The Commissioner of Inland Revenue v. Sincere Insurance and Another

Case No.HCIA 1/1973

Court

HCIA

Date—

Judge—

Case Document

100%Judiciary

HCIA000001/1973

IN THE SUPREME COURT OF HONG KONG

(APPELLATE JURISDICTION)

INLAND REVENUE APPEAL NO. 1 of 1973

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BETWEEN
	THE COMMISSIONER OF INLAND REVENUE	Appellant
	and
	SINCERE INSURANCE and INVESTMENT CO., LTD.	Respondent

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Coram: Leonard, J. in Court.

Date of Judgment: 27th November, 1973.

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JUDGMENT

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1. This is an appeal by the Commissioner of Inland Revenue by way of case stated from a decision of the Board of Review under section 69 of the Inland Revenue Ordinance in which decision the Board of Review upheld the Respondent's appeal from a determination of the Commissioner who in his turn had decided that gains made by the Respondent on the sale of three of the Respondent's properties No. 2 Staunton Street, Nos. 428-440 Queen's Road West and Nos. 376-388 Reclamation Street were chargeable to Corporation Profits.

2. The proceedings in question came before the Board in the form of an appeal by the Respondent against the assessment for Corporation Profits Tax for the year of assessment 1970/71 insofar as it related to the inclusion of profits made on the sale of three properties mentioned as forming part of the profits of the Respondent chargeable to Corporation Profits tax. The issue before the Board was therefore a narrow one namely whether the rains made on the sale of the three properties arose in or was derived from the Colony from the business of the Respondent or were in the nature of profits arising from the sale of capital assets.

3. The primary facts as agreed or found by the Board may be summarised as follows:

4. The Respondent carries on a business of fire insurance and insurance covering Workman's compesation As a natural and necessary adjunct to such business it owns landed properties and shares.

5. The Respondent has been assessed to profits tax since the year of assessment 1947/48 and the assessable profits have included interest received in the Colony as well as profits from letting and from sales of shares and property.

6. The profit and loss account lodged by the Respondent for the year ended 31st December 1969 contained a credit item "profit on sale of properties $735,008" which sum represented the differences between the cost of purchasing the three properties in question and the amounts realised on their sale in 1969. The Staunton Street property had been acquired in 1932, the Queen's Road West property in 1940 and the Reclamation Street property in 1928. In reply to queries by the assessor the Respondent's representative had contended that the company was in reality carrying on 2 businesses, Insurance and Investment, and that the assets in real estate were assets of the investment business and not of the "Insurance fund". It appeared however that there was always an excess of immediately realisable assets over the amount of the Insurance Fund consisting of cash, deposits, current accounts, outstanding premiums and agents' balances. There was no specific earmarking of investments for either of the 2 alleged businesses. The assessor being unable to agree that the company was carrying on two businesses a Notice of Assessment for 1970/71 was issued cha ging profits of $469,074 which took into account the profits of $735,008 on the sale of the three properties in question. An objection was lodged on the ground that "in arriving at the assessable profits the assessor has incorrectly included profits arising from the sale of capital assets".

7. Apart from these agreed facts the only evidence accepted by the Board was that of the Chief Manager of the Respondent. He had not joined the company until 1940 when he acted as sub-manager. He had become Chief Manager in 1964. The facts which were accepted by the Board as proved by him were that the Respondent carried on the business of insurance against fire and claims under the Workmen's Compensation Ordinance. In respect of the latter there is a statutory period within which claims must be brought so the Respondent's policy was to reinsure retaining part of the risk. In respect of fire insurance the Respondent bears the whole risk and can compute how much it is at risk from year to year. A fund, shown in the Respondent's books as "Insurance Funds" was established by appropriation from surplus and built up to provide support against possible claims. There was no specific marking of any asset to represent insurance funds. The Respondent had never had insufficient assets to meet claims and due to its policy of re-insurance in respect of workmen's compensation claims there was no likelihood that the Respondent could not "back up" any claims. The three properties in question were pre-war properties in poor condition yielding a low rent and for this reason they were sold. The proceeds of sale were devoted towards the development of land owned by the Respondent. This land is ideally located in Wanchai and the Respondent has erected a 19-storey building on it. All the floors in this building have been unsold: the Respondent occupies one floor and has let the remaining floors and intends to retain the building on a long term basis; it is part of the normal operation of an insurance company to hold and "turn over" investments from time to time and the Respondent has "turned over" between fifteen to twenty properties since 1950; it is desirable for a fire insurance company to build up assets as a matter of prestige and strength; the Respondent also owned shares in which they traded in a manner normal for an insurance company.

8. This evidence and the agreed facts to which I have referred comprised the only evidence before the Board and led the majority of the Board to infer that the three properties in question were held and regarded as capital assets and that the profits made by their realization were, therefore, accretions to capital and not assessable to tax. The Chairman of the Board Mr. L.J. Remedios reluctantly dissented from the view of the Board and was influenced in doing so by such decisions as those in Scottish Union & National Insurance Co. v. Smiles; Northern Assurance Co. v. Russell 2 T.C. 551; Liverpool & London & Globe Insurance Co., Ltd. v. Bennet 6 T.C. 327; Colonial Mutual Life Assurance Society Ltd. v. Federal Commissioner of Taxation 73 C.L.R. 604 to the conclusion that as the three properties in question were investments sold by the Respondent the profits made were assessable "because it is part of the business of any insurance company to invest its funds for which it has no immediate requirement and to turn over those funds as and when it is expedient to do so." His reluctance to dissent arose because he considered that "such a decision" (as that arrived at by the majority of the Board) "would accord with my understanding of common and accepted commercial practice." I take him in view of the reason for dissent given to respect of workmen's compensation claims there was no likelihood that the Respondent could not "back up" any claims. The three properties in question were pre-war properties in poor condition yielding a low rent and for this reason they were sold. The proceeds of sale were devoted towards the development of land owned by the Respondent. This land is ideally located in Wanchai and the Respondent has erected a 19-storey building on it. All the floors in this building have been unsold: the Respondent occupies one floor and has let the remaining floors and intends to retain the building on a long term basis; it is part of the normal operation of an insurance company to hold and "turn over" investments from time to time and the Respondent has "turned over" between fifteen to twenty properties since 1950; it is desirable for a fire insurance company to build up assets as a matter of prestige and strength; the Respondent also owned shares in which they traded in a manner normal for an insurance company.

9. This evidence and the agreed facts to which I have referred comprised the only evidence before the Board and led the majority of the Board to infer that the three properties in question were held and regarded as capital assets and that the profits made by their realization were, therefore, accretions to capital and not assessable to tax. The Chairman of the Board Mr. L.J. Remedios reluctantly dissented from the view of the Board and was influenced in doing so by such decisions as those in Scottish Union & National Insurance Co. v. Smiles; Northern Assurance Co. v. Russell 2 T.C. 551; Liverpool & London & Globe Insurance Co., Ltd. v. Bennet 6 T.C. 327; Colonial Mutual Life Assurance Society Ltd. v. Federal Commissioner of Taxation 73 C.L.R. 604 to the conclusion that as the three properties in question were investments sold by the Respondent the profits made were assessable "because it is part of the business of any insurance company to invest its funds for which it has no immediate requirement and to turn over those funds as and when it is expedient to do so." His reluctance to dissent arose because he considered that "such a decision" (as that arrived at by the majority of the Board) "would accord with my understanding of common and accepted commercial practice." I take him in view of the reason for dissent given to refer to commercial practice among such companies as do not have for part of their business the investment of funds and the turning over of investments.

10. My jurisdiction to hear and decide such appeals as this stems from s.69 of the Ordinance which provides that the decision of the Board shall be final but enables either party to an appeal heard by the Board to require the Board to state a case on a question of Law. It is clear then that I can only consider questions of law and those posed for my opinion by the case stated are as follows:

	"(1)		Was the Board wrong in law to conclude that the profits made by the taxpayer as a result of the sales of properties situated at 2 Staunton Street on 21.7.1969, 428-440 Queens Road West on 16.10.1968 and 376-388 Reclamation Street on 23.10.1969 were accretions to the capital of the business of the taxpayer and therefore not chargeable to Corporation Profits Tax.
	(2)		Alternatively was there any or any sufficient evidence from which the Board of Review could have concluded that the profits derived by the taxpayer from the sale of the properties were profits arising from the sale of capital assets within the meaning of s.14 of the Inland Revenue Ordinance (Cap. 112)"

I consider those suggested "alternative" to be no more than alternative methods of posing the same question for if the profits derived were profits arising from the sale of capital assets within the meaning of section 14 they were accretions to the capital of the business.

11. Notwithstanding the suggestion implicit in the opinion of Lord Clyde & Blackburn in Commissioner of Inland Revenue v. The Scottish Automobile & General Insurance Co., Ltd. 16 T.C. 381, that an inference that a profit was not a profit of trading is a conclusion of fact I am quite satisfied that such an inference may be made the subject of appeal if it be clearly, having regard to legal authority, made from insufficient evidence. As appears from the speech of Lord Radcliffe in Edwards v. Bainston 1955 3 All E.R. at p.57.

"I think that the true position of the court in all these cases can be shortly stated. If a party to a hearing before the commissioners expresses dissatisfaction with their determination as being erroneous in point of law, it is for them to state a case, and in the body of it to set out the facts that they have found as well as their determination. I do not think that inferences drawn from other facts are incapable of being themselves findings of fact, although there is value in the distinction between primary facts and inferences drawn from them. When the case comes before the court, it is its duty to examine the determination having regard to its knowledge of the relevant law. If the case contains anything ex facie which is bad law and which bears on the determination it is, obviously, erroneous in point of law. But, without any such misconception appearing ex facie it may be that the facts found are such that no person acting judicially and properly instructed as to the relevant law could have come to the determination under appeal. In those circumstances, too, the court must intervene. It has no option but to assume that there has been some misconception of the law, and that this has been responsible for the determination. So there, too, there has been an error in point of law. I do not think that it much matters whether this state of affairs is described as one in which there is no evidence to support the determination or as one in which the evidence is inconsistent with, and contradictory of, the determination or as one in which the true and only reasonable conclusion contradicts the determination. Rightly understood each phrase propounds the same test."

As I see it that is not a test essentially different to that appearing in 20 Simons at p.692 approved by the Full Court in Rico International Ltd. v. Commissioner of Inland Revenue 1965 H.K.L.R. at p.523:

"In cases where the commissioners (the English equivalent of the Board of Review) have to deduce a conclusion of fact from primary facts admitted or proved before them, the question of law is whether the primary facts found or admitted can support the further conclusions of fact and the point ought to be so stated."

In our case then the appellant, must satisfy me, that there was no evidence to support the inference drawn by the Board or as Mr. Moshinsky put it "the evidence to warrant the conclusion was so slight that the view the Board reached was a view of the facts which could not be reasonably entertained".

12. Section 14 of our Ordinance reads as follows:

"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 the Colony in respect of his assessable profits arising in or derived from the Colony 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."

Since our Ordinance uses the phrase "excluding profits arising from the sale of capital assets" and since this phrase is not used in English or Australian legislation (where such expressions as "property acquired by him for the purpose of profit-making by sale or for the carrying on or carrying out of any profit-making scheme" are used) I enquired of counsel whether it was suggested that our legislature could have intended that some principles different to those set out in the English authorities should be applied. Mr. Litton, quite correctly as I now consider, immediately set my mind at rest, conceding succinctly that "If the operations were trading operations the Board was wrong".

13. It is well settled law that although "where the owner of an ordinary investment chooses to realize it and obtains a greater price for it than he originally acquired it at, the enhanced price is not profit" in the sense of its being assessable income, "it is equally well established that enhanced values obtained from realization or conversion of securities may be so assessable where what is done is not merely a realization or change of investment, but an act done in what is truly the carrying on, or carrying out of a business". The test is "Is the sum of gain that has been made a mere enhancement of value by realizing a security or is it a gain made in an operation of business in carrying out a scheme for profit-making". (Per Clerk, C.J. in California Copper Syndicate (Limited & Reduced) v. Harris 5 T.C. 159 @ 166 which was followed in General Re-insurance Co., Ltd. v. Tomlinson 1970 2 All E.R. 436.

14. It has long been recognised that where the person making the gain is an insurance company that fact alone makes it the more likely that the gain arises in the carrying on, or carrying out of business. Thus in The Liverpool & London & Globe Insurance Co. v. Bennett 6 T.C. 327 a decision of the House of Lords Hamilton, L.J. says at pp. 357-358:

	"There is another point with regard to the Insurance Company. It embarks its funds in its business simply by having money ready to pay its debts with. We are not here concerned with manufactories or the maintenance of a stock which is to be sold. The business of insurance consists in making promise to pay, by way of indemnity, in futuro and contingent sums in consideration of present payments of money, and the whole business therefore, apart from the wisdom and prudence with which it is conducted, consists in being ready to meet the liabilities if they accrue, and to the extent to which they accrue, out of one class of funds or another. Conseouently the money is embarked in the business as soon as it is money which belongs to and is available to the Insurance Company. If they have paid it away in the shape of dividends, it is no longer available, but all their assets substantially are only possessed for the purpose of meeting the contingencies of losses on the policies if they should fall in. I am speaking of fire insurance only as an illustration, but I do not think that either indemnity business or, for this purpose, life business differs, although of course the calculation of risks and the mode of carrying out the transaction are enormously different.
	Now, the practice of English Insurance Companies, which is found to be the practice of the companies in question here, has, as far as I know, always been to start from the very first accumulating large accessible funds for the purpose of meeting losses. The advantages are numerous. It renders the calling up of unpaid capital an extremely improbable event; it presents to the insuring world an enormous reserve of security; it assures within the company a uniform dividend and a uniform state of solvency apart from the changes and chances of a business which is essentially a bussiness of hazards, and consequently it is the very pivot of the conduct of a fire insurance business to build up with prudence, by not distributing surpluses of premiums as and when they are received, large reserve funds and to invest them, of course, so that they may not be fruitless while they are held in hand. That is the policy that is pursued here under Class C, and thanks to it and thanks to the usual policy of not putting all the eggs in one basket, either with regard to the risks or the investments, the companies have under all imaginable contingencies large available funds in different parts of the world readily realisable in case of need. As it appears from the case of the Liverpool and London and Globe that emergency practically does not arise. But the funds received from the investments are just as much part of the receipts of the business, and the making of the investments is just as much part of the mode of conducting the business, as the taking of the risks, and except to the extent to which the current account at the bank, fed by premiums on the one side and depleted by losses paid on the other, is sufficient to carry on the business, all these funds in their several degrees may have to be called upon at some time or in some way or other."

The peculiar position of insurance companies and in particular of life assurance companies was also recognised by the High Court of Australia in Colonial Mutual Life Assurance Society Ltd. v. Federal Commissioner of Taxation 73 C.L.R. 604. The appellant in that case, a mutual life-assurance company, was guided in its investments by acturial calculations which indicated that, to meet its liabilities under insurance policies it must obtain a certain effective yield on its investments. The interest yield was the governing factor influencing the company's policy and it held its securities as investments rather than for the purpose of constantly seeking profits from realizing them. In the relevant tax year the amount realised by it on the sale of securities exceeded the cost to it of those securities and the amount of the excess was regarded as assessable income. Having canvassed the view that a profit on the sale of investments was not a profit made by trading but a profit made on a change of investments, the court in its judgment, went on to say:

"the sounder view is that profits and losses on the realization of investments of the funds of an insurance company should usually be taken into account in the determination of the profits and gains of the business".

The judgment of the court goes on to state that:

"an insurance company whether a mutual insurance company or not, is undoubtedly carrying on an insurance business and the investment of its funds is as much a part of that business as the collection of the premiums and to make the point that the acquisition of an investment .. is an acquisition with a view to producing a yield of a composite character, the effective yield comprising the actual interest less any dimunition or plus any increase in the capital value of the securities. Such an acquisition and subsequent realization is a normal stop in carrying on the insurance business, or in other words an act done in what is truly the carrying on of the business of the [company]".

15. This case was mentioned with approval in General Re-insurance v. Tomlinson 1970 2 All E.R. 436 and I must say that I find the reasoning in it and, in particular, of the quotations from it which I have set out quite compelling.

16. The question with which therefore I find myself faced is was there any evidence before the Board to indicate that the acquisition and subsequent realization of the three pieces of land in question was not in this particular case such a normal step.

17. Mr. Litton in summary of his very able argument postulates five pieces of evidence each of which he contends, when seen in the context of the business carried on by the Respondent, go some way to suggest that that the acquisition and realisation in this particular case was not trading or was not a normal step in carrying on the insurance business. I say "in the context of the business carried on by the respondent" because it was Mr. Litton's suggestion that the actual insurance business (as distinct from any investment of its funds and in particular of their investment and realisation in respect of these three pieces of land) was peculiar and differed from the businesses of the companies in the cases cited in that the Respondent does not carry on any life insurance business which would have placed it at risk over a much longer period and the company could adequately predict the amount at risk from year to year. It was thus, he suggested in a much better position to identify parts of its assets as surplus to its insurance business. The company undoubtedly had readily realisable assets to meet its claims, those in any past year could have been amply met from quoted shares or current assets. From this, he suggests, it follows that the three properties were surplus to the ordinary insurance business. With respect I consider that in this part of his argument he fails to appreciate the continuing nature of the Respondent's business and what must inevitably be the ambition of its directors and shareholders alike, namely its growth. All insurance companies whether they carry on the business of life insurance or not must if they are to remain in business be able to attract new customers and be able to predict with a considerable degree of accuracy the risks that lie ahead. That the Respondents are able so to predict more easily or with a greater degree of accuracy does not make their position different in principle - any difference there may be, is one of degree only. It was almost certainly with this fact in mind that the court in Colonial Mutual Life Assurance Society Ltd. used what at first sight might appear an unnecessarily tautological sentence when it said "an insurance company whether a mutual insurance company or not is undoubtedly carrying on an insurance business and the investment of its funds is as much a part of that business as the collection of the premiums". The investment of its funds is a part of its business not only because it must have a backing from which to cover anticipated claims but also because it must have not only the reality of financial soundness but also its appearance. Investments have a two fold value to an insurance company; they not only provide financial soundness and the gains of income and appreciation but also that appearance of financial probity which will attract new business. They are, in fact, the "stock-in-trade" of all insurance companies.

18. I cannot see that the business of the Respondent differs in principle from that of any insurance company in relation to the holding acquisition or realization of investments.

19. Nevertheless I do consider that the manner in which the Respondent carries on business should be considered in relation to the five matters postulated by Mr. Litton as indicating that in realizing the three pieces of land the Respondent did not act in the course of its trade. It is necessary to get a complete picture and although I must examine each of the five matters put forward individually I must also see them collectively against the general nature of the business carried on.

20. The five factors are:

	(a)		Length of holding. At the time of their realization the three properties had been held for 38 years, 30 years and 32 years respectively. This Mr. Litton argued indicated that the Respondent regarded them as capital assets and that they were. If, however, investments are regarded as the "stock-in-trade" of insurance companies and if the investments in question are enjoying a considerable rate of appreciation, as these properties did, length of holding is in my opinion not a valuable criterion. Any company, part of the business of which is the management of an investment portfolio, will tend to postpone selling an appreciating asset in favour of an asset which is not appreciating.
	(b)		The nature of the property - real estate. In Hong Kong where almost all land is a chattel real leased from the Crown and since land is inevitably and continuously in short supply it is as much the object of speculation as any other type of investment and almost as readily realizable.
	(c)		The fact that these properties were purchased with surplus funds gave rise, Mr. Litton argued, to an inference that they were acquired as a capital asset. I do not consider such an inference warranted. All investments must necessarily be made with funds that are surplus to immediately foreseen requirements - particularly so in the case of an insurance company.
	(d)		The circumstances of realization. The rental income was poor, the buildings dilapidated. This I do not think, can affect the nature of the investment or of the dealing with it.
	(e)		The purpose of realization. The property was sold in order that the proceeds of sale might be channelled to the development of a 19-storey building in Wanchai, one floor of which is occupied by the Respondent as its head office. The other floors are all let; none has been sold. If an insurance company can be regarded as owning capital assets, Mr. Litton argues by implication, this Wanchai building should be so regarded. It contains the office building which must be regarded as a permanent venture - as a capital asset. The building itself must therefore be regarded as a capital asset. I doubt very much if this follows. The building as it stands almost certainly fulfils a double, if not a treble, function. It provides offices for the Respondent, it gives a good return on the money invested, and it gives prestige to the Respondent and thereby attracts further customers. The presumed permanence of the Respondent's offices in the building may go some way to indicating that the new building is a capital asset; as I see it, however, it is by no means conclusive and the other functions I have outlined go a long way to negative the indication and to suggest that this building is part of the "stock-in-trade" of the Respondent. Assuming however, that the new building is a capital asset, one is by no means compelled to the conclusion that what took place on the sale of the three properties was no more than a change of investment. This is firstly because of the finding that there was no specific earmarking of investments by the Respondent to represent insurance funds and secondly because there was no evidence before the Board as to where the balance (if any) of the cost of development of the Wanchai site came from.

21. Individually then no one of the five factors is, in my view, sufficient to establish that the sale of these three properties should be regarded as the sale of a capital asset. Are they sufficient when taken as a whole? I do not so consider them when they are balanced against the admitted facts that "since 1950 the Respondent had 'turned over' between 10 to 15 properties and that the turning over of investments which include landed properties is part of the normal function of an insurance company".

22. To my mind the sale of these three properties was so clearly a sale which occurred in the normal carrying by the Respondent of its business within the principles enunciated in the cases cited that the Board could not reasonably have inferred from the facts before it that it was the sale of a capital asset.

23. For these reasons I would allow this appeal.

	(P.F.X. Leonard)
	Puisne Judge

Representation:

Moshinsky, C.C. for Appellant

Litton, Q.C. & K.H. Woo (J.S. & M.) for Respondent