The Commissioner of Inland Revenue v. The Hong Kong Bottlers Ltd

Case No.HCIA 3/1970[1970] HKLR 581

Court

HCIA

Date24 Dec 1970

Judge—

Case Document

100%Judiciary

HCIA000003/1970

IN THE SUPREME COURT OF HONG KONG

(APPELLATE JURISDICTION)

INLAND REVENUE APPEAL No. 3 OF 1970

(Appeal by way of case stated)

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BETWEEN
	The Commissioner of Inland Revenue	Appellant
	AND
	The Hong Kong Bottlers Ltd.	Respondent

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Coram: Hon. Blair-Kerr J. in Court.

Date of Judgment: 24 December 1970

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JUDGMENT

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1. The respondent company (hereinafter referred to as "the taxpayer") was incorporated on 28th July 1965 with a view to taking over the business of Hong Kong Bottlers Fed. Inc. (hereinafter referred to as "the American company"). The taxpayer acquired the share capital of the American company; and its business was transferred as a going concern with its assets in specie to the taxpayer. The American company then went into voluntary liquidation.

2. Mobil Petroleum Co. Inc. (hereinafter referred to as "Mobil") were Crown lessees of certain land situated at Laichikok. Mobil came to an arrangement with the Crown for the surrender of this land in exchange for new Conditions of Exchange involving the re-grant of a Crown lease. The American company held a lease from Mobil in respect of part of this land; and the term of the lease was due to expire in 1972; but there was a proviso for earlier determination. The American company had incurred capital expenditure on the construction of industrial buildings on the land which they had leased from Mobil.

3. Mobil exercised their powers of earlier determination of the lease; and, on 22nd February 1966, the American company surrendered their interest in the premises to Mobil. But it was agreed that Mobil would, immediately after the execution of the Conditions of Exchange by the Crown, grant to the taxpayer a tenancy of the premises at the same rent and upon the same terms and conditions then applicable between Mobil and the American company. Pursuant to this arrangement, Mobil let the premises to the taxpayer under an agreement dated 24th March 1966.

4. The American company commenced voluntary liquidation on 6th April 1966, but continued to carry on business till 30th April 1966. The taxpayer commenced business on 1st May 1966; and, for accounting purposes in the books of the two companies, the plant, machinery and industrial buildings of the American company were transferred at the written down values for taxation purposes. There was no written agreement regarding the transfer of ownership; but the statement of affairs of the American company (in voluntary liquidation) as at 31st October 1966 and the accounts of the taxpayer for the year ending 30th April 1967, evidenced the acceptance and use of such values for accounting purposes.

5. In their first return in respect of corporation profits tax for the year of assessment 1966/67, the taxpayer showed an assessable profit of $2,875,399. In computing this figure, the taxpayer claimed to be entitled to a balancing allowance of $1,090,738 in respect of the industrial buildings (s.35 of the Inland Revenue Ordinance Cap.112), and to initial and annual depreciation allowances totalling $564,816 in respect of the plant and machinery (s.37 of the Ordinance).

6. There was a provisional assessment dated 13th October 1967; and on 29th May 1968 a firm assessment was issued the effect of which was to allow the depreciation allowances on the plant and machinery as claimed by the taxpayer, but the balancing allowance on the industrial building was reduced from $1,090,738 to $13,800.

7. The taxpayer lodged an objection in respect of the disallowance of the greater portion of the balancing allowance; and the matter came before the appellant (hereinafter referred to as "the Commissioner") for his consideration under s.64(2) of the Ordinance.

8. In his determination, the Commissioner said:-

"By the Indenture dated 22nd February, 1966, (the American company) surrendered all their estate, title, or interest in the land on which the factory was built to Mobil. By the agreement dated 24th March, 1966, Mobil granted a new estate or interest in the land on which the factory was built to (the taxpayer). Therefore, the surrender extinguished the 'relevant interest' of (the American company) and (the taxpayer) obtained on 24th March, 1966 not that 'relevant interest' but an entirely new estate or interest in the land. 'Relevant interest' is a prerequisite of the granting of allowances in respect of industrial buildings; and it follows therefore, there being no relevant interest in the cost of construction of the factory buildings vested in (the taxpayer) no allowance is due; and the balancing allowance granted by the Assessor ($13,800) must be withdrawn."

In other words, the Commissioner was of the opinion that both the taxpayer and the Assessor had erred, and he disallowed the balancing allowance in toto.

9. The Commissioner then proceeded to consider the depreciation allowances granted by the Assessor in respect of the plant and machinery under s.37 of the Ordinance. In his determination the Commissioner said:-

".............. in considering the objection it is part of my function to review the assessment as a whole and determine what ought to have been the proper sum assessed. ................... with regard to the plant and machinery taken over by (the taxpayer) I am ........... of the opinion that no allowances are due. The first requirement which must be satisfied before plant and machinery can qualify for depreciation allowances under the Ordinance is that the persons carrying on the trade or business must have incurred capital expenditure on the provision of the plant and machinery in respect of which the allowances are claimed. In the present case, the assets in question were taken over by way of a distribution in specie to (the taxpayer) as shareholder, in the course of the liquidation of (the American company). I am at a loss to see how (the taxpayer) can be said to have incurred capital expenditure on the provision of this plant and machinery within the meaning of s.37(1) of the Inland Revenue Ordinance or that there is any cost to this owner on which to calculate annual allowance under s.37(2). There are no provisions in the Hongkong Ordinance to deal with succession to a trade; and, this being so, the allowances claimed ought not to have been granted in respect of this plant and machinery. Accordingly the initial and annual allowances totalling $564,816 on the assets acquired without incurring capital expenditure must be withdrawn."

10. From this determination, the taxpayer appealed to the Board of Review, the grounds of appeal being that:-

	(1)	the Commissioner acted ultra vires his powers under the Inland Revenue Ordinance in purporting to set aside the firm assessment made by the Assessor dated 29th May 1968 granting to the taxpayer a balancing allowance on the industrial building and an initial and annual allowance on the plant and machinery;
	(2)	even if the Commissioner acted intra vires, he erred in disallowing the balancing allowance as claimed on the industrial building; and
	(3)	even if the Commissioner acted intra vires, he erred in disallowing the initial and annual depreciation allowances on the taxpayer's plant and machinery.

11. As regards the first ground of appeal, the Board, by a majority was of the opinion that the Commissioner acted ultra vires in reopening the assessment with respect to the allowances on plant and machinery. The Board was unanimously of the opinion that the Commissioner acted intra vires as regards his consideration of the balancing allowance on the industrial building. The minority opinion was that the Commissioner acted intra vires throughout.

12. On the first ground of appeal, the majority expressed their views thus:-

"Since the decisions of the Court in Mok Tsze Fung's case⁽¹⁾ and the Herald International case⁽²⁾ s.64 of Cap.112 has been amended. The Commissioner's powers are derived solely from the Ordinance. The material question appears to be whether the assessment the Commissioner is empowered under s.64(2) to confirm, reduce etc. is the entire assessment covered by his determination or whether it is limited to that portion covered by the notice of objection. In our view, the words 'the assessment objected to' in the 3rd line of s.64(2) are governed by the 'notice of objection' in the first line, which is all that the Commissioner is under a duty to consider and as a result of such consideration may confirm, reduce etc. The terms of the objection lodged by the taxpayer is ................ restricted to an appeal against the disallowance of a claim for a balancing allowance on the Laichikok property. Neither of the two court decisions ............................. was concerned with this point. However, some indication that the wide words used by Mills-Owens J. in Mok's case as to the Commissioner's duties and powers should be limited is to be seen on p.274 of (1962) HKLR where the judge said that the function of the Commissioner was 'to review and revise the assessment in pursuance to the taxpayer's notice of objection'. Looking at the Ordinance as a whole, it will be seen that if the Commissioner considers that a taxpayer has been assessed for tax at less than the proper amount, it is open to the Commissioner, through his Assessor, to assess the taxpayer at an additional amount under s.60. This appears to us to be the proper method to vary an assessment or part of one when it is not the subject of a notice of objection. For the foregoing reasons, we are of the opinion that the Commissioner's duties and powers are limited to the matter as presented to him by the said notice of objection, that he is entitled to reopen the case in so far as it concerns the objection and that he is not entitled to reopen any matter not objected to."

The minority expressed their views thus:-

"We consider the words of Mills-Owens, J. in Mok's case ........... govern this point. The judge said that the Commissioner's 'duty is to review and revise the assessment and this, in my view, requires him to perform an original and administrative ............. function of considering what the proper assessment should be. He acts de novo, putting himself in the place of the Assessor, and forms ............. a second opinion in substitution for the opinion of the Assessor. He determines what should be the proper assessment afresh ...............' Looking at s.64(2) we note that the assessment objected to, which the Commissioner may confirm etc., is not limited in any way to the part thereof which is the subject of a notice of objection. As a matter of conveniency and expediency, we consider that once an assessment is objected to even in part, the Commissioner is empowered to reopen and make alteration to any part of the assessment in his determination and that he should not be restricted to the part which is the subject matter of the notice of objection."

13. However, the Board being of the opinion that the case might be taken on appeal to this court, then proceeded to consider the second and third grounds of appeal on the assumption that the Commissioner had not acted ultra vires. On these matters, they were unanimous. As regards the second ground of appeal, the Board expressed themselves as follows:-

"The taxpayer submitted that .................... it was the intention for the taxpayer to take the same leasehold interest as the American company ............................... had immediately prior to the surrender and regrant. By s.35(1) a balancing allowance is only allowed to the person entitled to the 'relevant interest' as defined in s.40. That definition is identical with the definition in s.11(1) of the Capital Allowance Act 1968 except that in the latter it is stated to be qualified by other provisions of the section. Subsection (3) makes express provision for the continuation of the relevant interest in leasehold despite the surrender of the original leasehold interest. In Cap.112 there is no similar saving. The Board consider that this element, in addition to the case of Woods v. R.M. Mallen (Engineering) Ltd.⁽³⁾ is fatal to the taxpayer's contention ........................"

14. As regards the third ground of appeal, the Board said:-

"	Mr. Litton, in the course of his submission, abandoned the claim to the initial allowance under s.37(1), subject to his overall contention that the Commissioner had acted ultra vires his powers in reopening this matter when it had not been the subject of an objection by the taxpayer.
	The Board is of the opinion that the taxpayer's contention with respect to the annual allowance under s.37(2) is well founded. On the facts, at the end of the basis period for the year of assessment in question the taxpayer owned and had in use machinery and plant for the purpose of producing profits which were charged to tax thereby satisfying the requirements of s.37(2). The reducing value of the assets on which the allowance is to be computed is known or readily ascertainable. We are disposed to accept the assets at their written down values .................."

The Board proceeded to assess the annual allowance in accordance with s.37(2), the sum fixed being $237,483.

15. The taxpayer has not appealed from the Board's decision upholding the Commissioner's determination as regards the balancing allowance on the industrial buildings. This is an appeal, by way of case stated, at the instance of the Commissioner, the questions of law for the opinion of this Court being:-

	(a)	whether the Board was correct in ruling that the Commissioner had acted ultra vires in re-opening the assessment with respect to the allowances on plant and machinery; and
	(b)	if the answer to question (a) is 'no', whether the Board was correct in the opinion which it expressed in relation to the machinery under s.37(2) of the Inland Revenue Ordinance.

16. Under s.64, as originally enacted, the proceeding before the Commissioner was termed an "appeal", and the notice of objection required him to "review and revise" the assessment. Sub-section (4) of the section dealt with the "hearing" of the appeal and gave the Commissioner power to "adjourn" the hearing, and to "dismiss" the appeal.

17. Despite the use of such phraseology, the Full Court, in The Herald International Ltd. case⁽²⁾, agreed entirely with the views expressed by Mills-Owens, J. in the Mok case⁽¹⁾, that is to say that in considering an objection to an assessment, the Commissioner does not act judicially but administratively, putting himself in the shoes of the assessor and determining what, according to his view, the assessment ought to be.

18. Before the Board of Review, Mr. Litton, for the taxpayer, submitted that under s.64 as originally enacted, the Commissioner was clearly required to examine the entire assessment de novo because his duty was to "review and revise" the assessment; but that because the legislature had, in 1965, omitted the words "review and revise" from s.64(1) and had required the Commissioner to consider "the assessment objected to," the Mok⁽¹⁾ and Herald International Ltd.⁽²⁾ cases were no longer authorities for the proposition that in considering an objection the Commissioner acts do novo, putting himself in the place of the assessor, forming a second opinion in substitution for the opinion of the assessor, and determining what should be the proper assessment afresh.

19. Mr. Litton's submission to this Court was substantially to the same effect, although he said that he put it upon a broader basis. It may be summarised thus:-

Section 64(1) states that no notice of objection shall be valid unless it states precisely the grounds of objection; if a notice of objection raises no grounds, or no precise grounds, the jurisdiction of the Commissioner under s.64 has not been invoked; the jurisdiction of the Commissioner is invoked to the extent of, and is limited by, the notice of objection; the Commissioner's jurisdiction under s.64(2) was not considered by the courts in the Mok⁽¹⁾ and Herald International Ltd.⁽²⁾ cases; if the Assessor confirms a provisional assessment, the taxpayer's right is to object to the confirmed assessment; if the Assessor makes an additional assessment under s.60 so that the provisional assessment is increased, the taxpayer's right is to object to the additional assessment; but in either case there is only one assessment for the year in question; if the Commissioner's contention is correct, it is tantamount to saying that there can be two assessments for any one year - one made by the Assessor and the other by the Commissioner. It is not open to the Commissioner to do under s.64(2) what the Ordinance empowers the Assessor to do under s.60; if the Assessor errs in giving a taxpayer the benefit of an allowance to which he is not entitled, that is to say if it appears to the Assessor at any time within the statutory period of 6 years, that the taxpayer "has been assessed at less than the proper amount", he say assess the taxpayer at the amount or additional amount at which the taxpayer ought to have been assessed; the Commissioner has assumed to himself the jurisdiction of making an additional assessment; he has usurped the function of the Assessor; and has therefore exceeded his jurisdiction; if his contention in this case is correct, there is nothing to prevent him increasing an assessment in any manner he likes such as by the inclusion of other income as Hongkong income.

I asked counsel what, in his submission, the legislature had in mind in giving the Commissioner power to increase an assessment under s.64(2). Mr. Litton said that he could visualise circumstances in which an assessment might be increased. As an example, he said that a property developer who sold flats on an instalment basis might prefer to have future instalments brought into charge as at the date when possession was given - the reverse (according to counsel) of the situation in C.I.R. v. Montana Lands Ltd.⁽⁴⁾. In other words, that the taxpayer might challenge the basis of the assessment and seek, by his notice of objection, to have his assessment increased.

20. It may be that an Assessor, at any time within six years, has power under s.60 to correct a mistake by means of an additional assessment. But that is not what I am asked to decide on this appeal. The question is simply this: Is a taxpayer entitled to limit the jurisdiction of the Commissioner to consider an assessment by the terms of his notice of objection? In my view the answer to that question is, clearly, 'no'. Admittedly, the foundation of the Commissioner's jurisdiction under s.64(2) is the receipt by him of a valid notice of objection; and a notice of objection is not a valid notice unless it states precisely the grounds of objection. But it does not follow that because the grounds of objection must be stated precisely in order to give the Commissioner jurisdiction to consider the assessment at all, that his jurisdiction is circumscribed by the grounds as framed by the taxpayer. Once the Commissioner is seized of the matter, his first duty is, of course, to consider questions raised by the notice of objection; but it is the assessment he is concerned with. I do not agree with the majority opinion of the Board of Review that "the words 'the assessment objected to' are governed by the notice of objection". The assessment objected to is the assessment, not part of the assessment or such aspects of the assessment as the taxpayer chooses to have considered. One can readily visualise cases in which it would be utterly impossible for the Commissioner to consider one aspect of an assessment to the exclusion of other aspects. His duty is to consider the assessment made by the Assessor, and to consider it as a whole. Having done so, his powers are not confined to confirming, reducing, or annulling the assessment. The subsection states specifically that he may increase it; and, clearly, the Commissioner's power to increase an assessment is not limited to cases in which the taxpayer, by his notice of objection, may, for any reason, seek to have his assessment increased. If the taxpayer's submission in this case were well founded, it would mean that in every case in which the Commissioner considered that an assessment should be increased, his duty would be to direct his Assessor to raise an additional assessment under s.60. He would, himself, be powerless to increase the assessment, although s.64(2) says that he may do so.

21. The Assessor's jurisdiction under s.60 is more extensive in point of time than that of the Commissioner; and it does not depend upon any initiating process, such as the lodging of a notice of objection. But, the jurisdiction conferred by s.60 upon the Assessor does not affect the Commissioner's jurisdiction under s.64(2) to consider assessments, already made and confirmed, which he is required to consider upon the filing of a valid notice of objection. In my view, the decisions in the Mok⁽¹⁾ and Herald International Ltd.⁽²⁾ cases were not affected in the slightest by the amendments to s.64 which were effected by Ordinance no.35 of 1965. In redrafting s.64, it would appear that the intention was simply to give legislative effect to judicial criticism of the phraseology which had been employed in the section as originally enacted.

22. I would, therefore, answer the first question posed by the Board of Review in the negative.

23. As regards the second question posed by the Board, s.37, so far as relevant, reads:-

	"(1)	Where a person carrying on a trade profession or business incurs capital expenditure on the provision of machinery or plant for the purposes of producing profits chargeable to tax ....................... there shall be made to him, for the year of assessment in the basis period for which the expenditure is incurred, an allowance to be known as an 'initial allowance' equal to one-fifth of that expenditure;
	(2)	Where at the end of the basis period for any year of assessment a person owns and has in use machinery or plant for the purposes of producing profits chargeable to tax .............................. there shall be made to him in respect of that year of assessment an allowance to be known as an 'annual allowance' for depreciation by wear and tear of those assets. The allowance shall be calculated at the rates prescribed by the Board of Inland Revenue and shall be computed on the reducing value of the asset, which shall be the cost of the asset reduced by

	(a)	any initial allowance computed in accordance with this section; and
	(b)	by the annual allowances computed under the provisions of this section ......................................................................................."

24. As I have said, the claim for an initial allowance was abandoned during the proceedings before the Board of Review because it was common ground that the plant and machinery of the American company had been transferred to the taxpayer in specie. There was no purchase. No money passed. It was purely a book transaction between the two companies, the figure being the written down value for taxation purposes; and therefore it could not be argued that the taxpayer had incurred capital expenditure on the provision of machinery and plant.

25. However, both before the Board and on this appeal Mr. Litton submitted that the taxpayer was entitled to an annual allowance under sub-section (2) because, although there was no direct sale and purchase of the assets, the taxpayer had, in effect, paid for the assets in that it paid for the shares of the American company, and the value of the assets must have been taken into consideration in arriving at the purchase price of those shares; that this was the "cost" of the assets to the taxpayer; that every company which is operated on sound business lines, makes an annual allocation of a proportion of profits to provide for the day when the assets have to be replaced; that it is sound accountancy and company practice to depreciate assets in the annual accounts; and that the book values should be taken as being the cost of the assets for the purpose of calculating the annual allowance.

26. The submission of Mr. Clancy, who appeared on behalf of the Commissioner, may be summarised thus:-

It is inconceivable that the legislature intended to benefit gratuitously beneficiaries of gifts at the expense of the Treasury (which means all other taxpayers in Hong Kong); although the taxpayer did, at the relevant time, own and have in use machinery and plant, sub-section (2) of section 37 should not be read in isolation the sub-section is part of a section which provides for allowances to persons who have actually incurred capital expenditure on the provision of plant and machinery; the words 'plant and machinery' in sub-section (2) refer to plant and machinery for which there has been such expenditure on the part of the person claiming the allowance; the whole basis of the calculation of the annual allowance is the 'cost' of the asset; if the taxpayer had actually purchased this second-hand plant and machinery, it would have been entitled to an initial allowance based upon the cost to the taxpayer, and annual allowances thereafter; but the plant and machinery did not cost the taxpayer anything; there is, therefore, no basis upon which to calculate an annual allowance; the fact that in their accounts a company may depreciate their assets (however acquired) and allocate a proportion of annual profits as a reserve against capital replacement, cannot affect the question of whether a taxpayer is, or is not, entitled to an annual allowance in accordance with the provisions of s.37(2).

27. No doubt it is sound business and accountancy practice for a company to put a value on their plant and machinery (however acquired) and to depreciate those assets in their accounts, and to allocate annually, from profits, such amounts as are considered necessary for eventual capital replacement. But, I agree entirely that in this appeal I am not concerned with business practice and sound accountancy principles. Furthermore, it matters not to this Court whether the legislature has, unwittingly, conferred a benefit upon the taxpayer to which it is not morally entitled. The question is simply one of statutory interpretation. One looks to the language of the section in order to decide whether or not the taxpayer is entitled to the annual allowance claimed.

28. It is common ground that at the relevant time, the taxpayer owned and had in use the machinery and plant for the purpose of producing profits. So far as the first sentence of sub-section (2) is concerned, ownership and use of the plant and machinery are the only qualifying conditions; and, on a plain reading of that first sentence, viewed in isolation, the taxpayer qualifies for an annual allowance.

29. The difficulty arises when one proceeds to consider how this allowance is to be computed. It is computed "on the reducing value of the asset". Although the plant and machinery were not purchased by the taxpayer, these assets undoubtedly have a "value", and it is "a reducing value" from year to year on account of wear and tear. However, I do not understand how the Board of Review came to the conclusion that the reducing value was "known or readily ascertainable". "Reducing value" is defined. The sub-section says that, for the purpose of computing the annual allowance, reducing value

".... shall be the cost of the asset reduced by -

	(a)	any initial allowance computed in accordance with this section; and
	(b)	by the annual allowances computed under the provisions of this section."

The "cost" of the asset is, clearly, the purchase price and the cost of installation of the asset - not the book value written down for tax, or any other, purpose; and it must mean the actual cost of the asset to the person who is claiming the allowance, not the purchase price and cost of installation paid by some previous owner. Of course, if one looks at the first sentence of sub-section (2) in isolation, it would appear to give the owner of machinery and plant (irrespective of how such assets were acquired) a right to claim an annual allowance, provided the owner has such machinery and plant in use for the purpose of producing profits. But I agree with Mr. Clancy that the first sentence should not be considered in isolation. Sub-section (2) must be considered as a whole; and it is clear that what the legislature had in mind was that if a claimant could show that he had incurred "cost" or "capital expenditure on the provision of" machinery and plant, he should be entitled to an annual allowance computed on such cost reduced, of course, by whatever initial allowance may have been paid previously on the authority of sub-section (1) and any annual allowances paid to the claimant prior to the date of the claim.

30. The case stated does not disclose what factors were taken into consideration in fixing the purchase price of the shares of the American company; but, as I have said, there was nothing before me to suggest that any money passed from the taxpayer to the American company in respect of the transfer of the plant and machinery. There was therefore no "cost of the assets", so far as the taxpayer is concerned; and consequently, in my view, there is no basis upon which to calculate any annual allowance under s.37.

31. I would answer the second question posed by the Board also in the negative.