Richfield International Land and Investment Co Ltd v. Commissioner of Inland Revenue

CACV000059/1988

Headnote

(1) On case stated by Board of Review, Court is only entitled to interfere with Board's findings or inferences of fact if they are unreasonable, Edwards v Bairstow [1956] AC 14 or insupportable Furniss v Dawson [1984) STC 153.

(2) On fact Board's findings upheld.

IN THE COURT OF APPEAL

BETWEEN

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Coram: Hon. Clough & Hunter, JJ.A. & Macdougall, J.

Date of hearing: 26th, 27th & 29th July, 1988

Date of handing down judgment: 9th August, 1988

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J U D G M E N T

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Hunter, J.A. :

1. This is the judgment of the Court.

2. In January 1980 the respondent, Richfield International Land and Investment Company Ltd (the Company) completed the sale of its interests in 15 units in Gardena Court at 2A & 2B Kennedy Terrace. It asserted that its resultant profit arose from the sale of a capital asset. The appellant Commissioner concluded that this profit arose from the Company's trade or business within the meaning of section 14 of the Inland Revenue Ordinance and raised an assessment accordingly. The Board of Review (the Board) dismissed the Company's appeal against this assessment but stated a case for the determination of the court. Sears J allowed the Company's appeal and quashed the Assessment. From that determination the Commissioner appeals.

3. The material facts can mostly conveniently be taken from the facts agreed before the Board, to which a number of appendices were attached. What follows is in part drawn from the agreed facts and in part from the appendices.

1. The Company was incorporated on 22nd September 1972 as a private limited company.

2. (a) On 9th October 1972 the Company entered into, three sale and purchase agreements to acquire by an issue of 10,005,000 fully paid shares of HK$1 each the properties listed in appendix l at their then market value.

(b) The relevant properties for the purposes of this appeal are :-

3.    (a)    The Company has acquired no other direct interests in properties.

(b) The Company made no further acquisitions in Hong Kong. Its later acquisitions were all indirect through subsidiaries, and in California.

4.    (a)    At all material times, all of the said properties have been classified as Fixed Assets in the Company's Balance Sheet. The Company's Annual Reports to shareholders for the years 1972/1973, 1980/1981 are shown in Appendix 3 and the Company's financial statements for those periods in Appendix 4. Throughout the years since 1972, the Company has consistently made known in its annual statements its business of long term property investments.

(b)    Perusal of the Chairman's Statements accompanying both the Company and Group Accounts shows the last sentence to be an oversimplification, as the Board recognised. The Statement accompanying the Group Accounts for the year ending 31st March 1973, which showed the sale of property (a) Tai On, and that accompanying the group accounts for the year ending 3lst March 1974, which recorded the sale of property (b) LungCheong Villa, and dated 1st June 1973 and 1st September 1974 respectively, referred to the search for or acquisition of suitable properties in Hong Kong or abroad. The latter statement came shortly before the Commissioner's challenge to the tax payable on these properties, para 8 below. Thereafter the statements contained no further, reference to property investment in Hong Kong only to disposition: and all the actual and potential property investment referred to was in California.

5.    (a)    In November 1972 the Company became a public company. The prospectus dated 31st October 1972 issued for the said floatation (Appendix 5) contains the Company's declared policies.

(b)    The prospectus stated that the Company was incorporated "for the purpose of pursuing the objects as outlined in the Memorandum Association". The principal objects there shown referred to carrying on the business of an investment company in stocks and shares (Article 3(a), (c)) and to deal in land. The prospectus continued : "The Directors plan to concentrate the Company's activities in high class residential flats in Hong Kong with a view to bringing into the company attractive rental income".

(c)    In December 1972 the Company purchased all the share equity in the Wan Shang Overseas Investment Co Ltd. This newly acquired subsidiary owned two properties in Loa Angeles, Lucerne Towers and Orange Plaza. They were then fully let : were bought for long term investment and are still owned. Since that event all the company's new indirect property investment has occurred in California.

6.    On 20th February 1973 the Company sold property (a) (Tai On Building) realising a profit of HK$42,000 which was shown in its 1972/73 accounts as a capital gain. This was not at first assessed for profit tax (Appendix 6).

7.    (a)    On 22nd August 1973 the Company sold property (b) (Lungcheong Villa) realising a profit of HK$90,660 which was shown in its 1973/74 accounts as a capital gain. The Inland Revenue Department in correspondence for the Company's auditors challenged the classification of profits realised on properties (a) & (b).

(b)    The challenge was initiated by letter dated 10th September 1974. In reply the Company's auditors alleged that the sale of both properties constituted the realisation of unsuitable or unprofitable investments.

8.    (a)    In the end an additional assessment was made for 1972/73 in respect to the profit realised on property (a), Appendix 8, and the profit realised on property (b) was also assessed to profits tax for 1973/74, 1974/75, Appendix B. The Company did not lodge any objection against the said assessments. The profits tax borne by the Company on the profits of properties (a) & (b) totalled HK$33,341.

(b)    The assessments asserted "property dealing" and the charged tax appears to be based upon the difference between original cost and the price realised.

10.    The Company continued to claim and obtain capital allowances on the remaining properties shown in Appendix 1.

11.    From 1972 the rents receivable from properties (c) Kellett heights and (g) Gardena Court, until their respective dates of disposal, represented the bulk of the Company's rental income.

12.    (a)    On 7th December 1976 the Company sold one of the units of property (c) (Kellett Heights). The remaining seven units of property (c) were sold between May 1978 and November 1978. The profits of approximately HK$2.5m realised on the sale of property (c) were included in the Company's trading profits and assessed for profits tax. Up to the time of sale property (c) had been fully let out.

(b)    In a minute dated 28th October 1976 the Board resolved to sell "3A or 5A" Kellett Heights, but it is uncertain whether or not this "or" should read "and". In fact only 5A was sold. The profit on this of HK$196,233 apparently calculated on the difference between cost and re-sale price appeared in the Company's profit and loss account for the year ending 31st March 1977.

(c)    In a minute dated 18th October 1978 the Board resolved to sell the remaining 7 units at Kellett heights. The profit on these sales of HK$2,446,233, also apparently calculated on the difference between cost and re-sale price, appears in the Company's profit and loss account for the year ending 31st March 1979.

(d)    The Company and Group Accounts for the year ending 31st March 1979 were accompanied by Chairman's Statements dated 9th August 1979. Both were written after the decision to sell Gardena Court referred to in paragraph 14 below. Statement accompanying Group Accounts included the following :-

"While your group will continue to sell a further portion of its Hong Kong properties if favourable terms are obtained, investments in real estate in Los Angeles USA will he increased through the group's subsidiary".

13.    On 3rd June 1979 the Company revalued its remaining properties to reflect their then estimated market value and credited to capital reserve a total revaluation surplus of HK$14,905,707 including a surplus of HK$12,567,865 in respect of property (g) (Gardena Court).

14.    On 12th July 1979 the Company's hoard of directors resolved to sell property (g) (Gardena Court) at HK$24,500,000. The sale was completed on 31st January 1980. The book profit realised of HK$6,395,800 was shown in the Company's 1979/80 accounts as a surplus on disposal of capital assets. The Company had let out property (g) for rental income from the time of its acquisition in 1972 up to the date of sale.

15.    The correspondence on the assessment for 1979/80 between the Company's Auditors, Messrs. Kwan, Wong, Tan & Fang, and the Inland Revenue Department is shown in Appendix 10.

16.    A full set of the Company's board minutes relating to the above-mentioned sales is shown in Appendix 11.

17.    On 8th February 1980 the Company's board of directors resolved to utilise part of the above-mentioned surplus on revaluation of its properties for an issue of bonus shares. On 8th October 1980, the Company issued 3,320,000 bonus shares of HK$1 each with total face value of HK$3,320,000 to its existing shareholders in the ratio of 5 to 1.

4. Until his death in February 1981 Mr Y M Wong was the Chairman, the only executive director, and the governing mind of the Company. The three witnesses who were called before the Board, his daughter, Mrs Shum, Mr Chan and Mr Chuang had, as the Board concluded, very second-hand know ledge of the material events. The auditors who had some direct knowledge were not called. The Board were we think very conscious of this position and anxious not to be unfair to the deceased.

5. Based largely upon the prospectus, the very early Chairman's Statements, and the indirect acquisition and retention of property for long term investment in California, the Board accepted that the Company's initial intention in relation to property in Hong Kong also was to buy and retain for long term investment. But the events of 1973 led the Board to doubt how long this intention survived. Such doubts were raised tentatively by the Tai On sale in February and more substantively by the Lungcheong Villa sale in August.

6. Although no point had been taken in argument before it, the Board drew attention to a possible connection between the sale of 5A Kellett Heights and the third major property acquisition in California, that of Oxford West Apartment in October 1976. No advantage was sought to be placed upon any such connection in argument before us. In these circumstances it cannot we think have escaped the Board's notice that the purchase of the Wan Shang shares might be seen as a landmark decision. There after all new property investment and development was indirect and in California. The emphasis in Hong Kong was upon finding an appropriate moment for disposition.

7. At this point in their reasoning the Board considered a minute of 15th December 1976 at which the sale of 5A Kellett Heights was reported, and the mechanics of the acquisition of Oxford West was considered. It misread a somewhat ambiguously framed minute. In itself this minute gave rise to no inference of further sales, but the whole circumstances showed that the pace of Hong Kong disposition was quickening. Reference to this minute in our view therefore in no way vitiates the board's conclusion that by the date of the minute of 18th April 1978 relating to the sale of the balance of the Kellett Heights units : "Mr Y H Wong, who was the policy maker, had lost his resolve to so restrict the Company's affairs and was quite willing to sell the Company's properties".

8. The Board's crucial findings then followed and are as follows :-

"But, we had to ask ourselves, was he merely procuring the Company to realise its investments or had he embarked the Company into trading? Were it not for the submission to profits tax on the sales of the Tai On, Lungcheong & Kellett Heights, the answer would on balance have been in favour of realisation. The Company's accountant was not called to give evidence, but we drew no inference one way or the other from that".

9. Having then gone on to point out, correctly, that the Company's accounts were not conclusive the Board concluded:

"(f)    We therefore reached the conclusion that at least by April 1978 Mr Y M Wong looked upon the Company's properties as trading stock. We came to that decision due to the absence of a cogent contrary explanation. It is parhaps glib and even callous to remark that the onus to provide any contrary explanation lies upon the taxpayer when (at least so far as we are aware) the only person capable of providing it, if indeed he were to do so, has passed beyond human concourse.

(g)    Having found as a fact that the original intention of the Company on going public was to hold its then property portfolio for rental and having also formed the view that by April 1978 the Company's properties formed its stock-in-trade, we had to decide when the conversion from investment took place. We were tempted to think the first sale in February 1973 of the Tai On unit at a profit of HK$42,000 (tax at 15% = HK$6,300) was nothing more than the realisation of an investment which should not have been there in the first place with reluctance however we did not believe that the second-hand explanations we received - plausible though they were - can outweigh the undoubted fact that the Company did submit to profits tax on that transaction, and when to that fact is added the subsequent submission to tax on the profitable sales of Lungcheong Villa and the Kellett properties we did not think it was open to us to treat Tai On as a case apart.

(h)    We therefore reached the conclusion that by the time of the Tai On sale Mr. Y M Wong was treating all the Hong Kong properties as trading stock".

10. The Board accordingly upheld the Commissioner's assessment and rejected a further submission from the Company that the profits tax should be measured against the 1979 valuation. The Board then formulated the following questions for determination by the court :-

"(1)    Whether as a matter of law there was any evidence upon which the Board of Review could properly conclude -

(a)    that the Company had altered its original intention to hold its properties as investments; and

(b)    that the said properties had become or been converted into the Company's stock-in-trade; and if so at what date.

(2)    Whether the Board of Review was correct in law in concluding that the profits on sale of the Gardena Court properties are chargeable to profits".

11. The relevant law, both substantive and procedural, can most conveniently be derived from two summaries in Lionel Simmons Properties Ltd (In Liquidation) and Others v Commissioners of Inland Revenue^(l). The first appears in the judgment of Orr LJ in the Court of Appeal, at p 488, which was later approved by Lord Wilberforce :-

"It is clear on the authority of Edwards v. Bairstow ([1956] AC 14) 36 TC 207 that a decision of the Income Tax Commissioners can be reviewed only if the court is satisfied that they have made an error of law or that the only reasonable conclusion on the facts found by them is inconsistent with their determination. It is also clearly established that on appeal to the Commissioners the burden is on the taxpayer to displace the assessment, and in these circumstances the burden in the present case was clearly on the taxpayers to establish that the sales in question gave rise to a surplus on capital account and not to a trading profit (Norman v Golder 26 TC 293, at page 297, and Shadford v H Fairweather & Co Ltd 43 TC 291, at page 300). On the other hand it is also clear that if an asset is acquired in the first instance as an investment the fact that it is later sold does not take it out of the category of investment or render its disposal a sale in the course of trade unless there has been a change of intention on the part of the owner between the dates of acquisition and disposal (Eames v Stepnell Properties Ltd ([1967] 1 WLR 593) 43 TC 678). The question, moreover, whether an item is held as capital or as stock-in-trade is not concluded by the way in which it has been treated in the owner's books of account (Commissioners of Inland Revenue v Scottish Automobile and General Insurance Co Ltd ([1932] SC 87) 16 TC 381, at page 390) or by the Revenue in past years (Rellim, Ltd v Vise 32 TC 254)".

12. The second appears in the speech of Lord Wilberforce at p 491:

"One must ask, first, what the Commissioners were required or entitled to find. Trading requires an intention to trade: normally the question to be asked is whether this intention existed at the time of the acquisition of the asset. Was it acquired with the intention of disposing of it at a profit, or was it acquired as a permanent investment? Often it is necessary to ask further questions: a permanent investment may be sold in order to acquire another investment thought to be more satisfactory; that does not involve an operation of trade, whether the first investment is sold at a profit or at a loss. Intentions may he chanced. What was first an investment may be put into the trading stock - and, I suppose, vice versa. If findings of this kind are to be made precision is required, since a shift of an asset from one category to another will involve changes in the company's accounts, and, possibly, a liability to tax (of Sharkey v Wernher (36 TC 207) [1956] AC 58). What I think is not possible is for an asset to be both trading stock and permanent investment at the same time, nor to possess an indeterminate status - neither trading stock nor permanent asset. It must be one or other, even though, and this seems to me legitimate and intelligible, the company, in whatever character it acquires the asset, may reserve an intention to change its character. To do so would, in fact, amount to little more than making explicit what is necessarily implicit in all commercial operations, namely that situations are open to review".

13. The addition is Furniss (Inspector of Taxes) v Dawson⁽²⁾, where Lord Brightman shoved that the principle of Edwards v Bairstow applies equally to findings of primary fact and to inferences from such primary facts. An appellate court is not entitled to interfere with the inference unless in Lord Brightman's word it is "insupportable" p 167.

14. Stars J allowed the Company's appeal and discharged the assessment on the basis that the Board's decision was unreasonable within the meaning of Lord Radcliffe's test it Edwards v Bairstow. Unfortunately the basis of decision his not clear. The judge rightly criticised the Board's use of the minute of 15th December 1976, but then seems to us substantially to have exaggerated the reliance the Board placed upon it. He charged the Board with reaching two illogical conclusions, but in neither case does his criticism stand up because he failed fairly or accurately to summarise what the Board held. We are therefore minded to accept and adopt. Mr Denis Chang, QC, 's submission that on a generous reading of the judgment as a whole, the judge was intending to convey that he did not think the Board was entitled to draw the inference that it did from the payments of tax, either because such 'payments supported no inference at all, or no inference in relation to Gardena Court. There can hb no question on the Board's reasoning, that it attached decisive importance to the series of three sales and to what if called the "submission" to profits tax thereon. The reasonableness or supportability of the Board inferences in this respect are therefore central to this appeal.

15. Mr Chang's first submission is that what he prefers to call these payments of tax, support no inference at all. The second hand explanation advanced by Mrs Shum of the Payment in late 1974 of the additional assessments on Tai On and Lungcheong that it was too small a matter to justify a fight about, is, he suggests, feasible. In relation to the two payments on Kellett Heights in 1977 and 1979 of tax on over HK$2.5m, he recognises his difficulty occasioned by the absence of any explanation from the auditors, and does not seek to support the judge's observation upon the onus of proof. He could only suggest that the payment might have resulted from some mistaken view of the auditors associated with the method of disposition employed.

16. We cannot accept either proposition. In the absence of a very compelling explanation to the contrary, and as the Board pointed out it received none, a public company must be judged by its conduct and taken to be acting deliberately and responsibly in the interests of its shareholders. This Company had no business to give away without objection HK$33,341 in 1974 and still less the tax on HK$2.5m in 3977 and 1979; neither could the Board have imputed such conduct to them. On the contrary it seems to us not only permissible but correct for the Board objectively to measure the Company's intentions by consequences of its acts. In relation to the first two payments of tax this could be said to import at least a desire to avoid contemporary investigation of the Company's Hong Kong property investment intentions, coupled with a conclusion that it could fail on such enquiry to establish that the two properties were not properly to be regarded as stock-in-trade. The two Kellett Heights payments seem to us readily to import an acceptance by the Company that all the units were in fact stock-in-trade.

17. Secondly, and this is perhaps the crucial point, Mr Chang submits that any inference or admission arising from these tax payments only affects or perhaps contaminates the three properties concerned, and does not touch Gardena Court. The Board itself clearly inferred that the Company's Hong Kong properties could and should he treated as a whole and without drawing individual distinctions between them. This emerges from the Board's reasoning and particularly from the reference to "all the Hong Kong properties" at (h) and to the way in which the first question is framed. So this submission further involves the validity or supportability of this inference also.

18. Looking at the whole of the evidence we do not find the Board's approach surprising. From first to last, the Hong Kong properties seem to have been treated as a group. We have detected no attempt to differentiate between individual properties in the prospectus, when any potential investment problems associated with Tai On or Lungcheong were likely to be known; in any Chairman's Statement or in any other contemporary document. By contrast in relation to the California properties, a distinction is drawn between long term investment and development.

19. The differences now relied upon between Kellett Heights and Gardena Court are difficult to regard as significant. In relation to the treatment of these properties in the accounts prior to sale, in their being fully let, and in collectively accounting for the bulk of the rental income, there is no distinction at all. The first major distinction relied upon is that the one was sold by units and the other as a whole building. But this seems to us to he the likely consequence of the nature of the holding. If only 8 units are held individual sales may well be the most profitable method: but a whole building may realise more than the sum of its parts. Then there is the immediate pre-sale revaluation of Gardena Court. This can be viewed as consistent with capital treatment: it could equally be viewed as an attempt to reverse the established past practice and save tax.

20. Finally there is the statement accompanying the Group accounts for the year ending 31st March 1979 which accounts showed the major trading profit earned on Kellett Heights. This statement was drafted after the decision to sell Gardena Court was taken. The phrase "continue to sell a further proportion of its Hong Kong properties", could in such circumstances, we think, betaken by the Board to mean: "the existing pattern of sales of Hong Kong properties, which by these accounts we acknowledge to have been sales of properties held as stock-in-trade, is to continue and is to include Gardena Court".

21. In these circumstances we are unable to conclude that the Board's inferences are unreasonable or insupportable.

22. Thirdly Mr Chang particularly criticised what he called the inconsistency between the Board's acceptance of the Company's initial investment intention, and its back dating of the change of intention to February 1973. In this context it is relevant to consider whether these payments of tax lend support to any inference as to the date of the commencement of trading; as to the date when in the words of the Board "Mr Y M Wong was treating all the Hong Kong properties as trading stock". In each case the profit was computed and the tax paid upon the difference between value measured initially by historic cost and value measured by the net price of realisation. It seems to us that this circumstance is capable of supporting two inferences :-

(i)    that trading started with acquisition; or

(ii)    that trading started not then but very soon after and before value and initial cost had moved seriously apart.

Possibly out of respect to Mr Wong the Board declined to draw the first inference. What the Board did infer is that very soon afterwards, after the purchase of Wan Shang, Mr Wong abandoned his long term Hong Kong investment plan and launched upon a programme shortly revealed by subsequent conduct to have been one of trading. Logically, it may be that to accommodate the payment of tax on the sale in February, the Board could and should have inferred a slightly earlier date. But the date it chose sufficed for the assessment before it and neither party has suggested the need for further inquiry into the value of Gardena Court in February 1973 to consider whether this materially departed from initial cost.

23. In all the circumstances we are unable to conclude that the Board's factual conclusions and inferences were either unreasonable or insupportable. We accordingly allow the appeal and give the following answers to the questions posed by the Board :-

(1)    (a)    Yes.

(2)    Yes.

24. In handing down this judgment we make an order nisi that the respondent pays the appellants' costs of this appeal.

(1) [1980] 53 TC 461

(2) [1984] STC 153

Representation:

Mr P F Feenstra with Mr Wu (Crown Solicitor) for Appellant/Respondent

Mr Denis Chang, QC, with Mr Denis Yu (M/s Kao, Lee & Yip) for Respondent/Appellant