RICHARD PAUL MARK AIDAN FORLEE v. COMMISSIONER OF INLAND REVENUE

CACV 453/2021

[2022] HKCA 1098

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO 453 OF 2021

(ON APPEAL FROM HCIA NO 1 OF 2019)

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J U D G M E N T

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Hon G Lam JA (giving the Judgment of the Court):

1.  This appeal, brought by the Commissioner of Inland Revenue (“Commissioner”), concerns whether or not (i) certain forfeitable shares which were awarded to the taxpayer previously during his overseas employment but which ceased to be forfeitable during his subsequent Hong Kong employment within the same group, and (ii) certain dividends received by the taxpayer on those shares, are assessable to salaries tax.

Facts

2.  The primary facts are as follows.  At all material times up to 30 June 2014, Mr Forlee, the taxpayer (“Taxpayer”), was employed in the United Kingdom by Investec Bank plc, a company in the Investec Group (“Group”).  From 1 July 2014 the Taxpayer began his Hong Kong employment with Investec Capital Markets Ltd (“Investec HK”), also a Group company, pursuant to a contract of employment dated 14 June 2014.

3.  Investec 1 Ltd, another Group company, operated the Group’s Share Incentive Plan (“Plan”).  The shares awarded under the Plan are fully paid ordinary shares in Investec plc listed on the London Stock Exchange.  The rules of the Plan are set out in a document entitled: “Investec 1 Limited – Share Incentive Plan”. 

4.  By letters dated 29 May 2012, 4 June 2013 and 27 May 2014 respectively (i.e. during his UK employment), each attaching an award certificate, the Taxpayer was granted three awards of Investec plc shares under the Plan.  These awards were called “EVA Share Awards”, and we shall refer to these shares as the “EVA Shares”.  EVA (Economic Value Added) apparently refers to the extent to which net operating income before tax exceeds the amount of capital utilised multiplied by the weighted average cost of capital.[1]

5.  According to the Taxpayer’s testimony, which the Board of Review (“Board”) accepted, EVA Shares awarded were a component of bonuses for past, actual financial performance and were generally granted to employees coming within the regulatory designation of “material risk takers”.  EVA Shares were in almost all cases only issued out of historical earnings.[2]  Investec HK likewise stated, in response to the assessor’s enquiries, that EVA Share Awards were bonuses for historical financial performance which implied that the financial performance exceeded a minimum expectation and as a result created value for the organisation.  The EVA Share Awards for the years 2012 to 2014 were granted to the Taxpayer for the good financial performance of the business unit in the respective financial years for which the Taxpayer was responsible while he was in the employment of Investec Bank plc in the UK.  The arrangement that divided EVA Share Awards into an upfront payment and several deferred payments was introduced as a direct requirement of the Financial Services Authority (“FSA”) in the UK.  The deferral was intended to promote good long-term behaviour following the excesses of the global financial crisis in 2008.  The requirement of being employed by the Group on the Release Dates of the shares, being a prudent measure, was a means to achieve this objective, and could be satisfied by employment with other Group entities not necessarily in Hong Kong.[3]

6.  EVA Share Awards may be contrasted with another type of awards known as “Conditional Awards”, involving a conditional right to acquire fully paid ordinary shares of Investec plc.  Shares awarded under this type of award are known as “LTIP Shares” (Long Term Incentive Plan Shares) which, according to the Taxpayer’s evidence, were issued as incentives for employees’ prospective performance and conduct whilst remaining in employment with the Group.[4] Investec HK also explained that the award of LTIP Shares was an incentive designed to foster good future performance by employees and to serve as a means to retain key staff.[5]

7.  The key provisions of the Plan, as applied to the EVA Share Awards of the Taxpayer, are as follows.  Awards must be granted by deed.[6]  In this case, each of the award certificates, being the deed required, stated the award was granted by way of a deed and “creates a right which the [Taxpayer] may enforce against Investec 1 Limited”.

8.  Rule 2.11.1 of the Plan provides that:

“ The Grantor will procure that, with effect from the Award Date, the relevant number of Shares are transferred to the Participant, or to another person to be held for the absolute benefit of the Participant, on the terms of the Plan.”

The Grantor in this case was the Taxpayer’s UK employer, Investec Bank plc.  The EVA Shares awarded were, on or about the Award Date, transferred to a nominee, Investec plc Jersey 1 Trust (“Nominee”), and held on the Taxpayer’s behalf “for his sole and absolute benefit” on the terms of the Plan.[7]

9.  Rule 4.1 of the Plan provides:

“ Unless otherwise agreed in the Award Agreement, a Participant will have all the rights of a shareholder in respect of the Forfeitable Shares from the Award Date. In particular, where the Participant has not waived his dividend rights, he will receive any dividends earned on his Forfeitable Shares after the Award Date. Where the Participant has not waived his voting rights, he will be entitled to vote or to direct the Nominee how to vote the Shares.”

The Taxpayer was not required to waive those rights.  In fact, the award certificates expressly stated that he was entitled to receive dividends and exercise voting rights from the Award Dates.  In addition, according to the Plan, the Taxpayer had the same rights as other shareholders in respect of variations in the share capital of Investec plc, any special dividend or other transaction which the Committee that administers the Plan (“Committee”) considers might affect the value of the EVA Shares.[8]

10.  The rights of the Taxpayer in respect of the EVA Shares were, however, qualified in three important respects: (i) there were restrictions on transfer until a specified date called the “Release Date” and thereafter the expiry of a further period called the “Retention Period”; (ii) the shares were subject to forfeiture upon cessation of employment until the Release Date; and (iii) the Awards were subject to “clawback” until the Release Date.  These qualifications are explained below.

11.  Within each of the EVA Share Awards made to the Taxpayer, the shares were divided into four tranches with four respective “Release Dates” in four consecutive years, and four “Retention Periods” each being six months from the Release Date.  In all three awards, the Release Date for the first tranche had already passed by the date of the award letter (the “upfront” portion), and was taken by the Board as the Award date.[9]  For example, under the first award in the letter dated 13 June 2012, the Release Dates for the four tranches of shares were 29 May in the four consecutive years of 2012, 2013, 2014 and 2015 respectively; the Retention Periods were the six months from 29 May to 29 November in the same four years respectively.

12.  By way of restriction on alienation, the Plan provides that “[b]efore the Release Date the Taxpayer may not transfer, assign or otherwise dispose of the Shares subject to his Award or any rights in respect of any Forfeitable Shares comprised in it”,[10] and that his Award will lapse if he does so,[11] with the exception of transmission on death to personal representatives or a transfer with the permission of the Committee.[12]  The terms of the award letters to the Taxpayer extended this restriction, apparently in order to comply with the FSA Remuneration Code, by providing that upon the Release Date “the Shares will continue to be held by the Nominee for [the Taxpayer’s] benefit until the end of the Retention Period”.[13]  The award certificates also stated that the Taxpayer “will not transfer, assign or dispose of the Shares or any interest or rights in them before the end of the retention period (except as permitted under the Rules).”

13.  As for forfeiture, rule 5.1 of the Plan provides:

“ Subject to the following provisions of this Rule 5, if the Participant ceases to be an employee before the Release Date for any reason, he will forfeit the Shares in his Award immediately and will have no entitlement under the Plan.”

Ceasing to be an employee essentially means ceasing to be an employee of a Group company.  Exceptions to rule 5.1 are provided for in rule 5.2 which deems the Release Date to be the date of termination of employment due to disability or death, and in rule 5.3 which enables the Committee to decide in its discretion that some or all of the shares in an award will not be forfeited despite cessation of employment.  Further, the Release Date is advanced in the event of a takeover or merger affecting Investec plc.[14] Rule 6.1 provides that: “On the Release Date, … the Shares comprised in the Award cease to be subject to forfeiture …”.

14.  Before the Board, the Taxpayer accepted that if he left employment before the release of certain shares awarded, that would put at risk the shares to be released.  He testified that in his experience as a senior manager over his 31 years of employment within the Group, EVA Shares, once awarded, were seldom forfeited upon an employee’s resignation.  If an employee had his employment terminated for misconduct, however, the shares would be forfeited.[15]

15.  Each of the award letters stated that as the Taxpayer’s role had been identified as meeting the criteria for “Code Staff” employees as defined in the FSA Remuneration Code, his award was subject to “clawback”, which “permits Investec to reduce awards before the Release Date as set out in Appendix 2” to the letter.  Appendix 2 provided that:

“ 1.1 Review of Awards

In respect of any portion of your Award which has not been released, the Directors may, at any time, on or before the Release Date determine in their sole and absolute discretion, whether or not some or all of the unvested portion of the Award should be reduced (including reduced to nil), as set out in paragraph 1.4 below.

1.2 Review Events

In determining whether or not to reduce the unvested portion of your Award (and the extent of the reduction), the Directors will consider:

1.2.1 In respect of the financial year in relation to which your Award was made:

(i) whether the results announced for that financial year have subsequently appeared materially inaccurate or misleading as determined by the Directors in their sole and absolute discretion;

(ii) whether a business unit or profit centre in which you worked has subsequently made a loss out of business written in that year or from circumstances that could reasonably have been risk-managed;

(iii) whether information has emerged since your Award was granted relating to the relevant financial year which would have affected the amount of Award granted;

1.2.2 any error or a misstatement which has resulted in a material overpayment to you whether in the form of your Award or otherwise, irrespective of whether you are at fault, and/or

1.2.3 whether the Investec group or the business unit in which you work has suffered a material downturn in its financial performance.

[1.2.4 Any other matter which appear relevant][16]

1.3 Other considerations

In carrying out their review under paragraph 1.2 above, the Directors will take into account the following factors:

1.3.1 the extent to which you had control over the outcome;

1.3.2 failure of internal control systems;

1.3.3 the impact of the risk profile of the relevant Group Company or business unit;

1.3.4 any violation of the Company or any Group Company’s culture and values;

1.3.5 the long term impact of the outcome on the Company or any Group Company or relevant business unit;

1.3.6 external factors including market conditions;

1.3.7 the extent to which the applicable bonus was paid from realised profits; and

1.3.8 any other relevant factors.

1.4 Reduction of Award

Following a review under this paragraph 1, the Directors may, in their sole and absolute discretion, make any determination in respect of any part of an Award that has not vested, including reducing the number of Shares subject to an Award.

2 Definitions

… ‘Directors’ means the board of directors of the Company, the DLC Remuneration Committee or another duly authorised committee including a committee comprising the Chairman of the Staff Share Executive Committee, the Global Head of Human Resources and two executive directors of Investec plc.”

16.  The Taxpayer testified that EVA Shares awarded to an employee would mainly be “clawed back” in case of a reversal of performance of the business unit in the financial years for which the awards were made to the employee.  He had never heard of a case where an award of such shares was forfeited merely because there was a decline in the general financial performance of the Group or of the relevant business unit in subsequent years. He said that such factors about future performance would be relevant to LTIP Share Awards but not EVA Share Awards.[17]

17.  There were statements in the award letters and certificates that the EVA Shares “will vest on each of the four Release Dates”.  The award letters required the Taxpayer to undertake not to use hedging strategies to lessen the impact of a reduction in value of the award or any “vested” shares which were subject to a Retention Period following the Release Date, and stated that any breach of this condition would result in the lapse of any “unvested” portion of the award unless the Directors determined otherwise.  Clauses 1.1, 1.2 and 1.4 of Appendix 2 to the award letters, quoted above, also referred to portions of the shares not yet released as being “unvested” or “not vested”.  We shall discuss the Commissioner’s reliance on these descriptions below.

18.  From §11 above it can be seen that although the awards were made during the Taxpayer’s UK employment, the Release Dates and the expiry of the Retention Periods for some of the EVA Shares awarded fell within the currency of his Hong Kong employment.  In addition, the Taxpayer received dividends on certain EVA Shares during his Hong Kong employment prior to their release.  This has given rise to the present dispute, which relates to the tax assessment for the 2015/16 and 2016/17 years of assessment (“Relevant Years”).

19.  The Taxpayer was also granted two Conditional Awards of LTIP Shares by his UK employer in June 2012 and 2013.  The terms of these awards were governed by a separate part of the Plan[18] and were different from those of the EVA Share Awards.  In particular, it was stated that until the “Vesting Dates” (being specified dates in 2015, 2016 and 2017), the Taxpayer did “not have any interest or right in respect of the shares” in question, would not be able to transfer or dispose of the shares, and would not be entitled to receive dividends or to exercise voting rights in respect of them.  The Taxpayer accepted that the value of the LTIP shares, which vested during his employment with Investec HK, was assessable income in Hong Kong.  The present appeal is concerned only with his EVA Shares and their dividends.

The statutory provisions

20.  The relevant sections of the Inland Revenue Ordinance (Cap 112) (“Ordinance”) provide as follows:

“ 8. Charge of salaries tax

(1) Salaries tax shall, subject to the provisions of this Ordinance, be charged for each year of assessment on every person in respect of his income arising in or derived from Hong Kong from the following sources –

(a) any office or employment of profit …

9. Definition of income from employment

(1) Income from any office or employment includes –

(a) any wages, salary, leave pay, fee, commission, bonus, gratuity, perquisite, or allowance, whether derived from the employer or others, …

…

11B. Ascertainment of assessable income

The assessable income of a person in any year of assessment shall be the aggregate amount of income accruing to him from all sources in that year of assessment.

…

11D. Receipt of income

For the purpose of section 11B –

(a) income which has accrued to a person during the basis period for a year of assessment but which has not been received by him in such basis period shall not be included in his assessable income for that year of assessment until such time as he shall have received such income, when notwithstanding anything contained in this Ordinance, an additional assessment shall be raised in respect of such income:

Provided that for the purposes of this paragraph income which has either been made available to the person to whom it has accrued or has been dealt with on his behalf or according to his directions shall be deemed to have been received by such person;

(b) income accrues to a person when he becomes entitled to claim payment thereof …”

The assessment and objection

21.  The Taxpayer was assessed by an assessor of the Revenue on the basis that, during the Relevant Years, he received (a) such of the EVA Shares whose Release Dates fell within the Relevant Years (valued at their market prices on the Release Dates); and (b) the dividends which the Taxpayer received during the Relevant Years on such EVA Shares as had not reached their Release Dates (“Dividends”).  In the discussion below, references to EVA Shares are to these particular portions of the EVA Shares.

22.  The Taxpayer raised an objection on the ground that the values of the EVA Shares released in the Relevant Years should not be chargeable to salaries tax in Hong Kong as they were awarded for work performed for his UK employer prior to his employment in Hong Kong, and that, as a corollary, the Dividends should also not be assessed to salaries tax.

23.  The Deputy Commissioner considered that the values of the EVA Shares should be regarded as income derived from the Taxpayer’s employment in Hong Kong and therefore chargeable to salaries tax under section 8(1)(a) of the Ordinance.  The Deputy Commissioner reasoned that since the relevant EVA Shares were released when the Taxpayer was employed in Hong Kong during the Relevant Years, and the rules of the Plan and conditions of the awards required the Taxpayer to remain in the employment of the Group before the shares would be released to him, the release of the shares resulted directly from the Taxpayer’s employment in Hong Kong.  For the same reason, the Taxpayer received the Dividends as his employment income.  The Taxpayer’s objection was therefore rejected.

The appeal to the Board

24.  The Taxpayer appealed to the Board.  In its Decision dated 3 May 2019 (“Board’s Decision”), the Board noted that the EVA Shares were held by the Nominee subject to the rules of the Plan and that it was only on the Release Dates that the EVA Shares ceased to be subject to forfeiture.  The Board went on to reason as follows:

“43. … those tranches of EVA Shares that ceased to be subject to forfeiture in the years of assessment 2015/16 and 2016/17 necessarily became so due to the Taxpayer’s continuing employment within the Group in Hong Kong; those Shares became truly the Taxpayer’s as a result of his continuing employment in Hong Kong with a member of the Group. In the relevant retention period there were some restrictions on disposal and transfer but the Revenue conceded that these were of limited scope and duration so as not to affect the vesting on the release date.

44. In the result, this Board rejects the Taxpayer’s submission that he was vested with, became entitled to, or otherwise received the value of the EVA Shares before he began his employment in Hong Kong. While the EVA Shares were awarded by deed and it was expressed on the award certificates that the Taxpayer had a right to enforce against the grantor for the EVA Shares, that right, like other rights and obligations relating to the award, must be considered on the terms of the rules of the Plan, Appendices 1 and 2 to the award letters and the award certificates. The EVA Shares only ceased to be forfeitable on the relevant release dates.

45. … This Board lastly considers whether s 11D(b) itself applies and how it applies in the context of this Appeal.  This Board finds that since the time at which the shares were no longer subject to forfeiture was the release date (albeit the Taxpayer would only be entitled to insist on a sale at the expiry of the retention period), the time that he became entitled to the value of a tranche of EVA Shares awarded to him was the release date and this was the time when the value of that tranche accrued to him as income for the purpose of s 11B.”

25.  As to the Dividends, the Board said:

“46. … The Taxpayer was entitled to be paid the Dividends not only because of the relevant award of the EVA Shares but also because the EVA Shares award in question was not forfeited or reduced during the basis period and one of the reasons that was so was that he was in continuing employment in Hong Kong with a member of the Group.”

26.  Accordingly, the Board rejected the Taxpayer’s appeal in relation to both the EVA Shares and the Dividends.

Proceedings in the High Court

27.  Pursuant to section 69 of the Ordinance, the Taxpayer sought leave to appeal against the Board’s Decision on a question of law.  Leave to appeal was initially refused by Deputy High Court Judge Dawes SC,[19] but was granted upon the Taxpayer’s further application to the Court of Appeal.[20]  The appeal proper came before Mimmie Chan J (“Judge”).  The question of law advanced for determination is as follows:

“ Upon the basis of:

(1) the true construction of sections 8(1), 9 and 11B-11D of Part 3 of the Inland Revenue Ordinance (Cap 112), which charge to salaries tax ‘income’ (including ‘perquisites’, such as a gratuitous transfer of shares) ‘accruing to [an employee] … in [a] year of assessment’ ‘from’ any Hong Kong employment ‘when he becomes entitled to claim payment thereof’; when applied to

(2) the facts which have been agreed and/or found by the Board of Review in relation to:

(a) the Taxpayer’s 2002 – 30 June 2014 UK employment, during which (in 2012, 2013 and 27 May 2014) his UK employer awarded EVA Shares to him which (together with all dividends later accruing thereon) became his property, albeit they were subject to compulsory retention periods (the ‘UK Awards’); and

(b) his Hong Kong employment with the UK employer’s Hong Kong subsidiary, from 1 July 2014 onwards, during which the retention periods upon the UK Awards of EVA Shares expired –

did the Board err in law in concluding that, for the purposes of sections 11B-11D(b), the UK Awards of the EVA Shares only accrued to the Taxpayer upon the [Release Dates][21] during the 2015/16 and 2016/17 years of assessment, so that the UK Awards of the EVA Shares plus the dividends received during those years of assessment constituted chargeable income from the Taxpayer’s Hong Kong employment?” (original emphases)

28.  In her judgment dated 24 August 2021 (“Judgment”),[22] after setting out certain observations of the Court of Final Appeal in Fuchs v Commissioner of Inland Revenue (2011) 14 HKCFAR 74 at §§14 and 16 to 18, the Judge referred to the cases of Weight v Salmon (1935) 19 TC 174, Ede v Wilson and Cornwell (1945) 26 TC 381, and Abbott v Philbin [1961] AC 352, relied upon by the Taxpayer for the contention that the date when a non-monetary perquisite accrued is the date when the recipient became able to “turn it to pecuniary account”.  The Judge noted that the EVA Shares were transferred to and held in the name of the Nominee on the Taxpayer’s behalf and for his sole and absolute benefit and that he had also been paid the Dividends.  Applying the tests set out in the cases, the Judge said she could not see how it could be said that the Taxpayer had not received perquisites which were derived from his employment at the time when the EVA Shares were awarded to him and for his services under his UK employment.[23]

29.  The Commissioner submitted to the Judge that the matter turned on the question under section 11B of the Ordinance as to when the income “accrued to” the Taxpayer, and that it accrued at the time when the EVA Shares ceased to be subject to forfeiture and became freely disposable by the Taxpayer upon the expiry of the Retention Periods, by virtue of his having remained in his Hong Kong employment.  The Judge considered that given that the Taxpayer had received the Dividends and exercised all the rights of a shareholder in respect of the EVA Shares, they had been “made available” to the Taxpayer or “dealt with on his behalf or according to his directions” within the meaning of the proviso to section 11D(a) and are therefore deemed to have been received by and accrued to him.[24]

30.  The Judge considered that the fact that the EVA Shares were not fully transferable does not preclude the accrual of the benefit.  From the Award Dates, the Taxpayer became “entitled to claim”, within the meaning of section 11D(b), and did claim, the income represented by the EVA Shares. It follows that the income in question had accrued to the Taxpayer when awarded to him.  The Judge accepted the Taxpayer’s submission that the Board erroneously focused on the issue of the “formal alienability” of the EVA Shares, when the Taxpayer could make an unconditional sale for their full market value following receipt of them.  The Board’s treatment of the restriction on disposal during the Retention Period as being insufficient to affect the “vesting” on the Release Date also shows the irrelevance of such restriction.[25]

31.  The Judge held that the fact that the EVA Shares could be forfeited did not affect the accrual of the income.  Forfeiture does not preclude vesting; there can be no forfeiture without the prior vesting of the interest.  The EVA Shares can be vested in the Taxpayer, even though they may be “clogged” with a liability to forfeiture.  The Board had placed erroneous focus on the fact that the shares were liable to be forfeited.[26]

32.  The Judge also found that the Board effectively applied a “but for” test and lost sight of the point made in Fuchs[27] that the fact that a taxpayer would not have received the payment in question if he had not been an employee is not sufficient to render the payment chargeable income from employment. She concluded that the EVA Shares were awarded to the Taxpayer by virtue of, and were derived from, his UK employment.[28]

33.  As to the Dividends, the Judge accepted the Taxpayer’s submission that they were received by him as a result of his receipt of the EVA Shares awarded by virtue of his UK employment and, further, that it would be double taxation to tax both the receipt of the EVA Shares and the Dividends.[29]

34.  In the result, the Judge allowed the Taxpayer’s appeal and annulled the two assessments affirmed by the Board in respect of the Relevant Years. 

The appeal

35.  The Commissioner now appeals to this Court against the Judge’s order, seeking to restore the Board’s Decision.  The grounds of appeal advanced as elaborated upon by Mr Brewer and Ms Wong in their submissions on behalf of the Commissioner are broadly as follows:

(1)  In relation to sections 11B and 11D, the Judge was wrong to apply the concept of “turning to pecuniary account” for determining when the Taxpayer became entitled to claim payment of the EVA Shares and the Dividends.  The question was not whether the Taxpayer was able to turn the benefit to pecuniary account but when he became entitled to claim payment thereof.  The EVA Shares were repeatedly expressed in the award documents not to vest in the Taxpayer until the Release Dates.  The Board’s finding that the EVA Shares were vested in the Taxpayer on the Release Dates was the correct test for determining when he became “entitled to claim payment thereof”.  The Taxpayer’s right to have the shares transferred to a nominee and held for him should not be equated with an entitlement to claim payment thereof.  The Taxpayer was “entitled to claim payment” of the Dividends as and when they were declared.  His right to receive dividends arose not as the right of a registered shareholder but as part and parcel of the Plan terms.

(2)  The Judge was wrong to characterise the Board’s decision as based on a “but for” approach and to say that the Board had overlooked the point made in Fuchs that the fact that a taxpayer would not have received the payment if he had not been an employee is not sufficient to render the payment chargeable income.  The Taxpayer had to do much more than simply remain in employment in order for the EVA Shares to be released, as is plain from the “clawback” provisions in Appendix 2 to the award letters.  The review events required continued and active performance of the Taxpayer’s obligations as employee until each Release Date.

(3)  The Judge erred in finding that despite being forfeitable, the EVA Shares had vested in the Taxpayer prior to the Release Dates. This flies in the face of the language of the award letters which stated that the EVA Shares were to vest on the Release Dates and that the provisions for forfeiture and clawback applied to unvested portions.  Because of the conditions to which the awards were subject, the Taxpayer’s interest in the EVA Shares was in truth in the nature of a contingent interest, not vested in possession.

(4)  There is a ground set out in the Notice of Appeal contending that the Judge was wrong to characterise as erroneous the Board’s focus on the formal inalienability of the EVA Shares and to find that the Taxpayer could make an unconditional sale of the EVA Shares following the awards.  This was not however developed in any way in the written or oral submissions for the Commissioner.

36.  There is no dispute that the Board is the decision-maker on all questions of fact.  An appeal only lies to the court in point of law.  Where however the court is satisfied that the Board has reached a conclusion contrary to the true and only reasonable one, the court may find that the Board has erred in law and substitute the correct conclusion: see Kwong Mile Services Ltd v Commissioner of Inland Revenue (2004) 7 HKCFAR 275, §§31-37; Zarin v Commissioner of Inland Revenue [2022] HKCA 412, §§31-33. 

The principles

37.  The starting point is that for each year of assessment the charge of salaries tax is imposed under section 8(1)(a) in respect of a person’s “income arising in or derived from Hong Kong from … any office or employment of profit”.  Section 11B provides that a person’s assessable income in any year of assessment is the aggregate amount of income accruing to him from all sources in that year.  Accordingly, for the purposes of this appeal, for salaries tax to be chargeable, there must be (i) income, (ii) accruing in the year of assessment, (iii) from Hong Kong, and (iv) from any office or employment of profit.

38.  Section 9(1)(a) defines income from any office or employment widely as including “                  any wages, salary, leave pay, fee, commission, bonus, gratuity, perquisite, or allowance, whether derived from the employer or others”.  A “perquisite” may in common parlance have a wide meaning but its scope has been refined by the House of Lords’ decision in Tennant v Smith [1892] AC 150, the effect of which was summarised by Lord Diplock in Heaton v Bell [1970] AC 728, 764 as follows:

“ In Tennant v Smith [1892] AC 150 the House of Lords placed a judicial gloss upon the word ‘perquisite’ appearing in the corresponding sections of the Income Tax Act 1842, by confining it to actual money payments and to benefits in kind variously described by Lord Halsbury LC, at p 156 as ‘capable of being turned into money,’ by Lord Watson, at p 159 as ‘that which can be turned to pecuniary account,’ by Lord Macnaghten, at p 163, as ‘payments convertible into money’ and by Lord Hannen, at p 165, as ‘that which could be converted into money.’ … In the Income Tax Act 1918, the relevant sections were re-drafted and in the process the word ‘payable’ disappeared, but this professed to be a consolidation Act and the presumption is that the change in wording was not intended to give to the new enactment a meaning different from that of the enactment which it replaced. Further changes in drafting and arrangement which were made by subsequent legislation, including the Income Tax Act 1952, and the Finance Act 1956, which are applicable to the present appeal, have not, in my view, affected the meaning which the word ‘perquisite’ bore in the Income Tax Act 1918. I think that it must be accepted that ‘perquisite’ in each of these subsequent statutes still means what it meant in the Income Tax Act 1842.”

39.  In Glynn v Commissioner of Inland Revenue [1990] 2 AC 298, the Privy Council held, on appeal from Hong Kong, that the meaning of the expressions “salaries” and “perquisites” have the same meanings in Hong Kong tax law as their meanings based on UK income tax law provided that the Hong Kong legislation does not attach different meanings to them.[30]  There is no suggestion that the Ordinance relevantly does so for the purposes of this appeal.

40.  There is no dispute that shares in companies, especially publicly listed companies, are perquisites when given outright to an employee and therefore part of his income.  The cases illustrate that the grant of other rights relating to shares may also amount to perquisites.  In Weight v Salmon, a managing director of a company was granted the privilege to apply for shares in the company at their par value, which was considerably lower than their then market value, and he actually applied for and was allotted the shares.  But he argued that there was no profit received assessable to income tax.  Finlay J held that the taxpayer had been given a privilege which was not itself money but money’s worth and therefore taxable. His judgment was upheld by the English Court of Appeal, where Slesser and Romer LJJ both considered that the privilege, when conferred, was capable of being turned to pecuniary account.  The House of Lords dismissed the appeal, but for the different reason that although the taxpayer was permitted to apply for shares, the company was not bound to issue them; no right was given and no profit was received by him until the application had been accepted and the shares allotted to him.  On the facts, however, as the taxpayer had indeed applied for and been allotted shares in the year, that distinction was immaterial.

41.  In Ede v Wilson, the taxpayers were also granted the privilege to subscribe for shares in their employer at par value which was lower than the current market value, albeit on their verbal undertaking not to sell the shares, so long as they remained in the company’s employ, without the permission of its directors.  Wrottesley J considered that the shares could be sold not only with the consent of the directors, but also without, though in that case the seller would expose himself to the displeasure of the board, possibly even to dismissal.  He concluded:

“ Looking at the substance of the matter, the Respondents have received an advantage which is of such a nature that it can be turned into money. At the same time, these shares in the hands of these shareholders are doubtless not so valuable for certain purposes as they would be but for the restriction. Nevertheless, they are a valuable nest-egg, and will doubtless produce a good income in the form of dividend, at any rate, when calculated on the purchase price, that is to say, of course, the purchase price by the recipients. They are, therefore, within Rule 1,[31] though it will be for the Commissioners to say whether any, and if so what, reduction ought to be made in the proposed assessment in view of the agreement entered into by the recipients not to sell them without the permission of the directors.”

42.  In Abbott v Philbin, the taxpayer was in 1954 granted, for the price of £20, an option to subscribe for 2,000 shares in his employer at the then market price.  The option was expressed to be non-transferable and to expire after 10 years or upon the employee’s earlier retirement or death. In 1956, when the market price had risen considerably above the option price, the taxpayer exercised the option in respect of 250 shares.  The issue arose whether the taxpayer received a perquisite in 1954 in the value of the option over and above the price he paid for it, as he contended, or only in 1956 in the amount of the difference between the option price and the market price of the 250 shares, as the Crown contended.  By a majority, the House of Lords held in favour of the taxpayer.[32]  It was considered that the option was a right that could be turned to pecuniary account.  Lord Reid, for example, said:

“ It is true that the option was not transferable, but there are other ways of turning such a right to pecuniary account than assigning it or calling for immediate performance of the obligation to allot the shares. Even taking this particular option I find nothing to indicate that there would have been much difficulty in finding someone who would have paid a substantial sum for an undertaking by the appellant to apply for the shares when supplied with the purchase money and called upon to exercise the option and thereupon to transfer the shares. It is not an unreasonable inference from the whole circumstances that both the appellant and his employers must have thought the option worth a good deal more than £20 and others may have thought the same. No doubt a person who wished to acquire an option on the shares would pay less for an undertaking such as I have indicated than he would pay for an assignable option because of the risks involved, but that only goes to valuation of the right which the appellant acquired.”^[33]

43.  Similarly, Lord Radcliffe said:

“ What the option did was to enable the holder at any time, at his choice, to obtain shares from the company which would themselves be pieces of property or property rights of value, freely convertible into money. Being in that position he could also at any time, at his choice, sell or raise money on his right to call for the shares, even though he could not put anyone he dealt with actually into his own position as option holder against the company. I think that the conferring of a right of this kind as an incident of service is a profit or perquisite which is taxable as such in the year of receipt, so long as the right itself can fairly be given a monetary value …”^[34]

44.  On the requirement in section 8(1)(a) that the income is “from … any office or employment of profit”, the Court of Final Appeal made clear in Fuchs that not every payment which an employee receives from his employer is necessarily income from his employment, and that a payment does not qualify as such income merely because the employee would not have received the sum in question if he had not been an employee.[35]  Assessable income is, however, not confined to income earned in the course of employment but embraces payments made in return for acting as or being an employee, or as a reward for past services or as an inducement to enter into employment and provide future services.[36]

45.  The requirement that the income be from the employment was a secondary ground of decision in Abbott v Philbin.  In that case, the Revenue did not claim to tax the advantage obtained on the exercise of the option if the earlier grant of the option itself was held to be taxable.  But views were nevertheless expressed that the subsequent benefit did not arise from the office or employment of the taxpayer.  Thus Lord Radcliffe said:

“ Even if there were no taxable subject in the earlier years I should regard the 1955-56 claim as failing on its own terms. The advantage which arose by the exercise of the option, say £166, was not a perquisite or profit from the office during the year of assessment: it was an advantage which accrued to the appellant as the holder of a legal right which he had obtained in an earlier year, and which he exercised as option holder against the company. The quantum of the benefit, which is the alleged taxable receipt, is not in such circumstances the profit of the service: it is the profit of his exploitation of a valuable right.”^[37]

Viscount Simmonds made similar observations.[38]  Lord Reid also pointed out that there would be no relation whatever between the service during the year in which the shares were issued and the giving of the option many years earlier or the exercise of the option during the later year.  Whilst refraining from expressing a concluded opinion on this point he said it seemed to lend support to the conclusion he had reached on other grounds.[39]

46.  For salaries tax to be charged for a particular year of assessment there must be assessable income in that year.  Income is assessed to tax on an accrual basis: see sections 11B and 11D of the Ordinance.  The history of the relevant statutory provisions was helpfully set out by Deputy Judge Muttrie in Commissioner of Inland Revenue v Sawhney [2006] 3 HKLRD 21 at §§9-23 and need not be repeated here.  Suffice it to say that salaries tax was previously based on receipt of income, with tax being charged on “the income of the recipient … arising in the year …”.[40]  In recommending that the measure of assessable income should be the income which accrued during the basis period, the Inland Revenue Ordinance Committee in its report of December 1954 also recommended that tax should not be charged on any portion until it is received, so that “a person who has earned a salary but is unable to obtain it because, for example, his employer is insolvent, will not be taxed thereon until it is received”, and that a sum which is available to a person but not drawn by him is deemed to have been received, so that “a person will be precluded from so arranging his affairs as to avoid receiving sums due to him”.[41]  These recommendations found their way into the statute and are now reflected in the provisions of sections 11B and 11D.

47.  The words “accruing”, “accrues” and “has accrued” as used in these sections are not defined in the Ordinance.  We have been referred to the English commercial case of Tael One Partners Ltd v Morgan Stanley & Co International plc [2012] EWHC 1858 (Comm), where the question arose as to whether certain payment premium payable by the borrower had accrued by a certain date under the loan facility documentation in question.  At first instance Popplewell J said:[42]

“ The natural meaning of a fee which has accrued by a certain date is that it comprises a vested right to a sum which is ascertained, or ascertainable by reference to past events. It includes a right to an ascertained, or ascertainable, sum where the payment obligation itself is deferred to a particular date in the future (as was the case with the interest provision in the Facility Agreement). It also extends, in my view, to a sum which will undoubtedly be payable at a future date, but the time for payment of which is uncertain. … But a fee cannot be said to have accrued if the existence of the right to payment is contingent upon the occurrence of an uncertain future event, as distinct from the time at which it may be enforced. This is just as much so if the uncertain future event affects the amount of any payment obligation as it is if the uncertainty affects the existence of any obligation at all. Accrual is concerned with the vesting of rights, albeit that it can include those which are not immediately enforceable.”

48.  When the case reached the UK Supreme Court, Lord Reed, with whom the other members of the court agreed, said:[43]

“ The word ‘accrue’ is generally used to describe the coming into being of a right or an obligation (as, for example, in Aitken v South Hams District Council [1995] 1 AC 262), so that the person in question then has an accrued right, or is subject to an accrued liability, as the case may be. That is the meaning which accrual usually bears, in particular, in relation to interest and other payments. The amount to which there is an entitlement may not be payable until a future date, but an entitlement may nevertheless have accrued. …”

49.  Mr Barlow SC, who appeared for the Taxpayer, did not dispute these descriptions of meaning.  He referred us to Commissioner of Inland Revenue v Lo & Lo (a firm) [1984] 1 WLR 986, 991, where the Privy Council considered, under the pension scheme in question, that the employee had a “vested right” to “accrued” retirement benefits, and the firm had a corresponding “accrued” liability, even though the benefits were only payable in future and even though they would be forfeited if the employee was dismissed for dishonesty, serious misconduct or gross inefficiency.  “He has a vested right which is defeasible only in one possible but unlikely event.”

Applying the principles to the present case

50.  We deal with the position of the EVA Shares first before coming to the Dividends.  Applying the principles to the present case, it seems to us clear that in respect of each award, the Taxpayer was given a perquisite on the Award Date in relation to all four tranches of shares.  The shares were bonuses paid with reference to historical financial performance of the unit for which the Taxpayer was responsible while in his UK employment. They were issued shares actually transferred to the Nominee to be held for the sole benefit of the Taxpayer.  Although the shares were forfeitable if the Taxpayer ceased to be a Group employee prior to their Release Dates, subject to and until forfeiture the Taxpayer was to all intents and purposes the beneficial shareholder, entitled to receive dividends, vote the shares and exercise other rights of a shareholder via the Nominee.  The dividends declared were his to keep even if the shares were subsequently forfeited.  If he should unfortunately die or have to cease employment because of disability, the shares would remain his and not be forfeitable.  If Investec plc was affected by a takeover or merger, the shares would also become non-forfeitable.  The evidence further suggests that in practice, EVA Shares awarded to an employee would seldom be forfeited upon his resignation, as opposed to termination for misconduct.

51.  While the EVA Shares were in addition subject to clawback until their Release Dates, the provisions of both clauses 1.2.1 and 1.2.2 of Appendix 2 to the award letters were concerned with the results of the financial year in respect of which the award was made, not with future performance.  Clause 1.2.3 and clause 1.2.4 (which applied to the second and third awards) were more widely worded, but the Taxpayer’s evidence, which the Board accepted, was that:

“ in his knowledge and experience, EVA Shares awarded to an employee within the Group would mainly be ‘clawed back’ in case of a reversal of performance of the business unit in the financial years for which the awards were made to the employee. He had never heard of a case where an award of such shares was forfeited just because there was a decline in the general financial performance of the Group or the relevant business unit in subsequent years. He also stated that such factors about future performance would be relevant to LTIP Shares awards but not the EVA Shares awards.”[44]

Whilst the Board correctly distinguished between the construction of the contract terms and the practical experience of the Taxpayer,[45] how the scheme operated in practice was part of the circumstances relevant to the factual question of whether the benefit could be turned to pecuniary account.

52.  As such, it seems to us that as soon as the EVA Shares were awarded to the Taxpayer, they were capable of being turned to pecuniary account.  The Board did not deal with the question but the Judge accepted that the Taxpayer could make an unconditional sale of the EVA Shares following the awards.[46] As shown by Ede v Wilson and as submitted by Mr Barlow, the restriction upon sale or transfer does not prevent the Taxpayer from contracting to sell the shares on a deferred-delivery basis, although it may affect the price a purchaser may be willing to pay.  Mr Brewer did not contradict this other than by submitting that the shares were inalienable on account of not yet being vested.  As explained below, the Taxpayer’s rights in the shares were in our view vested though defeasible.  The shares brought with them the entitlement to an income stream by way of dividends, which could be passed on to the purchaser as soon as they were paid.  The Board and the Commissioner themselves, in taking the position that the EVA Shares became taxable on the Release Date even though they continued to be subject to the restriction on alienation during the Retention Period, must be taken to have accepted that temporary non-transferability does not preclude the EVA Shares from being a perquisite.  Nor does the fact that the EVA Shares were forfeitable or subject to clawback prevent them from being turned into money, although again such risks may affect their value in the eyes of a purchaser depending on, among other things, his assessment of the prospects of the Taxpayer’s employment and perhaps also the warranties he may receive from the Taxpayer as seller.  

53.  Mr Brewer relied on Zarin v Commissioner of Inland Revenue [2022] HKCA 412.  That was a case where the taxpayer was granted a restricted award of shares, which were to vest on dates between 2013 and 2015. Before the vesting dates his employment was terminated.  By the termination agreement entered into between the taxpayer and his employer, the unvested shares would vest on the original terms, conditional on the taxpayer performing his obligations under the termination agreement, including providing assistance in respect of litigation regarding an investment by the employer.  The taxpayer was subsequently paid sums representing the interests in the shares that vested.  The relevant debate centred around whether the sums were predominantly for the taxpayer’s past services as employee or for fresh obligations undertaken by him post-termination.  Coleman J and, on appeal, this court[47] held that those sums were for the latter and hence not assessable to salaries tax.  In her judgment, Kwan VP stated that the taxpayer there was not contractually entitled to the vesting of the shares even though a grant was made since under the plan in question a relevant committee could in its absolute discretion at any time reduce or cancel an award or impose additional conditions before vesting.[48]  In our view that decision provides no assistance to the Commissioner in the present case.  The terms on which the share award in Zarin was made were different.[49]  It did not appear that the taxpayer became the registered or beneficial holder of the shares with voting and dividend rights before the vesting dates, and it was not apparent that anything of value could be said to have accrued to the taxpayer on the date of the award itself.  Nor did it appear that the discretion to reduce or cancel or impose conditions on an award was subject to any express or implied restraint.

54.  On behalf of the Commissioner, Mr Brewer submits that the appeal turns on the proper construction of the term “accrues” in the provision in section 11D(b) that “income accrues to a person when he becomes entitled to claim payment thereof”.  It is said that the cases of Weight v Salmon, Ede v Wilson and Abbott v Philbin dealt with the question of whether the benefit concerned was a “perquisite”, not when the taxpayer became entitled to claim payment of the particular benefit or more generally the question of accrual, which was absent from the relevant statutory language there.

55.  We do not think that these cases and the meaning of perquisite as explained in Tennant v Smith are irrelevant as submitted by Mr Brewer.  It is true that they were not concerned with any provision based on the word “accrual”, but the question of when income accrues may depend on the nature of the income and, in the case of a non-monetary benefit, on whether it is a perquisite, and therefore income, within the meaning of the statute as established by the cases.  In particular, the central issue in Abbott v Philbin was when the taxpayer should have been assessed to income tax in respect of the share option granted to him.  The principle adopted was that if the benefit when first obtained qualified on analysis as a perquisite, then it was taxable in the year of receipt.  The Board does not appear to have directed itself with reference to this question.

56.  The result of the above analysis is in our view entirely consistent with the statutory provisions in sections 11B and 11D.  Once awarded, rule 2.11.1 required the shares to be transferred, and the Taxpayer became entitled to claim “payment” of the shares, as the Judge held.[50]  The award certificates, which were issued as a deed – and thus actionable even in the absence of any consideration moving from the Taxpayer, specifically provided that a right was created which the Taxpayer could enforce against Investec 1 Limited. Supposing that despite an award having been made, no share was transferred to the Taxpayer or any nominee for his account, plainly the Taxpayer could make a claim against Investec 1 Limited in respect of such failure.  In our view the EVA Shares “accrued” to the Taxpayer upon the awards being made within the meaning of section 11D(b).  True it is that the shares were subject to forfeiture and clawback up to the Release Date and to restriction on transfer until the end of the Retention Period, but as discussed above they did not prevent them from being a “perquisite” and therefore “income”.

57.  This analysis is also consistent with the general meaning of the word “accrue” urged upon us by Mr Brewer with reference to Tael One Partners.  On the facts of this case the rights of the Taxpayer to the EVA Shares came into being, and he acquired vested rights to them when the awards were made, even though those rights could come to an end on certain conditions being activated.

58.  The Board’s error was in applying section 11D(b) not by asking when the Taxpayer became entitled to claim payment of the EVA Shares, but by asking when the shares ceased to be subject to forfeiture.  In saying that the Release Date was the time when the Taxpayer became entitled to the “value” of the EVA Shares awarded, the Board overlooked that the shares were immediately of value to the Taxpayer when awarded even if their full market trading price might not be realisable until the end of the Retention Period.[51]

59.  Mr Brewer placed great store on the language in the award letters and certificates that the shares would “vest” on their respective Release Dates and that before then they were “unvested”: see §17 above.  The draftsmen of those documents clearly assumed that “vesting” would occur upon the Release Date.  Such terminology is however far from conclusive for tax purposes.  As stated in Fuchs,[52] the question has to be approached as a matter of substance and not merely of form, and without being “blinded by some formulae which the parties may have used”.  As a matter of ordinary trust law, once the shares were transferred to the Nominee to be held for the Taxpayer, a trust was constituted and he had an equitable interest in the trust assets which was vested in possession, carrying the right to income.  This intention is clear from the terms that the Taxpayer was (in his case, through the Nominee) evidently the holder of the EVA Shares, entitled to vote and receive dividends and take part in any variation of share capital, unless the interest is determined.  It is true that the Taxpayer’s interest was both defeasible because it was capable of being brought to an end (or reduced) by the exercise of the power of clawback, and terminable because it was subject to forfeiture if he should cease to be a Group employee.  But neither prevents the Taxpayer from taking, from the inception of the awards, a vested interest in the shares, albeit both defeasible and terminable: see Lewin on Trusts (20^th ed), §§1-048 to 1-052.  Mr Brewer’s contention that the Taxpayer’s interest was “contingent” and subject to a “litany of conditions precedent” seems to us to be unfounded on the facts of this case.

60.  Quite apart from the requirement of accrual in the year of assessment, there seems to us to be a real question in this case whether the EVA Shares could properly be said to be income from the Taxpayer’s Hong Kong employment.  The peculiar feature of this case is that the Taxpayer’s employment moved from Investec Bank plc in the UK to Investec HK in Hong Kong, and the EVA Shares were granted during the former but ceased to be forfeitable and subject to clawback during the latter. The Board focused on the fact that the EVA Shares ceased to be terminable in the Relevant Years, and became truly the Taxpayer’s, due to his continuing employment with Investec HK.[53] In doing so the Board did not, it appears, attach any significance to the fact that the awards were made as bonuses for the Taxpayer’s performance under his UK employment in the first place.  It is true that the shares were forfeitable if the Taxpayer ceased to be a Group employee, and his employment with Investec HK meant that the condition for forfeiture was not triggered.  But viewed in the context of the entire circumstances, this does not in our view render the awards payments in return for acting as or being an employee or as an inducement to provide future services in relation to his Hong Kong employment (see Fuchs, §17).  There is force in the Judge’s criticism that the Board appears to have proceeded on a “but for” basis and regarded the EVA Shares as income from the Hong Kong employment simply because they would not have ceased to be forfeitable but for that employment.

61.  Mr Brewer said that the Taxpayer had to do much more than simply remain in employment.  But the fact is that the shares were bonuses for past performance.  Even if one takes clause 1.2.3 of Appendix 2 to the award letters at face value, what was needed was to avoid a “material downturn” in financial performance so as to avoid clawback, not to achieve performance which would warrant bonuses.  The evidence would suggest that as far as EVA Shares were concerned, the clawback was meant to apply to adjustment of the financial results of the year for which the awards in question were made.  The Taxpayer’s employment contract with Investec HK contained separate provision for a discretionary bonus scheme based on the EVA model and the Taxpayer was eligible for fresh EVA Share awards on the strength of his performance in his Hong Kong employment.  It is unrealistic on the totality of the facts of this case to characterise the EVA Shares awarded by his UK employer (as opposed to the LTIP Shares) as being “from” the Taxpayer’s Hong Kong employment.

62.  As to the Dividends, to the extent that they were declared by Investec plc during the Relevant Years, it may be correct to say that they accrued to the Taxpayer (via the Nominee as trustee) during that period, since dividends became a debt payable to a shareholder upon being declared.[54]  But they were payments that accrued to the Taxpayer pursuant to his trustee’s legal rights under the Articles of the company as a holder of shares – shares which had been transferred to the Nominee and held on trust for the sole benefit of the Taxpayer since the years 2012 to 2014.  It would be far-fetched to regard them as a perquisite from the Taxpayer’s Hong Kong employment during the Relevant Years.  In holding the Dividends taxable, the Board focused simply on the non-forfeiture of the EVA Shares due to the Taxpayer’s continuing employment with Investec HK, and failed to find the real source of such payments.  In our judgment, the Judge was right to hold that the Dividends were received by the Taxpayer as a result of his receipt of the EVA Shares awarded to him by virtue of his UK employment.[55]

Conclusion

63.  For the above reasons, in our judgment the application of the Ordinance, properly construed, to the undisputed primary facts required the conclusion that the EVA Shares were perquisites that accrued to the Taxpayer when awarded, and were not income from his employment in Hong Kong. The Judge was right to hold that the Board erred in law and was right to order that the relevant assessments be annulled. 

64.  Accordingly, the appeal is dismissed.  There will be an order that the Commissioner do pay the Taxpayer the costs of the appeal, which, by agreement, include also the costs of the application for leave to appeal before Deputy Judge Dawes SC.