Commissioner of Inland Revenue v. Swire Pacific Ltd

HCIA000002/1978

- - On section 16(1) of the Inland Revenue Ordinance - -

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Coram: Yang, J.

Date of Judgment: 24th October 1978

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JUDGMENT

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1. This is the Commissioner of Inland Revenue's appeal on a case stated by the Board of Review giving their decision in favour of the respondent company (hereafter referred to as Taikoo).

2. By an agreement dated 13th September 1972 Taikoo entered into a contract with Hong Kong and Whampoa Dock Co. Ltd. to merge their respective dockyard, shipbuilding, repairing and general engineering operations through a new company to be incorporated as the Hong Kong United Dockyards Ltd. The merger was announced on 16th September 1972.

3. On 18th September 1972 nearly the whole of the labour force of Taikoo went on strike and the business of the dockyard was brought to a standstill. In the course of negotiations between the management and the workers, the striking workers demanded cash payments which were later called "retirement grants". Most of the striking workers would not at 31st December 1972 have been entitled to receive retirement grants under any contract, agreement or terms of employment, although certain workers who, at or before that date, had reached retirement age would have been entitled, on retirement, to receive retirement grants. Payments to this latter category of workers are not in dispute in this appeal and the only payments that fall to be considered are those to workers who, except pursuant to the strike settlement terms, were not entitled to receive the payments at 31st December 1972.

4. For reasons which will become clear later Taikoo acceded to the strikers' demands and made payments totalling $22,416,202, and this payment was debited to the Staff Retirement Reserve in the accounts of Taikoo. It was this sum that was sought to be deducted for profits tax purposes. The Assessor refused to allow $18,156,748 of this sum, but allowed $4,259,454 as properly paid under approved retirement schemes. Taikoo objected to this allowance and the Commissioner of Inland Revenue rejected the objection. Taikoo then appealed to the Board of Review on this issue, Taikoo and the Commissioner agreed that if the $18,156,748 was disallowed as a deduction, the Profits Tax Assessment for the year of assessment 1972/73 on Taikoo would be $17,541,151 with tax payable at $2,631,172.

5. At the time when the strike occurred, Taikoo was carrying on its ship repairing business and intended to carry it on until 31st December 1972, the day before the merger took effect. On 18th September 1972 there were eight vessels in the dockyard in the course of or awaiting repair. A considerable number of other vessels came to the dockyard for repair between 25th September and 31st December 1972. These vessels would not have come for repair if the strike had not been settled. It was probable, and within the reasonable contemplation of the Taikoo management, that of the vessels in the dockyard on 18th September 1972, some could not be completed and others might be detained. There was a possibility of violence and sabotage by the strikers. Proper precautions could not be taken against typhoon damage while the strike continued, and that during the latter half of September there was a real risk of typhoons. Loss would be caused by damage to plant and machinery by insufficient maintenance if the strike continued. Substantial loss was being incurred through the strike and such loss would continue as long as the strike continued. Although the sum of $18,156,748 in dispute was paid to workers who were not entitled in law under any contract, agreement or terms of employment to receive these "retirement grants", the settlement of the strike involving such payments was the best the management of Taikoo could do in the circumstances. Without agreeing to such payments, such agreement being exacted by economic duress, the strike would not have been settled. The loss of goodwill that the strike would engender if continued, could be particularly damaging in a time of recession and of great competition for dockyard work such as subsisted in 1972.

6. The strike was called off on 25th September 1972 and Taikoo's ship repairing business ceased on 31st December 1972.

7. The Board found that the financial loss to Taikoo which had been saved by the settlement of the strike was not less than $5 million and probably over $10 million.

8. It is not disputed that the purpose and result of the agreement to make the payment were to get the workers to end their strike and resume work. This occurred. Short of calling off the merger there was no prospect of the strike being settled except upon terms that Taikoo made cash payments to the workers prior to 31st December 1972 in accordance with the strikers' demands. Taikoo in fact made trading profits from its dockyard operation in the period from 25th September 1972 to 31st December 1972 which it would not have earned if the strike had not been settled.

9. Having observed that the fundamental issue in this case is whether Taikoo made the payment of $18 million-odd to the strikers in the production of its taxable profits under s.16(1) of the Inland Revenue Ordinance, the Board said:

"Quite apart from the principle of law, we find as a fact that the paramount purpose of Taikoo in settling the strike on the strikers' very onerous terms was to avoid damages, unascertainable in September 1972, but known to be and obviously very substantial, which would be suffered by it if the strike continued, and that the expenditure was incurred in the production of Taikoo's profits for the year of assessment 1972/73. The purpose of the payment of the 'retirement grants' was the production of taxable profits and therefore did not fall to be disallowed under Section 17(1)(b)."

10. The question of law which calls for determination in this Court is -

"Did the Board of Review err in law in deciding that the sum of $18,156,748 was an admissible deduction in computing the amount of Taikoo's profits chargeable to profits tax for the year of assessment 1972/73?"

11. Before answering this, it is first necessary to determine, to what extent, this Court may go behind the findings of the Board. The matter was fully discussed by Hogan, C.J., in Lam Woo Shang (No.2) v. Commissioner of Inland Revenue⁽¹⁾. Counsel for the respondent company cited a number of authorities which at first view appear to go a different way. In Usher's Wiltshire Brewery Ltd. v. Bruce⁽²⁾ Lord Summer said (at p.466):

"Furthermore, the judgment seems to say that the question whether a given disbursement is 'wholly or exclusively laid out for the purposes of the trade or concern' is a question of law and not of fact. With this I am not able to agree. Though the answer to the question may itself be an inference from a wide area of facts, it is an answer of fact. There is no suggestion here that the Commissioners found the facts under any mistake in law, including in that term the view, conscious or unconscious, that a fact may be found which there is no relevant evidence to support."

This statement is not really inconsistent with the Lam Woo Shang Case⁽¹⁾. Whether one calls a finding a finding of fact or of law, the view taken in both cases was that the Court may go behind the finding if there had been a mistake in law or if the finding was not supported by evidence.

12. Gould J. followed Usher's Wiltshire Brewery⁽²⁾ in Commissioner of Inland Revenue v. Karston Larssen & Co. (HK) Ltd.⁽³⁾ and said:

"The main principles underlying these, and similar decisions (so far as they are here relevant) I think may be shortly stated. The first and clearest is that it is always a question of law whether the primary facts include any material upon which the conclusion could reasonably be founded. 'Any evidence such as would justify a reasonable finding', was the phrase used by the Master of the Rolls in Commissioners of Inland Revenue v. Turnbull, Scott & Co., 132 L.T. 296 at 299. The second principle is that if the conclusion arrived at is a question of degree, then it is a question of pure fact, a test not always easy of application. A third principle is that any question of construction of an enactment or instrument is always a question of law. Questions of construction, of course, arise in a great variety of ways including in the case of statutes the application of definitions specifically provided and the influence exerted on one provision by others of the same enactment. On the other hand, where a conclusion is to be arrived at merely by the application to primary facts of a section containing words or phrases (e.g. 'carrying on a trade') which are obviously intended to be interpreted according to their plain meaning, that is not a question of construction. (I am referring of course to the law as it affects income tax only - a different principle may apply elsewhere). Finally, it would seem that even in such a case the Court would have jurisdiction if it considered that the plain ordinary meaning of the words had not in fact been applied."

13. In Hancock v. General Reversionary and Investment Co.⁽⁴⁾ Lush J. said (at p.38):

"It is no doubt a question of fact whether a retiring allowance, whatever form it takes, is an expense incurred for the purpose of earning profits."

The learned judge did not elaborate, but it would seem that if the so-called question of fact had been decided upon a mistake in law or without the support of relevant evidence, an appellate court would not hesitate to reject it. Similarly in Smith v. Incorporated Council of Law Reporting for England and Wales⁽⁵⁾, though it was held that the question whether money was wholly and exclusively laid out or expended for the purposes of a trade was a question of fact, it was nevertheless pointed out (at p.683):

"If the facts stated are such that it is not possible from them to come to the particular conclusion of fact found, the Court is not bound by the conclusion of fact which the Commissioners have found with no evidence to support it; but if the facts stated are such that you may come to one conclusion or the other, the fact that the Court itself would have come to a different conclusion from that which the Commissioners have come to is no reason for disturbing the decision of the Commissioners."

14. Indeed in a recent case it was held that the question as to whether an expenditure is for tax purposes on revenue or on capital account is ultimately a question of law (Heather v. P.E. Consulting Group⁽⁶⁾).

15. When one looks at the Board's conclusion in the light of authorities, it would seem that what the Board was saying was simply this: In order to avoid damages which would be suffered if the strike continued Taikoo paid the "retirement grants" so as to be able to continue their business and the purpose of the business was of course to earn money.

16. I do not think it is seriously argued that that finding and the findings of other facts are not supported by evidence. But Crown Counsel submitted that the Board's finding was wrong (i) Taikoo could not have made any profits for the period 25th September to 31st December 1972 and (ii) their payments were for the purpose of protecting the company's assets.

17. "Profits" was explained by Viscount Finlay in John Smith & Son v. Moore⁽⁷⁾:

"The profit of a trade or business is the surplus by which the receipts from the trade or business exceed the expenditure necessary for the purpose of earning those receipts. That seems to me to be the meaning of the word 'profits' in relation to any trade or business. Unless and until you have ascertained that there is such a balance, nothing exists to which the name 'profits' can properly be applied."

18. However, under s.16(1) of the Ordinance expenditure in the course of business which is unremunerative is none the less a proper deduction if made with a view to producing profit. It does not require the presence of a receipt on the credit side to justify the deduction of an expense (Hughes v. Bank of New Zealand⁽⁸⁾).

19. The provisions of s.16(1) before its present amendment read:

"For the purpose of ascertaining the assessable profits of any person there shall be deducted all outgoings and expenses wholly and exclusively incurred during the basis period for the year of assessment by such person in the production of profits in respect of which he is chargeable to tax under this Part...."

20. The interpretation of the old s.16(1) was discussed at length in the Privy Council in Commissioner of Inland Revenue v. Mutual Investment Co. Ltd.⁽⁹⁾ Sir Garfield Barwick in delivering the judgment of the board said (at p.598):

"Section 16(1) does not provide for the deduction of expenses from the assessable profits but for the deduction of expenses 'for the purposes of the ascertainment of assessable profits. Its terms presuppose receipts from which deductions can be made to determine a balance which will be the assessable profit. On the other side of the account are the total receipts derived from the Colony not being from the sale of capital assets, ..."

21. The current s.16(1) reads:

"In ascertaining the profits in respect of which a person is chargeable to tax under this Part for any year of assessment there shall be deducted all outgoings and expenses to the extent to which they are incurred during the basis period for that year of assessment by such person in the production of profits in respect of which he is chargeable to tax under this Part for any period, ...."

22. In spite of the change of wording Sir Garfield Barwick's short passage quoted above is clearly equally applicable to the present s.16(1). Thus expenditure incurred in the production of receipts which could form part of the profits may be deducted.

23. If Crown Counsel's argument on his first ground of objection to the Board's decision is correct, then no company which is about to go out of business due to losses will ever be able to get any deduction for money spent with a view to reducing their losses. If a company knows what losses they have suffered and knows that in the few months prior to ceasing business they could not possibly turn their losses into a profit, then none of the expenditure on such items as rent, wages and purchasing of raw material would be deductible. This cannot be correct. The law was elucidated by Lord Sands in The Commissioners of Inland Revenue v. Falkirk Iron Co. Ltd.⁽¹⁰⁾:

"Every company carrying on business, as this Company carries on business, makes future contracts. It may turn out that one of these contracts is a source not of profit but of liability. The company must fulfil its contract, although there is no prospect of the execution of that contract bringing in any profit to it. The argument of the Revenue, I understand, to be as follows. The original bargain may be said, in such circumstances, to have been made for the purpose of earning profit, but, when that prospect has disappeared, then the payments you make, which happen in this case to be rent, have no relation to profits and can not result in any profit. Accordingly, as no profit can be attributed to them, they are not a legitimate deduction from profits. I think that that is a mistaken way of regarding this matter. The company must, if it is to carry on business, fulfil the contracts that it has entered into. If a company enters into contracts for the purposes of its business, genuinely and honestly - and nothing to the contrary is suggested here - I think that expenditure in the fulfilment of these contracts is expenditure for the purposes of the business."

24. The situation would be different if payment was made for the purpose of going out of business, as in the case of The Commissioners of Inland Revenue v. Anglo Brewing Co. Ltd.⁽¹¹⁾, and Godden v. A. Wilson's Stores (Holdings) Ltd.⁽¹²⁾. Here the payments were made to strikers because Taikoo wanted to carry on the business for another three and a half months.

25. In my judgment the Crown's first object must fail.

26. The Crown's objection that Taikoo's payments were made for the purpose of protecting assets must also fail. The payments were of a revenue character because they were made so that business could go on. The payments did not and were not intended to have the effect of changing the character of the business or add to the capital assets of the company (see The Commissioners of Inland Revenue v. Carron Company⁽¹³⁾.

27. The dilemma which Taikoo had to face was analogous to that of Tate & Lyle Ltd. in Morgan v. Tate & Lyle Ltd.⁽¹⁴⁾. There it was held that expenses incurred in defending or preserving the existence of capital assets (as in the present case) was deductible (see pp.51-52).

28. For the reasons given above the answer to the Board's question is "no".

Representation:

Mr. B. Barlow, Crown Counsel, for Appellant.

Mr. G. Horton (Johnson, Stokes & Master) for Respondent.

(1) (1961) H.K.L.R. 609 (see in particular pp.617-620).

(2) (1915) A.C. 433.

(3) (1951) H.K. Tax Cases 11, at pp.21-22.

(4) (1919) 1 K.B. 25.

(5) (1914) 3 K.B. 674.

(6) (1973) 1 Ch. 189, 224.

(7) (1921) A.C. 13, at 31.

(8) (1936) 21 Tax Cases 472, 524.

(9) (1967) A.C. 587.

(10) (1933) 17 Tax Cases 625, at p.632.

(11) (1925) 12 Tax Cases 803, 812.

(12) (1962) 40 Tax Cases 161, 174-175.

(13) (1968) 45 Tax Cases 18, at p.75.

(14) (1955) A.C. 21 (see p.39).