is not legally represented, rightly point out that the question is not covered by any authority directly on point. Section 16(1) of the Inland Revenue Ordinance has received the attention of the Privy Council. That was in the case of CIR v. Lo & Lo (1984)2 HKTC 34. However, their Lordships were careful (at p.72) to avoid laying down an exhaustive definition of the term "an expense incurred", saying that it "is not confined to a disbursement, and must at least include a sum which there is an obligation to pay, that is to say accrued liability which is undischarged." (emphasis added.)

25. So the question calls for, among other things, a careful consideration of the realities of the situation.

26. Now, in order to do business it is generally necessary to employ a workforce. When a company in business employs a workforce it is axiomatic that it does so in the production of profits. And once it employs a workforce it automatically incurs by operation of law a contingent liability to make severance payments.

27. That at once distinguishes the present circumstances from those which obtained before Rowlatt J in CIR v. The Anglo Brewing Co. Ltd 12 TC 803 where the payments were ex gratia and no liability of any kind ever arose.

28. Coming back to the liability in the present case, this is to be noted. By automatic operation of employment law and without the occurrence of any legal wrong, the liability to make severance payments arises in a contingent form before cessation and then crystallises upon cessation in specific sums.

29. That makes it very different from the possible liability concerned in Godden v. A. Wilson's Stores (Holdings) Ltd 40 TC 161 and Overseas Textiles Ltd v. CIR (1987)3 HKTC 29 cited by the Commissioner. The possible liability in those cases could not have existed in any shape or form whether contingent or otherwise before cessation. And upon cessation, assuming it arose then, it would have arisen as a liability to pay damages for a legal wrong, namely breach of contract.

30. Hence, Upjohn LJ (as he then was) said (at p.173) that the payment in Godden v. A Wilson's Stores (Holdings) Ltd (supra) "was not made for the purposes of the trade they were going to carry on; it was to get rid of a possible law suit after discontinuance." And in Overseas Textiles Ltd v. CIR (supra) Nazareth J (as my Lord then was) said (at p.52) much the same thing about the payment with which he was concerned.

31. A contingent liability is still a liability. And the liability to make severance payments to employees in specific sums is incurred by engaging those employees and continuing to employ them up to the time when they become redundant.

32. It is axiomatic that engaging those employees and continuing to employ them up to the time when they become redundant would have been done in the production of profits. Accordingly, the liability incurred by doing that would, by the same token, have been incurred in the production of profits.

33. In my judgment, the answer to the question posed at the beginning of this judgment is in the affirmative. All severance payments, including those made upon the cessation of the employer's business, are to be regarded as having been incurred in the production of profits and therefore deductible for the purposes of ascertaining taxable profits.

Result

34. Accordingly, I would dismiss this appeal.

Liu JA:

35. The facts are comprehensively set out in the judgment of Bokhary, J.A.. The question of law for our consideration is:

"Whether, as a matter of law, and on the facts found by it, the Board was correct in concluding that severance payments made according to the Laws of Hong Kong on the termination of business of the taxpayer should be allowed as deductions for profits tax purposes."

36. The provisions of the Inland Revenue Ordinance pertinent to the question of law posed for our opinion are sections 16(1) and 17(1)(b). Section 16(1) provides:

"In ascertaining the profits in respect of which a person is chargeable to tax under this Part for any year of assessment there shall be deducted all out-goings and expenses to the extent to which they are incurred during the basis period for that year of assessment by such person in the production of profits in respect of which he is chargeable to tax under this Part for any period ......"

37. Section 17(1)(b) reads:

"For the purpose of ascertaining profits in respect of which a person is chargeable to tax under this Part no deduction shall be allowed in respect of-

............"

38. The respondent taxpayer was statutorily obliged to make severance payments under section 31B of the Employment Ordinance when its business drew to a close. S. 31B(2)(b) enjoined the respondent so to pay its employees when it did or intended to cease operation. These payments were not made in the course of the respondent's trading activities but in the lawful discharge of its employees at the time of severance, when the respondent was putting an end to its business. The employees had no vested right to these severance payments before the respondent had "ceased, or (intended) to cease, to carry on the business". They would not be entitled to such statutory benefit until close of business or until a decision had been taken to close it. On the assumption that no business would go on in perpetuity, the respondent had to budget for these sums in its initial plan to do business for profits, but these expenses were not to be incurred during the commercial life of the respondent. These severance payments were clearly part of the respondent's financial commitments in the business venture it had chosen to undertake, but were they expenses incurred by it in the production of profits within the meaning of section 16(1)?

39. To qualify as a claimant for deductions from profits chargeable to tax, the respondent must be able to show that these severance payments were "incurred" by it "in the production of profits". These payments were made for the purpose or "paramount purpose" of lawfully discharging employees in the closing down, not of enabling the respondent to trade with the view to making profits. They formed part of the closing down cost, not running cost. When the respondent taxpayer brought its business to an end, trading ceased, and it is sheer logic that unless the respondent had carried on or intended to carry on in the trade, it could not have expected to earn further profits. After cessation of trading, save for the steps taken to close its business down the respondent would no longer involve itself in any or any revenue-generating activities with the view to, hopefully, bringing in profits liable to tax assessment for its last or any "basis period" within the last or any "year of assessment" as prescribed by the Inland Revenue Ordinance.

40. In Strong & Company of Romsey, Limited v. Woodifield, (1905) 5 TC 215 at p.220, Lord Davey said of personal injury damages in these terms:

"I think that the payment of these damages was not money expended 'for the purpose of the trade'. These words are used in other rules, and appear to me to mean for the purpose of enabling a person to carry on and earn profits in the trade, etc."

41. In CIR v. The Anglo Brewing Co. Ltd., (1929) 12 TC 803, at p. 813 Rowlatt, J held that ex gratia pensions and compensation payments were not "made for the purpose of trade, because (they were not made) for the purpose of keeping the trade going, and of making it pay. There was not any such purpose at all. The purpose was to wind it up." At the time of the making of these payments, Anglo Brewing was to bring its trading to a close and soon it went into liquidation.

42. In Godden (HM Inspector of Taxes) v. A Wilson's Stores (Holdings), Ltd., (1962) 40 TC 161, as regards the payment made to a manager in lieu of notice when the company's trading was to be discontinued, Upjohn, L.J. observed at p. 174:

"To my way of thinking, that payment cannot possibly be described as a payment for the purposes of trade. It was made because the Company was not going on to trade, and they were left with the possibility of an action for damages against them for breach of the agreement of employment. I accept Mr Borneman's submission that, though it was made on the occasion of discontinuance, it was not because of that, and it was not to enable them to discontinue business: they were going to do that anyway. But this payment was not made for the purposes of the trade they were going to carry on: it was to get rid of a possible law suit after discontinuance."

43. Our profits tax regime focuses on the words "in the production of profits", the ambit of which is much narrower than that of "for the purpose of trade" in the English Act under consideration in the cases I have referred to: Closure of business would not produce profits, and a payment required by law to be made upon the cessation of trading activities cannot sensibly be regarded as an expense necessary for the production of profits. Profits tax liability revolves about trading or, more accurately, the opportunity for making profits in trading. Inability to trade would generate no profits and without profits, no exactable tax. It is inconceivable that a payment made after the demise of a company can be properly claimed to be an expense incurred in its active production of profits. Moreover, unless liability to make these payments had accrued for calculating prior profits, how would an assessor have been able to consider claimed deductions without profits, or possibly without basis period or year of assessment?

44. Severance payments made statutorily payable upon the termination of an employer's business was held to be a non-deductable expense by the Board of Review in Case No. BR 13/70 (26 July 1970) and Case No. D 36/87 (1 October 1987). Compensation payments made for the purpose of terminating a business were once considered by the Vice-President in Overseas Textile Ltd. v. IRC in (1987)3 HKTC 29, then sitting as a Judge of the High Court. At p. 52, he then concluded:

"Far from being made for the purpose of carrying on the trade, such a payment is (sic) on the contrary is made for the purpose of ending it."

45. In this case, the severance payments given to the workers by the respondent in the discharge of its statutory obligation were made to end employer/employee relationship at the close of its business. They were paid on the occasion of closure although they were not paid for closing down the business. The respondent's business would in any case wind up with or without these payments. In the winding up, these payments would also have to be made whether or not there had been previous trading. These severance payments formed part of the respondent's overall financial commitments upon embarking on its business, but they were not "outgoings and expenses ..... incurred ...... in the production of profits (or) expenses ..... expended for the purpose of producing such profits" at a time when the winding-up activities could not possibly produce profits. The event that triggered the payment of these statutory amounts, coupled with the nature of these sums payable on severance, not in trading, would seem to fall outside any tax period for ascertaining profits envisaged by s.16(1).

46. There was no obligation to meet this statutory requirement until the closure of the respondent's business. A right which, but for cessation of business, would not have sprung from the employer/employee relationship, could not have enured to the benefit of an employee during the preceding trading period where a right had yet to arise. In other words, there existed no right which could have become accrued in the prior trading period. In the respondent company, an interim reserve fund was established for satisfying this anticipated future commitment, but the setting up of this fund could not create a right out of such a future statutory obligation. The setting up of this reserve fund would provide no basis for a non-existent liability to be taken into account, let alone to accrue. Contrast CIR v. Lo & Lo (1984) 2 HKTR 34 at p.72. In his speech in CIR v. Lo & Lo, supra, at p.72 Lord Brightman was simply considering "expense incurred" and "accrued liability which is undischarged" in terms of expenses and liabilities in the context of profits assessable under the Inland Revenue Ordinance. As I have endeavoured to illustrate, a personal financial commitment in a business venture, which is to be exacted from a businessman some day when all his business grinds to a halt is not an expenditure incurred in the production of taxable profits. Whether or not these severance payments might have become accrued or contingent liabilities within the Employment Ordinance, in no way could they be taken as accrued or contingent liabilities under the Inland Revenue Ordinance. In this case, the impact of the Inland Revenue Ordinance upon allowable deductions is to be felt in their link to profit-earning. The respondent ceased trading and there was to be no more profit-making activity. The fiscal authority could not even begin to speak of any chargeable profits, only in the production of which deductible expenses may be claimed to have been incurred. S. 31B of the Employment Ordinance required the respondent as an out-going employer to effect severance payments after closure of business when no further trading profits were expected, and the payments could not relate back to the prior trading period as accrued liability. S. 31B would seem to be unconcerned with the provisions of the Inland Revenue Ordinance whereby trading profits are sought to be taxed. The question that lies at the heart of this appeal is whether the sums representing these severance payments were sufficiently referable to the production of profits in the context of our revenue law. In my view, they were not. In conclusion, these severance payments were not expenses incurred in the production of profits as envisaged by S. 16(1) of the Inland Revenue Ordinance. The answer to the question of law stated for our opinion should be answered in the negative.

Nazareth V-P:

The background

47. The appellant appeals against the judgment of Findlay J handed down on 21 November 1995. By that judgment the judge upheld the decision of the Board of Review against which the Commissioner had appealed to the High Court. The underlying facts are as follows.

48. The respondent operated a factory in Hong Kong where it employed a work force of some 123 people. A majority of the workers had been with the respondent for more then 10 years. In 1988, the respondent became aware that the owner of the building in which it had its factory intended to demolish it. In the financial year 1987/1988, the respondent established a long service payment reserve fund reserve of $1,500,000. This was included in the audited accounts of the respondent for the year ended 31 March 1988. Notice to quit was given to October 1989. By early 1990, the respondent's employees became aware of the fact the building would be demolished and the factory closed. The respondent operated its business until 9 March 1991. Until this time, the long service employees of the respondent stayed with the respondent, and became redundant when the factory closed. Employees who were recruited during the final year of operation, almost without exception, resigned shortly after starting work. During the financial year 1990/1991, the respondent operated its business profitably. When the respondent closed its business, it gave notice to all its employees and made severance payments to them as required by law; a total sum of $2,937,981. The respondent sought to treat this sum as a deduction in its profits tax return. The assessor disallowed this. The Commissioner upheld the assessor's decision in part. The respondent appealed to The Board of Review, which allowed the appeal. It was from that decision that the Commissioner appealed to the High Court by way of case stated.

The question

49. The question of law is stated thus ----

"Whether, as a matter of law and on the facts found by it, the Board was correct in concluding that severance payments made according to the Laws of Hong Kong on the termination of the business of the Taxpayer should be allowed as deductions for profits tax purposes."

The statutory provisions

50. The relevant provisions of the Inland Revenue Ordinance, Cap 112 are ss 16(1) and 17(1)(b).

51. Section 16(1) provides:

"In ascertaining the profits in respect of which a person is chargeable to tax under this Part for any year of assessment there shall be deducted all outgoings and expenses to the extent to which they are incurred during the basis period for that year of assessment by such person in the production of profits in respect of which he is chargeable to tax under this Part for any period ..."

52. Section 17(1)(b) says:

"For the purpose of ascertaining profits in respect of which a person is chargeable to tax under this Part no deduction shall be allowed in respect of ----

53. Under section 31B of the Employment Ordinance, Cap 57, an employer is bound to pay a severance payment to an employee who has been employed under a continuous contract for a period of not less than 24 months and is dismissed by reason of redundancy.

The Board's decision

54. The Board allowed the appeal because it decided that the severance payments should be deductible as expenses. It came to the conclusion that the paramount purpose for incurring the expense of the severance payments was the production of assessable profit.

55. It was against that decision that the appellant appealed to the High Court.

The purpose of the payments

56. The Commissioner's first ground of appeal is framed in the following way: that the learned judge erred in fact and in law in concluding that the liability of the respondent to pay severance payments to its employees was for the paramount purpose of producing profits, and thereby erred in concluding that such payments were deductible "expenses incurred during the basis period in the production of profits" pursuant to s.16(1) of the Inland Revenue Ordinance, Cap. 112.

57. The Board's findings of fact relevant to this ground included the following matters. During the financial year 1990/91, the respondent was able to continue its business profitably. Production at the factory ceased on 9th March 1991. With a few exceptions, all of the employees of the taxpayer were made redundant in the months of December 1990, January and February 1991. The Board went on to observe that the law relating to severance payments and termination and redundancy benefits is well known in Hong Kong. Workers in Hong Kong are well aware of their rights and the Board found as a fact that they would have known of their rights and that they were entitled to severance pay provided that they continued to work for the respondent until such time as they received termination notices. It found as a very clear fact that the knowledge of the impending closure of the factory and of their rights to redundancy payments on the closure of the factory was a very real incentive for the employees to continue to work until the factory was closed. Having set out the provisions of ss.16(1) and 17(1)(b) the Board concluded:

58. The judge took a similar view of the respondent's broad purpose. He said this:

"In order to qualify as deductible expenses, the liability to pay the severance payments must have been incurred in the production of profits for any period. I stress that one must look, not simply at the payment, but also at the underlying liability to pay. This, I think, is clear because it may be that a businessman, who is in the process of closing up his business, incurs all manner of expenses, such as for rent, wages and electricity, which are undoubtedly incurred for the purpose of the production of profits, but he does not actually pay these until after he has closed down. It cannot possibly be said that he has made the payments for the purpose of producing profits --- he knows he will make no more profits in that business --- but he incurred the obligation to pay for that purpose, and that it is deciding factor."

59. It can be seen that unlike the Board which addressed the purpose of the expenses that were incurred, the judge addressed the purpose of the obligation mentioned. The reason he chose to do so is apparent from the succeeding paragraph of his judgment which refers to the dictum of the Privy Council in the Commissioner of Inland Revenue v Lo & Lo (1984) HKTC Vol. 234 that for the purposes of s.16, deductions are not confined to sums actually paid by the taxpayer but "an expense incurred" includes a sum which there is an obligation to pay; that is to say an accrued liability which is undischarged. Having made his reference to the dictum in Lo & Lo, no doubt to explain his reliance upon "obligation" the judge continued with his consideration of the purpose of the obligation incurred:

60. In his conclusion, following his rejection of the authorities cited by Miss Shine as being of assistance in the present context, the judge said this:

"It was conceded by Miss Shine that, if the employer undertakes an obligation to pay his employees a bonus if they stay with him until the business closes, the payments made to discharge that obligation would be deductible. I can see no material distinction between this situation and the situation before me, in which the employer was obliged by law, if he wished to employ workers in order to produce profits, to undertake a similar liability. Both liabilities, and consequent payments, were for the purpose of producing profits."

61. Before us Miss Shine submits that the proximate and paramount purpose of the severance payments was not to enable the respondent to trade or to produce profits but rather that of terminating the business. She does not cite any authority for that approach, but simply points out that it was used by the Board and was mentioned in CIR v Swire Pacific Ltd (1970) HKTC 1145. The Board used it here upon the invitation of Crown counsel who did not cite any authority. Neither was authority cited in the Swire Pacific case nor the paramount purpose canvassed as a safe and valid basis. In addressing the same question in the Swire Pacific case, Leonard J (as he then was) said this (at p.1169):

"A factor creating difficulty in this case was that the purpose of the payment (getting the workers back to work) was clearly regarded by the taxpayer as fruitful of further advantages. Its achievement was necessary before those further advantages could be obtained. While there was only one immediate purpose --- to get the workers back to work --- the taxpayer was motivated by the further advantages but before these could be achieved the immediate objective had to be realised. The advantages were reasons behind the purpose rather than the purpose itself and the purpose itself could be effected only by payment of the sum and the payment of it in its entity."

He concluded that the payment being one to get the business functioning again (albeit only for 3 1/2 months) must necessarily have been for the purpose of producing profits.

62. In my view, Findlay J was right, at any rate in the circumstances, in adopting a parallel approach in seeking the underlying purpose. The immediate purpose was probably to comply with the mandatory requirement of the law to make the severance payments upon dismissal of the employees by reason of redundancy. However, that requirement was unavoidable and must have been accepted as the clearly known price of procuring and retaining employees for the purpose of producing profits. Moreover, the latter must surely be regarded as the purpose of the payments when that is the very question that has to be addressed.

The authorities

63. But Miss Shine also submits that there are authorities to the contrary, citing those she relied upon before Findlay J and one additional authority. I do not find Strong & Company of Romsey, Limited v Woodifield (5 TC 215) of assistance. In CIR v the Anglo Brewing Co Ltd (12 TC 803), a company closing down decided to give its employees generous extra gratia payments; and in Godden v A. Wilson's (Holdings), Ltd (40 TC 161), a company similarly sold off its plantations and paid the manager of the plantation business a substantial sum by way of damages for breach of his contract of employment. In both cases, upon the facts the payments were clearly not for the purpose of carrying on the trade or producing profits; there was no suggestion of that. In those circumstances the observations made by the judges concerned that the payments were not made for the purposes of the trade (in terms of the English statutory provisions applicable) cannot be regarded as authority for the situation here where the evidence points to the obligation having been undertaken for the purpose of the production of profits.

64. Like the judge, I do not find helpful the decisions of the Board of Review relied upon; they involved gratuitous lump-sum payments to employees upon the cessation of business, and severance payments, held not to be deductible. In the latter context, the Board did not give reasons in one instance and the others were concerned with a business which the payments enabled to continue. It appeared from these decisions and the complaints made to this Court by the director representing the respondent in the appeal, that the practice of the Board is to allow severance payments as deductions where they are paid while business is continuing but not to do so once there has been a cessation of business apparently upon the basis that no further profits could be produced. I do not think that can be right as a matter of principle, where a severance payment is made in a basis period and its purpose conceived earlier is the production of profits upon the basis I have outlined, particularly when regard is had to the words "in the production of profits in respect of which he is chargeable to tax under this Part for any period" in s.16(1). It may, however, be that the Board now takes a different view, having regard to its decision and reasons in this case.

65. Finally, Miss Shine relied upon Overseas Textiles Ltd v Commissioner of Inland Revenue (1987) 3 HKTC 29, which was not cited to the judge. In that case a company carrying on business in Hong Kong as a textile manufacturer decided to cease that business, demolish its factory premises and redevelop its land. When it ceased business, it had outstanding certain spinning and weaving contracts which it was not able to perform. In consequence it was obliged to pay compensation. The Board held the Commission was right in disallowing the compensation payments because they were not incurred in the course of trade or business previously carried out by the appellant. As the judge sitting in the High Court on appeal from that decision, in upholding the Board, I said this at p.52:

"I can see nothing wrong with the Commissioner's view that the payments were not incurred in the course of the trade or business previously carried on by the Appellant, and the Board's endorsement of that view, which, with respect, seems to me to be quite right. A sum paid 'to get rid of a possible law suit after discontinuance' of a business is not made for the purpose of the trade as Upjohn LJ, observed in Godden (H.M. Inspector of Taxes) v A. Wilson's Store (Holdings), Ltd 40 TC 161, 174. Far from being made for the purpose of carrying on the trade, such a payment is on the contrary made for the purpose of ending it."

It is the last sentence of that passage upon which Miss Shine relies. However, it does not avail her for upon the facts in that case, there could be no question of the compensation payments having been for the production of profits. In that sense, the matter having been decided by reference to the dictum of Upjohn LJ, that sentence was obiter; more to the point it can be seen to be inaccurate on the facts. It would have been better expressed in the way Plowman J described the similar situation at first instance in Godden's case at p.167 i.e.:

"... paid, not for the purpose of enabling the Company to earn profits, but in connection with the sale of the Company's estates ...".

66. For the reasons I have given, I conclude that the Board was right in its view that the expenditure was for the purpose of earning profits, and likewise the judge in his view of the purpose of the obligation he addressed.

Was there a sufficiently accrued liability?

67. The appellants' second ground of appeal was that the judge failed to take into account that the obligation or liability to pay severance payments did not accrue until cessation of business of the respondent, and that the right to severance payments was not a "vested right" legally enforceable by the respondent's employees until the respondent ceased its business and was therefore not an "expense incurred in the production of profits".

68. In reaching his relevant conclusion, the judge began by noting that:

"It is clear from the judgment of the Privy Council in Commissioner of Inland Revenue v Lo & Lo (1984) HKTC Vo1. 2 34 that, for the purposes of section 16, deductions are not confined to sums actually paid y the taxpayer, but 'an expense incurred' includes a sum which there is an obligation to pay; that is to say, an accrued liability which is undischarged. Their Lordships made it clear in that case that they regarded a liability as accrued although, in certain circumstances, it would not be payable."

He then stated that "the obligation under section 31B of the Employment Ordinance, Chapter 57, is an obligation that the employer is bound to undertake if he wishes to do business, and employ workers in that business". It has to be noted that the judge was there primarily engaged in addressing the purpose of the obligation to make severance payments, but in the process, at the same time, of concluding that there was such an obligation to pay. He rejected the appellants' contention that severance payments were incurred for the purpose of closing up a business and went on to say this:

"Once an employee has been employed under a continuous contract for a period of not less than 24 months, he acquires a right to receive a severance payment if he is dismissed by reason of redundancy, and the mirror of that is that the employer has incurred an obligation to make that severance payment if he closes down his business and his employees are made redundant."

69. To properly address the appellants' second ground of appeal, it is necessary to have close regard to their Lordships' exposition of their dicta in the Lo & Lo case in the context of the facts of that case. The taxpayer there was a firm of solicitors that prior to 1977 operated an ex-gratia system for the payment of retirement benefits to its employees. In January 1977, it introduced new terms under which employees who completed 10 years of service would become entitled to lump-sum payments upon retirement. It then began carrying to reserve "provision for staff retirement benefits". In the year 1977/78 it claimed deduction in the amount of $770,000 representing its obligations as at 31st December to the serving employees who had already qualified for such benefit. The Commissioner refused to allow the claim on the basis that the provision was not "expenses incurred during the basis period" under s.16(1). However, he allowed a small additional payment that was actually made to employees who retired in that year.

70. Turning to the Privy Council judgment at pp. 71, 72 their Lordships observed that in s.16 "the legislature was not thinking only of disbursement made during the basis period" and continued "the question is, therefore, how far beyond mere disbursements is s.16 intended to travel or, more specifically, does the section travel far enough to comprise the sum which the taxpayer seeks to deduct in the present case?" Their Lordships then turned to examine in more detail the precise nature of the retirement benefits in respect of which the deduction was claimed. Previously, at pp. 70, 71, they had observed that "in the instant case there was no liability during the year 1977 to pay any sum by way of retirement benefit to a long service employee who did not in fact retire during the year, and such employee could not be said to have any right thereto. The sum was only payable to him at a future day when he left the firm's employment and was contingent on his not leaving as a result of dismissal of honesty, serious misconduct or gross inefficient."

71. Their Lordships' detailed examination of the precise nature of the retirement benefits in that case can be seen at pp. 72 and 73. At p. 72 their Lordships said:

"For reasons already given, 'an expense incurred' is not confined to a disbursement, and must at least include a sum which there is an obligation to pay, that is to say an accrued liability which is undischarged. Their Lordships then ask themselves why the $50,000 in the example given is not to be considered a sufficiently accrued liability in the year 1977 to be admissible as an 'expense incurred' in that year within the meaning of the section?"

Their Lordships concluded that in the circumstances it would be placing an unduly narrow construction on s.16 to deny such $50,000 the description of "an expense incurred."

72. It seems to me that what is of significance in their Lordships' analysis and conclusions in that context are the following matters: That their Lordships regarded the right of the employee there to receive his retirement benefit as absolute in the sense that he needed to do nothing whatever except give a period of notice and pick up his money. That the possibility of the employee losing his entitlement if dismissed for dishonesty, etc before he gives notice or during the currency of notice does not make his right contingent. And that "'an expense incurred' is not confined to a disbursement, and must at least include a sum which there is an obligation to pay, that is to say "an accrued liability which is undischarged".

73. Turning then to the situation in this appeal, an employee who has completed 24 months has no right whatever that I can see, to a severance payment by reason merely of such completion. However long he continues to serve he will not by means of that service become entitled to severance payment. Such right and the corresponding liability for that sum will only accrue upon his dismissal by reason of redundancy or being laid off, that is to say not upon any action of his but that of his employer over which he does not have anything in the nature of control. If there is to be any assumption in that situation, it must surely be that the employment will continue until retirement. Upon that basis the employee would never become entitled to a severance payment (whatever other benefit he may attract). Nor would he be entitled to a severance payment if he was dismissed or the employment terminated for reasons other than redundancy or being laid off. In those circumstances it seems to me that the conclusion is irresistible that the employee would have nothing that can be regarded as a right to a severance payment, nor would any liability be incurred, prior to dismissal by reason of redundancy or upon being laid off. In the present context, expressions like contingent rights and potential rights, which were mentioned in argument before us, tend to confuse rather than to assist. In the case of severance payments, dismissal for redundancy is in the nature of a condition precedent, and prior to that the "contingent right" can hardly be regarded as a right, much less an absolute right as was the right to retirement benefit in Lo & Lo following the completion of ten years service. And as for "a potential right" to a severance payment upon completion of 24-months service but prior to dismissal for redundancy, that again is no right at all. I therefore do not see how so nebulous a "right" as the eligibility to receive a severance payment prior to dismissal for redundancy can be regarded as "an expense incurred", notwithstanding that the latter was not limited by the Privy Council to an accrued liability to pay.

74. It follows that the judge was wrong in concluding or assuming that an obligation was incurred in those circumstances, a fortiori that it was an obligation of the nature contemplated by their Lordships in Lo & Lo, and that his decision cannot be sustained upon that basis.

The result

75. But does that mean that the appeal has to be allowed and the Board's assessment set aside? I think not. The judge presumably felt unable to rely upon the actual payments made by the respondent because of his view that "it cannot possibly be said [the respondent] made the payments for the purpose of producing profits". In that respect, I consider he was wrong for the same reasons that I have relied upon in concluding that the payments were made for the purpose of producing profits. Moreover, it seems to me that if the purpose of the obligation to pay was to produce profits, then so must be the purpose of the payments made to meet that obligation. It follows that the purpose of the payments (as opposed to that of the obligation) is no obstacle to deductibility under s.16.

76. The Board found that the severance payments were made between December 1990 and February 1991, i.e. during the basis period. That finding is not questioned. And the expenditure was incurred, upon the basis I have outlined, for the purpose of producing profits. Revenue was received and profits made during the basis period 1990/1991. Accordingly, I find that both the Board and the judge were correct in their conclusion that the severance payments were deductible, although my reasons differ from those of the judge in the one respect mentioned. I would therefore answer the question of law stated by the Board in the affirmative and dismiss the appeal.

77. In the result, the appeal is dismissed by a majority.