Hong Kong Tax alert. Time limit for a section 70A application may not be as generous as it appears

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1 4 March Issue No. 4 Hong Kong Tax alert Time limit for a section 70A application may not be as generous as it appears Under section 70A of the Inland Revenue Ordinance (IRO), a taxpayer can apply to correct an assessment within 6 years after the end of the year of assessment concerned or 6 months after a relative notice of assessment is served, whichever is later, if they can prove that the tax charged for that year of assessment is excessive by reason of an error or omission. However, the Court of Appeal (CoA) ruled in a recent case 1 that the time limit for a section 70A application is on a per assessment basis (i.e., assessment specific). Therefore, taxpayers cannot use the relevant 6-month period for a relative notice of assessment to make a section 70A application to correct a separate and earlier assessment where the otherwise normal time limit for making an application in respect of that earlier assessment has already expired. In such circumstances, the relevant 6-month period can only be used to make a section 70A application to correct the later notice of assessment. Clients who have any questions as to how section 70A is to be applied in a particular set of circumstances, including what constitutes an error or omission for the purposes of the section, can contact their tax executives. 1. The case in question is Good Mark Industrial Limited v Commissioner of Inland Revenue (CACV 90/2014).

2 Brief facts The taxpayer is a company engaged in the business of the provision of manufacturing or processing services for plastic product manufacturers. The timeline detailed in the diagram below illustrates the relevant events in chronological order, the timeline being simplified in order to aid an understanding of the issues involved. 1 Apr 2003 Events 2003/04 year of assessment 31 Mar Sept 2004 Original assessment Assessable profits (per return submitted) HK$ 3,903,764 6 years after the end of the 2003/04 year of assessment 17 Mar 2010 Additional assessment Additional assessable profits to disallow tax depreciation allowances claimed HK$ 5,673, Mar months after the date of issue of the 2003/04 additional assessment 15 Apr 2010 Taxpayer lodged a notice of objection against the additional assessment and at the same time sought to re-open the original assessment under section 70A. 17 Sept

3 In respect of the 2003/04 year of assessment, the taxpayer offered in its tax return profits of $3,903,764 for tax assessment. The assessor issued a per-return assessment (the 2004 original assessment ) to the taxpayer on 17 September The taxpayer did not object to the perreturn assessment of $3,903,764 within the normal onemonth objection period. The 2004 original assessment therefore became final and conclusive under section 70 of the IRO. On 17 March 2010, an additional assessment for the 2003/04 year of assessment (the March 2010 additional assessment ) was issued by the assessor to disallow tax depreciation allowances of $5,673,599 claimed by the taxpayer in the return. This assessment was made just before the expiration of the time limit for raising an additional assessment for the 2003/04 year of assessment under section 60 of the IRO, namely 31 March 2010 (i.e., 6 years after the end of the 2003/04 year of assessment). On 15 April 2010, i.e., within the normal one-month objection period, the taxpayer lodged a notice of objection under section 64(1) of the IRO against the March 2010 additional assessment. In addition to objecting to the disallowance of the tax depreciation allowances of $5,673,599, the notice of objection also sought to re-open the 2004 original assessment under section 70A of the IRO. The taxpayer requested the re-opening the 2004 original assessment under section 70A because certain offshore, non-taxable profits were erroneously included in the profits of $3,903,764 offered for tax assessment in the return 2. Issue in dispute The Commissioner of Inland Revenue (CIR) did not dispute that the notice of objection dated 15 April 2010 also constituted an application by the taxpayer under section 70A of the IRO. Nor did the CIR dispute that the prior treatment of the relevant profits as onshore constituted an error within the terms of section 70A. The crux of the issue in dispute was, therefore, whether the section 70A application on 15 April 2010 to re-open the 2004 original assessment was within the time limit stipulated in the section. If the time limit was calculated as being 6 years after the end of the 2003/04 year of assessment, the section 70A application on 15 April 2010 would be out of time. This would be the case because the time limit for making an application expired on 31 March As previously accepted or conceded by the CIR in several other cases, and as held by several Board of Review decisions, an error of the nature claimed by the taxpayer is generally regarded as an error of law (i.e., an error caused by a taxpayer s ignorance of the law at the relevant time) and is correctible under section 70A. However, if the time limit was calculated as being 6 months after 17 March 2010 when the March 2010 additional assessment was served, the section 70A application submitted on 15 April 2010 would be within time. This would be the case because the time limit would only expire at the later date of 17 September 2010 (i.e., 6 months after 17 March 2010). Dissatisfied with the CIR s decision to reject its section 70A application to re-open the 2004 original assessment as being out of time, the taxpayer applied to the Court of First Instance (CFI) for a judicial review of the decision. The CFI ruled against the taxpayer and the taxpayer thereafter further appealed to the CoA. Decision of the Court of Appeal The case concerned how to interpret the time limit specified in section 70A which reads as follows: Notwithstanding the [finality] provisions of section 70, if, upon application made within 6 years after the end of a year of assessment or within 6 months after the date on which the relative notice of assessment was served, whichever is the later, it is established to the satisfaction of an assessor that the tax charged for that year of assessment is excessive by reason of an error or omission in any return or statement submitted in respect thereof the assessor shall correct such assessment: Provided that no correction shall be made to any assessment in respect of an error or omission where the return or statement was in fact made on the basis of or in accordance with the practice prevailing at the time the return or statement was made [Emphasis added to help explain the reasons given by the CoA for its judgment]. The CIR contended that the 6-month period after the issue of the March 2010 additional assessment on 17 March 2010 (i.e., up to 17 September 2010) can only be used by the taxpayer to make a section 70A assessment to correct the March 2010 additional assessment, but not the 2004 original assessment. As regards the time limit for a section 70A application to correct the 2004 original assessment, it had already expired on 31 March 2010 (i.e., 6 years after the end of the year of assessment 2003/04). Therefore, the taxpayer s section 70A application on 15 March 2010 to correct the 2004 original assessment was out of time and must be rejected. On the other hand, the taxpayer argued that it was entitled to use the 6-month period after the issue of the March 2010 additional assessment to correct all the assessments made in respect of the year of assessment 2003/04, a claim for correction in the 6-month period not being confined to a correction of only the March 2010 additional assessment. 3

4 After taking into account the rationale of section 70A, i.e., striking a balance between the finality of an assessment and fairness of an assessment to a taxpayer, the CoA rejected the taxpayer s argument and dismissed the appeal. The CoA considered that an application under section 70A is to correct an assessment, as evidenced by the section containing phrases such as the assessor shall correct such assessment and no correction shall be made to any assessment. As such, the CoA ruled that the right to apply for correction is restricted to a specific notice of assessment, and for this reason section 70A includes the phrase the relative notice of assessment. The CoA further noted that in the case of Good Mark Industrial Ltd, the relative notice of assessment referred to the March 2010 additional assessment, but not the earlier 2004 original assessment. The CoA reasoned that although section 70A also contains the words year of assessment in the context of the tax charged for that year of assessment, it does not mean all the assessments made in respect of that year of assessment are susceptible to an application for correction regardless of the expiry of the 6 year restriction. In this regard, the CoA reasoned that the year of assessment in this context must refer back to the relative notice of assessment. The CoA also noted that inevitably the relative notice of assessment deals with an assessment of a particular year but if the rationale of section 70A is to strike a balance between finality and fairness, then the right of the taxpayer to correct an assessment must relate to the subject matter of the March 2010 additional assessment and not to other assessments also issued for the year of assessment 2003/04. The CoA added that to construe otherwise would render the finality principle meaningless. Rejecting the taxpayer s argument that fairness requires that it be able to correct the 2004 original assessment as well, the CoA noted that the taxpayer could have invoked section 70A earlier (i.e., on or before 31 March 2010) if it considered that a proper case for correction could have been made of the 2004 original assessment. Commentary It is of note that the CoA ruled the case as if it were a court of the first instance rather than a court of appeal, referring to none of the analysis and reasoning given by the CFI for rejecting the taxpayer s case. In this regard, the CoA appears to have taken the same view as outlined in our tax alert of 2 July 2014 wherein we commented that the CFI judge s reliance on the terms of proviso (c) to section 64(1) as supporting the CIR s contention that section 70A should be narrowly construed, does not appear very persuasive. In that alert we noted that given the different objectives of, and different conditions for invoking section 64(1) and section 70A, the proviso to section 64(1) did not appear relevant to interpreting the time limit for a section 70A application. The CoA now appears to have taken the same view and simply made its decision based on its interpretation of the wording of and the rationale for enacting section 70A alone, without relying on the terms of the proviso (c) to section 64(1). Some commentators may perhaps still be tempted to argue as being a bit extreme, the CoA s view that to construe section 70A otherwise would render the finality principle meaningless. In this regard, it is worth noting that taxpayers can at most extend the relevant time limit by only 6 more months. This is particularly the case given that section 70A is a relief provision aimed at achieving fairness and therefore a more generous time limit in certain circumstances may not be unwarranted. Nevertheless, the CoA decision appears to be a reasonable one and the taxpayer is unlikely to be granted any further right to appeal to the Court of Final Appeal, the case seemingly concerning a matter of more academic than public interest. Clients who have questions as to how section 70A may be applied with regard to a particular set of circumstances, including what constitutes an error or omission for the purposes of the section, can contact their tax executives. 4

5 Hong Kong office Agnes Chan, Managing Partner, Hong Kong & Macau 22/F, CITIC Tower, 1 Tim Mei Avenue, Central, Hong Kong Tel: / Fax: Principal tax contact Tracy Ho tracy.ho@hk.ey.com Hong Kong Tax partners Agnes Chan agnes.chan@hk.ey.com Joe Chan joe-ch.chan@hk.ey.com Owen Chan owen.chan@hk.ey.com Wilson Cheng wilson.cheng@hk.ey.com Chee Weng Lee chee-weng.lee@hk.ey.com May Leung may.leung@hk.ey.com Grace Tang grace.tang@hk.ey.com Karina Wong karina.wong@hk.ey.com Jo An Yee jo-an.yee@hk.ey.com EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com Ernst & Young Tax Services Limited. All Rights Reserved. APAC no ED None. This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, or other professional advice. Please refer to your advisors for specific advice. ey.com/china 5