Commissioner of Inland Revenue v. Messrs. Lau Wong & Wong & Chan Solicitors

Case No.HCIA 2/1988

Court

HCIA

Date—

Judge—

Case Document

100%Judiciary

HCIA000002/1988

IN THE SUPREME COURT OF HONG KONG

HIGH COURT

I.R. Appeal No. 2 of 1988

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BETWEEN

	Commissioner of Inland Revenue	Appellant
	and
	Messrs. Lau Wong & Chan Solicitors	Respondent

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Coram: Mortimer, J. in Court

Date of Hearing: 21st and 22nd July 1988

Date of Delivery of Judgment: 22nd July 1988

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TRANSCRIPT OF JUDGMENT

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Mortimer, J.:

1. This is an appeal by the Commissioner of Inland Revenue by way of case stated from a decision of the Board of Review in favour of the taxpayer on the 28th of July 1987.

2. The taxpayer is a firm of Solicitors. In accordance with the solicitor's accounts rules that firm maintained client's accounts with the bank. Some of those accounts were interest bearing. As found by the Board of Review at all material times, the capital sums in those clients' accounts belonged to the clients and not the taxpayer.

3. The interest earned on this money in the clients' accounts was distributed among the partners of the taxpayer in proportion to their partnership shares.

4. Up to and including the year of assessment of 1980/1981, the taxpayer included this interest in its profits for the purpose of profits tax. For the next three years, the taxpayer did not include this interest and was assessed. Objection was made to the Commissioner. He decided against the taxpayer on the 29th of November 1985; the Board of Review later find in its favour; hence, in due course, these proceedings. The provisions with which I am concerned are as follows:-

5. First section 14 of the Inland Revenue Ordinance Cap. 112, that is the main charging provision. It reads:

"14. Subject to the provisions of this Ordinance, profits tax shall be charged for each year of assessment at the standard rate on every person carrying on a trade, profession or business in Hong Kong in respect of his assessable profits arising in or derived from Hong Kong for that year from such trade, profession or business (excluding profits arising from the sale of capital assets) as ascertained in accordance with this Part."

6. Then, Section 15(1)(g) is a provision in a deeming section of the Ordinance for the purposes of section 14 and others. Section 15 reads:

"15. (1) For the purposes of this Ordinance, the sums described in the following paragraphs shall be deemed to be receipts arising in or derived from Hong Kong from a trade, profession or business carried on in Hong Kong -

(g)

sums received by or accrued to a person, other than a corporation, carrying on a trade, profession or business in Hong Kong by way of interest derived from Hong Kong which interest is in respect of the funds of the trade, profession or business and is exempt from interest tax under Part V."

7. And then section 28(1)(a) of the ordinance provides:

28. (1) Interest tax shall, subject to the provisions of this Ordinance, be charged for each year of assessment on the recipient to any sum paid or credited to him in that year being -

(a)

interest arising in or derived from Hong Kong in any debenture, mortgage, bill of sale, deposit, loan, advance or other indebtedness whether evidenced in writing or not;

8. There is a proviso that there shall be exempt from interest tax -

(a)

any interest paid or payable by a bank licensed under the Banking Ordinance."

9. Those are provisions which fall to be considered. Not all of them as will appear, do I consider to be relevant to my consideration of this case.

10. The Board of Review in finding in favour of the taxpayer, determined that this interest was not assessable profit 'arising in or derived from' the profession and was not liable to tax under that main charging provision. Also, that the interest did not fall within the deeming prevision section 15(1)(g), as the interest was not in respect of funds of the taxpayer's profession and that the interest was therefore not taxable under section 28(1)(a) because of the proviso to which I have referred.

11. In the course of his submissions for the Commissioner, Mr. Feenstra, did not argue that the funds in the clients' account were funds of the profession within section 15(1)(g). I agree. If it is of importance, hereafter, I find that the clients' accounts were not funds of the profession. It follows that other things being equal the proviso in section 28(1)(a) would exempt such funds from interest tax.

12. The question of law for me in the case stated is; was the Board of Review correct in law in finding that the interest income in question was not assessable profit arising out of or deriving from the firms professional activities? I am not asked by the Commissioner to make any findings in respect of the second question.

13. In considering this matter, it is necessary to turn first and foremost to the words of the charging section itself. The deeming provisions in section 15 are not exhaustive. They were never intended to be so.

14. It is important to note in the provisions of section 14, the difference of approach of the Hong Kong legislation and the legislation in the United Kingdom. The distinction which is drawn in the United Kingdom between earned income "immediately derived" from the trade or profession of the taxpayer and other income is not part of our legislation. The only question which arises in Hong Kong is whether the profits arise in or are derived from Hong Kong from such profession.

15. The interest earned upon the funds in the taxpayer clients' account in the absence of agreement do not belong to the taxpayer. The funds are fiduciary. They are held on trust and the interest belongs not to the taxpayer but to his clients. Of this, there is no dispute. The authority is Brown v. Inland Revenue Commissioners [1965] A.C. 244 at 258. Lord Reid said:

"I can find no ground on which it could be held that this interest ever became the property of the appellant."

16. The interest with which he was dealing was interest on a solicitors' clients' account.

17. After that decision, clarification was necessary on the way in which solicitors dealt with the interest on client's account. In the United Kingdom, the postion was clarified or regularised by statute. The Solicitors Act 1965 section 8(3) provided that Solicitors did not have to account to their clients for this interest. It produced a statutory windfall.

18. There is no such similar provision in Hong Kong. Here after much consideration, the matter was dealt with by agreement. That is by agreement between the Solicitor and his Client. The client does not have to agree to anything but if the solicitor wishes to keep the interest on the clients' funds an agreement must be made to this effect. No doubt usually the client is prepared to agree. There is a copy of the type of agreement which a solicitor will usually ask his client to sign in the bundle of documents at page 53. I refer to that without reading out all the provisions. After a provision for the retainer of the solicitor there is a paragraph which reads:

"I hereby agree that any moneys or funds received by you (that is the solicitor) from me or for my account will be subject to the printed conditions appearing in your standard form of receipts the printed conditions whereof are set out hereunder. "

19. And the first of those is:

"Save as otherwise provided herein, no deposit interest will be paid or credited by us on the funds concerned in this receipt, and no compensation will be paid in lieu thereof. "

20. That provides for the solicitor to keep the interest on the funds. There are other provisions should the agreement be that the client should receive some of that interest which is, of course, his.

21. Those conditions are repeated on the reverse of the receipts which are signed when the solicitor receives clients' funds. I have been shown a copy of the receipt which is signed by this taxpayer.

22. In relation to this the Board of Review found the taxpayer became entitled to the interest because of:

	(1)	an agreement with each client that the taxpayer should be so entitled and
	(2)	the separate agreement between the taxpayer and its banners.

23. For the taxpayer, Mr. Bharwaney argues that the receipt of this interest is not 'profit arising in or derived from the profession' of the solicitor taxpayer. He agrues that the interest is a receipt of interest for the deposit with the bank which is collateral. He relies greatly upon the finding of the Board of Review on pages 11-12 of the bundle at paragraph 8:

"	However, the Board of Review said there is no suggestion that the interest earned on the deposit of clients' funds represented a charge levied by the taxpayer for the purposes of dealing with those funds.
	Later:
	The taxpayer is a partnership of solicitors and it is proposed to tax upon the basis that that partnership earned profits by way of interest as part of its profession. We think it is clear that the interest did not form part of the professional profits any more than, say, if the partners had agreed to use part of the profits of the firm to speculate on the commodities market. The interest arose from the separate agreement with the bank and the solicitors were entitled to it by reason of an agreement with their clients."

24. And further Mr. Bharwaney relies upon that part of the Case stated Page 7 paragraph 6(3)(a) which reads:

"Although the intake and disbursement of clients' funds are part of a solciitor's normal practice there is no suggestion that the interest represented a charge levied by the taxpayer for the purposes of dealing with those funds."

25. Mr. Bharwaney relies upon those findings and he submits that in order to test the matter one must look at the source of the money. He submits that here in Hong Kong only professional fees are subject to tax within the meaning of section 14 and considering broadly the provisions of the Ordinance. He submits that one must look at the source and the quality of the income, or the money, which is interest.

26. He turns to rely heavily upon the decision in Northend v. White & Leonard and Corbin Greener and others (1975) 50 Tax Cases 121 in which it was decided by Templeman J (as he then was) that the solicitors (respondents in that appeal) were not entitled to earned income relief on this type of interest because the interest was not "immediately derived" from the carrying on of their practice as solicitors but from the loan to the bank on the terms that interest should be paid. Mr. Bharwaney relies upon the reasoning in that case as applicable to the interest income of the solicitors in this case. In particular, he relies upon two passages of the learned judge which are to be found on page 129. In the course of dealing with the argument of counsel, the learned judge said at C:

"I observe that the clients do not provide the interest or pay in advance to enable the firm to receive interest in return for professional services. The mechanics of a solicitor's practice necessitate his holding clients' money, and the Solicitors Act 1965 entitles him on terms to keep the interest which he obtains by legitimately exploiting that necessity. "

27. Later in dealing with an argument of counsel with which he agrees, he said:

"	The interest could be more accurately described as deriving from a loan or investment than from the carrying on of the profession of a solicitor. I agree with Mr. Medd. Of course, if the Solicitors Act 1965 had not been passed, or if the firm had not carried on or exercised the profession of solicitors, there would have been no deposit account and no interest. But it does not follow that the interest was "immediately derived" from the carrying on of the profession. To produce the interest there must be an intervening event which could not be described as the carrying on of the profession of a solicitor; namely, the loan of money by a customer to a bank on terms that interest should be paid."
	And his decision is at page 130 H:
"	The authorities therefore support the view that the earned income of a solicitor is limited to the moneys which he receives from his clients in return for his professional services, and does not include interest credited to his clients' deposit account and received by the solicitor as consideration for the loan of money to the bank."

28. Following those passages, Mr. Bharwaney argues that I must and should find in favour of the taxpayer and that I should find this interest was not 'profit' within the provisions of section 14.

29. Mr. Feenstra submits that the case is not in point. He submits that that case is dealing with a different question. The question whether deposit interest was "immediately derived" from the carrying on of the profession and the question whether it was earned income and whether earned income relief was to be granted. He submits that the only basis upon which the solicitors in the instant case could retain the interest was the contract. There is being no equivalent of the Solicitors Act 1965 as in England. Further that the contract was with the clients who owned the interest and the consideration for passing over that interest was the rendering of professional services and could not he anything other than for the rendering of professional cervices. It thus became part of the profits within section 14 and that is an end of the matter.

30. I agree with those submissions. If one turns to the Northend case and considers the particular issue which was in front of the judge it is found at page 129A:

"The question is whether the deposit interest was "immediately derived" by the firm from the carrying on or exercise by them of the profession of solicitors."

31. That was the issue and the section with which the learned judge was concerned was section 525(1)(c) of the income tax at 1952. That provided a definition of earned income as "income immediately derived by the individual from the carrying on or exercise of his profession. " There was no issue whether the receipt was taxable. It was only a question of into which category it fell.

32. The difference between those provisions relating to earned income and the limiting words "immediately derived" and the words in section 14 of the Hong Kong Ordinance is to be noted. All profits in Hong Kong which "arise in or are derived from Hong Kong from such profession" are taxable. The question is whether this interest in these circumstances fall into the Hong Kong definition.

33. The only basis upon which this taxpayer receives the interest is by agreement with his client. It is true that the money is interest. It is earned upon a deposit consequent upon an agreement between the solicitor and the bank. But the money with the interest remains the property of the client until the taxpayer receives it in consequence of the agreement. I have no doubt considering the agreement that is made that the solicitor receives that interest in consideration of the professional services which he renders. In these circumstances, this interest "arises in or is derived from" his profession in Hong Kong.

34. Nothing in section 15, the deeming provision, detracts from this. It is not exhaustive and was never intended to he exhaustive, in my Judgment.

35. In the Northend case, it is important to bear in mind the issue there being considered, to which I have referred. It was not in issue that the interest was subject to tax. The interest was income but was not "earned income" within the limited definition to which I have also referred. In that case, the interest was received by the solicitor not by an agreement, as here in Hong Kong, but consequent upon the statute. It was not remuneration or fees but a statutory windfall. The reasoning of the learned judge in that case must be regarded in the light of that fact. The moneys are received in Hong Kong by the solicitor in entirely different legal circumstances.

36. I am satisfied that the taxpayer here was only entitled to this interest by reason of the retainer. When one returns, in the light of that, to the two passages in the Northend case upon which Mr. Bharwaney relies I am satisfied it is not authority (and, of course, it would only be persuasive authority in any event) for saying in Hong Kong that this interest is not profit within the meaning of section 14. I am satisfied that it is. The answer to the question which I am asked is No. This appeal therefore succeeds.

	(J. B. Mortimer)
	Judge of the High Court

Representation:

Mr. P.F. Feenstra (DPCC) for the Commissioner of Inland Revenue/Appellant

Mr. Mohan Bharwaney (Lau, Wong & Chan) for the Respondent