The HK Court Cases Review and Learn
As Hong Kong adopts a territorial source principle of
taxation. Only profits which have a source in Hong Kong are
taxable here.
Profits sourced elsewhere are not subject to Hong Kong Profits
Tax. That mean tax is possible exempt.) Company can claim
offshore income with provide enough evidence proof. The
principle itself is very clear but its application in particular
cases can be, at times, contentious. To clarify the operation of
the principle, we have prepared this simple guide on the
territorial source principle of taxation. It gives a brief
explanation of how the principle operates and provides simple
examples for illustrative purposes of the tests applied to
different types of businesses. If you wish to explore the
subject in greater depth, we recommend that you consult your
professional advisers.
CIR
v The Hong Kong Whampoa Dock Co .Ltd.
This case concerns the profit derived by a
Hong Kong ship-building company from a ship-salvage operation
performed in waters outside Hong Kong's boundary. The company
argued that because the operation was done outside Hong Kong,
the profit was not taxab1e. The Board allowed the company's
appeal.
CIR appealed to the
court. The court upheld the Board's decision and held that the
payment of services is of no importance in deciding the issue
and because almost the entire services performed, which gave
rise to the profits, were performed outside Hong Kong, the
profit did not arise in or derive from Hong Kong. ~
CIR v
Euro Tech (Far East) Ltd.
The taxpayer was incorporated in Hong Kong.
It was a subsidiary of a UK public company. Its business
comprised of marketing and trading of e1ectronic equipments. The
equipments were bought from the UK parent company as well as
from within the group companies. It entered into a
distributorship agreement with a Korean company and a
Singaporean company. Having received orders from these two
companies, the taxpayer sent orders to its UK parent or group
companies. Then, the equipments were shipped directly from UK to
the two companies. The profit earned by the taxpayer was
assessed to Profits Tax. The taxpayer appealed to the Board who
al1owed the appeal. Then, CIR appealed to the High Court and got
the Board's decision reversed. The court ru1ed that it was the
bridging operations done by the taxpayer between the UK
companies and the two overseas buyer companies in Hong Kong that
gave rise to the profit..
The court said: “If. taxpayer has a principal
place of business in Hong Kong, it is likely that it is in Hong
Kong that he earns his profits. It will be difficult for such
taxpayer to demonstrate that the profits were earned outside
Hong Kong and therefore not chargeable to tax."
CIR v International
Wood Products Ltd.
The company acted as agent for two overseas
principals for sale of 1ogs. It appointed sub-agents outside
Hong Kong for the sale. Orders and payments were sent directly
to its principals. The company received commission and passed on
sub--commission to the sub--agents. Profits Tax assessments were
raised to assess the amount retained by the company. The Board
annulled the assessments because the work giving rise to the
commission was found outside Hong Kong. This decision was upheld
by the court saying that the source of the commission income was
the place where the services were rendered to earn the income
and the source in the case was outside Hong Kong ------ the
services done by the sub--agents outside Hong Kong--- even
though the company did some ancil1ary services in Hong Kong.
CIR v
Karsten Larssen & Co.(H.K.)Ltd.
The case also concerned commission involving
overseas services but the commission was held to be taxable. In
the case, the commission was earned by a ship broker for seeking
chatterers and concluding charter agreements. Although some
services were carried out overseas by an agent appointed by the
taxpayer, the profit retained by the Hong Kong company was held
to be derived from Hong Kong ---based on the fact that there was
an agreement identifying the taxpayer and the overseas agent and
their share of the commission.
Sinolink
Overseas Ltd. V CIR
The company bought plywood for sale in Hong
Kong and main1and China. The company did not have an office in
China but had one in Wanchai.
Its sales to China were concluded in China by
a director who had full power to sign contract on behalf of the
company. After conclusion of the sales, the company sent
purchase orders to overseas manufacturers. The company argued
that it had carried on two businesses: one in Hong Kong and the
other in China. Both arguments were rejected by the court.
Applying the operations test, the judge Hunter J ruled that it
was the activities of the Hong Kong office that produced the
profits. The reasoning is as follows:
(1 )The setting for business and the
1ogistics for the purchase and sale were all done in Hong Kong.
(2)The purchases were managed and arranged in
Hong Kong.
(3)The China sales were conc1uded in China.
But the company's profits should be regarded as from both the
purchase and sale. This factor could not alone make the profit
from China sales non-taxable. -
(4) The post--contract activities and
management work were done in Hong Kong. On a totality of the
above factors, the judge conc1uded that all the profits
---Whether from Hong Kong sales or China sales --- were taxable.
The decision in Sinolink case is controversial. Its importance
has been falling, especially after the recent case CIR v. Magna
Industrial Company Ltd.
CIR v. HK-TVB
International Ltd.
The taxpayer (hereinafter called TVBI)
carried on the business of 1icensing films that had been
produced by its parent company HK-TVB Ltd (hereinafter called
TVB). Pursuant to agreements between the taxpayer and TVB, the
taxpayer was granted the exclusive right to broadcast and export
TVB's television films and programs outside Hong Kong and to
grant sub-licenses to others. The negotiations between the
taxpayer and its customers usually took place outside Hong Kong.
The business contracts signed by the overseas customers were
sent to the taxpayer in Hong Kong for conclusion. The taxpayer
objected to the profits tax assessment on the grounds that the
profits were outside Hong Kong. The Board agreed to the
taxpayer's arguments. The case final1y went to Privy Counci1.
It was held that the profits were assessab1e
because the operations producing the profits ---the acquisition
of the exclusive rights of granting sub-1icenses together with
the relevant films and the grant of those sub-licenses together
with the provision of the film by contracts with individual
customers --- were carried out in Hong Kong.
CIR v
Emerson Radio Corporation
The taxpayer is an American corporation
manufacturing and sel1ing e1ectronic equipments. It was the
registered owner of a trade mark "E". It had a wholly owned
subsidiary in Hong Kong. The Hong Kong subsidiary contracted
with manufacturers in various Asian countries, inc1uding Hong
Kong, for the manufacture of electronic equipment to be sold
main1y in US. No goods were sold in Hong Kong. Profits tax was
paid by the Hong Kong subsidiary in respect of its trading
profits arising from its course of business in Hong Kong. The
Hong Kong subsidiary had entered into a royalty agreement with
the taxpayer under which the Hong Kong subsidiary was allowed to
use the trade mark on goods sold by the Hong Kong subsidiary to
the US. CIR assessed the taxpayer to profits tax on its royalty
income under Section 15(1 ) (b). The taxpayer appealed to the
Board on the grounds that the trade mark was not used in Hong
Kong. The Board dismissed the taxpayer's appeal and ruled that
the royalty income was indivisible sum --- it could not be
apportioned between goods manufactured in Hong Kong and goods
manufactured outside Hong Kong. The taxpayer appealed to Court
of First Instance. It was held that only the royalty income
attributable to the goods manufactured in Hong Kong is taxable
and the income attributable to the goods manufactured outside
Hong Kong is not taxab1e. Therefore, apportionment of income
could be made. The ruling of the Court of First Instance was
uphe1d by the Court of Final Appeal.
Bank of India v CIR The Bank was carrying on
business in Hong Kong and was active in trade financing through
discounting of foreign bills. The bi1ls originated from
international trade. The drawers of the bills, companies of Hong
Kong, were suppliers of goods. The drawees were importers of
goods residing outside Hong Kong. The Bank was the payee. On
application of the customers, the Bank discounted the bills and
paid the proceeds to the customers in Hong Kong while the
collection of the value of the bills on maturity was performed
overseas by the Bank's agent.
The Bank made profits from the difference
between the costs of the bills and proceeds on the maturity of
the bills. The profits were assessed to Profits Tax. The Bank
appealed to the Board who decided in favor of CIR. The Bank
appealed to the High Court. CIR won. It was held that the
operations from Which the profits arose took place in Hong Kong.
Board of Review case Dl4/96The company was a
travel agent se1ling outbound tours through its retai1 outlets
in Hong Kong. It claimed that the outbound tour income should
not be assessable because such income arose main1y from
activities outside Hong Kong. The Revenue disallowed the claim
and the company appealed to the Board of Review. The Revenue
contended that the income was derived from the buying and
selling of tour packages and all such activities were done in
Hong Kong. In fact, the company had a number of retail outlets
in Hong Kong. It also purchased al1 airline tickets for its
tours in Hong Kong. The Board's approach was to analyze the case
by identifying the company’s activities concerning the issue. It
found that the company's relevant activities consisted of:
1. the marketing and sale of the tours
through its retail outlets
2. the purchase and sale of airline tickets
3. the discharging of the obligations of the
company and its agents for the tour services No doubt, the first
and second type of activities were done in Hong Kong. As for the
third activity, the Board found that it took place mainly
outside Hong Kong. In this activity, although no formal agency
agreement was entered into by the company with its 1and
operators in each tour destination, the 1and operators acted on
behalf of the company to perform the various activities which
the company had contracted to provide for the tour. The
relationship between the company and the land operators was
based on trust and the land operators should be regarded as
agents of the company and their activities were also relevant to
the earning of the profits. The Board considered whether the
profits should be apportioned between the three activities.
However, the Board found this question problematic because
neither the company nor the CIR admitted the possibility of
apportionment. The Board said:
“Presumably this was on the basis that the
profit was on inseparab1e Whole obtained as the indiscriminate
result of the entirety of operations.” So, the Board adopted the
principle of the Whampoa Dock case: where apportionment was not
possib1e, the 1ocality where the profits arise must be
determined by considerations which fasten upon the acts more
immediately responsib1e for the receipt of the profit. Having
considered all the relevant facts, the Board took the view that
the first and second activities namely marketing and sale of the
outbound tour in Hong Kong was more immediately responsib1e for
the receipt of the profit. The Board therefore held that he
profit arose in Hong Kong and was taxab1e.
Exxon
Chemical International Supply SA v CIR
The taxpayer was the wholly--owned subsidiary
of a multi-national corporation in the USA. It carried on
business in Hong Kong and the Bahamas. In the course of business
in Hong Kong, it purchased goods from one affiliate within the
group and sold them to another at a profit. The taxpayer invoked
Section 70 A to correct a profits tax assessment on the argument
that all services (for example shipping of goods) were performed
outside Hong Kong. After his claim rejected by CIR, the taxpayer
appealed to the Board which upheld the CIR's determination. The
taxpayer then appealed to High Court and his appeal was
dismissed
In the Exxon case, the court said: "ECIS
submits that before deciding Where a profit is derived (or, I
suppose, Where it arises) it is necessary first to determine how
the profit is derived and then (and then on1y) secondly to
determine where it is derived. I am content for the purposes of
the present case to accept this; having already demonstrated how
the profit on the transaction in question was derived 1 can
satisfy myself that it was derived from a “mark-up" on sales (as
ECIS itse1f submitted) and I can go on to consider where it was
derived. I ask myself Where did ECIS obtain the buyer's order
for the goods? The answer is that it obtained that order in Hong
Kong. I ask myse1f:Where did ECIS p1ace its order with the
seller for the goods to meet the buyer's requirement?
The answer is that it placed that order from
Hong Kong. These acts, the obtaining of the buyer's order in
Hong Kong and the placing of the order with the seller from Hong
Kong, are the foundations of the transaction; for it is the
differential between the selling price and the buying price
("the mark--up" ) which generates, indeed represents, the
profit... In my judgment (and on this I agree with the Board),
on the facts ECIS derived its profit from what it did in Hong
Kong. The income which arose from the "mark--up" taken by ECIS
arose where the mark--up was taken; that is to say, in Hong
Kong. No doubt, income arose on the de1ivery of the goods to the
buyer, but that was the income of those responsible for getting
the goods from Houston to Singapore. The on1y income of ECIS was
its "turn" between the se11ing and buying prices. ECIS does not
operate, outside Hong Kong, any activity with a view to profit.
It is in my view immaterial that the subject of the transaction,
effected in this case by the acceptance of ECIS of the order
from the buyer and matched (at a profit) by its own order p1aced
with the seller, was a load of lube oil additive destined for
transshipment from the USA to Singapore. The business was
transacted in Hong Kong." ~
CIR v.
Magna Industrial Company Ltd.
The taxpayer was a limited company carrying
on business in Hong Kong. It acquired industrial products from
its wholly-owned subsidiary and so1d them to overseas customers.
The subsidiary acquired the products from overseas supp1iers and
warehoused them in its name in Hong Kong. The taxpayer set up a
sales network comprised of independent contractors in their own
countries. The independent contractors were to find suitable
distributors, to train and supervise them and to promote the
sale of the taxpayer's products. The independent contractors
were authorized to enter into sales orders. The independent
contractors sent the sales orders to taxpayer in Hong Kong for
processing. Then, the taxpayer bought the goods from its
subsidiary and shipped the goods to the customers and collected
the sales money. The profit made by the taxpayer on the sale of
the goods was assessed to Profits Tax. The taxpayer appealed to
the Board successfully. It was held that the activities in the
purchase of products were those of the wholly--owned subsidiary,
and not the taxpayer, and the sales of products were effected by
a network of overseas independent contractors who had the
authority to bind the taxpayer to specific orders. Therefore,
the profits were derived outside Hong Kong.
CIR appealed to the High Court. The High
Court allowed CIR’s appeal based on the findings that the
subsidiary was the taxpayer’s agent in its purchase activities
in Hong Kong. The taxpayer appealed to Court of Appeal. This
time, the taxpayer won and the Board's findings and decision
were restored.
Note the following court comments :"More
often than not, it wou1d not be the quantity of activities but
the nature and quality of them that matters more. The cause and
effect of such activities on the profits is the determining
factor. It is what role such activities p1ayed and the relative
importance of them in the making of profits that would usually
tilt the scale and not the number of activities carried out at a
particular place…''' This is a case of trading profit and the
purchase and the sale are the important factors. We p1ace on
record that we have inc1uded in our deliberations al1 of the
relevant facts and not just the purchase and sale of the
products. C1early everything must be weighed by a Board when
reaching its factual decision as to the true source of the
profit. We must look at the totality of the facts and find out
what the Taxpayer did to earn the profit... Obviously the
question where the goods were bought and so1d is important. But
there are other questions : For example: How were the goods
procured and stored? How were the sales solicited? How were the
orders processed? How were the goods shipped? How was the
financing arranged? How was payment effected?"
It is noteworthy that different judges have
different decisions on the same issue in the same case. This
reflects the practical difficulty in identifying what is the
immediate operation to earn the profit in question. The reality
is: If the IRD disallows an off-shore claim, the taxpayer has to
appeal to the Board or even the court and then to bear all the
costs involved and the uncertainty of the judgment. Therefore, a
prudent taxpayer must endeavor to put forward all the relevant
facts as early as possible to convince the IRD to accept his
claim
Wardley Investment
Services (Hong Kong Limited) v CIR Taxpayer was a company
incorporated in Hong Kong and carried on business as investment
adviser. In the course of business, it arranged for sale and
purchase of overseas securities on behalf of its c1ients; and
from such activities it earned rebate from overseas
stock--brokers. The rebate was assessed but the taxpayer
appealed to the Board against such assessment. In its decision,
the Board of Review ruled that the rebate was not assessable.
The ruling was based on the 'operation test' and its findings
that the 'operations' giving rise to the profits were done
outside Hong Kong.
The Board's findings and
decision were overturned by the High Court. The taxpayer
appealed to Court of Appeal. It was held by majority that the
profits were taxable because the taxpayer did nothing outside
Hong Kong to earn the profits. Author's comment: In my
experience, it is hard to convince the Revenue to accept the
offshore c1aim where the taxpayer's activities outside Hong Kong
were minimal. It should be noted in this case that the overseas
operations giving rise to the profits were not done by the
taxpayer but by the overseas stock--brokers.
Commissioner of Inland Revenue v. Hang Seng Bank Ltd.
This case concerned the investment activities
of a Hong Kong bank in the purchase and sale of certificates of
deposit, bonds and gi1t edged securities. Both the purchase and
sale of these financial instruments (that gave the profits) took
place outside Hong Kong (in London and Singapore). It was he1d
that the relevant profits were made as a result of activities
that took p1ace outside Hong Kong even though the decision to
buy or sell the instruments in question was made in Hong Kong.
Accordingly, the profit was not taxable. It should be noted that
after this case the relevant law was amended, vide section 15(1
) (l), so that such income of a Hong Kong fincancial
institution, wherever it took place, was deemed to be chargeable
income.
It was held that there were three conditions
for a charge to arise:
(1 ) the taxpayer must carry on a trade,
profession or business in Hong Kong;
(2) the profits to be charged must be "from
such trade, profession or business" carried on in Hong Kong;
(3) the profits must be "profits arising in
or derived from" Hong Kong." The principle derived from this
case is: "one looks to see what the taxpayer has done to earn
the profit in question." To summarize, Lord Bridge of Harwich
made the following comments : "It is not enough for the purposes
of section 14(1) mere1y to find the existence of profits which
have been made by a business carried on in Hong Kong. It does
not follow that such profits arose in or were derived from Hong
Kong. Thus, for example, the fact that a company carries on
business in Hong Kong (as many Hong Kong companies do) does not
mean automahcal1y that a1l its profits become liab1e to profits
tax. One must go further to inquire whether the relevant profits
actual1y arose in or were derived from Hong Kong. These are the
very words found in section l4(1) as we1l as other re1ated parts
of the Ordinance such as section15 and also rule 2A of the
In1and Revenue Rules…
The three conditions must be satisfied before
a charge to tax can arise under section l4:
(l ) the taxpayer must carry on a trade,
profession or business in Hong Kong;
(2) the profits to be charged must be 'from
such trade, profession or business,' Which their Lordships
construe to mean from the trade, profession or business carried
on by the taxpayer in Hong Kong;
(3) the profits must be 'profits arising in
or derived from' Hong Kong. Thus the structure of the section
presupposes that the profits of a business carried on in Hong
Kong may accrue from different sources, some located within Hong
Kong, others overseas. The former are taxable, the 1atter are
not. The determination of whether or not profits arise in or are
derived from Hong Kong is ultimately a question of fact
depending on the nature of the relevant transactions:-see
322H(4).However, the "broad guiding principle" is that one must
1ook to see what the taxpayer has done to earn the relevant
profits. Section 14(1 ) also requires that the relevant profits
must have arisen from activities or operations carried on by the
taxpayer in Hong Kong. This 1ast requirement follows from the
words in section l4(l), "assessab1e profits arising in or
deriving from Hong Kong".
Kwong Mile
Services Limited v CIR
The taxpayer carried on business in Hong
Kong. It got profit from a property development in mainland
China. Such profit was assessed to Profits Tax. In fact, the
profit was from its underwriting of the sale of the property in
Hong Kong. The underwriting contract was a two--page document
and contained six short c1auses. The taxpayer agreed to
underwrite the sale of the units in the building in the sum of
$84,314,015. The underwriting period was up to 30 June 1992. If
on or before that day, the total price the developer received
from the sale of the building exceeded $84,314,015, then the
developer would pay the difference to the taxpayer. If the
amount was 1ess than the underwritten amount, the taxpayer would
have to pay the difference to the deve1oper and take up the
unso1d units. To implement the underwriting, the taxpayer
advertised the property development in Hong Kong and secured
contracts of sale for the units with purchasers in Hong Kong.
The purchasers had to sign in Hong Kong a
"pre--contract provisional agreement" with the deve1oper.The
taxpayer arranged for these purchasers to go to Main1and to sign
a pre-contract formal agreement" with the developer.
The taxpayer was not a party to these
agreements. The sale was a big success. The amount from the sale
exceeded the underwritten sum of $84,314.015. The taxpayer
received the agreed difference from the deve1oper. The taxpayer
appealed to the Board against the Profits Tax assessment. The
Board allowed the taxpayer's appeal. Then, CIR appealed to High
Court and CIR won. Then, the taxpayer appealed to Court of
Appeal and again, CIR won. The court ru1ed that it was the
underwriting of the sale that gave rise to the profit and
because the underwriting was substantially carried out in Hong
Kong, the profit derived from Hong Kong and therefore taxable
CIR v
Orion Caribbean Ltd.
This case concerns source of interest income.
In this case, the company received deposits from its ho1ding
company outside Hong Kong. Then, it lend the money to a person
outside Hong Kong. The CIR argued that by accepting the deposits
the company was a financial institution under section l5(1 ) (i)
and therefore the interest income is taxable. This argument was
rejected by the court. The following court's comments are
noteworthy. "There are three difficulties inherent in this
proposition. The first is that it attributes to Lord Bridge's
words, even if they are taken in isolation, a rather broader
meaning than that which they naturally bear. Lord Bridge speaks
of profit earned' by the exploitation of property assets as by
letting property, lending money or dealing in commodities or
securities'. The reference to' property assets' in relation to
the letting of property or the lending of money may have been
intended to refer simply to the exploitation of property or
money owned by the taxpayer. 1f ORPL lent its own money to a
borrower in, say, New York, then other things being equal there
might be 1itue difficulty in saying that the 1ocation of the
source of the interest on the 1oan was New York. If on the other
hand, Lord Bridge was intending to cover, by his examp1es, a
case such as that of OCL where they money has to be borrowed
before it can be lent-1ike the commodities which have to be
bought before they can be reso1d – it would be surprising if he
were suggesting that regard should be had solely to the place of
lending, to the exclusion of the p1ace of borrowing.
Secondly, and more generally, the proposition
that Lord Bridge was laying down a rule of law to the effect
that, in the case of a loan of money, the source of income was
always 1ocated in the p1ace where the money was lent, is one
that cannot stand with the opening words of Lord Bridge quoted
above, nor with the explanation of his remarks by Lord Jauncey
in the HK-TVB case, nor with the who1e range of authority
starting from the judgment of Atkin LJ in F.L. Smidth & Co v
Greenwood onwards, to the effect that the ascertaining of the
actual source of income is a ‘practical hard matter of fact', to
use words employed, again by Lord Atkin, in Liquidator, Rhodesia
Metals Ltd v Commissioner of Taxes [ l940] AC 774 at page 789.
No simp1e, single, 1egal test can be emp1oyed..."
In general, the HK IRD will adopt the
"provision of credit" test to decide the source of interest
income. However, because of the above court comments, other
tests may be used if the "provision of credit" has apparently
been used as a trick to avoid tax.
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