Wing Tai Development Co Ltd v. Commissioner of Inland Revenue

HCIA000003/1978

Coram: Yang J.

Date of Judgment: 19 April 1979

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JUDGMENT

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Difference between trade and investment.

1. The appellant company was, at all material times, empowered by their memorandum of association to hold shares for investment and to trade in shares. It is common ground that the company carried on both of these activities.

2. The brief facts of the case are as follows. On 1st October 1972 the appellant company acquired the entire issued capital of one Yiu Nin Development Co. Ltd. (hereafter referred to as Yiu Nin) for $6,208,502. Yiu Nin had, on 9th September 1972, purchased the property at N.K.I.L. 4867 and the industrial building thereon known as 9 Luk Hop Street, San Po Kong, with the existing tenancies, for $6,000,000 and commenced business by receiving rents from that building. This property was Yiu Nin's only asset. By an agreement dated 23rd February 1973 the appellant company sold the entire issued capital of Yiu Nin (which then consisted of 75,000 shares of $100 each fully paid) to Mr. Cecil Chao, one of the promoters of Wah Kwong Properties Ltd. (hereafter referred to as Wah Kwong). The consideration for sale as set out in the agreement was that -

"The consideration payable by the Purchaser (Mr. Chao) for the said shares (Yiu Nin's) shall be $7,500,000 ... and shall be satisfied by the payment in cash of $3,000,000 on the signing hereof and by the allotment or transfer of 4,500,000 shares of $1 each in the capital of Wah Kwong Properties Limited credited as fully paid up."

After its incorporation Wah Kwong adopted the agreement on 28th February 1973 and on that same day alloted 4,500,000 shares of $1 each in their capital to the appellant company, credited as fully paid. There was no agreement, verbal or written, which bound the appellant company to retain these shares for any length of period. The appellant company was therefore free to dispose of these shares at any time. The certificates of the 4,500,000 shares were delivered to the appellant company by Wah Kwong on 1st April 1973.

3. In the prospectus of Wah Kwong the San Po Kong property owned by Yiu Nin was listed at a "Directors' Valuation" of $7,500,000 against a "Professional Valuation" of $7,760,000 made by a chartered surveyor.

4. The Wah Kwong shares were first quoted on the local Stock Exchanges on 2nd April 1973. Their prices during the first three days of trading were:

5. On the 4th and 6th April, 1973, the appellant company sold their Wah Kwong shares on the Stock Exchanges:

6. The appellant company's profits tax return for the year of assessment 1972/73 showing an assessable profit of $137,740 was supported by their accounts for the period 12th September 1972 to 30th September 1973. The operating profit of $3,004,748 appearing in the Profit & Loss Account was made up of the following itemsof income less expenses -

The other items of income in the Profit & Loss Account entitled "Surplus from Disposal of Investment" and amounting to $14,053,883 was arrived at as follows:-

7. The tax computations submitted on behalf of the appellant company excluded the "Surplus from Disposal of Investment" of $14,053,883 as it was considered that this was not assessable to tax. The Assessor disagreed.

8. The appellant appealed to the Board of Review against the respondent's determination on the grounds that -

9. The Board of Review accepted the evidence of Mr. Lee King-yue, a director of the appellant company, (1) that the offer from Mr. Chao to buy the Yiu Nin shares was immediately accepted because the share market was booming, that he expected the Wah Kwong shares would be quoted at a premium on their being listed, and that he would sell those owned by the appellant if a good price was offered; (2) that the appellant company engaged in stagging operations on new issues with surplus funds, but the proceeds of sale of the Yiu Nin shares were not surplus funds available for such purpose; (3) that he would not have sold the Yiu Nin shares for $7,500,000; (4) that although in the appellant company's prospectus the property owned by Yiu Nin had been professionally valued at $6,500,000 on 13th October 1972, the appellant company's shares had risen from their issue price of $1,50 to about $4.20 when Mr. Chao made his offer, and the value of the Yiu Nin shares was reflected in the increase in value of the shares of its parent company (i.e. the appellant company); (5) that in February 1973 the market value of shares in property companies was generally higher than their asset value. The Board however rejected Mr. Lee's estimate that on 23rd February 1973 the rights to Wah Kwong shares were worth $3.50 to $4.00 per share.

10. The Board also rejected the expert evidence of Mr. Bokhary, a member of the Hong Kong Stock Exchange that, on 28th February 1973, the estimated value of Wah Kwong shares was between $6.00 and $7.00.

11. Having found that the consideration given by Wah Kwong to the appellant company for the Yiu Nin transaction was $3,000,000 cash and 4,500,000 Wah Kwong shares and that the appellant company could sue Mr. Chao for those shares or damages if he proffered the whole purchase price in cash, the Board went on to say that "in the then climate of the share market and the appellant's history of share trading, the appellant agreed to take the 4.5 million shares as a speculation and that it embarked on a venture to trade in those shares." The Board further found that the realisation of the appellant company's capital asset of the Yiu Nin shares was completed on 23rd February 1973, that the capital profit on it was $3,000,000 cash plus the value of the right to 4,500,000 Wah Kwong shares on that date less the cost of the Yiu Nin shares of $6,208,502.

12. In calculating the value of the Wah Kwong shares, the Board found that the value of the 4,500,000 Wah Kwong shares for the purpose of arriving at the profit of the appellant company's trade in those shares was their estimated value as on 23rd February 1973, but the Board had difficulty in arriving at this estimated value.

13. The Board said:

" We are satisfied that in the ten booming (crazy according to Mr. Bokhary) stock market, the Appellant's entitlement under the Agreement to Wah Kwong shares was worth more than the par value of $1 on 23rd February 1973. But there is no evidence acceptable to us to enable us to determine such value. What is lacking is evidence from some person recognizable as an expert who would give his reasons for a certain value in a credible manner. The onus is on the Appellant to prove that the assessments appealed against are excessive or incorrect, the assessment being based on each Wah Kwong share having a value of $1. We find that this onus has not been discharged."

14. The questions of law for the opinion of this court are:

15. On the first question Mr. Beattie argued on behalf of the appellant company that the company did not acquire the $4,500,000 Wah Kwong shares for $4,500,000 but at some larger figure, depending on the value of those shares. The sale of Yiu Nin was the sale of an investment asset, and the sale of the Wah Kwong shares was the end or completion of the appellant company's investment transaction. There was here no trading in the Wah Kwong shares, and the sale of Yiu Nin and the sale of the Wah Kwong shares constituted but a single and isolated transaction. The mere acquisition of the Wah Kwong shares with a view to selling them would not turn the transaction into a trading operation.

16. On the second question, Mr. Beattie submitted that one had to take into account the market value and not the par value of the shares. The Board therefore should have looked at the market value and not the intrinsic value. The value of a company's property or assets is not the same thing as the value of the company's shares. The speculative hopes of the people wishing to buy Wah Kwong shares showed exactly what the shares' market value was. Firstly, as Yiu Nin shares were not quoted the market value of Yiu Nin shares must be ascertained by the price these shares were sold at. They were sold for $3,000,000 cash plus 4,500,000 Wah Kwong shares, so it is necessary to ascertain the value of the Wah Kwong shares in order to arrive at the value of the Yiu Nin shares. Thus, if, for example, the Wah Kwong shares were worth $10,000,000, then the Yiu Nin shares were worth $10,000,000 plus $3,000,000, and if the Wah Kwong shares were worth $4,500,000 then the Yiu Nin shares were worth $4,500,000 plus $3,000,000. The formula suggested by Mr. Beattie for calculating the value of the shares is as follows:

17. Mr. Beattie contended that on the evidence the value of the Wah Kwong shares was $3.196 per share and not the par value of $1 per share. The appellant company therefore had discharged the onus of proving that the Assessor's assessments based on par value were excessive and incorrect.

18. Finally, on the third question for this court's opinion, it was contended on behalf of the appellant company that the Board was not entitled to reject all the evidence given on the value of the Wah Kwong shares. It was further argued that as soon as the appellant company had produced evidence on the value of the shares, the burden of proof shifted, so that in the absence of any rebutting evidence from the Crown, the Board should accept the evidence given on behalf of the appellant company.

19. Mr. Nolan on the other hand submitted that the answers to all three questions for this court's opinion should be answered in the affirmative. The Board was fully entitled, if not bound, to arrive at the conclusion that the sale of the Wah Kwong shares amounted to an adventure in the nature of trade. On the issue of the value of the Wah Kwong shares, Mr. Nolan followed the findings of the Board and added that the best evidence of the value of the shares was to be ascertained by reference to the price of $7,500,000 agreed between the appellant company and Wah Kwong in the 23rd February 1973 agreement. Referring to the rise of the appellant company's shares from $1.50 to $4.20, it was submitted that the rise was a rise in the stock exchange price of quoted shares; therefore it does not follow that there was a corresponding or equivalent rise in Yiu Nin shares (Yiu Nin being but part of the appellant company's assets).

20. Mr. Nolan pointed out that on 23rd February 1973 Wah Kwong had not even been formed. Many transactions were concluded at the par value of Wah Kwong shares, of which the Yiu Nin deal was but one. Whilst the appellant company obviously hoped that Wah Kwong shares would go up once they were listed, it was nevertheless only a hope and not something which could be included in the valuation of Wah Kwong.

21. Mr. Nolan also argued that it was open to the Board to reject the evidence of Mr. Lee and Mr. Bokhary even though it was the only evidence before the Board.

22. A number of authorities dealing with the distinction between trade and investment were cited.

23. In Lewis Emanuel & Son, Ltd. v. White⁽¹⁾, Pennycuick, J., said (at p. 376):

"Upon the appeal, Mr. Borneman, for the Company, contended that the only legitimate conclusion from the particular facts found by the Commissioners was that the Company was carrying on the trade of dealers in securities in the two relevant years, 1960-61 and 1961-62. He relied on the principle stated in Californian Copper Syndicate v. Harris, 5 T.C. 159, at page 165, which has frequently been cited since:

'It is quite a well settled principle in dealing with questions of assessment of Income Tax, that where the owner of an ordinary investment chooses to realise it, and obtains a greater price for it than he originally acquired it at, the enhanced price is not profit in the sense of Schedule D of the Income Tax Act of 1842 assessable to Income Tax. But it is equally well established that enhanced values obtained from realisation or conversion of securities may be so assessable, where what is done is not merely a realisation or change of investment, but an act done in what is truly the carrying on, or carrying out, of a business. The simplest case is that of a person or association of persons buying and selling lands or securities speculatively, in order to make gain, dealing in such investments as a business, and thereby seeking to make profits. There are many companies which in their very inception are formed for such a purpose, and in these cases it is not doubtful that, where they make a gain by a realisation, the gain they make is liable to be assessed for Income Tax. What is the line which separates the two classes of cases may be difficult to define, and each case must be considered according to its facts; the question to be determined being - Is the sum of gain that has been made a mere enhancement of value by realising a security, or is it a gain made in an operation of business in carrying out a scheme for profit-making?'"

24. The learned judge then went on to consider such matters as the number and size of the company's purchases and sales of shares, and the rapid and continuous turnover. He also said that the word "speculation" is not, as a matter of language, an accurate antithesis either to the word "trade" or to the word "investment": either a trade or an investment may be speculative. Referring to the findings of the Commissioners, he said (at p.377) that if the only proper conclusion from the primary facts is that the operations conducted by the company amounted to a trade, then he must reverse the decision of the Commissioners, but on the other hand, if the Commissioners could properly have come to either conclusion then he must not interfere (vide Edwards v. Bairstow⁽²⁾).

25. The facts of Commissioner of Inland Revenue v. Reinhold⁽³⁾ were that the respondent, a director of a company carrying on the business of warehousemen, bought four houses in January, 1945, and sold them at a profit in December, 1947. He admitted that he had bought the property with a view to resale, and had instructed his agents to sell whenever a suitable opportunity arose. On appeal before the General Commissioners he contended that the profit on resale was not taxable. On behalf of the Crown it was contended that the purchase and sale of the property constituted an adventure in the nature of trade, and that the profits arising therefrom were chargeable to Income Tax. The General Commissioners, being equally divided, allowed the appeal. It is to be noted that the respondent was not a property agent and that his business was not said to operate outwith the ordinary scope of warehousemen and was not associated the purchase and sale of estates. The transaction was therefore an isolated one. Referring to Leeming v. Jones⁽⁴⁾, Lord Carmont said (at p.392):

"Lord Dunedin says, in the case I have already cited, at page 423:

'... The fact that a man does not mean to hold an investment may be an item of evidence tending to show whether he is carrying on a trade or concern in the nature of trade in respect of his investments, but per se it leads to no conclusion whatever.'

I do not wish, however, to read this passage out of its context and without regard to the facts of the case then under consideration, and I draw attention to Lord Dunedin's language being used with reference to 'an investment', meaning thereby, as I think, the purchase of something normally used to produce an annual return such as lands, houses, or stocks and shares. The language would, of course, cover the purchase of houses as in the present case, but would not cover a situation in which a purchaser bought a commodity which from its nature can give no annual return. This comment of mine is just another way of saying that certain transactions shew inherently that they are not investments but incursions into the realm of trade or adventures of that nature. In my opinion, it is because of the character of such transactions that it can be said with additional definiteness that certain profits are income from trade and not capital accretion of an investment, the purchase and sale of, for instance, whisky, as in Fraser's case, 1942 S.C. 493, 24 T.C. 498, was a trading venture and so too in regard to toilet paper: Rutledge, 1929 S.C. 379, 14 T.C. 490. This means that, although in certain cases it is important to know whether a venture is isolated or not, that information is really superfluous in many cases where the commodity itself stamps the transaction as a trading venture, and the profits and gains are plainly income liable to tax."

26. In Edwards v. Bairstow⁽²⁾, Lord Radcliffe said (at pp. 229-230):

27. In a case decided by the Hong Kong Inland Revenue Board of Review, Case No. BR 11/76, (1977) I.R.B.R. Decisions 239, it was held that the appellant company's acquisitions and sale of certain shares did not amount to trade. There the appellant, a public company, was not only engaged in the textile business but also dealt in public quoted shares. It subsequently decided to expand its business into the property field and various means of raising fresh capital were considered. Finally, a company agreed to purchase a number of new shares which the appellant proposed to issue but insisted that payment was to be by an exchange of shares in lieu of cash. In consequence, the appellant acquired a certain number of shares in that company which it sold at a profit and the proceeds were used in the purchase of real property. The Board said (at p.243):

"The features of this case militate against the suggestion that the Appellant intended to embark on a trading venture in relation to these shares. The Appellant required $9 million for employment in its real estate business. The proposal to issue its own shares to X Ltd. was on the expectation of receiving this sum in cash but X Ltd. declined to pay for the shares in cash and insisted on effecting payment in kind to the value of $9 million represented by the 167,000 X Ltd. shares at $54 per share. The Appellant had no intention of trading. Its intention from the outset was to raise $9,000,000 in cash by the issue of its shares and the agreement with X Ltd. was the means of carrying out this intention even though, against its wishes, the Appellant was forced to take payment in kind. The importance of motive in cases of this kind involving special circumstances is well illustrated by the cases cited in Whiteman and Whentcroft on pages 263 and 264."

28. The Board in that case also referred to Erichen v. Last⁽⁵⁾, where the Master of the Rolls said (at p. 423):

"I do not think there is any principle of law which lays down what carrying on a trade is. There are a multitude of incidents which together make the carrying on a trade, but I know of no one distinguishing incident which makes a practice a carrying on of a trade, and another practice not the carrying on of a trade. If I may use the expression, it is a compound fact made up of a variety of incidents."

29. Next, Murphay v. Australian Machinery and Investment Co. Ltd.⁽⁶⁾ was cited in support for the proposition that the cost of the Wah Kwong shares must be measured by the true value of those shares at the time of the agreement between the appellant company and Wah Kwong, namely, 23rd February, 1973. This proposition appears to be also supported by the decision of the House of Lords in Humphrey v. Gold Coast Selection Trust Ltd.⁽⁷⁾. The value stated in the agreement is therefore not conclusive.

30. In answering the Board's first question for the opinion of this court, the realistic approach is to treat the sale of Yiu Nin and the sale of the Wah Kwong shares as two different transactions. Having considered counsel's submissions and the authorities cited, I have come to the view that it was clearly open to the Board to hold that the appellant company's sale of the Wah Kwong shares was a venture to trade. In addition to the observation of the Master of the Rolls in Erichen v. Last⁽⁵⁾, it must also be noted, inter alia, that the appellant company apparently accepted Mr. Cecil Chao's offer without evaluating the precise value of the Wah Kwong shares; that there was no evidence to show that Wah Kwong insisted on making payment in the form of cash as well as shares, and that the appellant company disposed of about two-thirds of their holdings in the Wah Kwong shares two days after the shares were first quoted. It seems to me that the acquisition and disposal of the Wah Kwong shares took on the character of trade rather than that of investment. In all the circumstances of the case, it seems an artificial argument to say that the sale of Yiu Nin and the sale of the Wah Kwong shares constituted one single transaction and that the sale of the shares was the final stage of the sale of the appellant company's investment asset. To my mind the sale of Yiu Nin and the sale of the Wah Kwong shares were quite separate and distinct transactions. For my part, I would say that the only reasonable conclusion which the Board could have reached on the evidence was that the appellant company had traded in the Wah Kwong shares. If this view is wrong then I would still say that it was open to the Board to find either that the sale of the Wah Kwong shares was a trading venture or that it was an investment (vide Edwards v. Bairstow⁽²⁾. Accordingly, the answer to the Board's first question for the opinion of this court is in the affirmative.

31. Coming now to the Board's second question, it is clear law that not only must the appellant company discharge the burden of proving that the respondent's assessments were wrong, they must also show what the correct assessments should have been. The Board found that the value of the right to the Wah Kwong shares as on 23rd February 1973 was higher than the par value of $1. It therefore follows that the respondent's assessments based on par value were wrong. Having rejected the evidence of Mr. Lee and Mr. Bokhary as to the value of the Wah Kwong shares, the Board decided that as the appellant company had failed to show what the value of the right to the Wah Kwong shares was, they were unable to make any finding as to the value of the right to the shares. The Board was therefore unable to determine what the correct assessments should be. Mr. Beattie's formula is attractive for its logic and simplicity. However, I agree with Mr. Nolan's comment that the fact that the appellant company's share had gone up from $1.50 per share to $4.50 per share did not necessarily mean that Yiu Nin shares would also have gone up in the same proportion. The result is that whilst the appellant company had succeeded in proving that the value of the right to the Wah Kwong shares was higher than the par value of $1, they had failed to prove what the correct value was. Mr. Nolan made the suggestion that this court might feel disposed to remit this case to the Board for them to determine what the value of the right to the Wah Kwong shares was. This question had already been considered by the Board, and they were not able to make a finding. In my judgment little useful purpose would be served by sending the case back to the Board. There being no evidence acceptable to the Board to enable them to determine such value, the answer to the second question must also be in the affirmative.

32. In my view, the third question for the opinion of this court must also be answered in the affirmative. The burden being upon the appellant company to show that the respondent's assessments were wrong and what the correct calculations should be, it follows that the Board's rejection of the evidence adduced by the appellant company in this case could lead to one conclusion only, namely, that the appellant company had failed to discharge their burden of proof. It matters not that the evidence thus adduced as to the value of the right to the Wah Kwong shares on 23rd February 1973 was the only evidence before the Board. If the Board felt that the evidence was not worthy of credence, then they were duty bound to reject it. I do not think the Board was in any way obliged to act on evidence which they were unable to accept simply because no rebutting evidence had been produced.

33. For the reasons given above the appeal is dismissed.

Representation:

Mr. Charles Beattie, Q.C. & Mr. Robert Kotewall (Woo, Kwan, Lee & Lo) for Appellant.

Mr. Michael Nolan, Q.C., Mr. T. Iu & Mr. A. Major, C.C. for Respondent.

(1) 42 T.C. 369

(2) 36 T.C. 207

(3) 34 T.C. 389

(4) (1930) A.C. 415

(5) 4 T.C. 422

(6) 30 T.C. 244

(7) 30 T.C. 209, 235