Beautiland Co Ltd. v. Commissioner of Inland Revenue
Read the full judgment text of HCIA 1/1989 on BabelCite. This HCIA judgment was delivered on 9 November 1989.
1. Ten years ago, Wheelock Marden & Co. Ltd. (WM) was approached by Cheung Kong (Holdings) Ltd. (CKH) with a proposal for the joint redevelopment of two properties owned by WM, namely Wheelock House and Marden House. Following discussion, the proposal crystal1ized in a letter dated 12th March 1979 from CKH to WM.
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HCIA000001/1989 IN THE SUPREME COURT OF HONG KONG INLAND REVENUE APPEAL NO. 1 OF 1989 ___________ BETWEEN
___________ Coram: The Hon. Mr. Justice Barnett in Court Dates of Hearing: 24 - 27 October 1989 Date of Delivery of Decision: 9 November 1989 ______________ D E C I S I O N ______________ 1. Ten years ago, Wheelock Marden & Co. Ltd. (WM) was approached by Cheung Kong (Holdings) Ltd. (CKH) with a proposal for the joint redevelopment of two properties owned by WM, namely Wheelock House and Marden House. Following discussion, the proposal crystal1ized in a letter dated 12th March 1979 from CKH to WM. 2. That letter set out detailed proposals for the redevelopment of the two properties and then added:
3. WM urgently considered the proposal. By letter dated 15th March, it agreed in principle, subject to certain amendments, and asked CKH for a draft agreement for approval. By another letter of even date, WM asked for "details of the proposed participation in other development projects". CKH accepted WM's amendments by letter of the same day. 4. By letter of 22nd March, CKH provided a list of properties held by its subsidiaries or associated companies which, or a part of which, it offered to the joint venture at prices indicated. In turn, CKH sought details of properties which WM would offer. The letter continued:
5. The schedule to that letter contained a number of columns which were headed Property, Owner, Area (sq. ft.), Valuation, Percentage and Price. Three further columns provided for payment, the third payment of 90% to be within 4 years. The Property column contained details of 8 pieces of land, and Letter B Entitlements. However, it was clear that the joint venture was not to be offered the land or Letters B, but all or part of the share capital of the companies which owned the respective properties. There was a number of remarks at the end of the schedule. Remark 4 reads:
My emphasis. 6. The final item on the schedule is important, because it is to that which this appeal relates. The final item constituted certain land at Tin Shui Wai. A company call Rostock Enterprises Ltd. owned 52.36% of 50 million sq. ft. The land was valued at $200 m. The joint venture was being offered 30% of Rostock at a price of $60 m. 7. By letter dated 23rd March, WM submitted a list of properties for the joint venture. A schedule to that letter contained details of 8 properties. It is clear that the land itself was being offered to the joint venture. In the event, one of those properties was not acquired by the joint venture, and in respect of another, Thorpe Manor, shares in the company which owned it were acquired rather than the land itself. 8. By letter dated 26th March, CKH returned WM's list, omitting one property, with prices for consideration. It also asked WM to consider making part of the tram depot at Canal Roan available. CKH was advised orally that WM did not own any part of the depot. 9. On 27th March, the Appellant was incorporated. It became the vehicle for the joint venture. 10. On 6th April, CKH wrote to WM. The letter commenced: "Re: Joint Venture in Real Estate Projects
11. The terms included a proposal for a deadlocked company to be owned equally by WM and CKH, each having an equal number of nominated Directors, with the Chairman having no casting vote. Mr. Li Ka-shing would be Managing Director. 12. Paragraph 4 of the letter headed "Financing Arrangements" contained the following clause:
13. Paragraph 6 entitled "Acquisition of Properties" contained the following two paragraphs:
14. Paragraph 7 headed "Remuneration of Management" contained provisions for payment of the Project Manager, the Project Supervisor and Sales Agents. 15. Paragraphs 8 and 9 are entitled respectively "Architect and Consultant Architect" and "Solicitors for Unit Sales". 16. On 19th April, CKH sent WM an initial draft agreement for consideration. The draft contained the following recitals:
17. Clause 1 contained a number of definitions including:
My emphasis. 18. Clause 7.1 provided for sale of the properties to the company i.e. the Appellant in the following terms:
My emphasis. 19. Clause 11.1 headed "Development" read:
My emphasis. 20. Clause 16 provided for Finance. Paragraph 1(iv) specified one source of finance and reads:
21. Otherwise, the draft refers repeatedly to land, the development of land, new buildings to be erected on the land; and provides for the appointment of architects, a project manager and consultant; for the sale of new buildings, for sales agents and sale prices, and for solicitors for the sale of new buildings or units erected on the land. 22. The draft agreement was then considered by the parties and worked upon by their lawyers. In the mean-time, Mr. Li advised WM in May that he had had an approach from parties who had expressed interest in acquiring Rostock's interest in the Tin Shui Wai land for some $300 m. 23. On 8th June 1979, the parties executed the joint venture agreement (the Agreement). CKH were one party, and Cranmore Land Company Limited, owned by WM, the other. The first recital to the Agreement read:
My emphasis. 24. Clause 1 again contained a number of definitions including:
My emphasis. 25. Clause 7.1 again provides for the acquisition by the appellant of the Properties which, by virtue of the definition, includes assets and shares. 26. Clause 10 relates to Development Policy and reads:
My emphasis. 27. Clause 14 provided for "Finance for Development Costs", the finance to come from inter alia:
28. Otherwise, the Agreement again talks about land, development of land, submitting plans to government, appointment of architects, project manager and consultant, sale of new buildings or existing buildings. 29. On the same day, Cranmore gave CKH a letter which contained inter alia the following:
Following execution of the Agreement, the Appellant obtained the land and shares set out in the Schedule to the Agreement. The Rostock shares were acquired by way of formal Sale and Purchase Agreement dated 28th June 1979. 30. Almost immediately Mr. Li received overtures from another party, via a broker, for the sale to that party of the Rostock shares as opposed to Rostock's interest in the land. On 21st August, the Appellant joined with CKH, which still held 53% of the Rostock shares, and certain other small shareholders in offering 81% of the Rostock shares to Commotra Co. Ltd. The Appellant itself was to sell 25% out of the 30% which it had acquired. The offer was accepted and the sale was concluded on 6th November 1979. Rostock received $103,750,000, thus making a profit of just over $43,000,000. 31. The Appellant was assessed for tax on this profit. Upon a notice of objection, the Commissioner of Inland Revenue confirmed the assessment, taking the view that the profit arose from a trade or an adventure in the nature of trade. The Appellant appealed to the Board of Review. The Board dismissed the Appellant's appeal. At the request of the Appellant, the Board stated a case for the determination by this Court of the following questions:
Annexed to the Case is the Board's Decision. This is a somewhat lengthy document for two reasons. First, it recites a large number of agreed facts. These facts encompass the documents to which I have already referred, as well as the acquisition and disposal of various pieces of lane and shares. The Board, however, did not rely on the latter facts. No complaint is made of that. I need not, therefore, dilate further. Second, it deals with another appeal by the Appellant in relation to the sale of shares in another company, Hoi Tuen, which in turn owned the Letters B. That appeal was allowed by the board, the profit from the sale of those shares not being found to be by way of trade or an adventure in the nature of trade. As I understand it, the Commissioner of Inland Revenue accepts that decision by the Board. 32. The Board's finding that the Rostock shares were acquired and disposed of by way of trade, or that the operation was an adventure in the nature of trade, was essentially based upon the findings which are challenged in Question 4, and which are themselves all findings relating to intention. 33. By Question 1, however, the Appellant takes the Board head on. Accepting all the inferences of fact drawn by the Board, the Appellant contends that the Board's conclusion was wrong in law on the basis of the facts found by them. The Appellant first complains of the following passage in the Board's decision:
34. The Appellant argues that there is no concept in law of indirect dealing in land, a concept which permeates and therefore vitiates the Board's decision. The Appellant says that the Board continually fails to distinguish between the shares in a company, and the underlying assets thereof, namely land. 35. As far as the South African case is concerned, the Commissioner accepts this as being simply a statement of common sense rather than some firm proposition of law. The Commissioner, does, however, seek to extract the principle from Henriksen. 36. In Henriksen, a property dealer and developer found itself unable to dispose of a piece of land. It formed, in effect, a joint venture with another party, and the piece of land in question was acquired by the joint venture company. The Court of Appeal agreed with the Commissioners that the profit made by the sale of shares in the company was properly treated as a profit made in the ordinary course of the taxpayers' business. Lord Greene MR said at p. 52:
Later, he went on:
37. In Fundfarms, the appellant carried on the trade of buying and developing land and selling it off in plots. It wished to acquire a certain site. It was unable to do so, so it acquired the company which owned it. The appellant took no part in the development of that site. It received dividends as a result of its shareholding. Subsequently, the company which had owned the land was liquidated after a distribution had been made, and the appellant made a loss in relation to the original cost of the shares. It was held that the appellant's acquisition of the shares was not a transaction forming part of its trade. Buckley J. distinguished Henriksen on the basis that the land in Henriksen had previously belonged to the appellant company, and had formed part of its stock in trade. At p. 721, Buckley J. said:
38. In my judgment, these cases are not authority for any principle other than the well-known one that each case must depend upon its facts. There may be cases where, as in Henriksen, the reality of the situation is that the taxpayer is, by the purchase and sale of shares, carrying on his normal business. In others, the reality may show that there is simply an isolates investment not constituting part of the taxpayers' normal business affairs. And that, I think, is the way in which the Board approached the problem rather than by trying to apply some non-existent principle of law. The question, therefore, is whether the Board correctly assessed the situation. 39. Although he made it with great care and precision, for the Appellant, Mr. Gardiner had one simple point. He said that the Board found the purchase and sale of the Rostock shares to be a one-off or isolated transaction. This is implicit from the following statement by the Board:
40. In the circumstances, I think that argument must be accepted. 41. Therefore, said Mr. Gardiner, a one-off transaction in relation to something which is normally the subject of investment i.e shares could not, in the circumstances, be found to be trading or dealing or an adventure and concern in the nature of trade, if the principles laid down and illustrated in a number of well-known cases are properly applied:
42. Mr. Gardiner also pointed out that, although the board referrer to the "badges of trade", the Board made no attempt to relate them to the facts. Had they done so, he said, the only conclusion which they could have reached would have been that the transaction was not trade or an adventure in the nature of trade. 43. Looking at the badges in brief, Mr. Gardiner commented:
44. The Board apparently relied upon two other matters. First, that there was an intention to sell the Rostock shares, even before the formal acquisition thereof on 28th June. This intention, which is evidenced at least in the letter of authority given to Mr. Li when the joint venture agreement was executed, was brought about because of the interest which had been shown by another party, and by problems which had emerged in connection with the acquisition of the whole of the Tin Shui Wai land and the development thereof. In my view, however, that overlooks the fact that the Rostock shares were put forward by CKH at the outset before any approach had been received, or any difficulties canvassed. 45. Second, the Board adverted to the two approaches which were received by Mr. Li for the Rostock interests or shares and the fact that a broker was involved in the second and successful approach. I can see no relevance in this whatsoever. If anything it militates against any intention to sell, because it was not the Appellant which was actively hawking its shares. 46. For the Commissioner, Mr. Feenstra took a broad approach in support of the Board's decision. He adopted the words of Donovan LJ in Jenkinson v. Freedland 39 TC 389, who said at p. 647:
47. That, said Mr. Feenstra, is what the Board have done, and upon a review of the facts have not found that the Appellant discharged the onus of showing that, on the balance of probabilities, the Rostock transaction was not trade or an adventure in the nature of trace. 48. Mr. Feenstra contended that the Board was right is the construction which it placed upon the documents and other agreed facts. He said that it is plain that the Appellant was interested in land, and did not distinguish between acquisition of lane itself, and acquisition of shares through which land could be developed or otherwise turned to account. The shares were therefore part and parcel of the Appellant's business in dealing with land and constituted stock in trade. The documents, to which I have already referred, demonstrated a clear intention to sell and, as the Board found, that encompassed a specific intention to sell shares. Mr. Feenstra pointed out how the recital in the draft agreement had referred to "developments", but that this had been replaced in the Agreement by "development and/or sale of the properties". He pointed also to the repeated use of "shares" and turning to account", and to the reference to "profit taking sales" in Remark 4 of the schedule of property to CKH's letter of 22 March. 49. The definition in the Agreement of "Properties" includes assets and shares. Clause 18 of the Agreement refers to the sale of assets. Rightly, said Mr. Feenstra, the Board refused to accept that this was, as it were, a sweeping up clause to cover assets which might be acquired in the future, and which might not be ordinary interests in land, and rightly found that it could cover the sale of shares. 50. I find myself unable to accept the latter argument. As the Agreement itself demonstrates, assets and shares are regarded differently. Further, in the context of the Agreement, I can see no warrant for the construction put on this clause. 51. Mr. Feenstra referred to James Hobson & Sons Ltd. v. Newall (1957) 67 TC 609. The objects of the taxpayer included carrying on the business of building and acquiring real property for business purposes or for investment and resale. The taxpayer built and sold several thousand houses but had been unable to sell 21 which it let. It built and let another 22 to keep its labour force together. Several years later, after World War II, it sold these houses. The Commissioners found the houses to be trading stock. Harman J., dismissing the taxpayers appeal said at p. 617:
52. Mr. Feenstra contended that the situation is analogous to the instant case. He said the Appellant, as part of its business, acquired land and shares. The land was to be developed or sold. Both land and shares were acquired for business purposes and hot for investment. 53. I was also reminded of California Copper Syndicate v. Harris (1904) 6 TC 159. Mr. Feenstra argued that the joint venture here is no less an operation of business in carrying out a scheme for profit making, and the gains, by selling shares or otherwise, no less gains made in the operation of that business. 54. I do not find these cases to assist the Appellant. Certainly the Appellant had a profit making scheme but, in my view, the gain made on the sale of the Rostock shares was "a mere enhancement of value by realising a security". It was the land that the Appellant intended to, and did, turn to account, not the shares. 55. I can see no warrant, as Mr. Gardiner submitted as part of his address, for the construction which the Board appears to have put on the Agreement and other documents. The whole thrust of the preliminary correspondence, the draft and the Agreement, is the acquisition of land, and the obtaining of profit therefrom by development or by sale. Profits would accrue to the Appellant by the direct development or sale of land which it acquired, or by way of dividend from shares acquired in companies owning land. Those companies, pursuant to obligations contained in the Agreement, the parties would procure to deal appropriately with their land. Nothing, in my view, gives any hint of an intention to buy and sell shares other than for the purpose of ultimately obtaining dividends from those shares as a result of the working of the land by the subsidiary or associated companies which owned the land. 56. If there was any real intention to dispose of shares, it is difficult to understand why no express provision was included in the Agreement. Furthermore, it is also difficult to understand why it was necessary to provide Mr. Li with authority to dispose of the Rostock shares if, as it is contended, the documents and particularly the Agreement in Clause 18 provide not only an intention but also the necessary authority to sell shares. 57. In my judgment, there is simply not available the material upon which the Board could properly come to the conclusion that the sale and purchase of shares was an intergral part of its business in dealing with land. 58. In Ducker v. Rees Roturbo Development Syndicate [1928] AC 132, the company's business was the general purpose of purchasing and acquiring patents, licences and concessions, improving them, using them and turning them to account. It sold a patent. The profit therefrom was held to be taxable. At page 141, Lord Buckmaster said:
59. In my view, precisely the converse position applies here. The sale of the Rostock shares was a mere accidental dealing. It was not a particular method of dealing with land which special circumstances required. 60. Accordingly, the Rostock transaction should have been analysed in accordance with the principles laid down in the cases to which I referred earlier, and by an application of the badges of trade. Mr. Feenstra, relying principally upon his argument in relation to the documents and the reality of the situation, did not address me on Ransom v. Higgs and the allied cases. He did, however, deal with the badges of trade and made the following points:
61. The Board focussed, as Question 4 indicates, almost exclusively on intention. Their findings appear based on 5 facts. First, Remark 4 to the schedule of property accompanying CKH letter of 22nd March referred to "profit taking sales". Such sales must have encompassed the sale of shares because shares were what were acquired. 62. Second, the Agreement referred to sales and shares. Third, the offer in May to buy Rostock's interest in the land. Fourth, the problems in acquiring and developing the whole of the land at Tin Shui Wai. Fifth, the authority given to Mr. Li. 63. Apart from the documents and agreed facts, 2 witnesses gave evidence before the Board, partly by statement, partly orally. I need only refer to one, Mr. Henry Leung, who had been a director of WM and the Appellant at the material time. It was Mr. Leung's evidence that the Appellant, initially, had no intention of selling the Rostock shares. Ultimately, he agrees that the Appellant was canvassing 3 options, to press on with developing the land, to sell the Rostock interest or to sell the shares. He did not agree that the last option was particularly favoured. 64. The Board rejected Mr. Leung's evidence on this. They found there had been an intention to sell throughout and that this became a "genuine prospect intended to be brought about". 65. The Board were, of course, entitled to reject Mr. Leung's evidence, provided there was a proper basis for so doing. The first factor in such rejection was their construction of the documents which revealed an intention to sell shares if appropriate from the contest. I have already found this to be wrong. 66. With that support, at least, removed, in my view the only proper conclusion that can be reached on the facts is that the sale of the Rostock shares was brought about by a substantial increase in their value and emerging difficulties in developing the land. Even then the Appellant retained 5% of the shares so that it remained involved in the subsequent development of the land. That appears more consistent with investment than trading. 67. I am unable to see any legitimate grounds on which the Board could justifiably find that this one-off share transaction constituted trade or an adventure in the nature of trade. 68. Accordingly, the answer to Question 1 is "No", and on that ground alone, the appeal must be allowed. 69. Although it is not necessary for me to deal with the other questions, I can perhaps venture an opinion. 70. Intention, of course, played an important part in this matter. The Board took the view that it should ascertain intention by reference at the earliest to the 8th June, when the Appellant by virtue of the Agreement could enforce acquisition of the Rostock shares. Before that, the venture had remained "subject to contract". 71. The Appellant contended that by April at the latest, there had been a meeting of the principals' minds and a commercial contract had been concluded. It only remained for the lawyers to reduce it into written terms. 72. "Subject to Contract" has recently been debated, to the particular interest of Hong Kong, in AG and others v. Humphreys Estate (Queen's Gardens) Ltd. [1987] HKLR 427. In my view, the possibility of a change of mind had not been conclusively ruled out. The Board were therefore right to ascertain intention as at 8th June. The answer to the question would be "yes". 73. Question 3, Mr. Gardiner acknowledged that this is a fall back position for the Appellant which would have the effect of reducing, but not eliminating, the amount of tax paid. The principle is that, where a taxpayer transfers an item from a taxable to a non-taxable activity, or vice versa, the taxable activity is credited with the market value then obtaining to the item. Mr. Gardiner contended that, even if the Board was right in finding that the Rostock transaction was trade or an adventure, the shares only came into that category in May when the first approach was made to Mr. Li, and the possibility of a sale rather than redevelopment arose. The Appellant should be credited with the market value of the shares as at that date which would have the effect of considerably reducing the taxable profit. 74. I do not think this question can be answered. If the Board's findings of fact are correct then the application of the principle does not arise. Nor does it arise if my view is correct. 75. It is implicit from what I have said already that the answer to Question 4 must be "no".
Representation: Mr. J. Gardiner, Q.C. & Mr. D. Yu instructed by M/s Woo, Kwan, Lee & Lo for Appellant Mr. Feenstra, Sr. C.C. and Mr. Wu, C.C. of Crown Solicitor for Respondent |