BANK OF INDIA v. COMMISSIONER OF INLAND REVENUE

Headnote

S.14 Inland Revenue Ordinance; whether "profits arising in or derived from Hong Kong.

Held:

IN THE SUPREME COURT OF HONG KONG

HIGH COURT JURISDICTION

INLAND REVENUE APPEAL NO. 4 OF 1988

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BETWEEN

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JUDGMENT

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1. This is an appeal by way of case stated by the Bank of India against the decision of the Board of Review given in favour of the Commissioner. In its business in Hong Kong, the Bank made substantial profits in discounting foreign bills of exchange and, to a lesser extent, in respect of commitments on loans to overseas borrowers.

2. Under section 14 of the Inland Revenue Ordinance (Cap. 112):

"... profits tax shall be charged ... on every person carrying on a trade, profession or business in Hong Kong in respect of his assessable profits arising in or derived from Hong Kong ... from such trade, profession or business..."

3. The Commissioner assessed the profits for certain years to tax. The Bank appealed to the Board, which rejected the appeal and upheld the assessment. The crucial question in the appeal is whether the profits in question are "profits arising in or derived from Hong Kong".

4. The facts are fully recorded in the case stated and the documentary exhibits annexed to it. It is accordingly only necessary for me to describe them very briefly. It is not disputed that the Bank carries on business in Hong Kong. It was active in trade financing and dealt in large numbers of bills of exchange which had not matured. The bills in question originated from international trade and the drawers of the bills were suppliers of goods. The drawees were importers of goods residing outside Hong Kong. The Bank was the payee. Upon maturity of the bills they were presented for payment overseas in the country of residence of the import by the Bank's overseas correspondent bank. It was from these transactions that the Bank derived profits representing the difference between the costs to the Bank of the bills and the proceeds due to the Bank upon maturing of the bills. Such transactions accounted for a substantial portion of the profits earned by the Bank during the years in question.

5. A "topical" transaction involved the following steps:

6. As to the commitment fee, the Bank was involved in a syndicated loan arrangement. The loan was granted to a Burmese corporation. The leading bank in the syndicate was Chase Manhattan Asia Ltd. which made the arrangement. The Manager of the Bank in Hong Kong flew to Rangoon and the agreement was signed there. In committing itself to provide a loan of up to US$4 million, the Bank became entitled to a commitment fee of 0.75% on the undrawn amount of the loan. The loan agreement was governed by the Laws of Hong Kong.

The Questions of Law for the Opinion Of the Court

7. The questions of law for the opinion of the court are:

8. The answers to (ii) turn on the proper test to be applied in determining whether the profits were profits "arising in or derived from Hong Kong" in terms of section 14 of the Ordinance. It is convenient to consider that test first and I now proceed to do so.

9. The Board applied the operations test; that is not disputed. It it what the test is or should be that is disputed. I think it fair to assume from the case stated, that the board accepted as the operations test, the formulation concisely set out by Hunter J. (as he then was) in Sinolink Overseas Ltd. v Commissioner of Inland Revenue (1985) 2 HKTC 127; 130; 131, which was urged upon the Board by the Commissioner's representative although not necessarily by reference to that decision. Hunter J. put it this way :

"There was no issue between Counsel as to the proper tests to be applied in the construction of section 14. In Hong Kong and Whampoa Dock Company (No. 2) v. Commissioner of Inland Revenue (1960) HKLR 166, the Full Bench adopted as appropriate to the construction of this section two tests particularly associated with Lord Atkin. First in Smidth v Greenwood (1921) 3 K.B. 583, 593, Atkin L.J. formulated the question arising in these terms: 'Where do the operations take place from which the profits in substance arise".

 

Later when giving the advice of the Privy Council in Rhodesia Metals Limited v Taxes Commissioner (1940) 3 All ER 422, 426, he quoted with approval a test in fact first formulated by Isaacs J. in Nathan v. Federal Commissioner of Taxation (1918) 25 C.L.R. 183 as follows :

 

 

I readily accept these tests which raise a pure question of fact, are those which I must seek to apply.

10. Mr. Gordon Fisher for the Bank submits that that is an over simplification of the decision of the Full Court. He submits that the test should be:

"Where do those acts/operations take place which are more immediately/proximately/ directly responsible for the receipt by the appellant of the particular income (sought to be assessed)?"

He seeks to arrive at that result by a not uncomplicated route. I will touch upon it only briefly since I regard decision of the Full Court in the Hong Kong and Whampoa Dock Co. Case ("the Dock case") as binding on this court, a factor that did not escape Mr. Fisher since he claims to found his exposition of the proper test not in conflict with the Dock case, but as the test properly discernible from it.

11. It is clear that the Full Court in the main adopted the test formulated by the English courts. Mr. Fisher submits that the Smidth v Greenwood principle, while a correct principle to be taken into consideration in determining source, is in fact a geographical locational test (Dock case p.105; Smidth case pp.207- 204); and that the Australian authorities should be looked to as far more relevant to the determination of source than are the English authorities. I pause to observe that the references made by the Full Court to Australian authorities in the Dock case (at pp.111 and 112) do not necessarily concede that. In the context of the sort of survey possible in this appeal, I do not feel able to say that the relevant basis, scheme and language in the Australian legislation are closer to those in section 14 than are the English provisions and that accordingly the interpretation and application of the former in the Australian authorities should be of more relevance that the English authorities.   The decisions and the principles they contain would have to be examined and compared. However, the Australian authorities were considered, and indeed partly relied upon, by the Full Court which nevertheless did not adopt the test contended for by Mr. Fisher, except to the extent of praying in aid the principle enunciated by Dixon J. ("the Dixon principle") in Commissioner of Taxation (New South Wales) v Hillsdon Watts Limited 57 CLR 36, in the context of the Australian legislation permitting apportionment of profits, in the following way:

"If it is possible to ascertain how much of the profit is obtained, although in an unrealised form at successive stages of the operations, the sum realised may be dissected and separate parts of it attributed accordingly to the places where the respective stages of the operations are completed. If this cannot be done and the total profit recovered is an inseparable whole obtained as the indiscriminate result of the entirety of the operations, the locality where it arises must be determined by considerations which fasten upon the acts more immediately responsible for the receipt of the profit." (Emphasis supplied)

12. Reverting to Mr. Fisher's submission, he urges therefore that the Australian authorities should be adopted and the test formulated by Lord Atkin qualified not only by the Dixon principle (i.e. the acts more immediately responsible for the receipt of the profit) but also by "proximately" responsible (see Esquire Nominees Limited v. Federal Commissioner of Taxation 129 CLR 177) and "directly" responsible(see Mr. Morgan Gold Mining Company Limited v Commissioner of Income Tax (Queensland) 33 CLR 76, 110)

13. Reece J. giving the leading judgment of the Full Court in the Dock case, immediately after quoting the foregoing passage of Dixon J's judgment, said:

"The salvage operations or services being partly performed or rendered in Hong Kong and in the absence of any provision in the Ordinance for apportionment it seems to me that the principle enunciated by Dixon J. above may properly and appropriately be applied to this case and that the locality where the profits arise' must be determined by considerations which fasten upon the acts more immediately responsible for the receipt of the profit'. Here the contract of salvage was entered into in the Paracels and all the work of refloating and putting the vessel into a condition to be towed to Hong Kong and nearly all the tow, except for the last 3 miles, were completed beyond the territorial limits of Hong Kong and consequently I take the view that the profits must be said to arise outside of Hong Kong rather than inside. "

The question thus arises of whether the Dixon principle was accepted as appropriate on the particular facts of that case. It seems to me that Hunter J. in Sinolink thought so in disregarding the principle altogether apart from explaining why he did so in the following words:

"I cannot however accept the further use counsel sought to make of these earlier authorities. They sought either to argue from or to criticise factual deduction made in these cases. I do not regard this as right or helpful. One of the problems of the authorities in this field to my mind, is that on occasions what were initially formulated as explanations of factual determinations had a tendency to harden into apparent presumptions of law. "

It should be noted that "these earlier authorities" referred to by Hunter J. included the Dock case. It seems to me that his observations are just as appropriate to the authorities cited by Mr. Fisher in support of the inclusion of "proximately" and "directly"; indeed some of those authorities seem to have been cited to him. Likewise Blair-Kerr J. who was a member of the Full Court in the Dock case also disregarded the Dixon principle in C.I.R. v. International Wood Products Limited (Hong Kong Tax Cases 551, 565) and observed that the facts in the dock case differed materially.

14. I would respectfully concur in the approach adopted by Hunter and Blair-Kerr JJ. It is not without significance that despite the extensive research that has been undertaken in this appeal, not one instance of the adoption of the Dixon principle subsequent to the Dock case has emerged.

15. The very meaning of "more immediately responsible" is far from clear. "Immediate" is defined in the Concise Oxford Dictionary as "direct, without intervening medium", and "occurring at once, without delay". It may be observed that "proximately" which Mr. Fisher has also contended for, conveys much the same meaning. Since in this case the operations concluded with the payment of the bill in Kuwait, the ordinary meaning of "immediately" would very likely result in the presentation of the bill being regarded as the act more immediately responsible for the receipt of the profit. But that is contrary to authoritative dicta in Australia, whence the Dixon principle comes. As pointed out by Reece J. in his leading judgment in the Dock case (at p.117) Lord Davey in the Kirk case said:

"The fallacy of the judgment of the Supreme Court in this and in Tindal's case is in leaving out of sight the initial stages, and fastening their attention exclusively on the final stage in the production of the income. "

And in Hillsdon Watts, Latham C.J. said:

"Income which is received by a person may be the result of a whole series of operations conducted in different countries. When it becomes necessary to determine what are the sources of income it is a mistake to concentrate attention on 'the final stage' in the operations which actually brings in the money which constitutes the gross income. "

Reece J. himself having held that the Dixon principle could properly and appropriately be applied in the Dock case (at p. 116) immediately went on to do so in the following terms, disregarding the final, albeit essential step:

"Here the contract of salvage was entered into in the Paracels and all the work of refloating and putting the vessel into a condition to be towed to Hong Kong and nearly all the tow, except for the last three miles, were completed beyond the territorial limits of Hong Kong and consequently I take the view that the profits must be said to arise outside of Hong Kong rather than inside. "

Hunter J., of course, adopted a similar approach in Sinolink, albeit without any reference to the Dickson principle in his judgment. There are other examples of that approach in Australia,and in Hong Kong (e.g. CIR v. International Wood Products).

16. In my view therefore the Dixon principle was prayed in aid in the Dock case on its own facts. If it is relied upon at all in the particular facts of a case, it should be construed in terms, not, for example, of proximity of time but of responsibility, as in the Dock case.

17. Mr. Fisher goes on to suggest that that approach in Sinolink (and presumably in other Hong Kong cases including the Dock case) was adopted per incuriam since the Privy Council decision in C.I.T. Bombay v. Chunilal B. Mehta (1938) AIR 521 was not drawn to the attention of any of the courts. However, despite the powerful judgments of the Board and the court below, and the similarity of the Indian statutory provision i.e. "profits ... derived, accruing or arising ... in British India" ..., the facts are clearly distinguishable. In that case the taxpayer in Bombay traded or speculated overseas in commodity futures contracts. The purchases and sales which between them produced the profit, both took place overseas e.g. in New York or Liverpool; only the instructions to purchase or sell originated in Bombay. In the present case the bills were purchased in Hong Kong, and much else was also done in Hong Kong. I am not persuaded that the courts in the Dock case or in Sinolink would have taken a different view had the Mehta case been cited to them.

18. As to the Australian authorities cited by Mr. Fisher to show that the proximate act in terms of time and sequence e.g. the sale in purchase and sale trading transactions, determine the locality where the profits arose, in my view they cannot be safely regarded as other than decisions on their own facts.

19. To sum up, in my judgment, the operations test as applying to Hong Kong in the light of the Dock case is that conveniently set out by Hunter J. in the Sinolink case (see pp. 5 and 6 above).

20. I turn now to the first question of law for the opinion of the court; Mr. Fisher submits that the Board:

21. As to (a) (the nature of discounting) it is not disputed that what took place was an outright sale. In fact the application was for purchase of the bill and in law the transaction was a sale (Willingale v International Commercial Bank Ltd. (1978) AC 834). It was not credit or a loan (Chow Yoong Hong v Choong Fah Rubber Manufactory (1926) AC 209, 215 - 216). But I do not think the Board erred as to the legal position. It stated at page 20 of the case that "the conclusion we have reached as a matter of fact (see the opening words of the Application Form) and of law the bank did purchase the bills and the whole property and interest in them”. And although it referred to credit, I do not think this was intended to refer to the legal position; see the Board's conclusions at paragraph 5:1 "we find as a matter of fact that the discounting by the Bank of its customer's Bills as described to us in this case was in the nature of granting credit" (emphasis supplied). And in a practical sense that is right. Even the Bank's Hong Kong branch manager viewed it in that light. Viewed as a whole, in practical terms, the transaction provided the customer with an advance pending payment by the drawee, and that was what the Borad had in mind. I can see no merit in this point and propose to waste no more time upon it.

22. Proceeding to (b), it should be apparent from what I have said in the preceding paragraph that the Board correctly identified the legal nature of discounting bills as an outright purchase.

23. As to (c), the Board found "as a mixed matter of law and fact" that the profits from the discounting were derived from or arose in Hong Kong. It is not disputed, and on the authorities is overwhelming clear that source is a question of fact. That being an error ex facie, on the authority of Edwards v Bairstow (1956) AC 14, this Court would have to intervene and, it is not disputed in the particular circumstances, itself review the facts found in the light of the proper test, rather than remit the matter to the Board. I will turn to that shortly. It must be said, though, that the error is not a matter that affects the determination of the Board.

24. Proceeding to (d), as to the weight given to the "treasury function", clearly the Board was entitled to give that factor weight, in my view, considerable weight this having been a financing transaction, which was not disputed. I am not persuaded that the Board did give undue weight to that factor or that it proceeded on any erroneous principle of law. No doubt the point was taken on the basis of the restrictive operations test contended for by Mr. Fisher. Not having accepted the qualified test contended for, I have no hesitation in rejecting the point.

25. Proceeding to the second question of law, in its three individual aspects, it can now be said quite shortly that upon the proper operations test as I have found it, the matters the Board took into consideration are neither irrelevant nor extraneous, that it did not give undue weight to relevant matters and that it did not fail to give weight or proper weight to relevant matters.

26. I turn finally to consider the application of the operations test to the facts of this case. The operations which produced the profits in a sense commenced even before the contracts to discount the bills were entered into i.e. in the ongoing discounting service provided to customers and so gaining their business. There is some dicta that it is not permissible to go beyond the contracts concerned; but now that the location where contracts are made is recognised not to have its former crucial effect in determining source, that is no reason for disregarding pre-contractual operations.

27. The contract itself was of course made in Hong Kong. The application for purchase of the bill was made in Hong Kong. It was processed in Hong Kong and that seems to have been the crucial factor in ensuring the flow of profits from the bills paid in full which depended upon the accurate and effective assessment of customers of the Bank and of the soundness of the related transactions.

28. The purchase of the bill was in Hong Kong and this was no less part of the operations that resulted in the profit than presentation in Kuwait and payment in New York. If too high a price were paid, there conceivably might not have been any profit at all. The funds to purchase the bills and to provide the credit or finance until payment was received many weeks or months later was also provided in Hong Kong.

29. The bills were forwarded to the correspondent Bank in Kuwait from Hong Kong and any instructions needed were formulated and issued in Hong Kong.

30. As against all that only the presentation operations took place in Kuwait. Mr. Fisher was at pains to demonstrate that the Kuwait operations were far more than bare presentation of the bill. Nonetheless, even if it is assumed that they were profit-making operations, they pale into insignificance by comparison to the operations in Hong Kong.  But more to the point, it seems to me that the routine presentation operations in Kuwait, farmed out to a correspondent bank and paid for by the buyer would not be regarded by a practical man seeking to determine a hard matter of fact as part of the operations from which the profits arise. Moreover, in practical terms, those operations in Kuwait were not operations of the Bank. True, there would be no profit if the Bill was not presented, but that is not the question. Furthermore, to suggest, as Mr. Fisher did, that no profits could have arisen in Hong Kong in terms of the discounting transactions until the bills were accepted in Kuwait, and until that time there could be no profit at all is beside the point and unreal. To adopt such a view would mean that to avoid the tax a tax payer would merely have to provide that he was not to be paid until e.g. an invoice was presented overseas. If that is the effect of Hilsdon Watts and Commissioner of Taxation v. D. & W. Murray Ltd. 42 CLR 332, which I do not accept, then, in regarding those Australian authorities as decided on their own facts, the Hong Kong courts in the Dock, International Wood Products, and Sinolink cases are clearly right.

31. In the result I have no hesitation in coming to the conclusion that on the proper test the operations from which the profits in substance arose took place in Hong Kong; indeed even on the restrictive test contended for by Mr. Fisher, upon the foregoing facts I should perforce have come to the same conclusion. As to the Board's decision, it follows from what I have said that it both applied the right test and that its conclusions as to source have not been shown to be wrong. There is ample evidence upon which it could properly come to those conclusions. The Bank's appeal accordingly fails, and it remains only for me to formally answer the questions of law stated for the opinion of the Court. I do so in the following way:

32. Unless counsel wish to address me on the matter I (propose to give the Respondent his costs.