Are multiple tax reserve certificates for alternative assessments on the same profits legitimate?

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1 News Flash Hong Kong Tax Are multiple tax reserve certificates for alternative assessments on the same profits legitimate? December 2018 Issue 15 In brief The Court of First Instance (CFI) handed down its judgement in Dairyfarm Establishment (DFE) and The Dairy Farm Company, Limited (DFCL) v Commissioner of Inland Revenue (CIR) on 8 October The case concerns an application for judicial review by the taxpayers against the CIR s decisions on ordering the holdover of each of the multiple alternative assessments on condition that a separate tax reserve certificate (TRC) be purchased under each assessment and rejecting the taxpayers proposals of dealing with the multiple alternative assessments in some other ways. While case law (e.g. Canray Investment Ltd v CIR 2 ) has established that assessors may lawfully issue multiple assessments based on alternative grounds on the same profits, the CFI s judgment in this case, if being eventually upheld as the correct interpretation of the law, can relieve the financial burden that taxpayers would have when the holdover of the tax in disputes is on condition that a separate TRC be purchased under each of the alternative, mutually exclusive assessments. The judgment in the present case has not yet become final since the CIR has filed an appeal to the Court of Appeal (COA). The hearing of the appeal has yet to be determined. In detail Background of the case The taxpayers, DFCL and DFE, are members of the same group. DFE was incorporated in Liechtenstein and owns various trademarks of the group registered in Hong Kong. DFCL was incorporated in Hong Kong and carries on business under the trademarks owned by DFE. A licencing agreement was entered into between DFE and DFCL in 2012 under which DFCL paid royalties to DFE for the use of the various trademarks owned by DFE in Hong Kong. For years of assessment 2012/13 to 2014/15, the CIR took the view that DFE carried on a business in Hong Kong and the transaction between DFE and DFCL was artificial and entered into for the sole or dominant purpose of enabling DFCL to obtain a tax benefit (i.e. in the form of a deduction of royalties). As such, the following three sets of profits tax assessments were raised for the above mentioned years of assessment: 1. direct assessments on DFE on royalties it received under section 14 of the Inland Revenue Ordinance (IRO) (the Section 14 Assessments) on the basis that it carried on a business in Hong Kong; 2. withholding tax assessments on DFE in the name of DFCL on the royalties paid by DFCL to DFE under deeming provision section 15(1)(b) at the tax rate of 16.5% under section 21A of the IRO (the Section 21A Assessments); and 3. assessments on DFCL denying its deduction of the royalties (the Section 61A Assessments). It is common ground that the Section 14 Assessments and Section 21A Assessments are alternative assessments on the same taxpayer and on the same profits. The taxpayers objected to the above three sets of assessments and the CIR determined against the taxpayers. The taxpayers have lodged an appeal against the CIR s determinations to the Board of Review (BOR).

2 The appeal will be heard on 4 March Pending the outcome of the appeal, the CIR granted a holdover of the taxes payable under the Section 14 Assessments and Section 21A Assessments on the condition that the taxpayer was required to purchase TRCs for both sets of assessments. The taxpayers duly purchased the two sets of TRCs as demanded by the CIR. Subsequently, three similar sets of assessments were issued to the taxpayers under sections 14, 21A and 61A for years of assessment 2015/16 and 2016/17 (the New Assessments). The taxpayers proposals In addition to lodging objections to the New Assessments, the taxpayers put forward the following three proposals to the CIR regarding the New Assessments: Proposal 1(1): To annul the new section 21A assessments for the time being, without prejudice to them being reissued within six years of the end of each relevant year of assessment; Proposal 1(2): To postpone the due date for payment of tax in dispute under the new section 21A assessments to two months after the BOR s decisions on the appeal, with further extension if necessary; and Proposal 2: To purchase TRCs for the new section 14 assessments (which are in the higher amounts) only as the security for both new section 14 and section 21A assessments. The CIR s decisions The CIR rejected all of the three proposals submitted by the taxpayers on the following grounds and requested the taxpayers to purchase TRCs for both the new section 14 and section 21 assessments: Proposal 1(1): The new section 21A assessments cannot be annulled as they were validly issued. In addition, section 64(2) 3 of the IRO implies that the CIR cannot amend or annul the assessments before a determination on the taxpayers objections to the assessments has been made; 71(2) of the IRO, tax shall be paid notwithstanding any objection or appeal unless a holdover order has been made by the CIR; and Proposal 2: Particulars of the assessment and tax in dispute are specified in a TRC purchased. Section 71(7)(e) of the IRO explicitly provides that a TRC purchased in pursuance of a particular conditional holdover order shall not be used for any other purposes so TRCs purchased for the new section 14 assessments cannot be used for tax payment under the new section 21A assessments. The CIR ordered a conditional holdover of the taxes payable under the new section 14 and section 21A assessments on the condition that a separate TRC be purchased for each assessment. The CFI s judgment In its judgment, the CFI made an overall comment that the unfairness of the situation faced by the taxpayers in the case was obvious since the CIR would not suffer any financial prejudice in accepting the taxpayers proposals but the taxpayers would suffer considerable financial hardship if they have to purchase multiple TRCs. The CFI also observed that there are huge disparities between the interest payable by a taxpayer to the CIR in the event the objection or appeal fails (i.e. 8% per annum) and the interest payable by the CIR to a taxpayer in the event the objection or appeal succeeds (i.e. less than 0.1% per annum 4 ). The CFI then ruled that the CIR erred in law in rejecting the taxpayers proposals based on the following analyses: Proposal 1(1): The CIR s view that an assessment could not be annulled once it has been validly issued is legally incorrect. Under section 64(2) of the IRO, the CIR is given a wide discretion to annul an assessment after receiving a valid notice of objection. Such discretion is not confined to situations where the CIR s determination has been made. The CIR also has power under section 46(c) 5 of the Interpretation and General Clauses Ordinance (IGCO) to withdraw the new section 21A assessments. Furthermore, the new section 21A assessments after the final determination and in doing so the new assessment does not involve re-opening of any matter which has been determined on objection or appeal. Proposal 1(2): It is the Inland Revenue Department (IRD) s policy that the tax payment due date, once allotted, will not be amended. In fact, under section CIR has the power to re-issue the 2 PwC Proposal (1)(2): The interpretation of the power to amend an assessment can be found in Section 46(a) 5 of the IGCO. Section 71(4) of the IRO also suggests that in certain cases, pending the determination of an objection or an appeal, the due date for payment of tax under an assessment can be uncertain. In addition, the CIR s comment that it is the IRD s policy not to amend the tax payment due date is an implicit recognition that the CIR does have the power to amend the due date. Proposal (2): The CIR s argument that a TRC with the particulars of the tax in dispute cannot be used for any other purposes seems to be based on an overly rigid way of reading section 71(7)(e) of the IRO. The CFI took the view that the particulars of two sets of assessments in dispute can be stated in a TRC to make it clear that the TRC is intended to stand as security for both assessments lawfully. Based on the above analyses, the CFI allowed the taxpayers application for judiciary review, quashed the CIR s decisions and remitted the taxpayers proposals to the CIR for fresh consideration. The takeaway While case law (e.g. Canray Investment Ltd v CIR 2 ) has established that assessors may lawfully issue multiple assessments based on alternative grounds on the same profits, the CFI s judgment in this case, if being eventually upheld as the correct interpretation of the law, can provide some financial relief for taxpayers as they will then not be required to purchase multiple TRCs for alternative, mutually exclusive assessments. The judgment in the present case has not yet become final since the CIR has filed an appeal to the COA. The hearing of the appeal has yet to be determined.

3 Endnotes 1. The CFI s judgment in the case can be accessed via this link: mon/ju/ju_frame.jsp?dis=117815&cu rrpage=t 2. The CFI s judgment in Canray Investment Ltd v CIR can be accessed via this link: mon/search/search_result_detail_fra me.jsp?dis=81896&qs=%2b&tp=ju 3. Section 64(2) of the IRO states that On receipt of a valid objection, the Commissioner shall consider the same and within a reasonable time may confirm, reduce, increase or annul the assessment objected to 4. The rate of interest payable on TRCs has been increased to 0.25% for TRCs purchased on or after 5 November Sections 46(a) and (c) of the IGCO states that where an ordinance confers power upon any person to make, grant, issue or approve any order, notice., such power shall include power to amend or suspend such order, notice or withdraw approval of any order, notice so approved 3 PwC

4 Let s talk For a deeper discussion of how this issue might affect your business, please contact the following PwC members: PwC s Corporate Tax Leaders based in Hong Kong: Charles Lee China South and Hong Kong Tax Leader charles.lee@cn.pwc.com Rex Ho Financial Services rex.ho@hk.pwc.com Kenneth Wong Tax Controversy kenneth.wong@hk.pwc.com Jeremy Ngai China South Tax Leader jeremy.cm.ngai@hk.pwc.com Cecilia Lee Transfer Pricing cecilia.sk.lee@hk.pwc.com Jeremy Choi Industrial Products jeremy.choi@hk.pwc.com Jenny Tsao Corporate Tax and Consumer Markets jenny.np.tsao@hk.pwc.com With close to 3,000 tax professionals and around 200 tax partners in Hong Kong, Macau, Singapore, Taiwan and 23 cities in Mainland China, PwC s Tax and Business Service Team provides a full range of tax advisory and compliance services in the region. Leveraging on a strong international network, our dedicated Hong Kong Corporate Tax Leaders based in Hong Kong are striving to offer technically robust, industry specific, pragmatic and seamless solutions to our clients on their Hong Kong, PRC and international tax issues. Senior tax buyers name PwC as their first choice tax provider in Hong Kong.* * These results are based on an independent survey of 100 primary buyers of tax services in Hong Kong, conducted by research agency Jigsaw Research (Q1-Q4 2016). 4 PwC 2018 PricewaterhouseCoopers Ltd. All rights reserved. PwC refers to the Hong Kong member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see for further details.

5 In the context of this News Flash, China, Mainland China or the PRC refers to the People s Republic of China but excludes Hong Kong Special Administrative Region, Macao Special Administrative Region and Taiwan Region. In the context of this News Flash, China, Mainland China or the PRC refers to the People s Republic of China but excludes Hong Kong Special Administrative Region, Macao Special Administrative Region and Taiwan Region The information contained in this publication is for general guidance on matters of interest only and is not meant to be comprehensive. The application and impact of laws can vary widely based on the specific facts involved. Before taking any action, please ensure that you obtain advice specific to your circumstances from your usual PwC s client service team or your other tax advisers. The materials contained in this publication were assembled on 24 December 2018 and were based on the law enforceable and information available at that time. This Hong Kong Tax News Flash is issued by the PwC s National Tax Policy Services in Hong Kong and China, which comprises of a team of experienced professionals dedicated to monitoring, studying and analysing the existing and evolving policies in taxation and other business regulations in China, Hong Kong, Singapore and Taiwan. They support the PwC s partners and staff in their provision of quality professional services to businesses and maintain thought-leadership by sharing knowledge with the relevant tax and other regulatory authorities, academies, business communities, professionals and other interested parties. For more information, please contact: Matthew Mui +86 (10) matthew.mui@cn.pwc.com Please visit PwC s websites at (China Home) or (Hong Kong Home) for practical insights and professional solutions to current and emerging business issues. 5 PwC 2018 PricewaterhouseCoopers Ltd. All rights reserved. PwC refers to the Hong Kong member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see for further details.