The Commissioner of Inland Revenue v. Lo and Lo, A Firm

CACV000048/1982

Inland Revenue Ordinance section 16(1) - permissible deductions for the purpose of ascertaining assessable income.

On the 3.1.1977 the respondents introduced a new term into the conditions of employment of its staff providing for the payment to those members of its staff who retired after not less than 10 years' service a lump sum arrived at by multiply the number o￡ years of service by half the average monthly salary for the last 12 months of employment. A staff member dismissed for cause was not eligible for this payment. Commissioner appealed from the decision of Hunter J. who held that the respondents to be entitled when computing assessable income to deduct the sum of $770,000 set aside in their books as representing the total they might become obliged to pay 23 members of their staff who continued in their service but who had already completed 10 years service. Held dismissing the appeal that the deduction claimed all within the phrase "all outgoings and expenses to the extent to which they are incurred during the basis period for that year of assessment" in section 16(1) of the Inalnd Revenue Ordinance.

BETWEEN

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Coram: Leonard V-P, Cons & Zimmern JJ.A.

Date: 28 September 1982

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JUDGMENT

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Leonard V-P:

1. Zimmern J.A. has authorised me to say that he has read this judgment in draft and that he agrees with it.

2. The notice of appeal as argued raises two closely allied issues. Before attempting to define these I should indicate the nature of the sum which the respondent claims to deduct under section 16(1) and the purposes of the remaining relevant sections in Part IV of the Ordinance. On the 3rd January, 1977, the respondents introduced a new term into the conditions of employment of all its staff, which read:

"Clause 5 -

Any member of the staff who leaves the firm's employment after not less than 10 years' service will be entitled to a lump sum payment calculated by multiplying the number of years (complete) employed by the firm by half of his average monthly salary for the last 12 months of his employment. Naturally this will not apply for a member of the staff who is dismissed for dishonesty, serious misconduct or gross inefficiency."

3. Two sums appeared in the respondent's accounts for the period between January and December 1977. Some staff members, all of whom had served for more than 10 years retired during that period and they received in all the total sum of $93,102. This sum was allowed as a deduction by the Commissioner. The sum which was disallowed by the Commissioner ($770,000) was based on a calculation made by the respondent as to the total of the lump sum payments that they might be obliged to pay 23 other members of the staff who had already completed 10 years' service but whose service continued. Each such staff member might by retiring secure his entitlement to his lump sum payment and could forfeit it only by dismissal for cause. The total of $770,000 then represented the total of minimum lump sums - what the 23 would have been entitled to had they retired then and there. Each would become entitled to an increasing lump sum for each complete year he served after December 1977. The first issue to be decide, then is whether the total of the lump sum payments should properly be deducted in ascertaining the profits in respect o￡ which the respondents were chargeable to tax; and the second whether the total of those lump sums could be dismissed as "no more than a rough estimate of liability".

4. Section 16(1) of the Inland Revenue Ordinance, Cap. 112 provides:

"In ascertaining the profits in respect of which a person is chargeable to tax under this Part for any year of assessment there shall be deducted all outgoings and expenses to the extent to which they are incurred during the basis period for that year of assessment by such person in the production of profits in respect of which he is chargeable to tax under this Part for any period".

5. That subsection was agreed by counsel in the Court below to contain "the general Rule" relating to the permissibility of making deductions for the purpose of ascertaining profits in respect of which a person is chargeable to tax. The remaining subclauses in section 16(l) give examples of permitted deductions and contain a list of outgoings and expenses introduced by the word "including". The use of this word suggests that unlisted outgoings and expenses are permitted to the extent to which they are incurred during the basis period for that year of assessment by such person in the production of profits in respect of which he is chargeable to tax. The examples given are not exhaustive and the question as to any deduction which is neither expressly permitted nor prohibited, is governed by the general rule set out at the beginning of section 16(1).

6. The matrix in which section 16(1) finds itself is Part IV of the Ordinance. This part is entitled "Profits Tax" but there is no definition to be found in the Ordinance of the word "profits". There is a definition in section 2 of the words "assessable profits" which "means the profits in respect of which a person is chargeable to tax for the basis period for any year of assessment calculated in accordance with the provisions of Part IV". This definition does not appear to me to be of assistance, it brings us back to Part IV and therefore does not help in its interpretation. Part IV consists of 39 sections, only 5 of which namely sections 14, 15, 16, 17 and 18, were referred to in argument before us. In the Court below it was agreed that the relevant sections were sections 14 (with the definition of "assessable profits" in section 2) 16 and 17 but that is not to say that other sections may not be looked to for their interpretation. One must look to the entirety of Part IV.

7. Section 14 is the charging section and provides that profits tax shall be charged for each year of assessment at the rates there mentioned on every person carrying on a trade, profession or business in the Colony in respect of his assessable profits arising in or derived from the Colony for that year from such trade, profession or business (excluding profits arising from the sale of capital assets) as ascertained in accordance with this Part.

8. Section 15 deems sums described in paragraphs (a) to (k) to be receipts arising in or derived from the Colony from a trade, profession or business carried on in the Colony. I need not concern myself with this section, save to note its position and that the sums described are deemed to be receipts. I can find no assistance in section 15B, 15C or 15D.

9. Although it was not cited to us in argument, section 16A is of interest, it reads:

"16A Where a person carrying on a trade, profession or business in the Colony makes a payment which is either:

(a)	a contribution, other than an ordinary annual contribution to a fund duly established under an approved retirement scheme, or
(b)	a premium, other than an ordinary annual premium, in respect of a contract of insurance under an approved retirement scheme,

such payment shall, to the extent that it is made in respect of individuals employed by such person for the purposes of producing profits in respect of which he is chargeable to tax under this Part and that it is not excessive in view of all the relevant circumstances, be deemed to be an expense wholly and exclusively incurred in the production of such profits and shall be allowed as a deduction therefrom in accordance with subsection (2).

(2)        For the purpose of making the deduction provided for in subsection (1), one fifth part of the payment shall be deemed to have been expended during the basis period in which the payment was actually made and the remaining four parts shall be deemed to have been expended at the rate of one part in the basis period for each of the succeeding four years of assessment;

Provided that in no case shall the total amount of the deductions exceed the amount of the payment.

(3)        For the avoidance of doubt it is hereby declared that this section is applicable only to payments made in or after the basis period for the year of assessment commencing on 1st April 1955".

10. Subsection (3) appears to suggest that in the opinion of the draftsman payments made prior to the coming into force of section 16A to a retirement scheme (even although approved) would not be an expense wholly and exhaustively incurred in the production of profits; the same conclusion may be reached from the use of the word "deemed" in section 16A(1). Section 16B, section 16C and section 16D are not of assistance.

11. Section 17 deals with deductions that are not permitted, it reads:

"17(1)     For the purpose of ascertaining profits in respect of which a person is chargeable to tax under this Part no deduction shall be allowed in respect of".

various matters set out in 8 sub-paragraphs.

12. Section 18 deals with the basis for computing profits and provides in general that assessable profits for any year of assessment from any trade, profession or business carried on in the Colony shall be computed on the full amount of the profits therefrom arising in or derived from the Colony during the year preceeding the year of assessment.

13. I have no doubt that the liability towards the staff, if incurred at all was incurred in the production of taxable profits so that the words calling for interpretation are "all outgoings and expenses to the extent to which they are incurred".

14. I consider that in any approach to the interpretation of our Ordinance it is necessary to bear in mind the warning in I.R.C. Appuhamy⁽¹⁾ at 72 that it is not useful to refer to decisions in other jurisdictions where the forms of the respective statutory provisions are not the same. The statutory provisions in the United Kingdom, those taxing "annual profits", are as the trial judge pointed out similar but not the same as ours. The words used there are:

"No sum shall be deducted in respect of:

(a)    any disbursements or expenses, not being money wholly and exclusively laid out or expended for the purposes of the trade, profession or vocation".

15. Section 15(l) of the Australian Income Tax Assessment Act 1936 to 1974 which reads:

"All losses and outgoings to the extent to which they, are incurred in gaining or producing the assessable income or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income, shall be allowable deductions except to the extent to which they are losses or outgoings of capital, or of a capital, private, or domestic nature or are incurred in relation to the gaining or production of exempt income".

again is similar but again there are important differences, to which I will refer, and what is being dealt with again is (judging by the title to the Act) income tax. What we are dealing with is an Ordinance which imposes taxes on property, earnings, profits and interest and which in Part IV imposes a tax on profits. As the trial judge recognised all the authorities cited to him (and to us) are, at most, indirectly persuasive. In the English cases the words falling for interpretation appear to have been "any disbursements or expenses not being money wholly and exclusively laid out or expended for the purposes of the trade, profession or vocation". The relevant words in section 51(1) of the Income Tax Assessment Act 1936 in Australia appear to have been "all losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income or are necessarily incurred in carrying on business for the purpose of gaining or producing such income", but section 51(1) not only bears a resemblance to our section 16(1), it also, by its reference to losses or outgoings of capital or of a capital, private or domestic nature introduces matters dealt with by our section 17 and by its reference to outgoings "incurred in relation to the gaining or production of "exempt income". I assume it pre-empts the argument unsuccessfully advanced in C.I.R. v. Mutual Investment Co. Ltd.⁽²⁾ Its structure then is quite different from ours as are the words "losses and outgoings" used in place of our words "outgoings and expenses". The differences in wording and the warning in Appuhamy's case have resulted for me in a complete stoppage of play in the England and Australia test due to bad light.

16. By its use of the words "outgoings and expenses to the extent they are incurred" our legislation would appear to recognise a distinction between "outgoings" and "expenses". We have seen that the word "profits" is not defined and although the phrase "assessable profits" is, it is defined in a somewhat circuitous way. Again the phrase "profits arising in or derived from the Colony" is defined for the purposes of Part IV "without in any way limiting the meaning of the term" as including "all profits from business transacted in the Colony whether directly or through an agent". The use of the phrase "without in any way limiting the meaning of the term" gives some slight indication that the term "profits" is intended to be a wide one to be interpreted in its every day commercial meaning. It is these profits that Part IV seeks to tax. Does our Ordinance by the words it uses compel its reader to hold that the legislature intends to impose and imposes a tax not on profits but on a figure arrived at by a statutory computation which prevents the respondents claiming a deduction which is normal commercially in ascertaining profits? To determine this we must look to the words "one has to look merely at what is clearly said. There is no room for any intendment. There is no equity about a tax. There is no presumption as to tax. Nothing is to be read in, nothing is to be implied (Cape Brandy Syndicate v. I.R.C.⁽³⁾

17. Because of the differences between our legislation and the English legislation on the one hand and the Australian legislation on the other the only case which I have found of assistance is C.I.R. v. Mutual Investment Co. Ltd.⁽²⁾ The following table shows the relevant sections as they were then and as they are now:

The Judicial Committee there regarded it as:

"Clear enough that sections 16 and 17 provide exhaustively for the deduction side of the account which is to yield the assessable profits. They relate deductibility to the production of profits in respect of which the corporation is chargeable to tax which by section 18A are the assessable profits calculated in accordance with Part IV. Section 16(1) does not provide for the deduction of expenses from the assessable profits but for the deduction of expenses 'for the purpose' of the ascertainment of assessable profits. Its terms presuppose receipts from which deductions can be made to determine a balance which will be the assessable profits. On the other side of the account are the total receipts derived from the Colony not being from the sale of capital assets see section 2 and section 14(2) and not being dividends, which in their Lordship's opinion, are excluded from the account by section 26(a). It is the balance of this account which, in their Lordship's opinion, is spoken of as the 'net profits' in the definition of assessable profits in section 2.

Having regard to these provisions there is no room in their Lordship's opinion for treating the profits to which section 14(1) refers as the balance of the total receipts over the total disbursements of the taxpayer arrived at upon ordinary business accounting considerations or for commencing the process of calculating assessable profits with an opening figure of the total of the business receipts and thereafter deducting the permitted deductions making the deductibility referable to the business receipts and not to the receipts forming part of the assessable profits. Indeed the use of the word 'profits' as distinct from receipts in section 14(1) is inconsistent with any such conclusion or process".

18. While appreciating that the legislative purpose in enacting the new section 16 was to avoid the interpretation of section 16 adopted by the Full Court (but ultimately not accepted by the Privy Council) in C.I.R.v. Mutual Investment Co. Ltd. ⁽²⁾ (see (1964) H.K.L.R. 173 and (1967) A.C. 587). I am puzzled as to why the introductory words to section 16(1) were changed to "In ascertaining ......." while the words "For the purposes of ascertaining" in section 17 were left unchanged. As to this and having regard to the ultimate result of the Mutual Investment case I am compelled to the view that the only legislative change effected by the new section 16(1) was that brought about by the substitution of the words ''to the extent to which they are incurred during the basis period" for the words "wholly and exclusively incurred during the basis period". Section 16 may then be paraphrased to read:

"In order to ascertain the taxable profits you shall deduct from the total of receipts and sums deemed to be receipts all outgoings and expenses to the extent to which they are incurred in the production of such profits".

19. I think this paraphrase also accords with the passage I have quoted from C.I.R. v. Mutual Investment Co. Ltd.⁽²⁾ If I am correct in this para-phrase the first issue can be decided by deciding whether the total of the lump sums can be said to be an "expense" "incurred". I think it must be in the ordinary meaning of those words for it is an allowance for the cost of administering a retirement scheme started to avoid losing experienced staff and as such is an expense. This is particularly so if there is to be a difference between "expense" and "outgoing". It is "incurred" in that liability for it was assumed. I do not, however, think that it is entirely proper to split up the words used in this manner and merely do so as a check on my interpretation of the words "expenses to the extent to which they are incurred in the production of profits" which to my mind embrace such an allowance as this. I cannot see that the liability was contingent affects the expense resulting from the contingent liability from being "incurred".

20. I have said that I believe that my paraphrase accords with the passage quoted from C.I.R. v. Mutual Investment Co. Ltd,⁽²⁾ although Mr. Barlow laid considerable stress on that part of the passage reading:

"There is no room in their Lordship's opinion for treating the profits to which section 14(1) refers as the balance of the total receipts over the total disbursements of the taxpayer arrived at upon ordinary business accounting considerations".

21. That however must be read in its context and what their Lordships were dealing with was an expense incurred in earning that part of mutual Investment's profits which was not to bear tax. One must if one is to give any significance to section 16(1) ascertain the expenses to be deducted (from receipts) - in the case in which the liability for those expenses has been assumed for the production of profits subject to taxation as distinct from the case in which the liability has been assumed for the production of profits not subject to taxation - upon ordinary business accounting considerations.

22. Does the presence of section 16A alter the position? It was not suggested before us that it did and I think this is the correct approach. On my interpretation it is unnecessary and in thinking that it was necessary the legislature made a mistake of law. This mistake cannot change the law. (see Smith Kline and French v. A.G.)⁽⁴⁾

23. As to the second issue it arises from paragraphs 16, 17 and 18 of the Board's case. Mr. Barlow complains that there is no true finding of fact in these paragraphs. They read:

"16.          The Commissioner's representative also contended that the taxpayer's appeal should fail on the ground that the sum claimed to be deducted was ‘in the nature of a rough reserve against the future rather than a measured provision' (Lord Radcliffe in Southern Railway of Peru v. Owen⁽⁵⁾). In particular Lord Radcliffe criticised the company for omitting to allow for discounting.

17.          The taxpayer's representative's reply to this point was that the amount sought to be deducted is reasonable accurate. That although the sum was not discounted, the margin which would be obtained by the discounting would serve to offset the inevitable increase of future payments due to salary increases. Also with only about 23 companies involved, there was no case for the employment of an actuary as in the Titaghur case where about 17,000 employees were involved. The report of the Southern Railway of Peru case does not indicate the number of employees involved and it is probable that the number is well in excess of the taxpayer's.

18.          In the circumstances the Board accepted the contention of the taxpayer's representative and held that it would not dismiss the appeal on this ground".

24. I consider that there is implicit in the Board's acceptance of the contentions of the taxpayer a finding that the sum sought to be deducted is accurate. Furthermore the trial judge found himself unable "to review or even criticise it" on the material before him. I find myself in the same position.

25. From these reasons I would dismiss the appeal.

Cons J.A.:

26. My Lord the Vice-President has sufficiently set out the facts and legislation which provide the background to this appeal.

27. Taken literally neither an "outgoing" nor an "expense" can be incurred until it is actually paid. "Outgoing" speaks for itself and "expense" is derived from the Latin, to pay away. However, neither of the two jurisdictions to which we have been referred. takes that strict view. Australia may allow the deduction of monies that are "due", although they are not actually paid until some later years: Nilsen Development Laboratories Proprietary Ltd. v. Federal Commissioner of Taxation.⁽¹⁾ England allows the present value of payments that will, as matter of commercial certainty, become payable in the future, provided the present value of the future payment can be satisfactorily determined or fairly estimated.

28. The leading authority in England is that of the House of Lords Owen v. Southern Railway of Peru. ⁽²⁾ The facts of that case differ from the present, apart from the nature of the business practiced by the tax-payer, in only two respects. Firstly the liability to pay on retirement was imposed by statute rather than by contract and secondly that there was no additional claim to deduct monies which might be thought referable to previous years. The first distinction is to my mind immaterial. The second is covered by I.R.C. v. Titaghur Jute Factory Co. Ltd. ⁽³⁾ A decision of the Scottish Court of Session which applied Owen⁽²⁾ and allowed both amounts to be deducted.

29. I appreciate that the circumstances of the present case do not fall strictly within the terms of the second principle laid down by Their Lord-ships of the Privy Council in De La Salle v. De La Salle, ⁽⁴⁾ namely that this Court is in effect bound by the decisions of the House of Lords where our legislature has adopted the same legislation as is in force in England. But the general tenor of Their Lordships' remarks inclined me to think that we should do so, unless there is an effective difference in the language used or the two sets of legislation operate upon different patterns.

30. It is suggested by the Commissioner that both exceptions apply. Firstly, the word used in section 16(1) is "incurred", whereas in England it is "laid out or expended", together with the difference between "in the production of profits in respect of which he is chargeable to tax" and "for the purposes of the trade, profession or vocation". Secondly, it is said that in Australia the taxable profits are calculated on a two stage system whereby the whole financial receipts of the taxpayer are added up and from the total thus achieved the statutory deductions are made, leaving a balance subject to taxation. The English system is said to be a one stage system or drawing a balance according to normal commercial or accounting practice.

31. "In the production of profits etc." is from the taxpayer's point of views, a more narrow exception than "for the purposes of the trade etc.", and I do not think much assistance could be drawn from any English case that dealt with the latter phrase. However, we are not concerned with that aspect. For us the crucial word is "incurred", and to my mind that has, if anything, a wider meaning than "laid out or expended", for it includes the acceptance of a liability as well as the meeting of that liability as and when it matures. Thus if there be any difference in meaning at all, it is a difference that can only be in favour of the taxpayer and would not detract from the authority of Owen.⁽²⁾

32. As to the second objection I must confess to some difficulty in appreciating the distinction suggested, for it seems to me that whether one applies statutory or commercial rules a profit can only be established by deducting the appropriate losses from the appropriate receipts. The vital difference between the jurisdictions, as I see it, is merely that in Australia what is appropriate by way of deduction is decided in the last resort by the judges applying statutory standards, whereas in England it is judged by the standards set by the accountancy profession, subject of course to any particular overriding legislation. In my opinion Hong Kong falls within the latter pattern for although there are some particular instances set out in subsection 16(1) those instances are introduced by the word "including". That implies that there must be other deductable items which have not been specifically mentioned, and how are these to be found except by reference to normal accountancy practice, provided of course that they do not contravene the general words of the subsection.

33. I do not think this conclusion is inconsistent with the words of Sir Jarfield Borwick in C.I.R. v. Mutual Investment Co. Ltd.⁽⁵⁾ The question in that case was not whether outgoings or expenses had or had not been incurred. There was not doubt that they had. The question was whether in the ascertainment of taxable profits they could be set off against particular receipts. The passage on which the Commissioner relies must be taken in that general context and in the particular context of the highly technical argument that their Lordships were at that stage re refuting.

34. The views I have just expressed follow more or less closely the line taken by Hunter J. in the Court below. But I would not go so far as he does to suggest that it produces a result which is necessarily "manifestly more convenient and more conducive to 'fairness and justice"' than that adopted by the Australian courts. It seems to me that there is much to be said for the simplicity and certainty of the Australian approach. The unfortunate situation that was highlighted in New Zealand Flax Investment Ltd. v. Federal Commissioner of Taxation⁽⁶⁾ which, together with the cirticism voiced therein by Dinson J., so heavily influenced the judge below, and which, incidentally, at least to some extent appears to have been of the taxpayer's own making, could easily be provided for by legislation

35. I agree with the comments made by my Lord the Vice-President upon section 16A and upon the further argument that the taxpayer had failed sufficiently to quantify his claim.

36. I also would dismiss the appeal.

(1)    (1963) 1 All E.R. 69

(2)    A.C. 587 (1967)

(3)    (1921) 1 K.B. 64 at 71

(4)    (1966) H.K.L.R. 498

(5)     36 T.C. 602 at 644

(2)    (1956) 36 T.C. 602  

(4)     (1979) H.K.L.R. 214 at 220

(3)    (1978) S.T.C. 166

(5)    (1967) A.C. 587

(6)    (1938) 61 C.L.R. at 179

Representation:

Mr. Barrie Barlow, Crown Counsel for appellant

Mr. Robert Kotewell (Lo & Lo) for respondent