China Mobile Hong Kong Co Ltd v. Commissioner of Inland Revenue

CACV 500/2020

[2022] HKCA 1637

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO 500 OF 2020

(ON APPEAL FROM HCIA NO 2 OF 2017)

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J U D G M E N T

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Hon Kwan VP:

1.This appeal brought by China Mobile Hong Kong Company Limited (“the Taxpayer”) raised the question whether the spectrum utilization fees paid upfront and in a lump sum (“Upfront SUFs”) by the Taxpayer to the Telecommunications Authority (“the TA”) are revenue in nature and thus allowed for deduction under section 16(1)[1] of the Inland Revenue Ordinance, Cap 112 (“the IRO”), or capital in nature and not deductible by reason of section 17(1)(c)[2] of the IRO.

2.The Taxpayer was assessed for additional profits tax for the years of assessment 2009/10 to 2011/12 on the basis that the Upfront SUFs are capital in nature[3]. On the Taxpayer’s objection, the assessment was confirmed by the Deputy Commissioner of Inland Revenue by a determination dated 30 December 2014 (“the Determination”). The Taxpayer brought an appeal to the Board of Review, which dismissed the appeal and confirmed the assessment by a decision dated 17 January 2017 (“the Decision”)[4]. The Taxpayer appealed to the Court of First Instance pursuant to leave under section 69 on a question of law and Chow J (as he then was) dismissed its appeal by his judgment of 28 July 2020 (“the Judgment”)[5]. The Taxpayer brought this appeal against the Judgment to the Court of Appeal as of right.

The facts

3.The Board made findings of fact based on the Statement of Agreed Facts dated 21 March 2016, the documents placed before it, and the background concerning the Upfront SUFs contained in the evidence of the Taxpayer’s Chief Executive Officer[6]. The findings of the Board were not challenged on appeal to the judge and were adopted by him for the purpose of the appeal[7].

4.The relevant findings of the Board, supplemented by the Statement of Agreed Facts and the documentary evidence not in dispute, are set out below.

(1) The Taxpayer’s business

5.The Taxpayer was incorporated in Hong Kong on 28 June 1994. It closed accounts annually on 31 December. At all material times, its principal activity was the provision of mobile telecommunication and related services in Hong Kong. Its revenue consisted mainly of “airtime and service charges”[8] for the provision of mobile telecommunication services.

6.Prior to the auctions mentioned below, the Taxpayer provided only 2G mobile services pursuant to a licence granted by the TA in 2008 (“the 2008 licence”).

7.As a holder of mobile carrier licence, the Taxpayer was required to pay annual licence fees. The licence fees were set out on a cost-recovery basis to cover the operating costs of the Office of the TA (or its successor, the Office of the Communications Authority) in administering the licences.

8.For use of radio spectrum for the 2G operations, the Taxpayer was required to pay an annual fee (“annual SUF”), the amount of which is stipulated in the Telecommunications (Level of Spectrum Utilization Fees) (Second Generation Mobile Services) Regulations, Cap 106AA.

(2) Background to the auctions

9.In a statement of the TA on 3 December 2007[9], it was proposed to allocate some frequency bands for the provision of broadband wireless access services and to hold an auction (“the 4G Auction”) to determine the SUF, with a minimum set by the Secretary for Commerce and Economic Development, which would be in the form of an upfront lump sum. The TA would recommend to the Secretary to make a regulation under section 32I(2) of the Telecommunications Ordinance, Cap 106 (“the TO”) specifying that the Upfront SUF for the broadband wireless access spectrum would be determined by auction and that the bidder with the highest bid would be successful.

10.Before the 4G Auction, the Taxpayer was not a 3G operator. In order to maintain its market position, the Taxpayer was eager to succeed in the 4G Auction because there was a concern that other mobile network operators would outbid the Taxpayer with a view to eliminating it from the market.

11.Separately, in 2008, the TA proposed[10] to make available certain frequency bands to incumbent 2G licensees, of which the Taxpayer was one. At the time, the 2G licensees had been assigned frequency bands for use in their 2G mobile network services, and the SUFs they were paying for the use of the bands were annual sums, with the first five years being at a rate per kHz assigned, and subsequent years at the higher of the per kHz rate or a sum calculated by reference to turnover. It was proposed that the annual SUFs for the use of the frequency bands to be assigned would be charged on the same basis because the frequency bands to be assigned would be incorporated into the existing 2G licences. It was further proposed that an additional, one-off lump sum component of the SUF would be charged as well, for the following reason:

“23. As mentioned in paragraph 17, the TA proposes to assign the frequencies by auction [“the 2G Auction”]. For the purpose of the auction, the TA proposes to assign the frequencies to the successful bidder(s) who has/have offered the highest additional one-off lump sum SUF on top of the annual variable SUF described in paragraph 20 above. Such additional component of SUF will also be used to determine the respective priority rights of the successful bidders in choosing preferred set(s) of frequency bands. The bid will have to be equal to or greater than the reserve price set by the Secretary for Commerce and Economic Development (‘SCED’) for each frequency block. The reserve prices for all frequency blocks will be set at the same amount and it will be determined and announced nearer to the time of auction.

24. Following the approaches outlined above, the TA proposes that a two-tier SUF payment arrangement be adopted. The SUF will consist of two components: (a) an annual variable component based on the SUF calculation formula for the 2G spectrum under the existing 2G licences as described in paragraph 21 above and (b) a one-off lump sum component based on a sum committed by the successful bidder(s) in the forthcoming auction as described in paragraph 23.”[11]

(3) The 4G Auction

12.The 4G Auction was completed on 22 January 2009. The Taxpayer was the successful bidder of one of the frequency bands.

13.According to the Notice of Terms and Conditions of the Auction (Including the Form of the Licence) of the TA dated 3 October 2008 (“the 4G Notice”): “By this Notice, the [TA], in exercise of the powers conferred by section 32I of the [TO], the Telecommunications (Determining Spectrum Utilization Fees by Auction) Regulation[12] and all other powers enabling him for this purpose, specifies the terms and conditions of the auction of the right to use the frequency bands specified in this Notice and the payment of the spectrum utilization fees.”

14.Among the terms of the 4G Auction specified in the 4G Notice are the following: (1) each provisional successful bidder was required to pay the TA the Upfront SUF (the amount payable by the Taxpayer was $494.7 million) within 30 business days after publication of the provisional successful bidder notice, failing which the TA would not grant it a licence and disqualify that bidder from the auction (clause 5.2); (2) if and when the Upfront SUF was paid, the TA would grant a licence to the successful bidder under which the frequency band or bands for which that bidder was successful would be assigned (clause 5.4). There was no provision for any part of the Upfront SUF to be refunded, even if the successful bidder did not actually use the spectrum in the 15-year period during which the spectrum was assigned.

15.On 10 March 2009, the Taxpayer duly paid the Upfront SUF of $494.7 million and on 31 March 2009, the TA issued to the Taxpayer a 4G licence (“the 4G Licence”). The 4G Licence provided inter alia: (1) the Taxpayer was licensed to provide “a public mobile radiocommunication service using cellular radiocommunications technology operating at [the assigned spectrum]” for 15 years till 30 March 2024 (Schedule 1, §1; Schedule 3); (2) the radiocommunications installation operated by or on behalf of the licensee “shall only be operated on such frequencies as the [TA] may assign” (General Conditions, clause 13.1); (3) on the date of issue of the licence, the licensee “shall have paid” the Upfront SUF “for use of the spectrum designated by the [TA] to be subject to SUF and assigned to the licensee, at such level as determined by auction”. (Special Conditions, clause 29.1)

16.As a result of the assignment of the 4G spectrum, the Taxpayer has enlarged its profit-earning structure and capacity by venturing into a new field of business and strengthening its market competitiveness[13].

17.On 1 June 2009, the TA issued to the Taxpayer a new licence replacing both the 2008 licence and the 4G Licence.

(4) The 2G Auction

18.The 2G Auction was completed on 10 June 2009. The Taxpayer was the successful bidder of two of the frequency bands. The total Upfront SUFs payable by the Taxpayer were $15.12 million.

19.The Notice of Terms and Conditions of the Auction (Including the Conditions to be added to the Licence) of the TA dated 24 April 2009 (“the 2G Notice”) contained a similar provision that by the notice, the TA “specifies the terms and conditions of the auction of the right to use the frequency bands specified in this Notice and the payment of the spectrum utilization fees.”

20.The 2G Notice also included the following terms: (1) each provisional successful bidder was required to pay the TA the Upfront SUF within 15 business days after publication of the provisional successful bidder notice, failing which the TA would not assign any frequency band to that bidder and disqualify it from the auction (clause 5.2); (2) if and when the Upfront SUF was paid, the TA would assign to the successful bidder the frequency band or bands for which that bidder was successful, for the provision of public mobile telecommunications services (clause 5.4). There was no provision for any part of the Upfront SUF to be refunded, even if the successful bidder did not actually use the spectrum in the 12-year period during which the spectrum was assigned.

21.In June 2009, the Taxpayer duly paid the Upfront SUF of $15.12 million and on 26 June 2009, the TA amended the 1 June 2009 licence. In respect of 2G mobile services, the terms of the amended licence included: (1) the Taxpayer was licensed to provide “a public mobile radiocommunication service using cellular radiocommunications technology operating at [the assigned spectrum]” for 12 years till 29 September 2021 (Schedule 1, §1; Schedule 3, §2); (2) the radiocommunications installation operated by or on behalf of the licensee “shall only be operated on such frequencies as the [TA] may assign” (General Conditions, clause 13.1); (3) the licensee “shall pay [SUF] for spectrum assigned to the licensee as designated by the [TA] by order and at such level or according to the method of determining the [SUF] as prescribed by the Secretary by regulation. The licensee shall pay the [SUF] to the [TA] during the period while the licence remains in force.” (Special Conditions, clause 29.1)

22.The Taxpayer’s success in the 2G Auction enlarged and strengthened its profit-yielding infrastructure by increasing its 2G spectrum capacity and improving the service quality of its 2G mobile services[14].

(5) The Taxpayer’s accounts and profits tax computations

23.In its audited financial statements for the years ended 31 December 2009 to 2011, the Taxpayer classified the Upfront SUFs as non-current intangible assets and amortised them on straight-line basis over the relevant licence periods, charging the amortised amounts to the profit and loss account[15].

24.The Taxpayer claimed to deduct the amortised amounts in computing its profits for profits tax purposes on the ground that the Upfront SUFs were revenue in nature. The Assessor disagreed and raised additional assessments to disallow the deduction of the amortised charges on the ground that the Upfront SUFs were capital in nature and not deductible.

The relevant principles

25.The relevant principles for determining whether an expenditure is revenue or capital in nature are well established and not in dispute and have been set out comprehensively in the Decision[16] and the Judgment[17]. What is in dispute is the application of the principles. A brief summary of the principles would suffice.

26.Whether an expenditure is capital or revenue in nature is a question of law, which must be answered in light of all the circumstances which it is reasonable to take into account, and the weight to be given to a particular circumstance in a particular case must depend on common sense rather than on strict application of any single legal principle[18].

27.Further, the question must be answered from a practical and business point of view, rather than upon the juristic classification of the legal rights, if any, secured employed or exhausted in the process[19].

28.Although there is no single decisive test, the courts have held that these factors may usefully be taken into account:

(1) whether the expenditure is incurred once and for all, or is going to recur every year[20];

(2) whether the expenditure is incurred with a view to bringing into existence an asset or advantage for the enduring benefit of a trade; a benefit is enduring for this purpose if it is of a permanent quality or has sufficient durability, it does not have to be everlasting; length of time, although not a deciding factor, does in practice shed a light on the nature of the advantage sought and the longer the duration of the agreements, the greater the indication that a structural solution was being sought[21];

(3) whether the expenditure relates to the cost of creating, acquiring or enlarging the permanent structure of which the income is to be the produce or fruit, or instead represents the cost of earning that income itself or performing the income-earning operations[22].

29.Three matters in the analysis of Dixon J in Sun Newspapers Ltd v The Federal Commissioner of Taxation (1939) 61 CLR 337 at 363 have been regarded as useful guidance in many subsequent cases. These matters are: (a) the character of the advantage sought, and in this its lasting qualities may play a part; (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head, recurrence may play its part; and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment.

The Decision

30.The Board took the view that it is clear that the subject matter of the 4G Auction and the 2G Auction was the granting of the relevant licence, together with the right to use the specified frequency bands. By paying the Upfront SUFs which resulted from the auctions, the Taxpayer acquired the exclusive right to use the assigned spectrum for a period of about 12 years under the amended 2G licence and 15 years under the 4G Licence, without the interference of other mobile telecommunications operators in the market[23].

31.Applying the indicia as suggested in the authorities, the Board reached the conclusion that the Upfront SUFs are clearly capital in nature for the following reasons[24]:

“(a) The Upfront SUFs were incurred once and for the right to use the specified frequency band(s) and the UCLs[25].

(b) The Upfront SUFs were paid with a view to bringing into existence an advantage for the enduring benefit of the Taxpayer’s mobile telecommunications business in Hong Kong.

(c) The Upfront SUFs were the cost of enlarging, enhancing and strengthening the permanent profit-producing business structure of the Taxpayer and its income-generating capacity.

(d) The Sun Newspapers’ 3 criteria[26]:

(i) Character of advantage sought: the Upfront SUFs were paid for the right to use the specified spectrums and the grant/amendment of the UCLs for the Taxpayer to operate its telecommunications business for a period of 15 years (in the case of 4G spectrum) and 12 years (in the case of 2G additional spectrum).

(ii) The manner in which it is to be used, relied upon or enjoyed: the Upfront SUFs were paid once and for all. There is no recurrence of paying the Upfront SUFs, as there is no legitimate expectation that there would be any right of renewal or right of first refusal of any licence or spectrum assignment upon the expiry of the licence or spectrum assignment: see Radio Spectrum Policy Framework §4.2.

(iii) The means adopted to obtain it - periodic payment or a final provision to secure future use: the Upfront SUFs were a final provision to secure the assignment of the specified spectrums and the grant of the relevant UCLs.”

The Judgment

32.The Taxpayer contended that the Board has erred in concluding that the Upfront SUF payments are capital in nature in that they were paid for the grant of the relevant unified carrier licence together with the right to use radio spectrum (as distinct from being paid for the use of such spectrum)[27]. Eight grounds of appeal were advanced in support of this contention as summarised in §9 of the Judgment.

33.Having considered the provisions of the TO (sections 32H and 32I), the terms of the 4G Notice, the 2G Notice, the 4G Licence and the licence amended on 26 June 2009, and looking at the matter from a practical, business and common sense point of view, the judge considered it clear that the Upfront SUF was the consideration, or price, which the Taxpayer had to pay in order to be able to use the designated spectrum and was paid for the right to use the spectrum[28].

34.The judge came to the view that the Upfront SUFs are capital in nature for these reasons[29]:

“(1) The Upfront SUFs were paid by the Taxpayer with a view to acquiring the right to use certain specified frequency bands in the 4G spectrum or additional frequency bands in the 2G spectrum (here, I use the expression ‘right to use’ in a general, and not any technical, sense…). The specified frequency bands in the 4G spectrum or additional frequency bands in the 2G spectrum so acquired were part of the necessary and permanent profit-earning structures required by the Taxpayer to venture into a new line of business (namely, the provision of 4G services), or expand and strengthen its existing line of business (namely, the provision of 2G services), thereby boosting its income-generating capacity.

(2) The specified or additional frequency bands in the 4G/2G spectrums so acquired by the Taxpayer from making the Upfront SUFs would bring about enduring benefits to the business of the Taxpayer, in that it could provide 4G/additional or enhanced 2G services to its customers for the next 15 years/12 years.

(3) The Upfront SUFs were lump sum payments incurred once and for all, instead of periodic payments to meet an ongoing demand for expenditure.”

35.The judge rejected the contention that in determining whether an item of expenditure is capital or revenue in nature, a decisive distinction can and should be drawn between a payment made for (i) the right to use, and (ii) the use of, spectrum. He regarded this as wrong in principle as one should apply a common sense, practical and business approach and not rely on nice legal distinctions or fasten upon specific words or forms of words used in statutory provisions as showing that the Upfront SUFs were paid for the use of, as opposed to the right to use, spectrum[30].

36.The judge questioned the utility of the “circulating capital” test in the present situation[31]. Lord Pearce explained the distinction between fixed capital and circulating capital in B P Australia in this manner[32]:

“Fixed capital is prima facie that on which you look to get a return by your trading operations. Circulating capital is that which comes back in your trading operations. The sums in question were sums which had to come back penny by penny with every order during the period in order to reimburse and justify the particular outlay. … Prima facie therefore the lump sums were circulating capital which is turned over and in the process of being turned over yields a profit or loss; they were part of the constant demand which must be answered out of the returns of the trade.”

37.In addition to the criticism that the “circulating capital” test is circular, the judge was of the view that this test failed to take into account the nature or character of the asset acquired or advantage sought by the outlay of capital. He opined that the test may be more useful “when one is concerned with the profits of a trading company which buys and sells goods and makes its profits from the difference between the purchase and sale price”, but is “less useful when one is concerned with a service company which employs its capital in building up an infrastructure to provide services to its customers in return for fees or charges”. He took the view that on the facts of this case, the Taxpayer paid the Upfront SUFs “to acquire the right to use spectrum, or to have the use of spectrum (it does not seem [to him] to matter much how it is described), in order to provide 4G services or enhance its 2G services to its customers in return for service fees or charges”[33].

38.The judge rejected all eight grounds of appeal[34]. He was not persuaded that the eight grounds, considered separately or cumulatively, would demonstrate the Board’s conclusion that the Upfront SUFs are capital in nature is wrong in law. He therefore dismissed the appeal.

The Taxpayer’s primary argument in this appeal

39.The Taxpayer relies on the same eight grounds in this appeal. In addition, it advanced what Mr David Goldberg KC[35] called his primary argument on behalf of the Taxpayer, namely that the judge had fundamentally misdescribed the way the Taxpayer provided its services to generate profits. The true and only reasonable view of the “accepted facts” is that the Taxpayer, having paid annual and Upfront SUFs to the Government for the use of spectrum, then sold the very thing it had paid for to its customers. In other words, the Taxpayer’s expenditure on SUFs (whether annual or Upfront and whether it paid for a right or not) was incurred by the Taxpayer to use specific bands of the radio spectrum as part, and in the course, of its income operating process, to meet the cost of satisfying the continuous and constant demand of its customers themselves to use the same specific bands of the spectrum by transmitting the signals and was recovered by the Taxpayer charging its customers by reference to airtime for their use of spectrum. Hence, the Taxpayer, as a mobile network operator, exploits what it receives from the Government by turning it to account by selling it to the public. The Upfront SUFs are revenue because they are the direct cost for a mobile network operator of providing airtime services to its customers. They are not – as capital expenditure is – a cost of being in a position to provide services.

40.Mr Goldberg submitted that the judge failed to take proper account of the Taxpayer’s manner of earning its receipts and profits as stated above, which is a matter of “accepted fact”. The judge failed to consider the most relevant factor of all, which is the nature of the services provided by the Taxpayer in the course of its trade to its customers and what it does to earn its receipts, which was to meet the continuous and constant demand of use of spectrum in the actual provision of mobile telecommunication services to its customers. This is plainly a situation to which the “circulating capital” test is apt in describing. In the premises, the judge misunderstood and had misapplied the test.

41.Even from a practical, business and common sense point of view, Mr Goldberg submitted that it makes perfect sense for the Taxpayer to be paying for the use of spectrum, when its business purpose was to meet the continuous and constant demand of its customers for usage of its mobile telephone network by re-selling the use of the spectrum, ie airtime, to them. There is no proper basis for concluding that the Taxpayer had acquired, in return for the SUFs, the frequency bands either as part of its “necessary and permanent profit-earning structures” or an expansion and strengthening of its existing line of business[36]. The SUFs were only paid for use of spectrum and so for airtime which the Taxpayer then provided to its customers.

42.The “accepted facts” upon which the above true and only reasonable view is said to be founded are the following:

(1)  The Determination, §3(5)[37]:

“The [Taxpayer] provided mobile telecommunications and related services in Hong Kong and derived income from sales of airtime and value added services. It rendered the services to customers through their usage of its mobile telephone network and facilities to transmit signals over specific bands of radio spectrum assigned by the TA.”

(2)  Statement of Agreed Facts, §§11(a) and (b):

“(a) The [Taxpayer] analysed its turnover for the years ended 31 December 2009 to 2011 as follows:

Year ended 31 December	2009 $	2010 $	2011 $
Airtime and service charges	2,315,578,225	2,495,286,850	2,664,853,144
Sales of handsets and accessories	239,831,454	268,389,088	440,127,935
	2,555,409,679	2,763,675,938	3,104,981,079

(b) The [Taxpayer] recognized telecommunications service revenue when the service was rendered to customers on the basis of the usage of its digital mobile radio telephone network and facilities.”

(3)  Witness statement of Lee Fan Fung Sean, §32(i):

“In the telecommunications business of the [Taxpayer],

(i) SUFs are ordinary business expenses for the telecommunications industry and are part of the costs necessary and incidental to, and are expenses actually incurred in the process of, the carrying on of its day-to-day income producing operations, i.e. the provision of a mobile telephone network service to its customers, so as to earn for the [Taxpayer] the charges paid by the customers. The SUF is a payment (whether as annual payments or as a one-off pre-paid lump sum) for the use by the user, i.e. a [mobile network operator], of the allocated frequencies, day in and day out (in fact, to be more precise, second in and second out), to transmit and receive radio signals, in the actual provision of mobile telecommunications service to its customers, so as to earn its income on revenue account;”.

43.The above contention regarding the way the Taxpayer provided its services to generate profits by paying annual and Upfront SUFs for the use of spectrum and selling the very thing it had paid for to its customers was raised for the first time only in the Court of Appeal. The passage quoted in §3(5) of the Determination is an earlier determination of the Deputy Commissioner and is not evidence. It was not in the subsequent Statement of Agreed Facts placed before the Board of Review. Besides, the Board’s function, on hearing an appeal under section 68 of the IRO, is to consider the matter de novo (Shui On Credit Co Ltd v Commissioner of Inland Revenue (2009) 12 HKCFAR 392 at §30).

44.An appeal to the Court of First Instance under section 69 against a decision of the Board is on a ground involving only a question of law. On hearing the appeal, the Court of First Instance may draw any inference of fact (section 69AA(1)(a)), and must not receive any further evidence, or reverse or vary any conclusion made by the Board on questions of fact unless the Court of First Instance finds that the conclusion is erroneous in point of law (section 69AA(1)(b)). Sections 69AA(1)(a) and (b) apply to the Court of Appeal on hearing the appeal (section 69AA(2)).

45.The other two “accepted facts” do not provide evidential support for the new inference sought to be drawn, as submitted by Mr Kevin Prosser KC for the Commissioner[38]. The “airtime” for which the Taxpayer charged its customers for provision of telecommunication services as stated in §§11(a) and (b) of the Statement of Agreed Facts provides no support for the inference that the Taxpayer charged its customers for the customers’ use of spectrum, as this is silent on whose use of the spectrum for which the customers were charged.

46.As for §32(i) of the witness statement of the Taxpayer’s Chief Executive Officer, the Board accepted his evidence only in respect of the background concerning the Upfront SUFs and refused to accept his evidence regarding the nature of the Upfront SUFs (with which §32(i) is concerned), noting that his evidence on this is just his personal opinion[39]. I do not agree with Mr Goldberg it is “wholly obscure” from the Decision which part of the witness’s evidence the Board was accepting and which part it was rejecting. Besides, the only mention in §32(i) of the use of spectrum was by the mobile network operator and not by the customers, so this would provide no support for the new inference.

47.Last but not least, the new contention was not argued before the Board and relevant evidence, such as the Taxpayer’s contract with its customers on provision of telecommunication services, was not adduced for the Board to make findings of fact from which appropriate inference may be drawn. Nor was there evidence showing that the Upfront SUFs have come back “penny by penny” (applying the “circulating capital” test in B P Australia) with customers’ subscription to the 4G and 2G mobile services operated by the Taxpayer[40]. The “state of the evidence bar” applies in this situation[41]. It would be unfair to the Commissioner to allow the Taxpayer to run this argument on appeal as the Commissioner had been deprived of the opportunity to adduce evidence and make submissions on findings and inferences of fact that should be made. To counter the new contention that the customers were charged by the Taxpayer for their use of spectrum, Mr Prosser has submitted that the use of spectrum was by the Taxpayer and customers were charged by reference to the Taxpayer’s use of the spectrum. The Board did not have before it the facts material to this and was not asked to investigate the point. The Taxpayer should not be permitted to raise this on appeal as it cannot be shown there is no reasonable possibility that the state of the evidence relevant to the point would have been materially more favourable to the other side if the point had been taken before the Board.

48.For the above reasons, the primary argument of the Taxpayer must be rejected.

49.As for the eight grounds of appeal pursued before the judge and sought to be maintained before us, they will be discussed under the following headings:

(1)  the distinction between payment for right to use and for use;

(2)  the proper construction of the TO and subsidiary legislation;

(3)  the judge’s conclusions on the nature of Upfront SUFs;

(4)  the distinction between payment as a condition for the assignment and as consideration for the assignment;

(5)  the relevance of annual SUFs; and

(6)  the overseas authorities.

The distinction between payment for right to use and for use

50.At the heart of the appeal before the judge was the contention that the Upfront SUFs were paid for the use of, as opposed to the right to use, radio spectrum and were therefore revenue in nature. The judge regarded it wrong in principle to treat the distinction between a payment made for (i) the right to use and (ii) the use of, spectrum as decisive. He rejected the contention that section 32I(1) of the TO should be read as providing that the Upfront SUFs were payments made for the use of the spectrum assigned, holding that the words in that provision (“the use of spectrum is subject to the payment of spectrum utilization fee by the users of the spectrum”) are consistent with either the notion that SUF is required to be paid for the right to use the spectrum or that it is required to be paid for the use of the spectrum. He held that on the facts of this case the Taxpayer paid the Upfront SUFs to acquire the right to use the spectrum, or to have the use of the spectrum – it does not matter much how it is described – in order to provide 4G services or enhance its 2G services to customers in return for service fees or charges[42].

51.The complaint here is that the judge refused to recognise this distinction between payment for the right to use and for use, said to be well established in revenue law, as it is a distinction that marks the true difference in nature between capital expenditure and revenue expenditure. As was before the judge, particular reliance was placed on this passage in the judgment of Lord Morris of Borth-y-Gest in Regent Oil Co Ltd v Strick at 334C to E:

“There may well be a difference between a case where a lump sum payment is made to acquire the right to occupy premises for a period say of 21 years and a case where by contract a right is acquired to occupy premises for 21 years with an obligation to make periodic payments for such right to occupy. In the latter case the periodic payments (being periodic payments for the use of premises) would probably be payments of a revenue nature. In such a case the right itself to go on occupying the premises (subject to making the periodic payments or subject to conditions) might be or become of considerable value. It would be a capital asset - but as no lump sum price would have been paid for it there would be no payment of a capital nature: there would be no payment calling for any inquiry.”[43]

52.It was further contended that this distinction was accepted by the Commissioner before the Board, as this was stated in §28 of the closing submissions:

“The Taxpayer’s contention that the word ‘use’ in section 32I(1) means ‘actual use’ involves giving a technical meaning to the word ‘use’. The term ‘actual use’ is generally used in tax law in contradistinction with ‘the acquisition of a right to use’; the former being a revenue and the latter a capital payment. There is nothing to suggest that section 32I(1) is not drafted at dealing with the spectrum user’s tax position.”

53.Mr Goldberg submitted that if the payments were truly for the use of the spectrum rather than to acquire the right to use the spectrum, the revenue nature of the payments is not affected simply because it was agreed that they should be paid upfront in a lump sum rather than periodically. In support of the proposition that the nature of a payment cannot be changed simply because the method of payment has changed, he cited Henriksen v Grafton Hotel Ltd at 189; Sun Newspapers Ltd v The Federal Commissioner of Taxation at 363; Bolem v Regent Oil Co Ltd (1956) 37 TC 56 at 68. Nor can the position change if revenue payments are to be made partly upfront and partly periodically, citing Lord Wilberforce in Regent Oil Co Ltd v Strick at 349B to C that “lump sums, paid at the start of the transactions to procure the immediate emergence of an asset or advantage, enjoyment of which was secured for a period” “were not, and did not represent the aggregation of, current payments made for the day-to-day use of or continuation of an advantage”. Mr Goldberg contended that the Upfront SUFs were “the aggregation of, current payments made for the day-to-day use of or continuation of an advantage”.

54.Leaving aside for the time the proper construction of section 32I(1), I do not think the judge was in error in refusing to recognise as decisive the distinction between payment made for the right to use the spectrum and payment made for the use of the spectrum. The distinction between payment for the right to use and payment for the use made in the judgments of Lord Morris, Lord Upjohn and Lord Wilberforce in Regent Oil Co Ltd v Strick was in the context of premium paid for a lease and rent paid under a lease and was regarded as “helpful”, “clear and intelligible”[44] in that context. Even so, Lord Reid expressed a contrary view at 315G to 316A that he was unable to understand the argument that “a rent and a premium paid under a lease are paid for different things – that the premium is paid for the right but that the rent is paid for the use of the subjects during the year”, taking the view that “payment of a premium gives just as much right to use the subjects as payment of a rent and an obligation to pay rent gives just as much right to the whole term of years as payment of a premium.”

55.As Lord Pearce has stated in B P Australia at 265A to B, felicitous phrases from earlier judgments are not the deciding factor, nor are they of unlimited application: “They merely crystallise particular factors which may incline the scale in a particular case after a balance of all the considerations has been taken.”

56.There is no error in the judge’s approach.

57.The other submissions of Mr Goldberg – that the nature or character of the payments in question is not affected by changing the method of payment – are premised on the expenditure being revenue in nature, and do not take the debate any further.

The proper construction of the TO and subsidiary legislation

58.The statutory provisions relied upon by the Taxpayer are principally sections 32H and 32I of the TO. The relevant parts of these provisions read as follows:

“32H. Power to allocate frequency

(1) The Authority may assign –

(a) frequencies and bands of frequencies in all parts of the radio spectrum used in Hong Kong …

and shall keep a central register of the frequencies, bands of frequencies … assigned.

(2) The Authority may –

…

(c) assign the frequencies or bands of frequencies to users of radiocommunications apparatus and specify the purpose for which and the conditions under which the frequencies or bands of frequencies are to be used.

…

(5) A person shall not, in Hong Kong … use a frequency in any part of the radio spectrum unless the frequency is assigned, or located within a band of frequencies assigned, by the Authority or the use is for the purpose and in compliance with the conditions specified by the Authority.

(6) Where an assignment which may be made under subsection (1) relates to the use of spectrum which under section 32I is subject to the payment of spectrum utilization fee –

(a) by the user of the spectrum; and

(b) the method for determining which is prescribed under section 32I(2)(b),

then the Authority may, in determining applications for the assignment, regard the fees, if any, arising or resulting from that method as a determining factor in relation to those applications.”

“32I. Spectrum utilization fee

(1) Subject to the consultation requirement under section 32G(2), the Authority may by order designate the frequency bands in which the use of spectrum is subject to the payment of spectrum utilization fee by the users of the spectrum.

(2) The Secretary may by regulation prescribe –

(a) the level of spectrum utilization fees; or

(b) the method for determining the spectrum utilization fees, which may be by –

(i) auction or tender or a combination of auction and tender; or

(ii) such method as the Secretary thinks fit, including any method combined with a method mentioned in subparagraph (i).

(3) A spectrum utilization fee may be calculated on the basis of a royalty or any other basis that includes an element in excess of the simple recovery of the cost of providing a service by the Authority.

…

(9) It is declared that –

(a) a spectrum utilization fee payable pursuant to this section is a fee payable in addition to any fee prescribed under section 7(2) or 37(1)(g);

…

(11) Without prejudice to the generality of subsection (4)(a), in this section (including subsection (3)) –

…

spectrum utilization fee (頻譜使用費) includes a fixed fee, a fee calculated by a formula or a fee ascertained by another method, or any combination thereof.”

59.The judge summed up the effect of these provisions in this way. Before any telecommunication service provider like the Taxpayer can use any particular frequencies or bands of frequencies of the radio spectrum for the purpose of providing telecommunication services to its customers, it must first obtain a relevant assignment from the Authority, and such assignment may be subject to the payment of such spectrum utilization fee as may be prescribed by the Secretary under section 32I(2)(a), or determined pursuant to the method prescribed under section 32I(2)(b)[45]. He held that sections 32H(6) and 32I plainly contemplate that an assignment relating to the use of spectrum may be subject to payment of spectrum utilization fee and there is nothing in the TO to suggest that the obligation to pay Upfront SUF would only arise upon actual use of the assigned spectrum. To the contrary, as expressly provided in the 4G Notice and the 2G Notice, the assignment of the right to use the specified frequency bands, or the granting of a unified carrier licence, was conditional upon payment of the Upfront SUF. In other words, the Upfront SUF was payable before, and regardless of whether, the Taxpayer made use of the spectrum to be assigned[46].

60.Mr Goldberg maintained the Taxpayer’s submissions in the proceedings below that on the plain and natural meaning of the words in section 32I(1) (“the Authority may by order designate the frequency in which the use of spectrum is subject to payment of spectrum utilization fee by the users of the spectrum”) construed in the context of the TO and relevant subsidiary legislation, it is the “use of spectrum” that is subject to payment of SUFs, and there is nothing to indicate that SUFs were paid for, or partly paid for, the assignment of spectrum or the grant of any carrier licence. His argument ran along the following lines:

(1)  The word “use” takes its meaning in ordinary parlance and there can be no ambiguity given that spectrum is capable of being used and is constantly used, in the natural meaning of the word, by mobile network operators such as the Taxpayer.

(2)  The “order” referred to in section 32I(1) is the Telecommunications (Designation of Frequency Bands subject to Payment of Spectrum Utilization Fee) Order[47], of which section 2 provides: “The frequency bands set out in the Schedule are designated as the frequency bands in which the use of spectrum is subject to the payment of spectrum utilization fee by the users of the spectrum.” (emphasis supplied)

(3)  Consistent with the above, provisions in other subsidiary legislation[48], by reference to which the 2G and 4G Auctions were conducted, all provide that Upfront SUFs were payments for the use of the relevant radio spectrum. The court was provided with a table in three parts, setting out references in documents to SUFs for “Use of the Spectrum”, references in documents to frequency bands or the like being subject to payment of SUFs, and references in the TO and regulations to SUFs for “Use of the Spectrum”, supplemented by additional references in the oral submissions of counsel. In particular, SUF was defined in the auction information as “the sum payable in respect of the use of a Frequency Band as determined in accordance with this Notice”, and the subject licences issued to the Taxpayer contained a provision that on the date of issue of the licence, “the licensee shall have paid [SUF] for use of the spectrum designated by the Authority to be subject to SUF and assigned to the licensee” (Special Conditions, clause 29.1; Schedule 10 to the amended licence, para 1.1).

(4)  Considering the TO as a whole, the statute carefully distinguishes between use, right to use, and licences, and contains separate provisions governing each of these matters. Use of spectrum and payment therefor are governed by section 32I, the assignment of the right to use is governed by section 32H, and licences are governed by section 7. Each of the latter provisions (section 32H(6) and 7(12)) acknowledges while SUFs can be used to determine which entity is to be allocated spectrum or granted a licence, SUFs are defined by section 32I(1) as payment for the use of spectrum. Section 32I(9) expressly declares that SUF is payable in addition to any fee payable for the grant or renewal of a carrier licence, showing that SUF is not a payment for the grant or renewal of a licence.

(5)  Section 8(1) of the TO provides that save under and in accordance with a licence granted under the TO, no person shall establish or maintain any means of telecommunications, or offer in the course of business a telecommunications service, or possess or use any apparatus for radiocommunications. It is expressly provided in the subject licences issued to the Taxpayer that the licence “shall not be construed as granting an exclusive right to the licensee to provide the service” (General Conditions, clause 1.2). And there is no provision in the terms of the licences granted to the Taxpayer that the Taxpayer has exclusive right to use the spectrum designated.

(6)  There is no basis to find that the assignment of spectrum may be subject to payment of SUFs when sections 32H(6) and 32I clearly prescribe otherwise. Whatever there was in the 4G Notice or the 2G Notice cannot affect or override the true nature of the SUFs which is defined by section 32I. The 4G Notice and 2G Notice, in describing the auctions as “auction of the right to use the frequency bands specified”, have to be read in their statutory context, insofar as one of their purposes was to decide which bidders were to be granted the right to use the spectrum. That does not mean SUFs were paid for the right to use, rather than for the use of spectrum, similar to a lease to be granted to a person making the highest offer for rent. The rent is paid for the use of the premises, not for the right to use the premises.

61.Mr Goldberg submitted that the correct construction of the legislation is determinative of the issue that the Upfront SUFs are revenue in nature. He contrasted the legislation in Hong Kong with legislation in Singapore, which grants to mobile network operators a “spectrum right”, defined in the relevant subsidiary legislation as “a right to use any specified part of the radio frequency spectrum”.[49]

62.I do not agree with Mr Goldberg that the terms of the TO would assist in determining whether the Upfront SUFs were payable for the actual use of, or instead for the right to use, spectrum. I agree with the judge that read in an ordinary and natural way, section 32I(1) simply means that a person is required to pay SUF in order to be able to use the spectrum designated by the Authority and to be assigned to that person, and that the phrase “the use of spectrum is subject to payment of spectrum utilization fee” is consistent with either the notion that SUF is required to be paid for the right to use spectrum or is required to be paid for the use of the spectrum[50]. Mr Prosser made a similar point that as a matter of ordinary language, the expressions “use” and “the use of” in the statutory provisions are sufficiently broad to cover both actual use and the right to use.

63.I share the judge’s view there is no reason to believe that the legislature would have such a distinction in mind when enacting section 32I or any of the statutory provisions relied on by the Taxpayer[51]. There is no reason for the legislature to be concerned that in receiving payment for the Upfront SUF, a right to use the spectrum is assigned as opposed to the use of the spectrum. Nor is there any limitation in the TO or the subsidiary legislation on the way in which the Authority can charge SUF. Even if one proceeds on the basis that the statutory provisions should be construed to mean that SUF is required to be paid for the use of spectrum, this does not answer the question whether the payment of SUF is capital or revenue in nature as there is no single decisive test[52].

64.Although it is not expressly provided in the statute or subsidiary legislation that the Taxpayer would have exclusive right to use the designated spectrum assigned to it, reading the statutory provisions as a whole and in the context of the terms and conditions of the auctions and the licences issued (summarised in the earlier part of this judgment), it is clear that no one else is permitted to use the designated spectrum assigned to the Taxpayer. Under section 32H(1), the Authority may assign frequencies and bands of frequencies and shall keep a central register of the frequencies and bands of frequencies assigned. Section 32H(5) prohibits a person from using in Hong Kong “a frequency in any part of the radio spectrum unless the frequency is assigned” by the Authority. Section 7(2)(a) provides that the Secretary may by regulations prescribe “the general conditions … for a carrier licence other than an exclusive licence”. General Conditions clause 13.1 of the licences issued to the Taxpayer provides that “the radiocommunications installation operated by or on behalf of the licensee shall only be operated on such frequencies as the Authority may assign”. It does not follow from the non-exclusive nature of the licence to provide the telecommunications service that the licensee would not have exclusive right to use the spectrum assigned.

65.The exclusive right to use the designated spectrum is plainly a valuable right granted to the highest bidder at the auction, for which the successful bidder was required to pay an Upfront SUF. As provided in the 4G Notice, if and when the Upfront SUF was paid, a licence would be issued under which the frequency band or bands for which the bidder was successful would be assigned. There is similar provision in the 2G Notice. The exclusive right to use the designated spectrum was 15 years for the 4G Licence and 12 years for the 2G services in the amended licence, and there is no provision for refund of SUF if the spectrum was not used during the period. There is no legitimate expectation of any right of renewal or right of first refusal of any licence or spectrum assignment upon expiry of the licence or assignment under the TO[53]. As submitted by Mr Prosser, there is no reason to think that the TO only authorises the TA to charge SUFs for the use of spectrum and not, instead of or as well, to charge SUFs for the assignment of the right to use spectrum.

66.There is no similarity between the Upfront SUFs and rent paid under a lease, as contended by Mr Goldberg. The Upfront SUFs were paid as a one-off lump sum for the assignment of the right to use designated spectrum, and were not refundable even if the Taxpayer did not use the spectrum. Upfront SUFs may be regarded to similar to premium for a lease, which is a capital expenditure.

The judge’s conclusions on the nature of Upfront SUFs

67.The judge’s reasons for concluding that the Upfront SUFs are capital in nature stated in §29 of the Judgment have been set out earlier. Mr Goldberg took issue with each of the judge’s reasons along these lines:

(1) There is no proper basis for holding in §29(1) that in return for the Upfront SUFs, the Taxpayer had acquired the specified spectrum as part of the necessary and permanent profit-earning structures required to venture into a new line of business for the provision of 4G services or for the expansion and strengthening of its existing line of business in the provision of 2G services. The judge failed to recognise that nothing like an asset was acquired in this instance, as the Taxpayer had acquired nothing until the designated spectrum was used. The SUFs were paid for the use of spectrum and so for airtime which the Taxpayer provided to its customers.

(2) Contrary to the holding in §29(2), the Upfront SUFs did not bring about “enduring benefits to the business of the Taxpayer”. The benefit obtained was that the Taxpayer had paid the continuing cost of providing spectrum and airtime to its customers.

(3) The judge was wrong to hold in §29(3) that the Upfront SUFs were “lump sum payments incurred once and for all, instead of periodic payments to meet an ongoing demand for expenditure”. If SUFs were incurred to allow the provision of services to customers, they could only have been incurred to meet a continuous demand and must be revenue expenditure. The Upfront SUFs were simply payment in advance for matters spread over a future period.

68.Mr Goldberg also relied on the Taxpayer’s accounting treatment of the Upfront SUFs (classified as non-current intangible assets, amortised on a straight-line basis over the relevant licence periods and charged to the profit and loss account) in support of his contention, as there was no suggestion that the accounting treatment was wrong.

69.I do not agree with the above submissions. The Upfront SUFs were incurred to obtain a valuable right granted to the successful bidder in the auctions to use designated spectrum exclusively for 12–15 years. They were the cost of acquiring or enlarging the profit-earning structure of the Taxpayer’s business, the payment of which (in the amounts of $494.7 million and $15.12 million) was not a regular part of expenditure in the business. This was not akin to buying stock in trade at one go and securing a supply extending over several years, as considered in Golden Horse Shoe (New) Ltd v Thurgood [1934] 1 KB 548 at 560 to 562. The Upfront SUFs brought into existence fixed assets of an enduring nature which are held and used by the Taxpayer in its business of providing mobile telecommunications services to its customers at a profit. The spectrum itself is not consumed or used up (although the period for which the right to use the spectrum exclusively would diminish with time), but is retained in the shape of assets and being used to produce income by providing services to the customers. They were in the nature of fixed capital, as opposed to circulating capital (Ammonia Soda Co Ltd v Chamberlain [1918] 266 at 286, per Swinfen Eady LJ).

70.The Board had made findings of fact that “As a result of the assignment of the 4G spectrum, the Taxpayer has enlarged its profit-earning structure and capacity by venturing into a new field of business and strengthening its market competitiveness” and that “The Taxpayer’s success in the 2G Auction enlarged and strengthened its profit-yielding infrastructure by increasing its 2G spectrum capacity and improving the service quality of its 2G mobile services”. These findings were based on the press release issued by the Taxpayer after the auction, which was put to the Taxpayer’s Chief Executive Officer and accepted by him as correct. There is no valid basis to challenge these findings on appeal.

71.The accounting treatment of the Upfront SUFs by the Taxpayer cannot be determinative of the issue as a matter of principle (Tyco Australia Pty Ltd v Federal Commissioner of Taxation (2007) 67 ATR 63 at §82). And the mere fact that the trader intends or expects to recoup the whole of the expenditure from his trading operations is of no relevance. As stated in Commissioner of Taxation of the Commonwealth of Australia v Sharpcan Pty Ltd (2019) 269 CLR 370 at §31, Lord Pearce’s statements in B P Australia at 265G to 266A quoted earlier (that circulating capital is that which comes back in the trading operations and the sums in question were sums which had to come back penny by penny with every order during the period in order to reimburse and justify the particular outlay) should not be understood as asserting that the amounts paid by the taxpayer in that case were on revenue account merely because the taxpayer could, did or even had to amortise them over the cost of producing income. “A taxpayer’s acknowledgment that a capital outlay can be expressed in terms of an economically equivalent projected stream of income payments does not convert the capital outlay into a revenue outgoing.”

The distinction between payment as a condition for the assignment and as consideration for the assignment

72.The judge took the view that the payment of the Upfront SUF was a condition for the grant of a licence incorporating the assignment of the right to use the designated spectrum, and the Upfront SUF can also be regarded as the consideration or part of the consideration for the assignment of the right[54]. Mr Goldberg criticised the judge in dismissing the distinction between payment as a condition for the assignment and payment as consideration for the assignment as “nice, technical distinction”[55]. He submitted that this is a conceptual distinction that addresses the core issue of what the payment is for and so whether it is capital or revenue.

73.I do not think the judge was in error in treating this juristic distinction to be of no or little assistance. The distinction is too narrow a focus for the answering of the question. It is common ground that it would be more useful to ask: “(1) What is the money really paid for? – and (2) Is what it is really paid for, in truth and in substance, a capital asset?” (Colonial Mutual Life Assurance Society Ltd v Federal Commissioner of Taxation (1953) 89 CLR 428 at 454)[56]. As explained above, looking to the business and practical effects and advantages sought in the whole context, the advantage or asset obtained by the Taxpayer by paying the Upfront SUFs was the right to use designated spectrum exclusively for 12−15 years and this is in truth and in substance a capital asset.

The relevance of annual SUFs

74.The complaint is that the judge failed to recognise the inherent inconsistency in the Commissioner’s case whereby he allowed the deduction of cost of spectrum met by annual SUFs but not the cost of spectrum met by Upfront SUFs. According to Mr Goldberg, the Upfront SUFs fulfil exactly the same business and economic function as annual SUFs. Whilst accepting the Taxpayer’s submission that the change in the method of fixing and payment of SUF from an annual, royalty basis to an upfront, lump-sum basis was driven by economic, business and administrative considerations, the judge did not think it should follow that SUFs paid by the licensees under the two bases must, as a matter of law, both be regarded as either capital or revenue. The judge also noted significant differences between annual SUF payments and the Upfront SUFs paid for the assignment of the 4G spectrum and the additional 2G spectrum. In particular, the annual SUFs were calculated by reference to the network turnover of the Taxpayer subject to a minimum amount as from the 6^th year of the relevant licence[57].

75.I do not agree with Mr Goldberg. I do not consider the Upfront SUFs fulfil exactly the same business and economic function as annual SUFs. The annual SUFs are periodical payments for the use of or the right to use spectrum for a short period only, and were calculated on a different basis. It is not correct to regard the Upfront SUFs as compounded annual SUF payments.

The overseas authorities

76.Mr Goldberg sought to distinguish the Singaporean and South African authorities relied upon by the Board, namely, BFH v The Comptroller of Income Tax [2013] 4 SLR 568 and ITC 1726 (2000) 64 SATC 236 (followed in ITC 1772 (2003) 66 SATC 211). He made the point that the Singaporean case was decided on legislation fundamentally different from the Hong Kong legislation and the South African case was in respect of payment for a licence to construct, operate and maintain a nationwide cellular radio telephone service.

77.The judge took the view that these cases applied well-established principles in determining whether the payments in question were capital or revenue in nature and did not consider that the Board had erred in law in relying on these cases. He did not think it necessary to analyse the cases in detail[58].

78.As the judge did not rely on these overseas authorities in reaching his decision, I do not propose to discuss them.

Conclusion and costs

79.I would dismiss the Taxpayer’s appeal. There is no dispute that costs of the appeal should follow the event with a certificate for three counsel. I would make a costs order in favour of the Commissioner accordingly.

Hon Yuen JA:

80.I agree.

Hon Au JA:

81.I agree.

Mr David Goldberg KC, Mr Stewart Wong SC and Ms Bonnie Y K Cheng, instructed by Squire Patton Boggs, for the Taxpayer (Appellant)

Mr Kevin Prosser KC, Mr Eugene Fung SC and Mr John Leung, instructed by the Department of Justice, for the Commissioner of Inland Revenue (Respondent)