FACV No. 1 of 2019
 HKCFA 38
IN THE COURT OF FINAL APPEAL OF THE
HONG KONG SPECIAL ADMINISTRATIVE REGION
FINAL APPEAL NO.1 OF 2019 (CIVIL)
(ON APPEAL FROM CACV NO. 94 OF 2016)
||COMMISSIONER OF INLAND REVENUE
||POON CHO-MING, JOHN
||Mr Justice Ribeiro PJ, Mr Justice Fok PJ,
Mr Justice Cheung PJ, Mr Justice Bokhary NPJ and Lord Neuberger of Abbotsbury NPJ
|Date of Hearing:
||17 October 2019
|Date of Judgment:
||14 November 2019
Mr Justice Ribeiro PJ:
1. I agree with the judgment of Mr Justice Bokhary NPJ.
Mr Justice Fok PJ:
2. I agree with the judgment of Mr Justice Bokhary NPJ.
Mr Justice Cheung PJ:
3. I agree with the judgment of Mr Justice Bokhary NPJ.
Mr Justice Bokhary NPJ:
4. This is an appeal by the Commissioner of Inland Revenue (“the Commissioner”) from a decision of the Court of Appeal (Macrae VP, Yuen and Kwan JJA). They granted him leave to appeal so that he may seek from us an unqualified affirmative answer to a question of law, he having failed to obtain such an answer from them.
Question on leave to appeal was granted
5. In the order granting such leave, the question is formulated thus. It begins by postulating the situation “[w]here a contract of employment is terminated by the employer, and the employer agrees at termination to pay to or confer on the employee (1) payment or benefit to eliminate or settle any threatened claim by the employee for, and the payment or benefit is paid or conferred in lieu of, a payment or benefit which if made had the contract of employment not been terminated would be chargeable to salaries tax; [and] (2) a benefit being the entitlement to exercise a right to acquire shares contingently conferred on the taxpayer as the holder of an office in or an employee of the employer”. And it then asks: “is the payment or benefit, or any gain from the exercise of any such benefit, so paid or conferred at termination chargeable to salaries tax under the Inland Revenue Ordinance (Cap 112)?”
6. But are the facts really as postulated in that question? Let us see.
Sum D received and Share Option Gain made
7. Immediately prior to 20 July 2008 the respondent Mr John Poon (“the Taxpayer”) was in employment in Hong Kong as the Group Chief Financial Officer and an executive director of a company (“the Employer”) incorporated in Bermuda and listed on the Hong Kong Stock Exchange. On that date the Taxpayer’s employment by the Employer was terminated pursuant to a “Separation Agreement” under which the Taxpayer received certain sums and benefits from the Employer in respect of all claims and rights of actions.
8. One of those sums was a sum of €500,000 paid under clause 4.1.4 of the Separation Agreement “in lieu of a discretionary bonus” for the financial year ended 30 June 2008. This sum of €500,000 has hitherto been - and will in this judgment continue to be - called “Sum D”.
9. As to benefits, clause 5 of the Separation Agreement provided that, despite the cessation of his employment, the Taxpayer was entitled to exercise his stock options set out in Annexure 2 of that agreement. He exercised those options by a number of tranches (which have hitherto been - and will in this judgment continue to be - identified by reference to letters of the alphabet). On 19 August 2008 the Taxpayer subscribed for 360,000 shares in the Employer at $24.20 per share (under “Tranche A”) and 720,000 shares in the Employer at $42.58 per share (under “Tranches B and C”). Those 1,080,000 shares were allotted to him on the following day. Their closing prices on 19th and 20th of that month were $73.15 and $76.50 respectively. The notional gain thus derived has been - and will in this judgment continue to be - referred to as “the Share Option Gain”.
Challenge to assessment to salaries tax of that sum and that gain
10. In the 2008/2009 year of assessment, the total on which the Taxpayer was assessed to salaries tax for 2008/2009 included (i) the €500,000 which forms Sum D and (ii) the Share Option Gain which gain was calculated at $43,250,400. He appealed to the Board of Review against their inclusion. The issues in that appeal were these. (1) Is Sum D taxable? (2) Is the Share Option Gain taxable? (3) If the Share Option Gain is taxable, is the date for its computation 19 August 2008 when the share options were exercised (“the Exercise Date”) or 20 August 2008 when the shares were allotted (“the Allotment Date”)?
11. The Commissioner contended that both Sum D and the Share Option Gain are taxable and that computation should be as at the Allotment Date. Disagreeing, the Taxpayer contended that neither Sum D nor the Share Option Gain is taxable but that if the latter is taxable then computation should be as at the Exercise Date.
Succeeded on appeal to the Court of Appeal
12. Dismissing the Taxpayer’s appeal, the Board of Review, agreeing with the Commissioner, held that both Sum D and the Share Option Gain are taxable and that computation should be as at the Allotment Date. The Taxpayer then appealed against the Board of Review’s decision. Agreeing with that decision, the Court of First Instance (Anthony Chan J) dismissed the Taxpayer’s appeal, whereupon the Taxpayer appealed against the Court of First Instance’s judgment. The Court of Appeal (by Yuen JA’s judgment with which the other members of the panel agreed) allowed the Taxpayer’s appeal, holding that neither Sum D nor the Share Option Gain is taxable.
Relevant statutory provisions
13. Under section 8(1) of the Inland Revenue Ordinance (“the Ordinance”), “income arising in or derived from Hong Kong” from various specified sources is chargeable to salaries tax. One of those sources, being the one specified in item (a) of that subsection, is “any office or employment of profit”. The expression “income from any office or employment” is defined by section 9 of the Ordinance to include various things including those specified in items (a) and (d) of that subsection. Item (a) specifies “any wages, salary, leave pay, fee, commission, bonus, gratuity, perquisite, or allowance, whether derived from the employer or others”. And item (d) specifies “any gain realized by the exercise of… a right to acquire shares or stock in a corporation obtained by a person as the holder of an office in or an employee of that… corporation”.
14. As relevant to what we have to decide in the present case, what we held in Fuchs v Commissioner of Inland Revenue (2011) 14 HKCFAR 74 is as follows. Income chargeable to salaries tax under section 8(1) of the Ordinance is not confined to income earned in the course of employment. It includes payments made in return for acting as or being an employee. In other words, it includes rewards for past services. It also includes payments made by way of inducement to enter into employment and provide future services. If a payment, viewed as a matter of substance and not merely of form and without being blinded by some formulae which the parties may have used, is found to be derived from a taxpayer’s employment in the foregoing sense, it is chargeable to salaries tax. That analysis provides guidance on the operation of the relevant statutory words without supplanting or even modifying those words. Payments which are for something else do not come within the analysis, and are not chargeable to salaries tax. All of that appears at paragraphs 17 and 18 of the judgment which was given by Mr Justice Ribeiro PJ and agreed with by all the other members of the panel.
Fuchs’s case itself
15. Before going further into the facts of the present case and applying the Fuchs analysis to them, let us examine how that analysis operated in the factual circumstances of Fuchs’s case itself. Mr Fuchs entered the employ of a German bank in 1976. After working for it in Germany and then in Singapore, he was seconded to its Hong Kong branch in July 2003. On 18 November 2003 he entered into a contract of employment to work for the bank at that branch for a three-year period commencing on 1 January 2004 as its Managing Director and CEO Asia. Within that three-year period, the following things happened. In November 2005 the bank was taken over by an Italian banking group. As part of the re-organization resulting from the takeover, it was decided that Mr Fuchs’s employment with the bank would be terminated. There were negotiations over the terms of such termination. The terms agreed upon were set out in an agreement dated 17 October 2005. It was provided in this agreement that Mr Fuchs’s employment was to end by 31 December 2005. That date, it will be observed, would be the last day of the second year of the three-year period for which he was employed. It was also agreed that the bank would pay him “a one-time compensation for the loss of his position due to the termination of the employment relationship for operational reasons” in the total sum of $18,276,667.
16. A breakdown of this total sum into three component sums was provided in the agreement. The first component sum was of $3,120,000. It was equivalent to Mr Fuchs’s salary for the remaining year of the three-year period for which he was employed. The second component sum was of $6,240,000 expressed to represent “two annual salaries for the duration of service with” the bank. The third component sum was of $8,916,667. It was expressed to represent “the average amount of the bonuses paid in the 3 previous years”.
17. Mr Fuchs contended that none of the total sum was taxable. The revenue accepted that the first component sum was not taxable. But it maintained that the second and third component sums were chargeable to salaries tax. Mr Fuchs’s employment contract...