THE COMMISSIONER OF INLAND REVENUE v. GENNON ENTERPRISES LTD

DCTC773/2015

IN THE DISTRICT COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

TAX CLAIM NO 773 OF 2015

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DECISION

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Background

1.  On 3 July 2015, the plaintiff (the “Commissioner”) commenced the present action for the recovery of additional profits tax against the defendant, Gennon Enterprises Ltd (the “Taxpayer”), in the sum of $36,738,008.

2.  The sum comprises the principal amount of additional profits tax assessed to be due and payable in respect of two years of assessment, namely, 2007/08 and 2008/09, together with surcharges imposed under ss 71(5) and 71(5A) of the Inland Revenue Ordinance, Cap 112 (“IRO”).

3.  There are two Summonses before the court.  They were heard together before me.

4.  By a Summons dated 25 September 2015, the Commissioner applied under O 18 r 19 of the District Court Rules to strike out the Defence on the ground that it disclosed no reasonable defence.

5.  By a Summons dated 14 October 2015, the Taxpayer applied for a stay of all further proceedings in this action pending the determination of the Taxpayer’s objections to the Notices of Additional Assessment and Demand for Tax and/or the determination of the appeal, if any, from the Commissioner’s determination to the Board of Review.

6.  According to the Affirmation of Wong Johnny (“Wong”) filed on behalf of the Taxpayer, the additional assessments were made in respect of two offshore companies, Goldmark Development Ltd (BVI) (“Goldmark”) and Chapman International Macao Commercial Offshore Company Ltd (Macao) (“ChapMacao”).  Wong asserts that neither Goldmark nor ChapMacao carried on any business in Hong Kong at the material time.

7.  The Taxpayer says that that the additional assessments were issued on a mistaken basis.  The Commissioner erroneously regarded the Taxpayer, a Hong Kong company, as the business agent of Goldmark and ChapMacao in Hong Kong.  In fact, the profits of Goldmark and ChapMacao in question came from knitting and dyeing of fabrics and the manufacture and sale of garments outside Hong Kong.   Furthermore, Wong argues that the Taxpayer is not the agent of Goldmark and ChapMacao.

8.  The Taxpayer has lodged formal objections against the additional assessments and is awaiting the Commissioner’s determination.  In the event that the determination is against the Taxpayer, it will lodge an appeal to the Inland Revenue Board of Review.

9.  At the hearing Mr Leon Ho, Counsel for the Taxpayer, did not contest the strike-out application.  Consequently he conceded that judgment should be entered against the Taxpayer. 

SUMMONS FOR STAY

10.  In the light of the concession, the argument before me focused on the Taxpayer’s Summons.  It is not disputed that the court has an inherent jurisdiction to grant a stay of execution of its judgment.  The key issue for determination is therefore whether the court should exercise its discretion to grant a stay in the present case.

11.  Mr Lam, Government Counsel for the Commissioner, forcefully submitted that in the light of the legislative scheme for recovery of tax under the IRO, there is no room for the court to stay the execution of its judgment.  In short, the court has little choice but give effect to the statutory imperative of “pay first, argue later”.

12.  At this point, it is convenient to identify the factual and evidential grounds relied on by the Taxpayer in support of its stay application.

Grounds for Stay Application

13.  In essence, the Taxpayer’s argument runs as follows.  If the judgment is not stayed pending the determination of its objections (and further appeals therefrom), the Taxpayer would instantly become hopelessly insolvent, and would probably be wound up. Consequently it would become unable to pay the legal and other professional fees needed to prosecute the objections (and further appeals).  The hardship to the Taxpayer would be oppressive as well as irreversible.

14.  In Wong’s affirmation, he exhibits, among other things, the Taxpayer’s audited financial statements for the year ended 31 December 2014 and its management account for the period ended 31 August 2015.  He includes in his evidence copies of bank statements in relation to the Taxpayer’s account with Standard Chartered Bank (SCB) in Hong Kong, which is said to be the only bank account of the Taxpayer.

15.  According to its latest balance sheet, the Taxpayer had a negative equity of over HK$9.4 million.  It had a cash deposit of HK$33.7 million with SCB in Bangladesh.  The deposit has been pledged to secure banking facilities granted to the Bangladeshi associated company of the Taxpayer to finance its operation in that country.

16.  The Taxpayer has a short-term loan of HK35 million consisting of revolving loan facilities granted by SCB in Hong Kong.  Apart from providing the deposit with SCB Bangladesh, they also provide the cash required to operate the Taxpayer’s business in Hong Kong.

17.  Furthermore, Wong points out that the Taxpayer has current assets with group companies worth about HK$27.2 million and account receivables of about HK$6.5 million.  But these are more than cancelled out by current liabilities with group companies of about HK$44.6 million.  In short, the Taxpayer has both a negative bank balance and a negative equity.

18.  In his affirmation, Wong suggests that the following events will be triggered by an immediate obligation to pay the judgment sum:-

(a) The Taxpayer will be obliged to notify SCB about the judgment (presumably under the terms of the revolving loan facilities);

(b) SCB is likely to freeze the Taxpayer’s account and seize the pledged deposit of HK$33.7 million.  This would render the Bangledeshi associate unable to continue its business;

(c) SCB is likely to cease and cancel any remaining loan facilities extended to the Taxpayer which have provided the only cash available to it to maintain its bare existence and to pay any legal and professional fees, including the fees needed to prosecute its objections to the disputed assessments;

(d) There is a real risk that the Taxpayer will be wound up by the Commissioner or other creditors.  It will be deprived of the opportunity to have its rights and obligations duly determined under the processes provided by law.

Statutory Scheme under the IRO

19.  I must now refer to two critical provisions of the IRO.  Section 71(2) states:-

“Tax shall be paid notwithstanding any notice of objection or appeal, unless the Commissioner orders that payment of tax or any part thereof be held over pending the result of such objection or appeal:

Provided that where the Commissioner so orders he may do so conditionally upon the person who or on whose behalf the objection or appeal is made providing security for the payment of the amount of tax or any part thereof the payment of which is held over either-

(a) by purchasing a certificate issued under the Tax Reserve Certificates Ordinance (Cap 289); or

(b) by furnishing a banker's undertaking,

as the Commissioner may require.”

20.  Next, the same Ordinance provides in s 75 that:-

“(3) In proceedings under this section for the recovery of tax the production of a certificate signed by the Commissioner stating the name and last known postal address of the defaulter and particulars of the tax due by him shall be sufficient evidence of the amount so due and sufficient authority for a District Court to give judgment for the said amount.

(4) In proceedings under this section for the recovery of tax the court shall not entertain any plea that the tax is excessive, incorrect, subject to objection or under appeal, but nothing in this subsection shall be construed so as to derogate from the powers conferred by the proviso to section 51 (4B)(a) to give judgment for a less sum in the case of proceedings for the penalty specified therein.”

21.  In opposing the stay application, Mr Law relied on a number of authorities which throw light on the meaning of those provisions.  It is sufficient for me to examine only two of them.

22.  In Tak Wing Investment Co Ltd v Commissioner of Inland Revenue [2001] 2 HKLRD 266, the facts are somewhat similar to the present case.  The Commissioner commenced an action in the District Court to recover tax assessed under s 75 of the IRO.  The taxpayer filed a defence on the basis that the assessments were incorrect.  This led the Commissioner to apply to strike out the defence on the ground that it was pre-empted by the terms of s 75(4).

23.  The taxpayer responded by filing a summons seeking either a stay or dismissal of the action.  This was apparently premised on an argument that it was an abuse of the court’s process, or at least inappropriate, for the Commissioner to commence enforcement proceedings when he had not determined the objections to the assessments.

24.  Shortly before the summonses were due to be heard, the taxpayer applied for leave to apply for judicial review of the decision of the Commissioner to (a) commence the enforcement proceedings; and (b) apply to strike out the Taxpayer’s defence in those proceedings.  The application having been dismissed by Seagroatt J at first instance, the Taxpayer appealed to the Court of Appeal.

25.  Referring to IRO ss 71(2) and 75(4), Keith JA observed that the statutory process for challenging the assessments on the one hand, and the enforcement proceedings in the District Court on the other, were clearly intended to run in tandem: sup cit, at 270C.

26.  At 270C-G, Keith JA recorded that Senior Counsel for the taxpayer accepted that the words “subject to objection” in s 75(4) would prevent the taxpayer from arguing in any enforcement proceedings in the District Court that the lodging of an objection, or any appeal from the Commissioner’s determination, or any appeal from the Board of Review’s decision to the Court of First Instance or the Court of Appeal, could justify the stay of the enforcement proceedings.

27.  His Lordship continued, at 270H-271G:-

“Since the enforcement proceedings in the District Court and the statutory regime for challenging the assessments are intended to be parallel processes, on what basis can it be said that the enforcement proceedings in the District Court should nevertheless be stayed? The taxpayer's case is that different considerations apply when there has been delay on the part of the Commissioner to determine an objection to an assessment. The principle of "pay now, argue later" embodied in the statutory recognition of the principle that a challenge to an assessment should not defer its enforcement does not apply when the determination of the objection to the assessment has been delayed. Otherwise, the Commissioner is getting both the advantage of relatively speedy payment of the tax and the benefit of being able to delay the time when he might have to repay the tax if his assessments are subsequently revoked or set aside.

I cannot go along with this argument. The statutory scheme is clear. Neither section 71(2) (which deals with when the liability to pay the tax assessed arises) nor section 75(4) (which deals with whether proceedings to enforce that liability can be deferred) can be read as not applying if there is delay on the Commissioner's part in determining an objection of the assessment. Indeed, Mr Scott accepted - and Ms Nancy Kwok for the Commissioner agreed - that the language of section 75(4) prevented the taxpayer from arguing in the enforcement proceedings in the District Court that delay on the part of the Commissioner in determining an objection to an assessment could be taken into account on the application for a stay of the proceedings.” (Emphasis supplied)

28.  At 271 H, his Lordship articulated two reasons for dismissing the appeal:-

“First, if the taxpayer's present application for leave to apply for judicial review was allowed to proceed, it would have the effect of giving to the taxpayer the relief which it could not obtain in the District Court, namely the stay of the enforcement proceedings. The taxpayer would be getting by the back door what it could not get by the front. Secondly, there is a far more appropriate remedy available to the taxpayer, namely an application for leave to apply for judicial review of the Commissioner's failure to determine the objections within a reasonable time.” (Emphasis supplied)

29.  The only other judge, Mayo V-P, concurred in the result, but gave his own reason for dismissing the appeal.  At 273G-I, he expressed it in the following words:-

“My main reason for coming to this conclusion is that it is quite clear from the legislative scheme that it contemplates that where an objection has been lodged it is open to the Commissioner by virtue of section 71(2) [of the IRO] to require the taxpayer to pay the tax payable and then proceed to consider the objection in accordance with the provisions contained in sections 64 to 69A of the Ordinance.”

30.  The second case that I need to refer to is the decision of Deputy DJ D Ho in Commissioner of Inland Revenue v Good Mark Industrial Ltd, DCTC 1003 of 2013, unreported, 29 November 2013.  In that case the taxpayer in its Defence pleaded that the notices of assessment were invalid due to non-compliance with certain arrangements for the avoidance of double taxation between Hong Kong and Mainland China.  The Commissioner applied to strike out the Defence.

31.  In response, the taxpayer applied for leave for judicial review of the Commissioner’s failure to comply with the arrangements.  The application was dismissed.  The taxpayer appealed.  Before Deputy Judge D Ho, it applied for a stay of the action pending determination of the appeal.

32.  After citing the passage from the judgment of Keith JA in Tak Wing, at 270-271 (quoted in paragraph 27 above) the learned Deputy Judge rejected the stay application.  His reasoning appears in the following paragraphs of the Decision:-

“31. In Mr. Lui’s submission, it is not just that the prospect of success in the defendant’s appeal in the judicial review proceedings is so low that no stay of the present proceedings should be granted. It is higher than that because of the effect of s.71(2) of IRO I mentioned above. If a taxpayer has to pay tax notwithstanding any appeal process, the same applies to any parallel judicial review proceedings. He suggested that this also underlined the first reason for Mr. Justice Keith to dismiss the appeal in Tak Wing (supra).

32. I agree.  The law is clearly against any stay of the present proceedings.”

33.  In an attractive and well-researched submission, Mr Ho sought to distinguish Tak Wing and Good Mark from the present case.  The cornerstone of his argument is a line of Australian cases in which the courts have granted a stay of tax recovery proceedings pending a review of a taxation decision, or an appeal from such a review.

34.  To understand this argument, it is necessary to explain the legislative regime for the recovery of income tax in Australia.  The Taxation Administration Act 1953 (“TAA”) of Australia contains the following provisions:-

“14ZZM Pending review not to affect implementation of taxation decisions

The fact that a review is pending in relation to a taxation decision does not in the meantime interfere with, or affect, the decision and any tax, additional tax or other amount may be recovered as if no review were pending.

14ZZR Pending appeal not to affect implementation of taxation decisions

The fact that an appeal is pending in relation to a taxation decision does not in the meantime interfere with, or affect, the decision and any tax, additional tax or other amount may be recovered as if no appeal were pending.

14ZQ General interpretation provisions

taxation decision means the assessment, determination, notice or decision against which a taxation objection may be, or has been, made.”

35.  Mr Ho submitted that ss 14ZZM and 14ZZR of the TAA are in substance equivalent to section 71(2) of the IRO.  They require the taxpayer to “pay first, argue later”.  Notwithstanding the restrictive statutory regime, the Federal Court of Australia has clearly recognised, and occasionally exercised, the inherent jurisdiction to grant a stay of execution of a judgment debt pending a review or appeal of a taxation decision.

36.  For present purposes I need only refer to the latest decision on this topic made by the Federal Court of Australia, namely, Southgate Investment Funds v Deputy Commissioner of Taxation (2013) 211 FCR 274.  The Court reviewed the Australian authorities and identified the factors which guided its exercise of discretion to grant a stay of execution, ibid, at [77]:-

“(a) the power to grant a stay should be exercised sparingly and the taxpayer bears the onus of persuading the Court that a stay ought to be granted in the particular circumstances;

(b) great weight must be given to the clear legislative policy manifested in provisions such as ss 14ZZM and 14ZZR of the TAA which give priority to the recovery of taxation revenue notwithstanding that a taxpayer has a Pt IVC proceeding on foot. The Commissioner is placed by the legislation in a position of special advantage and is generally free to pursue recovery proceedings despite the pendency of Pt IVC proceedings;

(c) the merits of pending Pt IVC proceedings may be a relevant consideration to be taken into account in the exercise of the discretion, but the court should not attempt to determine the merits unless it has sufficient material before it to do so and it should avoid speculation;

(d) in cases where a judge is unable to form even a tentative view of the strength of Pt IVC proceedings, it is unlikely that the judge’s discretion in refusing a stay will miscarry by reason only of the judge being unable on the material before him or her to reach a view as to the taxpayer’s prospects of success in having the assessment overturned;

(e) it is too narrow a view of the discretion to grant a stay of proceedings or execution merely because Pt IVC proceedings are pending, or because on review of those proceedings there appears to be an arguable case or complex questions to be determined by the [Administrative Appeals Tribunal] or the Court;

(f) that is not to say, however, that the outcome of Pt IVC proceedings has to be certain in the sense that they are bound to succeed or fail. That puts the bar too high;

(g) in cases where the Court considers that it is in a position to assess the merits of pending Pt IVC proceedings and that it is appropriate to do so, the weight to be attached to those merits will vary according to the relative strength of the merits. But the taxpayer needs to have more than merely an arguable case;

(h) similarly, more weight would be given to the merits factor if the case is one where the Commissioner has abused his position or it is clear that the Commissioner is endeavouring to collect tax in defiance of a decision of the High Court or other superior court which is precisely in point;

(i) due acknowledgment should be given to the asperity with which provisions such as ss 14ZZM and 14ZZR may operate, but in appropriate circumstances a court might consider that a stay is warranted in cases of extreme hardship to a taxpayer, noting however that:

(i) the mere obligation to pay income tax of itself does not impose extreme hardship; and

(ii) the possibility that the taxpayer may be bankrupted is generally not of itself an extreme hardship, however, different considerations may arise if, for example, it is demonstrated that the execution of a judgment debt would deprive the taxpayer of the financial resources needed to prosecute extant Pt IVC proceedings;

(j) irrespective of the merits of pending Pt IVC proceedings, a stay will not usually be granted where the taxpayer is party to a contrivance to avoid liability to pay the tax; and

(k) other considerations may need to be taken into account in determining whether to exercise the discretion in a particular case, such as any conduct on the part of the taxpayer or the Commissioner which impacts upon the efficient and expeditious conduct of Pt IVC proceedings.”

37.  It can be seen that under the Australian approach, one of the material factors is the merits of the proposed review or appeal.  Mr Ho accepts that it is incumbent on the taxpayer to demonstrate some merits, over and above a merely arguable case, before the Court can exercise its discretion.

38.  As foreshadowed above, the Taxpayer’s argument in the present case is founded on the extreme hardship in the form of the loss of its ability to challenge the Commissioner’s additional assessments.  This would be the severe and irreversible consequence of a judgment, and its enforcement by way of a winding-up petition, unimpeded by a stay of execution, even if the assessments turn out to be wrong.

39.  I will therefore proceed to analyse two issues, namely, (i) whether it is open to me to adopt the Southgate approach as a matter of law, and (ii) if it is, whether the Taxpayer has made out a case for a stay.

Is the Australian approach open to this Court?

40.  On the first issue, Mr Ho urges me to follow the Southgate approach and hold that it is open to the District Court to stay tax enforcement proceedings pending the determination (including any subsequent appeals) of an objection to an assessment in appropriate circumstances.

41.  However, as Mr Law pointed out in his reply, correctly in my view, the statutory scheme under the IRO differs from its Australian counterpart in at least two respects.  Those differences go some way towards mitigating the austerity of the local tax recovery regime.

42.  First, as noted above, under IRO s 71(2) the Commissioner may order a complete or partial holdover of tax payment.  Secondly, he may do so unconditionally, or conditionally upon the purchase of tax reserve certificates or the furnishing of a banker’s undertaking.  No such mitigating measures are available under the TAA.

43.  As far as the local authorities are concerned, Mr Ho contended that Tak Wing may be distinguished from the present case.  In that case the taxpayer complained about the Commissioner’s delay in the determination of its objections.  It did not rely on any individual hardship in challenging the Commissioner’s decision to commence enforcement proceedings.  Likewise, the taxpayer in Good Mark did not invoke any individual circumstances of hardship in applying for a stay of the tax enforcement proceedings.

44.  In effect, Mr Ho’s submission amounts to this.  As long as the taxpayer is able to demonstrate sufficient individual hardship arising from the enforcement of a judgment debt, the door is open for obtaining a stay pending the final determination of an objection. With respect, I do not think that the ratio in Tak Wing is so narrowly confined.

45.  As I read his judgment, Keith JA was of the firm view that a stay of enforcement proceedings pending the determination of an objection (or appeals therefrom) was fundamentally inimical to the statutory regime for tax recovery.  This view formed an essential step in his reasoning, in particular, the first of the two reasons he gave for his decision (sup cit, at 271E-F).

46.  Whilst the learned Vice-President did not express himself in identical terms, his reasoning was essentially the same.  For both members of the court, the challenge to the assessment was a parallel but separate process, and a stay of enforcement proceedings was simply out of the question.

47.  Given that a stay of enforcement proceedings is wholly incompatible with the legislative scheme, personal hardship, however extreme, does not enter into the equation.  It follows that the Southgate approach is not open to me.  Harsh as this conclusion may seem, I am nonetheless bound by the decision of the Court of Appeal. 

Has the Taxpayer made out a case for a stay?

48.  In view of my conclusion on the first issue, there is no need for me to address the second issue.  However, if I am wrong about that, I would nevertheless hold that the Taxpayer has failed to make out a case for a stay.  I would do so for two main reasons.

49.  The first is that the Taxpayer has put no material, and indeed made no attempt, before me to address the merits of its objections to the assessments in dispute.

50.  In Wong’s affirmation, the deponent simply expressed his disagreement with the view taken by the Commissioner on the “agency” issue.  He did not furnish any grounds or documentary evidence to validate or support his own view.

51.  In the circumstances the Taxpayer fails to discharge the onus, which Mr Ho accepts lies on him, of showing that it has more than an arguable case on the merits.

52.  The second reason is that I am not satisfied that there is sufficient evidence of the alleged hardship to the Taxpayer to justify a stay of execution.

53.  In addition to the points identified by Wong in his affirmation and summarised above (paragraphs 13 to 18), the following important matters emerge from the Financial Statements prepared by the Taxpayer’s auditors for the year ended 31 December 2014.

54.  Under “Current Assets” in the balance sheet, it is stated that the Taxpayer had a bank deposit of HK$34,1239,910.  In Note 11, it is explained that this deposit was pledged to secure banking facilities granted to a fellow subsidiary of the Taxpayer.

55.  I believe that deposit actually represents the HK$33.7 million deposit which, according to Wong, had been pledged in favour of SCB Bangladesh to support the operation of an associate company in that country (see paragraph 15 above).  The small difference of about half a million HKD is attributable to an overdraft which appears in the latest management account (as at 31 August 2015).

56.  Further, according to Note 12 to the Financial Statements, the HK$35 million short term loan (see paragraph 16 above) granted by SCB HK to the Taxpayer was secured by :-

(a) A “mortgage over a fellow subsidiary’s buildings situation in Hong Kong, which had an aggregate carrying value at the end of the reporting period of HK34,709,701…”; and

(b) A “pledge of bank deposit of a fellow subsidiary amounting to HK$23,354,085”.

57.  It is also noted by the auditors that the same loan of HK$35 million was further guaranteed by “certain fellow subsidiaries”.

58.  In short, it is apparent that the Taxpayer is part of a larger group of companies which have significant financial resources at their disposal.  They have chosen to devote those resources, worth around HK$58 million (the aggregate of the securities mentioned in Note 12) in carrying value, to supporting the business of the Bangladeshi subsidiary (or associate company).  This is effected through a series of back-to-back loans, deposits and pledges.

59.  What is not explained by Wong is how much of those resources would be left after payment of the judgment debt. There is no evidence of the current level of indebtedness of the Bangladeshi associate and the likely reaction of SCB (other than Wong’s personal opinion).

60.  But even if, as Wong conjectures, SCB were immediately to seize the entire $33.7 million of the deposit pledged by the Taxpayer, there would still be a substantial cash reserve of $23 million in the hands of its fellow subsidiaries.

61.  Similarly, there is no updated valuation of the buildings owned by the unnamed fellow subsidiaries.  I do not know, but it may be that more money can be raised by re-financing or a second mortgage.

62.  Plainly, in applying for a stay, it is incumbent on the Taxpayer to come clean and disclose in full the nature and amount of financial resources at its disposal.  In the context of a close-knit group of companies, such resources must include those which the Taxpayer is able to garner from its fellow subsidiaries and associates, or his “friends and relatives” in the context of an individual taxpayer.  After all, they share a common economic interest in the continued survival of the group as a whole.

63.  All in all, I am far from satisfied that the doomsday scenario envisaged by Wong will be the probable result of a refusal of a stay.  Why, I ask rhetorically, would the associates and fellow subsidiaries of the Taxpayer suddenly terminate the significant financial support that they have hitherto extended to it?  One would expect them at least to put up the relatively modest professional fees which may be required to contest what they believe to be an unjust and massive tax liability.

64.  For these reasons I would dismiss the stay application in the exercise of my discretion.

Conclusion

65.  On the Commissioner’s Summons, I would make the following order:-

(a) The Defence filed on 10 August 2015 be struck out on the ground that it discloses no reasonable defence;

(b) Judgment be entered for the plaintiff against the defendant for the sum of $36,447,092.52 together with interest on $36,738,008.00 at the rate of 8% per annum from 3 July 2015 to 7 August 2015, and on $36,447,092.52 at the same rate from 8 August 2015 to the date of Judgment and thereafter at judgment rate until payment;

(c) The costs of and occasioned by the application, and the costs of this action, be paid by the defendant to the plaintiff, with certificate for counsel, to be taxed if not agreed.

66.  The Taxpayer’s Summons dated 14 October 2015 is dismissed.  The costs of and occasioned by the application will be paid by the defendant to the plaintiff, with certificate for counsel, to be taxed if not agreed.

67.  In respect of both Summonses, the costs orders will be nisi in the first instance.

68.  I am indebted to both Counsel for their assistance in this matter.