FOXCONN (FAR EAST) LTD v. COMMISSIONER OF INLAND REVENUE

HCIA 3/2023

[2024] HKCFI 97

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

INLAND REVENUE APPEAL NO 3 OF 2023

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BETWEEN

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D E C I S I O N

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Introduction

1.  In its decision in B/R 52/20 dated 14 February 2023 (“the Board’s Decision”), the Board of Review upheld the assessments of the Respondent (“Commissioner”). The Board held that the source of profits of the Applicant (“Foxconn”) was in Hong Kong and that 2 items of expenses (ie. employees’ remuneration and operating expenses of a factory) were not deductible.

2.  This is Foxconn’s application for leave to appeal against the Board’s Decision. Three purported questions of law have been raised by Foxconn that challenge:

Q1. The Board’s finding as to the geographical source of Foxconn’s profits (“Source of Profits Ground”);

Q2. The Board’s refusal to deduct 2 principal expenses from the assessable profits (“Deductible Expenses Ground”); and

Q3. The Board’s refusal to exercise its powers to determine public law challenges (“Public Law Ground”).

3.  Mr Barlow, SC, acting on behalf of Foxconn, accepts that, in order to obtain leave, Foxconn must satisfy the criteria in section 69(3)(e) of the Inland Revenue Ordinance Cap 112 (“the Ordinance”), namely, that: (i) the proposed appeal involves a question of law in respect of which the applicant has a reasonable prospect of success; and/or (ii) there is some other reason in the interests of justice why the proposed appeal should be heard. Mr Barlow, SC accepts that if he cannot satisfy the Court as to limb (i), limb (ii) will fall away.

4.  Limb (i) is not a high threshold. It only requires the proposed appeal to be reasonably arguable: China Mobile HK Co Ltd v CIR [2018] 2 HKLRD 146. §16 and 21, Chow J (as he then was).

5.  Even if the 3 questions posed by Foxconn appear to be of law, Foxconn still has to satisfy this Court that it has reasonable prospect of success.

6.  Mr Ma, SC, acting on behalf of the Commissioner, submits that none of the 3 questions are of law. What Foxconn is seeking to do is to challenge the Board’s findings of fact.

Background

7.  The relevant assessments occurred in the financial years from 1996-2001 (“the Assessments”). Before the Board, the parties have a set of Agreed Facts as set out in §§4-10 of the Board’s Decision. The following brief summary suffices for the purpose of this application.

8.  Foxconn was a subsidiary of Hon Hai Precision Industrial Co Ltd (“Hon Hai”) within the Hon Hai Group (“the Group”), which provided contract manufacturing services for computers, communications and consumer electronic products and parts.

9.  Foxconn’s case was that in 1992, Hon Hai engaged Foxconn under a subcontracting agreement to provide manufacturing and assembly services using raw materials owned and supplied by Hon Hai within the Fuhong Factory. It provided Foxconn with 2 forms of gross receipts (ie the Assessed Profits), namely, subcontracting fees paid to Foxconn by Hon Hai and gains from sale of residual materials belonging to Hon Hai but not required within the manufacture of the finished products. All Assessed Profits arose within Foxconn’s only business – contract processing, carried on in Shenzhen and were thus not chargeable to profits tax under section 14 of the Ordinance. In addition, the Assessed Profits arose from, amongst others, expenses including remuneration of its employees and expenses to keep Fuhong Factory operating.

The Board’s Decision

10.  The Board found that there was no subcontracting agreement between Hon Hai and Foxconn at all material times. Foxconn did not provide any subcontracting or processing service to Hon Hai through the Fuhong Factory, which was a separate entity. The Fuhong Factory was not established or owned by Foxconn, nor could it be considered an agent of Foxconn. In the case of a group of companies, for tax purposes, the business carried on in Hong Kong was the business of Foxconn which carried it on and not of the Group of which Foxconn was a member. In the manufacturing process, Foxconn played very little part. Foxconn’s profits could not be ascribed to the manufacturing or processing activities of the Fuhong Factory. Foxconn simply did not carry on any business outside Hong Kong (§§61-68 of the Board’s Decision).

11.  The Board referred to the restrictions on direct trade between Mainland China and Taiwan in the relevant years of assessment. The Board found that Hon Hai would not have been able to import raw materials to Shenzhen, export finished product from and to Taiwan or carry on any manufacturing or processing work in Shenzhen. Foxconn was created for a specific purpose, as an intermediary to allow the transactions to happen despite the trade barrier. In the tripartite relationship, each of Hon Hai, Foxconn and Fuhong played an independent but essential role as, the brain, the soul and the manufacturing or processing limb respectively. The hard reality was that without Foxconn, the business operations would simply not work. Foxconn employed a not insignificant number of staff in the Hong Kong Office. There were profit producing activities and not antecedent or ancillary activities there (§§70-74 of the Board’s Decision).

12.  Dissatisfied by the Board’s Decision, Foxconn filed the present Summons dated 13 March 2023 to seek leave to appeal on 3 Questions.

Q1 – Source of Profits Ground

13.  Q1 has been broken up into 3 sub-issues in the Summons:

“Upon the true construction of Part 4 of [the Ordinance], in particular sections 14 and 16, by reason of the facts agreed by the parties and/or found by the Board,

(a). Did the Board misconstrue those statutory provisions and apply the incorrect legal test concerning the source of Foxconn’s trading profits (Board’s Decision, §7(b)) that were assessed within the Assessments?

(b). Did the Board’s Decision misidentify the Commissioner’s primary burden of proving that profits tax was exigible upon Foxconn’s trading profits and/or erroneously fail to decide Foxconn’s appeal upon the balance of probabilities?

(c). Do the Board’s findings of primary fact require the conclusion in law (ie the true and only reasonable conclusion), that the Assessments upon the Assessed Profits were outwith the Ordinance’s section 14 charge since they derive from an offshore business?”

Q1(a)

14.  Section 14 of the Ordinance provides for profits tax to be charged on a person carrying on a business in Hong Kong in respect of his assessable profits arising in or derived from Hong Kong.

15.  Section 16 provides for, amongst others, deduction of expenses incurred in the production of chargeable profits.

16.  The question of the source of profits is one of fact. The guiding principle is that one looks to see what the taxpayer has done to earn the profit and where he has done it: CIR v Hang Seng Bank, [1991] 1 AC 306, §322H; Kwong Mile Service Ltd v CIR, (2004) 7 HKCFAR 275, §11. These principles are not in dispute as can be seen from Foxconn’s Statement of Grounds in support of the Summons, §§6(1)-(2).

17.  Mr Barlow, SC refers to 2 cases on general principles governing statutory construction. Sanford Yung-tao Yung v CIR [1979] HKLR 429, 431 and Collector of Stamp Revenue v Arrowtown Assets Ltd (2003) 6 HKCFAR 517 554 F-G Lord Millett NPJ: They do not advance Foxconn’s case. In the Arrowtown case, in particular, the Court of Final Appeal laid down the principle that it is a fundamental principle of the constitution of Hong Kong that the subject is to be taxed by the legislature and not by the courts. Every question of tax or not tax, is ultimately a question of statutory construction. The question is always whether what the taxpayer did was within the intendment of the particular statutory provision which is invoked. However, it is first necessary to analyze what the taxpayer did.

18.  What the Board in the present case did was exactly as laid down in Hang Seng Bank, Kwong Mile and Arrowtown Assets. The Board guided itself on the law (§§24-35 and 56 of the Board’s Decision). It expressly applied Kwong Mile to ascertain what services had been provided by Foxconn as a matter of practical reality (§§56, 72). There cannot be any suggestion that the Board had erred in principle. The findings on the source of profits were all of facts. Despite the opening words to Q1, there was no issue of construction of any statutory provision. The answer to Q1(a) is “no”.

Q1(b)

19.  The Board has guided itself on the burden of proof (§§16-18 of the Board’s Decision). Mr Barlow, SC could not point to anything to show that the Board applied the wrong burden and standard. The fact that Foxconn had allegedly produced voluminous evidence but the Board did not accept Foxconn’s case (with reasons), did not mean that the Board had not applied the civil standard of proof. The answer to Q1(b) is “no”.

Q1(c)

20.  A decision may be quashed if it was based on a finding of fact or inference from the facts which was perverse or irrational; or there was no evidence to support the decision; or the decision was made by reference to irrelevant factors or without regard to relevant factors. The appellate court will interfere with an inference drawn from primary facts, or with a conclusion drawn from a combination of primary fact and inference, if the true and only reasonable inference or conclusion was not the one reached by the fact-finding tribunal. Where the conclusion or inference was drawn from the assessment of numerous facts, appellate courts are reluctant to interfere with the conclusion or inference of the fact-finding tribunal because judges and tribunals can reasonably differ as to on what side of the line any particular case falls. See Kwong Mile, §§31- 37; Zarin, v CIR (No. 2) [2022] 3 HKC 491 §§32-33, Kwan VP (“Kwong Mile Tests”).

21.  The Board has aptly summarized each party’s case and issues in §§19-23, 32-35 and 13-15 of the Board’s Decision.

22.  Mr Barlow, SC seeks to make a distinction between primary facts and inferential conclusions. Central to his submission on Q1 is the contention that the Board erroneously found that Fuhong Factory was a separate entity and that the Agreed Facts showed that Foxconn’s profits were derived from providing manufacturing subcontracting services to Hon Hai within the Fuhong Factory.

23.  Mr Barlow, SC’s submissions ought to be rejected on the following grounds:

(1) He submits that Fuhong Factory was a geographical location, not a person or a separate entity. With respect, there was nothing in the Agreed Facts to show that Fuhong was part of Foxconn. In fact, it was an express term of the August-25 Agreement that factory premises were to be provided by the Mainland Party and not Foxconn or Hon Hai.

(2) Whilst the Agreed Facts stated that manufacturing and assembling activities were carried out in the Mainland, they did not say “by Foxconn”. None of the Agreed Facts support Mr Barlow, SC’s submission that Foxconn provided manufacturing subcontracting services to Hon Hai within the Fuhong Factory. In fact, the Board found to the contrary – that Foxconn did not provide any manufacturing or processing service to Hon Hai through the Fuhong Factory (§§62-68 of the Board’s Decision).

(3) Whilst the Agreed Facts stated that there were subcontracting fees paid to Foxconn by Hon Hai, the purpose of those fees has always been hotly disputed. The Board found that it was the role of Foxconn as an intermediary that was the effective cause of its profits.

(4) Foxconn’s assertion that none of the Assessments, the Agreed Facts or any other finding of primary facts concerned or identified any other income-producing business or trading profits from any other activities of Foxconn was wrong. The Board did find that Foxconn’s business activities included importing raw materials, exporting finished products into and out of the Mainland, engaging in customs declaration and making arrangements for shipment, all of which were done by its staff in the Hong Kong Office (§74 of the Board’s Decision).

(5) Insofar as Foxconn’s audited financial statements, and trading and profit and loss accounts were concerned, consistency between them and Foxconn’s stance did not go so far as to set up any prima facie case of the correctness of Foxconn’s stance. Even where accounting treatment amounted to strong evidence, it still fell to be considered together with the rest of the evidence. Real Estate Investment (NT) Ltd v CIR (2008) 11 HKCFAR 433, §§33-35.

(6) Mr Barlow, SC submits that the Hong Kong activities were ancillary services which produced no income or receipts. However, upon the Board’s rejection of Foxconn’s case that it had provided manufacturing subcontracting services to Hon Hai within the Fuhong Factory, there was no business that the Hong Kong activities could be “ancillary” to. Given the work involving the “not insignificant number of staff” in Foxconn’s Hong Kong Office (which increased from 4 to 26 in 5 years and involved salary of over HK$1,000,000 a year even on Foxconn’s own audited financial statements), the Board was entitled to come to its conclusion as to the effective cause of Foxconn’s profits from its role as an intermediary (§§73-74 of the Board’s Decision).

24.  Although said to be based on the Agreed Facts and/or facts found by the Board, Q1 is in substance an appeal against findings of facts and not law. Without disrespect, Mr Barlow, SC fails to show that the Board’s findings were arguably perverse or irrational or that the true and only reasonable conclusion contradicts the Board’s Decision. The answer to Q1(c) is “no”.

25.  Q1 has no reasonable prospect of success.

Q2 - Deductible Expenses Ground

26.  Q2 states that upon the true construction of sections 16 and 18F of the Ordinance, the Board erred in law in excluding 2 principal deductible expenses incurred in earning the profits concerned. Those 2 types of expenses were (a) salaries and allowances of the Fuhong Factory staff; and (ii) Part 6 depreciation and industrial building allowances in respect of Foxconn’s plant and machinery used in the Fuhong Factory.

27.  Section 16 provides for deduction of expenses. Section 18F is about adjustment of assessable profits as a result of balancing charge or allowance.

28.  Mr Barlow accepts that Q2 falls away if Q1 is decided against him. He is correct. For completeness, I deal with Q2 briefly.

29.  The Board found that “no sufficient evidence” was produced at the hearing to contradict the Assessments in relation to deductibility of allowances. The Board found no reason to disturb the Commissioner’s Determination in this respect (§76 of the Board’s Decision).

30.  Mr Barlow, SC submits that the Board’s finding was illogical and unreasonable and consequently perverse. Once again Foxconn relies on the Agreed Facts, which included the audited accounts. It is submitted that the Commissioner has never challenged the correctness of the manner in which the accounts were made up or the amounts of the outgoings and expenses. And yet the Commissioner unreasonably contended that Foxconn’s onus of proof required it to produce “every one of the hundreds of thousands of pay slips, invoices and receipts involved” which, 26 years later, were no longer available. Instead of addressing the Commissioner’s ruling, the Board simply ruled that the evidence was not sufficient.

31.  Mr Barlow SC’s submission is unsustainable.

32.  Firstly, “sufficiency” of evidence was a matter of fact for the Board and not the Court: CIR v Right Margin Ltd [2017] 5 HKLRD 398, §10, G Lam J (as he then was).

33.  Secondly, whilst the Agreed Facts reproduced part of Foxconn’s audited accounts, there was nothing to suggest that the Commissioner had agreed to the deductibility of the 2 expenses.

34.  Thirdly, it was Foxconn who failed to discharge the burden to prove that the Assessments were incorrect or excessive under section 68(4) of the Ordinance (§18 of the Board’s Decision). The Commissioner did not have to prove anything: Zarin, §25.

35.  As a matter of law, the accounts were concerned with whether expenses were actually incurred, not with whether they were deductible for tax purposes. The latter question turned upon, inter alia, whether the expenses in question were incurred in the production of profits in respect of which the taxpayer was chargeable to tax. The amount of assessable profits may be ascertained from the taxpayer’s accounts drawn in accordance with ordinary principles of commercial accounting, but only if this was in conformity with the Ordinance. See Koo Ming Kown [2018] HKCFI 2593, §100, G Lam J (as he then was).

36.  Neither the Commissioner nor the Board was obliged to assume that the auditors had inspected sufficient and proper primary documents to be satisfied of the truth of the figures in the accounts in conducting their audit. Neither the Commissioner nor the Board should be asked to simply rubber stamp the findings of the auditor. D25/15, §41.

37.  Mr Barlow SC has not demonstrated how the Kwong Mile tests can be satisfied in view of the Board’s finding of insufficiency of evidence.

38.  Q2 is in substance an appeal against finding of facts, and no question of law is involved. It has no reasonable prospect of success.

Q3 – Public Law Ground

39.  Mr Barlow, SC submits that the IRD Officials made ultra vires Assessments. Section 64(2) of the Ordinance required the Commissioner or his IRD Officials to determine a taxpayer’s notice of objection “within a reasonable time”. During the 18 years (from the first notice of assessment in 2003) until the Commissioner’s Determination in 2021 the IRD Officials “calculatedly and unlawfully” deferred the determination of Foxconn’s objections to the Assessments before confirming the same (“Public Law/Bad Faith Issue” referred to in the Board’s Decision). It was alleged that the IRD officials (i) resiled from their previous agreements concerning the facts material to the Assessments; (ii) pursued Assessments known to have been made ultra vires upon offshore profits; (iii) pressed Foxconn to “settle” those ultra vires Assessments by agreeing to pay lesser sums; (iv) when no such agreement was forthcoming, unlawfully excluded from the Assessments the deductible expenditure; and (v) throughout, relied upon the inevitable evidentiary prejudice of Foxconn’s discharging its evidential onus of proving (previously admitted) material facts 24 years afterwards.

40.  The Board took the view that the function was to look at the facts and decision whether the assessment had been made properly in accordance with the law. Whether there was abuse of power on the part of the IRD Officials was a matter for which the only remedy available was by way of judicial review in the High Court, citing Aspin v Estill (Inspector of Taxes) [1987] STC 723, 725g-h (§§82-83 of the Board’s Decision).

41.  Foxconn submits that the Board erred in law in concluding that section 66 of the Ordinance did not confer jurisdiction on the Board to determine public law challenges (§90 of the Board’s Decision); and in refusing to rule that the IRD Officials had willfully abused their statutory powers to determine Foxconn’s notice of objection within a reasonable time.

42.  Mr Barlow, SC relies on various authorities:

(1) Lam Soon Trademark Ltd v CIR (2006) 9 HKCFAR 391, §§30-31; following Harley Development Inc v CIR [1996] 1 WLR 727, p732C. The issue in Lam Soon Trademark on ultra vires was whether it was ultra vires for an assessor to make an additional assessment (after an original assessment that was deemed final and conclusive) without deducting outgoings and expenses incurred in the production of chargeable profits (§4 of the judgment). Bokhary PJ, held that the width of the objection and appeals procedure was perfectly competent to deal with challenges to assessments as being ultra vires. Lam Soon Trademark was a case deciding the extent of the statutory powers of the Commissioner and not abuse of power in the sense of bad faith of an assessor.

(2) In Harley Development, the taxpayer in Hong Kong actually applied to the High Court for judicial review of the assessor’s decisions on the ground that they were ultra vires. The Privy Council upheld the decision of the judge and the Court of Appeal in dismissing the application for judicial review, as the taxpayer had not made use of the comprehensive objections and appeals procedure to consider if an assessment had been made ultra vires and if appropriate to annul it under sections 64(2) and 68(8) of the Ordinance. The Courts would only entertain an application for judicial review in exceptional circumstances, typically where an abuse of power was alleged. Since the assessments involved no unfairness and therefore no abuse of power, judicial review was inappropriate.

(3) Reg v IRC ex parte Preston [1985] 1 AC 835, at 862G-863G. The House of Lords held that the inland revenue commissioners were amenable to the process of judicial review. However, that case did not decide that the powers of judicial review rested in the equivalent of a board of review.

(4) Shui On Credit Co Ltd v CIR (2009) 12 HKCFAR 392, §§30-31, held that the Board’s function, on hearing an appeal under section 68, is to consider the matter de novo, and taxpayers’ appeals to the Board are “against an assessment”; and that the Commissioner and the Board had a “duty to proceed fairly”. This case does not confer power on the Board to consider public law issues.

(5) Koo Ming Kown v CIR, §65, held that the Board must proceed fairly so that the taxpayer was not taken by surprise. The Board had erred in law by acting “in breach of natural justice”. Similarly, this case does not confer power on the Board to consider public law issues.

43.  Although the Board did not deal with allegations of abuse of power and bad faith, it did deal with the allegations of ultra vires and inordinate delay which were “with the remit of the Board” (§91 of the Board’s Decision) and the Board actually considered the public law issues as if it had jurisdiction to do so (§104)

44.  Firstly, the Board, rightly, held that what amounted to reasonable time under section 64(2) was a question of fact to be considered by the Board in the light of the circumstances (§93).

45.  Foxconn’s profits tax returns for the years 1996-2002 were received by the Commissioner on 29 November 2002. Four months later, on 17 March 2003, the Commissioner already issued a notice of profits tax assessment for 1996/97 to Foxconn on the basis that 100% of Foxconn’s profits were chargeable to profits tax. On the same day, the Commissioner already asked Foxconn’s then tax representative SYC for information and documents concerning the offshore claim. On 19 March 2003, SYC already submitted a notice of objection against the 1996/97 assessment on behalf of Foxconn. On 15 September 2023, the Commissioner issued a formal notice of enquiry. There then followed years of correspondence between the Commissioner and Foxconn’s tax representative, during which the Commissioner made clear its rejections of Foxconn’s offshore claim for every financial year in question. There were rounds of notice of assessments, objections, enquiries, replies and further enquiries. The Commissioner and Foxconn’s tax representative would take several months to make enquiries or reply in each round.

46.  The Board thus came to the decision that it did not see any unreasonable delay on the part of the Commissioner in dealing with the Assessments. There was also time spent on discussing settlement. There was delay upon Foxconn’s change of tax representative. In fact there was delay on both sides. (§ 94 to 104 of the Board’s Decision) These were findings of facts. Mr Barlow, SC has not demonstrated how the Kwong Mile tests could arguably be satisfied to show how the facts could point to the IRD Officials “calculatedly and unlawfully” deferred the determination of Foxconn’s objections.

47.  Secondly, even if there had been inordinate delay, the Board held that it did not mean that the Assessments could be annulled by the Board under section 68(8) of the Ordinance. In the context of the Ordinance, a failure to act within a reasonable time would not have deprived the Commissioner of jurisdiction or made any determination by him null and void. He could be compelled by an order of mandamus. See Nina Wang v CIR [1994] 2 HKLK 356,366, lines 22-23, 26-27, 39-41; Yue Yuen Marketing [2012] 4 HKLR 761. The Board was plainly aware of these principles (§103-104 of the Board’s Decision). Mr Barlow, SC has not come up with any contrary authority.

48.  Thirdly, equally, one can see from the Board’s analyses of the delay issue that the issue of whether Foxconn’s profits were taxable had always been a live issue, arising latest by 2003, 4 months after the tax returns were filed. Foxconn had engaged tax representatives throughout. It would have been apparent to Foxconn and its tax representative that the burden of proving that the profits were offshore and that the expenses were deductible and, hence, the burden of preserving the documentary evidence, rested on Foxconn. Foxconn could not benefit from its own failure to preserve the evidence and/or scarcity of evidence.

49.  Fourthly, on the question of “previous agreements concerning facts”, of the Commissioner’s Mr Ma, SC points out that Foxconn relied heavily on a letter sent by a Senior Assessor to Foxconn’s tax representative dated 4 December 2008, set out in §10(4) of the Board’s Decision. It would have been apparent to any reader that the “admission” was in the form of 2 paragraphs in one letter in a series of correspondence over 18 years in which the offshore profits were hotly contested. Mr Ma, SC submits that Foxconn was “cherry picking” and I could not agree more, given the detailed analyses of the circumstances by the Board.

50.  Fifthly, there was nothing peculiar in a party making concessions in negotiation for settlement but withdrawing them when settlement failed. Foxconn apparently had not succumbed to any pressure to settle.

51.  In the light of the above matters under Q3 and given this Court’s view that there is no reasonable prospect of success on Q1 and Q2, there is nothing left of the ultra vires and bad faith arguments. Accordingly, even if it is arguable as a matter of law that the Board had powers to deal with the public law challenge, there is no reasonable prospect of success on Q3. Some Other Reasons in the interests of justice why the proposed application should be heard.

52.  Mr Barlow SC has not suggested any.

Conclusion

53.  Despite Q1 and Q2 being prefaced by the words “upon true construction of” certain statutory provisions, there are no questions of law concerned. Those Questions are in substance appeals against findings of facts which do not arguably meet the Kwong Mile tests. They do not have reasonable prospects of success. Q3 appears to be a question of law. However, the Board has actually considered the public law challenge as if it had jurisdiction basis but decided against Foxconn on the ultra vires issue. Given this Court’s answers to Q1 and Q2 in the negative, there is nothing left for public law challenge that has any reasonable prospect of success. I therefore decline to give leave to appeal on any Question.

54.  On a nisi basis, costs should be to the Commissioner, summarily assessed at $140,000.

55.  I thank counsel for their assistance.