YEE AIK EE v. COMMISSIONER OF INLAND REVENUE

 HCAL49/2005

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

CONSTITUTIONAL AND ADMINISTRATIVE LAW LIST

NO. 49 OF 2005

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J U D G M E N T

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1.  In these proceedings, the applicant seeks to judicially review the decisions of the Commissioner of Inland Revenue (“the Commissioner”) refusing to re-consider his late objections to the assessments to tax for the years of 1997/1998 to 2001/2002.  The Commissioner has taken the view that since the revised assessment for the year 1997/1998 was agreed under section 64(3) of the Inland Revenue Ordinance, cap.112, the applicant has no right to re-open and object to it.  As for the assessment and additional assessments for the years 1998/1999 to 2001/2002, the Commissioner has declined to extend the time for lodging objection, having regard to the reasons advanced by the applicant.  The primary basis of the applicant’s case for judicial review is that he was operating under a mistake as to the computation of the undercharged tax.  It is also his case that the Commissioner should have known, but failed to ascertain whether, he was mistaken.

The facts

2.  Between 1995 and 2002, the applicant was the sole proprietor of Jianli Vacuum Forming Company (“Jianli”) that engaged in the manufacturing of plastic blister packs for packaging.  The company ceased trading on 31 March 2002 upon the incorporation of the business.

3.  For the years of 1997/1998 to 2001/2002, the applicant had submitted individual tax returns, in which he had declared the assessable profits of Jianli.

4.  By letter dated 27 May 2003, the Inland Revenue Department (“IRD”) informed the applicant that a tax audit would be conducted on him and Jianli.  An initial interview attended by the applicant and his wife and the representatives of IRD was held on 11 June 2003.  On 16 October 2003, the applicant appointed Mr Keith Grant of KWG Tax Services Limited (“KG”) as his tax representative.

5.  By a fax dated 22 October 2003, the IRD informed the applicant its proposed computations of the understated profits of Jianli for the year 2000/2001 and of the tax undercharged for the years 1997/98 to 2001/02 tax (“IRD 1^st Computation”).  The main features of the IRD 1^st Computation are:

(1) The understated sales of 2001/02 was assessed at $5,737,921;

(2) The overstated purchases of 2001/02 was assessed at $2,356,311;

(3) The overstated expenses of 2001/02 was assessed at $538,410; 

(4) The total discrepancy for 2001/02 therefore came up to $8,632,642; and

(5) The ratio of discrepancy to the amount of reported sales (i.e. $6,510,814) for 2001/02 is therefore 132.59%.

(6) Applying the ratio of 132.59%, the total understated profits or discrepancies for all the years came up to $34,809,560.

(7) The total undercharged tax therefore came up to be $5,212,292.

6.  There were further exchanges between the IRD and KG.  Noticeably by letter dated 2 February 2004, KG sent to the IRD a revised computation for the tax position of the year 2000/2001.  The position taken in this revised computation is that:

(1) For understated sales in 2001/02, the sales of China Jianli, a Mainland business ($3,053,326), and also the income of a Mr Bao Jingen ($1,800,000) should be excluded from the computation.

(2) In respect of the amounts of overstated purchases and overstated expenses for 2001/02 contained in IRD 1^st Computation, they were agreed.

(3) On the above basis, the discrepancy for 2001/02 should be reduced to $3,779,316 (i.e. $8,632,642 - $3,053,326 - $1,800,000).  But if only the sales of Jianli China were to be excluded, then the discrepancy for 2001/02 would be $5,579,316 (i.e. $8,632,642 - $3,053,326). 

(4) The ratio of discrepancy to the amount of reported sales (i.e. $6,510,814) for 2001/02 is correspondingly reduced to 58.05% if both the sales of Jianli and the income of Mr Bao were excluded, and 85.69% if only the sales of Jianli were excluded.

(5) Applying the reduced ratio of discrepancy, the total discrepancies for all the years assessed are reduced to $19,438,456.

(6) The total undercharged tax for all the years therefore become $2,960,477.

7.  In the opening paragraph of the letter, it was acknowledged that the calculated ratio of discrepancy to reported sales for 2001/02 was to be used to calculate the tax underpaid for the other years of assessment under audit.  Further in the letter, KG offered to the IRD to bring the field audit to a conclusion based on the position taken in the revised computation as outlined above.

8.  This was followed by further discussions and correspondence between IRD and KG with particular reference to the issue of Mr Bao’s income.

9.  In the meantime, the IRD issued an additional assessment for 1997/1998 on 9 March 2004, having regard to the limitation period.  KG lodged an objection on behalf of the applicant on 10 March 2004.

10.  On 25 March 2004, the IRD sent to KG a revised computation for 2000/2001 (“IRD 2^nd Computation”).  The main features of this computation are:

(1)  The understated sales, after deducting Jianli’s sales ($3,053,326) and Mr Bao’s income (revised at $1,800,310), became $884,285;

(2) The overstated purchases were assessed at $2,940,717;

(3) The overstated expenses remained the same as in the IRD 1^st Computation (i.e.$538,410);

(4) The total discrepancy therefore became $4,363,412; and

(5) Accordingly, the ratio of discrepancy to reported sales ($6,510,814) was 67.02%.

11.  Applying the ratio of discrepancy (i.e. 67.02%) to the reported sales for the years under audit, the total discrepancy for the years 1997/1998 to 2001/2002 was computed to be $17,594,663.   On the basis of the computed discrepancy, the total undercharged tax for the years in question was $2,622,171.

12.  By letter to the IRD dated 30 March 2004 and signed by the applicant (“the Offer”), the applicant offered “an additional tax liability for the years of assessment 1997/1998 to 2001/2002 of $2,622,171” with a view to bringing a conclusion to the field audit.  The Offer was made on the following premises:

(1)  The understated sales, after deducting the sales of China Jianli, was $884,285 (i.e. $5,737,921 - $3,053,326 - $1,800,310); and

(2)  The overstated purchases ($2,940,717) and the overstated expenses ($538,410) assessed by the IRD as per IRD’s 2^nd Computation were not disputed.

13.   On 14 June 2004, the IRD issued to the applicant:

(1)  Notice of revised assessment for 1997/1998;

(2)  Notices of additional assessment for 1998/1999, 1999/2000 and 2001/2002; and

(3)  Notice of assessment for 2000/2001.

The total further tax demanded was $2,622,171.

14.  On 22 July and 9 August 2004, KG on behalf of the applicant applied for payment of the further tax by instalments and provided information in support.  Included in the documents supplied to the IRD was an application for payment of tax by instalment dated 4 August 2004 signed by the applicant himself.  IRD rejected the application on 12 August 2004.

15.  In the meantime on 6 August 2004, the Commissioner gave notice to the applicant (copied to KG) of her intention to impose penalty on tax undercharged.  The notice enclosed a computation of tax undercharged and a breakdown of understated profit and overclaimed loss.  The applicant was invited to make representations under section 82A of the Inland Revenue Ordinance.

16.  On 26 August 2004, the applicant changed his tax representative to Lui Siu Tang & Company (“Lui”). 

17.  By letter dated 2 September 2004, Lui on behalf of the applicant lodged objection to the assessments for 1997/1998 to 2001/2002.  The grounds for objection were stated to be that “there was fundamental error and omission in respect of the basis of the said assessment”.  It was said that the sales discrepancy was excessive.

18.  The letter further stated that for the purpose of settling the field audit expeditiously, KG had proposed to accept a discrepancy of assessable profits, not tax liabilities, for all the years of not more than $2.6 million.  It stated that the applicant only realised that the IRD was demanding a total tax liabilities of $2.6 million on receipt of the letter dated 6 August 2004.

19.  In another letter to the IRD dated 14 September 2004, Lui mentioned that the applicant did not have an opportunity to meet with the IRD representative before the settlement and the issue of the notices of assessment, and he therefore did not have thorough information of the basis of assessment. It was said that the applicant was confused as to the quantum of discrepancy in dispute, was prejudiced and did not take timely and appropriate action.

20.  By letter dated 14 September 2004, IRD informed the applicant that the assessment for 1997/1998 was a revised assessment made in accordance with his offer of 30 March 2004 whereas the objection for the assessments for the years 1998/1999 to 2001/2002 was made outside the one month period.  The IRD referred to the letters dated 2 and 14 September 2004 from Lui and noted that the applicant had previously applied for payment of the tax charges by instalments.  The IRD indicated that it did not accept that the applicant was unaware of the agreed quantum of discrepancy and tax liabilities and considered that the applicant had not given reasonable excuse for the late objection.

21.  Lui replied by letter dated 24 September 2004, explaining that the applicant was frequently absent from Hong Kong and was infected with influenza in July.  It was also said that the applicant had delegated his tax affairs to his wife, who was confused about the details, and KG, who was busy.  The letter stated that as a result, the applicant failed to make the objection within the time limit.

22.  After considerations, the IRD replied by letter dated 12 November 2004, refusing to accept the late objection.  The IRD reiterated that there was no right to object to the revised assessment for 1997/1998.  The IRD also did not accept the applicant was prevented from lodging the objection in time due to his absence from Hong Kong or sickness, or that the delegation of the tax affairs and KG’s absence from Hong Kong constituted reasonable excuse.

23.    There were then further correspondences between the IRD and Lui.  On 8 December 2004, the applicant made a section 70A application for correction of the assessments.  The IRD refused the application on 23 December 2004.  The applicant had since lodged objections under section 70A(2), and the determination was pending.

24.  On 4 February 2005, a meeting was held between the applicant’s tax representative Lui and the IRD’s representative.  By letter dated 14 February 2005, Lui requested a re-consideration of the applicant’s late objection.

25.  By letter dated 21 February 2005, the Commissioner refused the request.  For the revised assessment for 1997/1998, it was because there was no right to object.  For the assessments for other years, the Commissioner refused to extend the time for lodging objection.

26.  By letter dated 21 April 2005, Lui on behalf of the applicant made another attempt to extend the time for lodging objection.  The request was refused by the IRD by letter dated 1 May 2005.

The application for judicial review

27.  On 21 May 2005, the applicant commenced these proceedings.  Leave to judicial review was granted on 25 May 2005.   The Notice of Motion was filed on 6 June 2005.

28.  The crux of the applicant’s case for the judicial review application is that he had left all matters of the tax audit to his wife, Miss Christine Ho Yee Shyuan, and also KG.  The applicant contends that he made the Offer under a mistake and that he did not genuinely intend to offer to pay undercharged tax of $2,622,171.  It is also said that the Assessor of IRD had failed to make such enquiry as an honest and reasonable man would make as to whether the applicant had made a mistake.  The applicant says that he only discovered the mistake when he received the section 82A(4) notice dated 6 August 2004, hence he did not make the objection within the prescribed one-month period.  

29.  The grounds for judicial review as indicated by Mr Ho for the applicant at the hearing are that:

(1) The Commissioner committed an error of law in relying on section 70 of the Inland Revenue Ordinance to refuse to re-open the revised assessment for the 1997/1998 assessment.  This is because the Offer was given under a mistake, thus the revised assessment cannot be regarded as “final and conclusive” and section 70 therefore does not apply.

(2)  The Commissioner acted unreasonably in refusing to entertain the applicant’s late objection in that he should have accepted that the applicant was unable, by reason of the mistake, to lodge the objection within the one-month period.

(3)  Alternatively, the Commissioner committed an error of law in not regarding the applicant’s mistake as constituting a reasonable cause within the meaning of proviso (a) of section 64(1) for extending the time for making objection.

The Inland Revenue Ordinance (“IRO”)

30.  Section 64(1) and (3) and section 70 of the IRO are relevant to the consideration of this application.

31.  Section 64 deals with objections to assessment of tax.  Under section 64(1), objection to assessment has to be made within one month, but the Commissioner may in some circumstances extend the time for making objection.  The relevant part of section 64(1) and proviso (a) read as follows:

“(1)  Any person aggrieved by an assessment made under this Ordinance may, by notice in writing to the Commissioner, object to the assessment; but no such notice shall be valid unless it states precisely the grounds of objection to the assessment and is received by the Commissioner within 1 month after the date of the notice of assessment:
Provided that-

(a) if the Commissioner is satisfied that owing to absence from Hong Kong, sickness or other reasonable cause, the person objecting to the assessment was prevented from giving such notice within such period, the Commissioner shall extend the period as may be reasonable in the circumstances;”

32.  Section 64(3) provides for revision of assessment based upon agreement between the Commissioner and the taxpayer:

“(3)  In the event of the Commissioner agreeing with any person assessed, who has validly objected to an assessment made upon him, as to the amount at which such person is liable to be assessed, any necessary adjustment of the assessment shall be made.”

33.  In the event the assessment is revised under section 64(3) or where no valid objection is received within the one-month period, section 70 provides that the assessment shall be final and conclusive.  The part of section 70, which is relevant to the present proceedings, reads:

“Where no valid objection or appeal has been lodged within the time limited by this Part against an assessment as regards the amount of the assessable income or profits or net assessable value assessed thereby, or … , or where the amount of the assessable income or profits or net assessable value has been agreed to under section 64(3), or … , the assessment as made or agreed to or … , as the case may be, shall be final and conclusive for all purposes of this Ordinance as regards the amount of such assessable income or profits or net assessable value: …”

The applicant’s mistake

34.  Critical to the present application is the applicant’s contention that he acted under a mistake when he made the Offer.  Mr Ho for the applicant accepts that all the grounds for the judicial review are built upon and depend on the mistake the applicant says he was under.   The burden is on the applicant to prove the existence of the mistake. 

35.  The applicant’s evidence on the mistake is contained in paragraph 8 of his affirmation leading to the present application.  In essence, the applicant said that when he gave the Offer and signed the letter to the IRD, he did not know how the $2,622,171 tax liability was arrived at as KG did not explain the letter or the computation to him. He was only informed by his wife that KG had advised that the amount could not be further reduced and that the Offer was his only option.

36.  In Mr Ho’s submission, the applicant’s mistake has the following salient features:

(1)  The applicant did not know that the Offer was premised upon a net profit ratio of 67.02%.

(2)  The applicant also did not know that under the Offer, the understated profits amounted to $17,594,663.

(3)  During the years assessed, the applicant could not have earned a net profit margin of 67.02% on sales. The gross profit was a lot lower and in the range of 8-12% per annum.

(4)  During the years assessed, the applicant did not make a profit of $17,594,663.

37.  Mr Ho is unable to say for sure whether KG had brought the IRD’s letter dated 25 March 2004 containing IRD’s 2^nd Computation to the attention of the applicant or his wife.   He submits that there is no evidence that the Offer was based upon the IRD’s 2^nd Computation.

38.  The first point to consider is whether the Offer was as a matter of fact given by mistake.  In this regard, several matters are relevant. Firstly, although in the letters from Lui to IRD, it had been asserted that the applicant thought $2,622,171 was the amount of assessable profits, it is now clear from the applicant’s affirmation that when he signed the 30 March 2004 letter containing the Offer, he was well aware that $2,622,171 represented his liability for the undercharged tax for the years assessed.  In his affirmation, he deposed that his wife told him KG had advised “the IRD initially demanded additional tax of $5 million odd and [KG] could negotiate to reduce the amount to $2 odd millions” and the amount could not be reduced further.  At any rate, the 30 March 2004 letter is plain and unambiguous when it stated: “I would like to propose that … will give rise to an additional tax liability for the years of assessment 1997/98 to 2001/02 of $2,622,171.”  It is not the applicant’s evidence that he did not or could not read or understand the letter when he signed it.  In the circumstances, the applicant’s assertion in these proceedings that he did not genuinely intend to offer to pay $2,622,171 tax is incompatible with the evidence filed.  

39.  Secondly, at the initial interview on 11 June 2003, the IRD representatives had informed the applicant and his wife that the IRD would begin with an audit of the year 2001/2002.  If irregularities were detected, then unless the applicant proved to the contrary, the IRD would assume there were similar irregularities in the earlier years and would use the findings for the audit year to project the discrepancies for the other years. Alternatively, the IRD might conduct tax audit of all the years of assessment starting from 1997/98.  It is clear from the IRD’s 1^st Computation that the IRD had used the understated profits and reported sales for 2001/02 to work out the discrepancy ratio and, applying this ratio to the other years, to compute the total discrepancies and the total undercharged tax.  The same methodology was used by KG in the revised computation sent to the IRD on 2 February 2004.  The IRD’s 2^nd Computation also adopted this methodology.  Further, the $2,622,171 tax liability contained in the Offer was also computed on this basis.

40.  Under this method of computation, the 67.02% does not represent the net profit margin or ratio.  It is the ratio of discrepancy for the year 2001/02 and it has been used as the basis for projecting the discrepancies for the other years of assessment.  Likewise, $17,594,663 is the total discrepancies for all the years and does not represent the profits actually made during the years assessed.

41.  It is not the applicant’s case that the 67.02% ratio of discrepancy for 2001/02 is erroneous.  Indeed, the applicant has not taken issue with the computation for the year 2001/02.  The basic figures for the computation of 2001/02, apart from the amount of understated sales, were throughout not disputed.  That being the case, the applicant’s assertions that his business did not make a profit of $17 million odd during the years assessed and that its annual gross profit was only in the range of 8-12% are irrelevant.  These assertions, even if accepted, do not mean that the Offer was made under a mistake. 

42.  Thirdly, insofar as the applicant does not dispute the computed discrepancy and the ratio of discrepancy for the year 2001/02, even if the applicant did not know how the $2,622,171 tax liability was worked out, which is doubtful, it cannot be said that he made the Offer under a mistake.

43.  Fourthly, it is immaterial whether the applicant was aware of IRD’s 2^nd Computation when he made the Offer.  As noted above, the same methodology was used for the IRD’s 1^st and 2^nd Computation as well as KG’s computations and the Offer.  The applicant was made aware of this methodology right from the beginning of the tax audit.  In my view, it is difficult to accept that the applicant had no idea how the undercharged tax was computed.  Not only was he informed of the method of computation at the early stage of the tax audit, but he also had the means of finding out.  He could have, if he so wished, ascertained this from his tax representative.     

44.  Looking at the events and the evidence before the court as a whole, I do not accept that the applicant has made out a case that, as a matter of fact, he made the Offer under a mistake.

The IRD’s knowledge of the alleged mistake

45.  As to the applicants’ suggestion that the IRD should have known that he was acting under a mistake when he made the Offer, it must fail in view of my conclusion that there was in fact no mistake.  That aside, there is no proper basis for the assertion.  The applicant was represented by professional accountant in the tax audit.  The IRD had no reason to believe that the applicant was not properly or adequately advised.  The Offer was preceded by KG’s revised computation dated 2 February 2004 with detailed particulars. There is simply nothing to suggest to the IRD that the applicant could possibly be under any mistake or was unaware of the basis and method for computing the Offer.

46.  The applicant places heavy emphasis on the fact that the IRD representatives did not hold an interview with him to explain the basis for assessments before issuing the Notices of revised and additional assessments.  There is no merit in this complaint.  The assessments as well as the revised and additional assessments for the years were in accordance with the Offer made by the applicant.  In issuing the relevant notices, the Commissioner was doing no more than accepting the applicant’s offer.  It would have been superfluous for the IRD representatives to meet with the applicant to explain to him the basis of his own offer, when the applicant was professionally represented and advised.  The fact that this was the usual practice of the IRD does not matter.  Such a practice has no useful purpose to serve in the present case.

Non est factum

47.  The applicant prays in aid the doctrine of non est factum as an alternative argument to the argument of mistake.  It is said that there was a “radical”, “essential”, “fundamental”, “serious” or “very substantial” difference between the Offer and the offer the applicant had intended to make.  In Mr Ho’s submissions, the difference lies between the “net profit ratio of 67.02% on reported sale and a gross profit ratio of 8-12%”.

48.  This argument is plainly untenable.  Firstly, as mentioned above, 67.02% is not the net profit ratio on the reported sale.  The so-called difference is therefore illusionary.  Secondly, net profit ratio or gross profit ratio does not feature in the Offer made by the applicant.  It is also not a component in the computation of the applicant’s understated tax liabilities.  Thirdly, there is no doubt from the applicant’s affirmation that he had intended to offer to pay underpaid tax of  $2,622,171.  Fourthly, even assuming that the Offer is radically different in nature from what the applicant thought he was signing, on the evidence available, he was plainly negligent in signing and making the Offer.

49.  In the circumstances, the Commissioner commits no error of law in regarding the revised assessment for the year 1997/1998 as one made under section 64(3) of the IRO and is therefore final and conclusive under section 70 of the IRO.  The applicant’s first ground for judicial review therefore fails.

Late objection

50.  The applicant’s second and third ground for judicial review relate to the Commissioner’s refusal to entertain the late objection to the additional assessments and assessment for the years 1998/1999 to 2001/2002.  The applicant’s case is that he was prevented by reason of his mistake from making timely objection to the assessments. It is submitted that the applicant did not know that the assessments were wrong until he discovered the so-called mistake upon receipt of the Commissioner’s Notice dated 6 August 2004.  The applicant contends that the Commissioner acted unreasonably or erred in law in not regarding the applicant’s mistake as amounting to reasonable cause for extending the time for lodging objection.

51.  I pause here to note that when Lui corresponded with the IRD, the applicant’s illness and absence from Hong Kong and the delegation of his tax affairs were put forward as grounds for the late objection. These reasons were rejected by the Commissioner and reasons were given for the rejections.   None of these reasons is being relied upon in these proceedings.  Indeed, the judicial review is not made on the basis that the Commissioner acted unreasonably or erred in not accepting these reasons.  The present challenge is mounted on the applicant’s mistake as to the computation of the tax liability under the Offer.  This is also different from what was put by Lui to the IRD, namely, the applicant mistakably thought $2,622,171 was the amount of assessable profits.  Properly speaking, the Commissioner had not rejected the mistake now claimed by the applicant when she rejected the late objection.      

52.  That aside, Mr Ho accepts that if the applicant’s present case of mistake is not made out, the challenge to the refusal to extend the time for lodging objection also fails.  As I have already concluded on the facts that the applicant did not make the Offer under a mistake, that will be sufficient to dispose of Grounds (2) and (3) for the application and the challenge to the Commissioner’s refusal to entertain the late objection.

53.  For completeness, I will deal briefly with Mr Ho’s submission that ignorance or mistake may be regarded as a reasonable cause for the purpose of the Proviso in section 64(1) of IRO.  Firstly, Mr Ho submits that the IRD had in the letter dated 12 November 2004 accepted that misunderstanding of one’s tax position could constitute a reasonable cause.  I do not agree.  When the letter said “other causes, including the misunderstanding of your tax position”, the IRD was only reciting the reasons given by the applicant for the late objection.  It did not endorse that proposition nor accepted that as a reason for extending time.    

54.  Mr Ho also relies on a line of Australian tax cases that suggest that the time limit should not be strictly applied and that a taxpayer should not be denied of the right to review only because of some oversight or omission: Tax Cases D176/98, 9/79, U175, W23 and Brown v. Commissioner of Taxation 99 ATC 4516.  In his submission, the Proviso in section 64(1) is an ameliorating provision and is aimed at avoiding injustice such that in appropriate cases, a unilateral mistake may also constitute a reasonable cause for extending time.

55.  I agree with Miss Tsui that the Australian tax cases have to be read in the context of the facts of the cases as well as the relevant Australian statutory provisions.  The fact that the Australian Commissioner of Taxation adopted was expected to adopt a more flexible approach has no bearing on how the Commissioner should exercise her discretion under section 64(1).

56.  I also respectfully agree with the judgment of Tang J (as he then was) in Chow Kwong Fai, Edward v. The Commissioner of Inland Revenue (unreported) HCIA 5/2004, 1 December 2004 that these Australian cases have little relevance.  It should also be noted that when the case of Chow Kwong Fai, Edward went to the Court of Appeal (unreported) CACV 20/2005, 7 October 2005, it was accepted that while the word “prevent” in section 64(1) should receive a liberal interpretation, “reasonable cause” could not possibly be extended to cover unilateral mistake made by the taxpayer: at paras.20-22.

Conclusion

57.  For the reasons above, the application for judicial review is dismissed.  Applying the normal rule of costs follow event, I make an order nisi that the applicant pays the respondent the costs of these proceedings, to be taxed if not agreed.