Chapman Development Ltd v. Commissioner of Inland Revenue

CACV 450/2024, [2026] HKCA 436

On appeal from [2024] HKCFI 2590

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO 450 OF 2024

(ON APPEAL FROM HCIA NO 6 OF 2022)

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BETWEEN

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J U D G M E N T

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Hon Kwan VP (giving the Judgment of the Court):

1.This is an application for leave to appeal to the Court of Final Appeal by the appellant, Chapman Development Limited (“Taxpayer”), against the judgment of this Court dated 30 October 2025 (“CA Judgment”)[1], by which we dismissed the Taxpayer’s appeal against the judgment of Cheng J (“Judge”)  dated 30 September 2024 (“CFI Judgment”)[2]. Unless otherwise stated, the terms and expressions in the CA Judgment will be adopted.

2.In short, the Taxpayer sought to challenge the determination made by the Inland Revenue Board of Review (“BOR Decision”)[3] and affirmed by the Judge[4] that certain Management Fees[5] paid to the Taxpayer’s associated company, Profit Gain[6], during the years of assessment 1997/98 to 2005/06 would not be deductible under sections 16 and 17 of the Inland Revenue Ordinance, Cap 112 (“IRO”)  and would be disallowed under section 61A.

Taxpayer’s Notice of Motion

3.By a Notice of Motion filed on 27 November 2025, the Taxpayer seeks leave to appeal on these three questions:

Question 1

“For the purpose of determining whether a transaction had or would have, but for section 61A of the IRO, the effect of conferring a ‘tax benefit’ on a taxpayer deriving trading profits from selling products manufactured outside Hong Kong by an offshore company, when considering the issue of source of profits under an appropriate alternative hypothesis whereby the taxpayer would additionally carry on production management operations relating to such offshore manufacturing processes (‘Offshore Production Management Operations’):

(a)  Are the Offshore Production Management Operations necessarily to be considered antecedent/ancillary or incidental to the profit-making transactions as a matter of law, such that these offshore operations should be excluded from consideration as part of the profit-producing activities?

(b)  If the answer to (a)  above is in the negative, what factual criteria should be used to determine whether the Offshore Production Management Operations, which would be taken over by a taxpayer under the alternative hypothesis, are merely antecedent/ancillary or incidental to its profit-producing transactions, or whether they should be included as part of the profit-producing activities?

(c)  If the issue as to whether the Offshore Production Management Operations is merely antecedent/ancillary or incidental to the taxpayer’s profit-producing transactions is an issue of fact or mixed fact and law, is it open to the Court of Appeal to hold that such operations would merely be antecedent/ancillary or incidental in nature, when the Board of Review (the ‘Board’)  and the Court of First Instance did not make any findings on this issue?”

Question 2

“Is it right for the Board to dismiss a case based on agreement by conduct between a taxpayer and its associated entity (including but not limited to a course of conduct comprising the charging of, and payment by, the taxpayer for goods supplied[7] by the associated entity), on the basis that the taxpayer did not adduce first-hand evidence on who, when and how the agreement had been made, and/or evidence from witnesses who had direct knowledge of the matter?”

Question 3

“For the purpose of determining whether a transaction had or would have, but for section 61A of the IRO, the effect of conferring a ‘tax benefit’ on the Taxpayer deriving trading profits from selling products manufactured outside Hong Kong by an offshore company, when considering the issue of source of profits under the Alternative Hypothesis, is it open to the Court of Appeal to find that the Offshore Production Management Operations to be antecedent/ancillary or incidental to the profit-making transactions, such that these offshore operations should be excluded from consideration as part of the profit-producing activities, in circumstances when neither the Board nor the Court of First Instance had made any factual findings on whether the production management work constituted merely ancillary or incidental activities?”

4.The Taxpayer contends that Questions 1 and 2 are of great general or public importance (“GPI”), and they ought also to be submitted to the Court of Final Appeal for determination on the “or otherwise” limb.  For Question 3, the Taxpayer only relies on the “or otherwise” limb.

5.It is trite that fact-sensitive questions which could not be answered as divorced from the specific facts of the case are not questions of GPI: Safder Tehseen v Permanent Secretary for Security (2014)  17 HKCFAR 567, at §14; Tsang Chiu Wing Florence v Li Kin Kan Samathur, FAMV 38 & 39/2014, 10 February 2015, at §12.

6.The legal approach in a tax appeal to the courts set out in the CFI Judgment[8] and the CA Judgment[9] is not challenged.  It is pertinent to bear in mind that since this is an appeal from the Board, the ultimate question remains whether the Board has committed an error of law covered by the questions for which leave to appeal from the Board was granted (“Leave Questions”), which have been set out in the CA Judgment at §§22, 24 and 25.  As correctly pointed out by the Commissioner, if leave to appeal to the Court of Final Appeal is to be granted on any of the questions in the Notice of Motion, they must relate to alleged errors covered by the Leave Questions, otherwise the questions in the Notice of Motion would not affect the outcome and they would be simply irrelevant and academic.  The Taxpayer would need to show a reasonably arguable issue involving a question of GPI properly arising, and which, if resolved in its favour, would establish an error of law committed by the Board and covered by the Leave Questions.

7.For the “or otherwise” limb, it is well established that it is the practice of the Court of Appeal to leave the matter to be decided by the Appeal Committee of the Court of Final Appeal, and that the discretion to grant leave to appeal on this limb is exercised only in exceptional circumstances: Re BGA Holdings Ltd (formerly known as Beibu Gulf Ocean Shipping (Group)  Limited)[2025] 6 HKC 442 at §34.

Question 1: applicability of section 61A

8.Question 1 concerns the application of section 61A of the IRO to the Transaction[10], and relates to Question (1)  of Ground 2 in the appeal before us.

9.We have set out our reasons at §§59 to 65 of the CA Judgment.  In summary, our reasoning is as follows:

(1)  The Board rejected the Taxpayer’s contention, holding that “[there] is no convincing evidence to substantiate the contention that if the Taxpayer took over Profit Gain’s role, the income would have been wholly offshore”[11] under the Alternative Hypothesis[12].

(2)  The Judge rejected the Taxpayer’s contention on two grounds: first, under the Alternative Hypothesis, there would not have been any profits derived from the Taxpayer’s hypothetical production management work in the Mainland[13]; second, it is for the Taxpayer to put forward evidence to show that under the Alternative Hypothesis, the source of the Taxpayer’s income or part thereof would have changed to become offshore[14].

(3)  The Taxpayer maintained before us that under the Alternative Hypothesis, the hypothetical profits arising from the production management operations would be sourced offshore and not chargeable to tax in Hong Kong, relying on Commissioner of Inland Revenue v Hang Seng Bank Ltd[15], Kwong Mile Services Ltd v Commissioner of Inland Revenue[16] and Ngai Lik Electronics Co Ltd v Commissioner of Inland Revenue[17] and argued that it is open to this Court to order a remitter of this issue to the Board[18].

(4)  We held the fact that the Taxpayer would not carry out manufacturing works under the Alternative Hypothesis distinguished the case from Ngai Lik Electronics Co Ltd and put it squarely within the principles and analyses in Commissioner of Inland Revenue v Datatronic Ltd[19] and Commissioner of Inland Revenue v CG Lighting Ltd[20],under which the production management work carried out by the Taxpayer under the Alternative Hypothesis would be activities ancillary and incidental to its profit-producing transactions, which continued to be the trading activities in Hong Kong, and ought to be disregarded in considering the source of the profits[21].

10.Question 1(a) purports to ask whether, for a taxpayer deriving trading profits from selling products manufactured outside Hong Kong, production management operations relating to offshore manufacturing processes carried out by the taxpayer under an appropriate alternative hypothesis[22] would be as a matter of law antecedent or incidental to the profit-generating transactions for the purposes of identifying the source of profits under section 61A.

11.The Taxpayer contends that the principles and analyses of Datatronic and CG Lighting are the “fundamental plank” upon which the Court of Appeal dismissed its appeal.  It submits that these authorities do not lay down an inflexible rule of law, and that the question as to whether the Offshore Production Management Operations are merely antecedent or incidental in nature is a question of fact (or at least mixed fact and law), relying on ING Baring Securities (Hong Kong)  Ltd v CIR (2007)  10 HKCFAR 417 at 435H-436A, 440F, §§38, 50 per Ribeiro PJ and 465H, §131 per Lord Millett NPJ; Hang Seng Bank Ltd at 322H per Lord Bridge.

12.We do not consider Question 1(a)  reasonably arguable. Besides, it is not a question of GPI properly arising, which, if resolved in the Taxpayer’s favour, would establish an error of law committed by the Board and come within the scope of the Leave Questions.

13.The discussion and application of Datatronic and CG Lighting are not referred to or relied upon by the Board in dismissing the Taxpayer’s appeal.  Question 1(a)  does not relate to any error of law committed by the Board and covered by the Leave Questions.  Similarly, nor does Question 1(c)  relate to any error of law made by the Board.  The analysis and result would be the same even if this Court (like the Board and the Judge)  made no mention of Datatronic and CG Lighting. For this reason alone, no leave should be granted for Questions 1(a)  and (c).

14.Furthermore, as acknowledged by the Taxpayer, the question of the source of profits of the Taxpayer under the Alternative Hypothesis is a question of fact.

15.We did not lay down any rule of law that the production management work under the Alternative Hypothesis should necessarily be antecedent or ancillary in nature.  What we did was to apply the principles and analyses in Datatronic and CG Lighting regarding the source of profits to the specific facts before us, where the relevant facts are not distinguishable[23].  Although the Taxpayer contends that the present case is “fundamentally different” from the facts in Datatronic and CG Lighting[24], we do not see any valid distinction.  Whether the arrangement between the Taxpayer and the manufacturer is characterised as “import processing” or “contract processing”[25] is immaterial to the analysis, as Datatronic was concerned with import processing[26] and CG Lighting was concerned with contract processing[27].  The descriptions of import processing and contract processing activities are not relevant since the ultimate question depends on the application of the relevant charging provision in section 14.  What is material is that the Taxpayer was a trader, not a manufacturer, whether under the Transaction or the Alternative Hypothesis[28].

16.Question 1(c) concerns whether, for a trader deriving trading profits in sales of products manufactured outside Hong Kong, it is open to the Court of Appeal to make a finding that such production management work under an appropriate alternative hypothesis would be antecedent or incidental to the profit-generating transactions for the purposes of identifying the source of profits under section 61A, in the absence of such findings made by the Board or the Judge.

17.We do not consider Question 1(c)  to be reasonably arguable.

18.The nub of the Taxpayer’s arguments is that we have made a factual finding not decided by the Board or the Judge.

19.As mentioned, neither the Board nor the Judge relied on Datatronic or CG Lighting.  We did not reverse or vary the conclusions made by the Board and the Judge, but gave an additional reason for our dismissal of the Taxpayer’s appeal, in which we refuted the Taxpayer’s reliance on Ngai Lik Electronics Co Ltd and pointed out that the case under the Alternative Hypothesis falls squarely within the analyses and principles of Datatronic and CG Lighting.  We did not set out to make a stand-alone conclusion that the production management work would be antecedent and ancillary to the profit-generating transactions.

20.Question 1(b) asks, regarding a trader deriving trading profits in sales of products manufactured outside Hong Kong, for the “factual criteria” for the determination of whether such production management work under an appropriate alternative hypothesis would be antecedent or incidental to the profit-generating transactions for the purposes of identifying the source of profits under section 61A.

21.The Taxpayer argues that while it would not be appropriate to ask the Court of Final Appeal to lay down an exhaustive list of the factual criteria, the stakeholders would still benefit from authoritative guidance on a non-exhaustive list of the key criteria.

22.We do not think Question 1(b)  is a proper question.  It is tantamount to asking the Court of Final Appeal to give a universal test for source of a profit in which the situations are too many and varied and an advisory opinion in this context would seem unwise, not to mention impossible[29].

23.Further, we do not consider Question 1(b)  relevant to the Taxpayer’s appeal.  The Courts were concerned with any error of law made by the Board under the Leave Questions.  There is no reason why the Court of Final Appeal should deal with legal issues not properly arising from the ambit of the Leave Questions.  We fail to see any link between this question and any error of law covered by the Leave Questions.

24.We reject the Taxpayer’s contention that Questions 1(a)  to (c)  are questions of GPI.  They raise matters that are inherently fact-specific. The fact that there may be many traders with related companies outside Hong Kong does not elevate these questions into those of GPI.

25.For the reasons given, we decline to give leave to appeal on Question 1.

Question 2: deductibility of Extraneous Fees

26.Question 2 concerns the deductibility of the Extraneous Fees[30], which relates to Ground 1 of the appeal before us.

27.We have set out our reasons at §§40-58 of the CA Judgment.  In summary, our reasoning is as follows:

(1)  The Board refused to draw a factual inference that the Extraneous Fees were paid pursuant to the Management Agreement as varied by an agreement by conduct[31].

(2)  The Judge held that the Board did not err by failing to recognise that the terms of payment of the Management Fees could be varied by conduct, and the Board did not impose any additional requirement that such variation by conduct could only be established by evidence of verbal exchanges between the parties in relation to the agreement[32].

(3)  We noted that this is a fact-finding exercise within the exclusive jurisdiction of the Board and that the Taxpayer did not raise the Irrationality Ground[33].  We did not think the Board had erred in law as contended, as the Board plainly recognised that an agreement could be inferred from conduct[34].  The Board observed that it was presented with different versions of evidence and that the Taxpayer had chosen not to call witnesses with direct knowledge, whereby the Board concluded it could not infer from the charging by Profit Gain that there had been a variation agreement by conduct, given the totality of the evidence[35].

28.The Taxpayer essentially repeats its arguments ventilated in the appeal before us.

29.We do not consider Question 2 to be reasonably arguable. For the reasons we have given in the CA Judgment, the Board did recognise that an agreement could be inferred from conduct, but was not satisfied that such an inference could be drawn in the present case on the basis of the evidence before it.  Furthermore, we do not consider Question 2 to be one of GPI, as it is plainly a fact-sensitive question.

30.We decline to give leave to appeal on Question 2.

Question 3: factual finding by the Court of Appeal

31.Question 3 closely resembles Question 1(c).

32.The Taxpayer argues that Question 3 concerns procedural fairness, complaining it had no proper opportunity to adduce factual evidence whether the Offshore Production Management Operations under the Alternative Hypothesis were ancillary or incidental, which point was not argued by the Commissioner or properly formulated before the Board.

33.As the Taxpayer relies solely on the “or otherwise” limb, we would leave this question to the Appeal Committee.

Disposition

34.For the above reasons, we dismiss the Taxpayer’s Notice of Motion with costs to the Commissioner.

35.Having considered the respondent’s statement of costs for summary assessment dated 29 December 2025, we are of the view that the costs stated are entirely reasonable and we allow the amount in full being $194,644.

Mr Johnny Mok SC and Ms Sharon Yuen, instructed by J Chan & Lai, for the Appellant (Appellant)

Mr Stewart Wong SC and Ms Elizabeth Cheung, instructed by the Department of Justice, for the Respondent (Respondent)