COMMISSIONER OF INLAND REVENUE v. MALAYSIAN AIRLINE SYSTEM BERHAD

IN THE SUPREME COURT OF HONG KONG

HIGH COURT

INLAND REVENUE APPEAL NO. 2 OF 1992

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J U D G M E N T

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1. This is an appeal, by way of a case stated by a board of review on 13th July 1992, pursuant to the provisions of s.69 of the Inland Revenue Ordinance, Cap.112 ("the Ordinance"). The stated case raises an interesting and possibly important point, arising out of the provisions of the Ordinance which allow losses to be carried forward for profits tax purposes. In relation to a taxpayer who keeps his principal accounts in a foreign currency this can give rise to difficulties, as the present case demonstrates.

2. The facts found by the board are set out in the stated case but I may summarise them as follows.

3. The respondent taxpayer is a company incorporated outside Hong Kong. It carries on an airline business. It has a branch in Hong Kong, which earns substantial revenue. It maintains its principal accounts in Malaysian ringgits ("the base currency").-

4. The taxpayer is subject to the regime prescribed by s.23C of the Inland Revenue Ordinance. This provides that its assessable profits for profits tax purposes for any year of assessment shall be a portion of its total world-wide profits calculated in accordance with the provisions of the Ordinance.

5. In most years over the last 20 years or so, the taxpayer's Hong Kong branch has made a loss. The assessor duly informed the taxpayer of the amount in Hong Kong dollar terms of the accumulated carry forward loss in each year, as ascertained by him, by the issue to the taxpayer of a "loss notice" in Form IR87A. The taxpayer has never agreed or accepted the content of these notices, nor the basis on which they were prepared.

6. Although an assessment has to be made of profits in order to arrive at the amount of profits tax payable by the taxpayer, there is no need, in a year in.which the taxpayer makes a loss, to make any assessment of its loss for tax purposes. Those losses may be carried forward to future '. years. In the books of account of the taxpayer maintained for its own purposes in its base currency, those losses will be carried forward in that currency.

7. The position, therefore, was that the taxpayer had no right or need to challenge and did not challenge the loss calculations made by the assessor. But in the years of assessment 1987/88 and 1988/89, the taxpayer made substantial profits. The profits the taxpayer made for 1988/89 exceeded the amount of the then available carry forward losses as calculated by the assessor. The method of calculation of the carry forward loss adopted by the assessor in respect of each year was to take an appropriate rate of exchange for the year of assessment in question and to convert the amount of that year's carry forward loss into Hong Kong dollars. This, so far as the assessor was concerned, was the final and fixed sum of the carry forward loss in Hong Kong dollars. To it was then added the amount in Hong Kong dollars of the balance of the previous carry forward losses. Whenever there was a taxable profit in any year of assessment, the same was likewise converted into Hong Kong dollars by applying an appropriate rate of exchange and the Hong Kong dollar amount was deducted from the then balance in Hong Kong dollars of the carry forward losses.

8. But, as I have indicated, the taxpayer, maintaining its own principal accounts in its base currency, did not in those accounts convert its losses in Hong Kong into Hong Kong dollars. It carried them forward in the base currency. The taxpayer says that even for Hong Kong taxation purposes this approach is correct, and that the approach of the appellant commissioner, under which the loss in each year is crystallized in Hong Kong dollar terms at the end of that year, is incorrect. I have to decide which of them, for Hong Kong taxation purposes, is right.

9. Although the tax regime to which this taxpayer is subjected is the special regime prescribed by s.23C of the Ordinance, the point which I have to determine is of general application. The parties, as I understand them, agreed that nothing turns, for the purposes of the present case, on the nature of the special regime to which the taxpayer is subjected by virtue of the provisions of s.23C. Any taxpayer with a foreign base and maintaining in its accounts in its own base currency might have to face the point which arises in the present case.

10. In my judgment, a correct analysis of s.19 in Part IV of the Ordinance reveals the answer to the problem. In s.19, provision is made for treatment of losses; and, in particular, in Section 19C provision is made for treatment of losses after 1st April 1975. (There is, in fact, no difference between the regimes existing before and after 1st April 1975 for the purposes of the present case; although there are other differences.)

11. Section 19C(4) provides, so far as is material, as follows:-

"Where in any year of assessment [the taxpayer] sustains a loss ... the amount of that loss shall be set off against the assessable profits ... for that year of assessment and to the extent not so set off, shall be carried forward and set off against ... assessable profit's ... for subsequent years of assessment."

Section 19D(1) provides, so far as is material, as follows:-

"For the purposes of section 19C the amount of loss incurred by a person chargeable to tax under this Part for any year of assessment shall be computed in like manner and for such basis period as the assessable profits for that year of assessment would have been computed."

12. There must be a matching, for Hong Kong taxation purposes, between profits and losses and, if s.19C.(4) is to work as it is intended to do, the commissioner's approach must in my judgment be preferred to the taxpayer's approach. under s.19C(4) it is necessary, before any profits tax assessment is made, for the assessable profits to be determined, for which purpose the amount of any loss (which, like the amount of any profit, will be expressed in terms of Hong Kong dollars) sustained in the relevant year of assessment is to be set off against the assessable profits. It may be that the losses will be less than the profits. If so, the profits will be reduced accordingly and the taxpayer will be assessed to profits tax on the reduced sum. But it may be that the losses will exceed the profits. If they do so, then the set-off will exhaust the profits, leaving an excess of losses. What is to happen then? The excess (still expressed in terms of Hong Kong dollars) is to be carried forward and set off against subsequent profits.

13. It seems to me that this scheme necessitates a fixing at the end of each year of assessment of the sum of the losses just as much as it does the sum of the profits. The profits have to be expressed in Hong Kong dollar terms for the purposes of the payment of the tax. So, too, it seems to me, the amount of the losses have to be expressed in Hong Kong dollar terms for the purpose of deciding both what is set off against the profits and what is not so set off, the latter being carried forward and set_.off against subsequent profits. The figure so quantified in Hong Kong dollar terms seems to me to be the only figure which can be carried forward in this way to be set off against subsequent profits.

14. The board was of a different opinion.

15. The board summarized the contentions of the commissioner in this way:-

"The only disagreement between the Taxpayer and the Commissioner is on a very small but very important point relating to the conversion of the losses from the base currency into Hong Kong dollars. The representative for the Commissioner put forward a very cogent argument that because assessable profits are assessed each year in Hong Kong dollars, therefore, tax losses must likewise be computed and converted into Hong Kong dollars and carried forward in Hong Kong dollars. In effect, she was saying that in normal circumstances where a profit is made, a tax assessment is issued in Hong.Kong dollars, paid in Hong Kong dollars and that is then an end of the matter. The tax affairs of the taxpayer have been concluded once and for all in respect of that year of assessment. In the next following year, the taxpayer starts with a clean sheet and the assessable profits are again computed and are then assessed and taxed in Hong Kong dollars."

The Board said that that submission had a certain logic about it.

16. The Board then turned to the contentions of the taxpayer (which were repeated before me). The Board summarized these as follows:

"The representative for the Taxpayer pointed out that though it may have a certain logic, a distinction must be drawn between computing profits and losses and issuing assessments. He pointed out that he did not dispute that a tax assessment must be in Hong Kong dollars and must be paid in Hong Kong dollars. ... [but] the assessment to tax is nothing more than that, it is an assessment. On the other hand, the computation of the profit is a different operation to the issuing of the assessment and the computation of the profit takes place in whatever is the appropriate currency which is not necessarily Hong Kong dollars and in the case before us was the base currency. In the course of the hearing it was pointed out that many businesses maintain their accounts in currencies other than Hong Kong dollars and it is necessary.to compute the assessable profits in such currencies. It is only after the profit has been computed that the profit can be and is converted into Hong Kong dollars for the purpose of issuing an assessment. The representative for the Taxpayer pointed out that losses should be computed in the same manner as assessable profits but as there is no profit to be assessed, it is inappropriate to convert the amount at the end of each year into Hong Kong dollars and carry it forward in Hong Kong dollars. It should remain in the base currency."

17. The board was referred to certain authorities, which seemed to them, as they seem to me, to be of no assistance.

18. The board preferred the approach of the taxpayer.

19. In my judgment, the board was wrong to do so. It was I think over-influenced by the fact that the taxpayer maintains its own accounts for its own purposes in its base currency (as it is of course entitled to do) and by the fact that there is no express provision in the Ordinance for the crystallisation of the value of losses for Hong Kong taxation purposes at the end of the tax year. The Board fell into error because it failed to recongize that the calculations which have to be made here are not calculations which have to be made in order that its accounts may give a true and fair view of the taxpayer's affairs to its Malaysian shareholders; they are calculations which have to be made in order to satisfy the requirements of the Ordinance under which it is liable to Hong Kong profits tax, Insofar as this involves the maintenance of separate sets of accounts, one of them for foreign taxation purposes, that is something which any taxpayer based in one country and carrying on business in another may have to face in order to satisfy its obligations to pay tax in the foreign country. I am not, myself, therefore, over-impressed with this consideration,

20. Section 19C(4) only works sensibly if losses (expressed in terms of Hong Kong dollars) are calculated and fixed at the same date as profits (similarly expressed in terms of Hong Kong dollars). To the extent that the losses (still expressed in terms of Hong Kong dollars) fall to be carried forward, they fall for Hong Kong taxation purposes to be carried forward in Hong Kong dollar terms. The board erred in holding otherwise. This appeal accordingly succeeds.

21. The taxpayer must pay the Commissioner's costs of the appeal.