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Nice Cheer Investment Ltd v Commissioner Of Inland Revenue

Judgment Cited authorities 19 Cited in Precedent Map Related
Vincent
Judgment Date28 June 2011
Subject MatterInland Revenue Appeal
Judgement NumberHCIA8/2007
CourtHigh Court (Hong Kong)
HCIA8/2007 NICE CHEER INVESTMENT LTD v. COMMISSIONER OF INLAND REVENUE

HCIA 8/2007

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

INLAND REVENUE APPEAL NO. 8 OF 2007

____________

BETWEEN

NICE CHEER INVESTMENT LIMITED Appellant
and
COMMISSIONER OF INLAND REVENUE Respondent

____________

Before: Hon To J in Court

Dates of Hearing: 22 - 23 March 2011

Date of Judgment: 28 June 2011

______________

J U D G M E N T

______________

INTRODUCTION

Introduction

1. This is an appeal by the taxpayer (“Taxpayer”) against the determination (“Determination”) of the Deputy Commissioner of Inland Revenue (“Deputy Commissioner”) in confirming the profits tax assessments for the years of assessment 2003/04 to 2005/06 issued to


the Taxpayer by the assessor. At the invitation of the Taxpayer, the Commissioner of Inland Revenue (“Commissioner”) consented to transfer the appeal from the Inland Revenue Board of Review to the Court of First Instance, pursuant to section 67 of the Inland Revenue Ordinance (Cap 112) (“the Ordinance”).

2. The central question in this appeal is whether unrealised gains arising from the revaluation of trading investments, being securities listed in Hong Kong, to their respective market value at the balance sheet date and credited in its profit and loss account according to ordinary commercial accounting principles is chargeable to profits tax.

The background

3. The Taxpayer is a private company incorporated in Hong Kong on 8 September 1999. It commenced business on 7 October 1999 and adopted 31 March as its account closing date. Its principal activity was investment trading.

4. Over the years, the Taxpayer submitted its profits tax returns for the years of assessment 1999/2000 to 2005/06 together with audited accounts and proposed tax computations with supporting schedules. In its auditor’s report accompanying the accounts, its auditor PricewaterhouseCoopers (“Auditors”) expressed the opinion that the accounts gave a true and fair view of the state of affairs of the Taxpayer and of its profits or losses for the respective financial years. The Auditors also stated:

“(i) that the [Taxpayer’s] accounts had been prepared in accordance with accounting principles generally accepted in Hong Kong; and

(ii) that the Auditors conducted their audit in accordance with Statements of Auditing Standards issued by the Hong Kong Institute of Certified Public Accountants (“HKICPA”) (formerly known as the Hong Kong Society of Accountants (“HKSA”)) and the audit included, inter alia, an assessment of whether the accounting policies are appropriate to the circumstances of the [Taxpayer], consistently applied and adequately disclosed.”

5. In the preparation of its accounts for the various financial years up to 31 March 2005, the Taxpayer adopted ordinary commercial accounting principles and Statement of Standard Accounting Practice 24 (“SSAP 24”) issued by the Hong Kong Institute of Certified Public Accountants (“HKICPA”), formerly known as Hong Kong Society of Accountants (“HKSA”). Note 2(a)(i) and (b) of the Notes to the Financial Statements attached to the Taxpayer’s accounts for the accounting years up to 2004/05 contained the following statement in respect of its accounting policies:

“(a) Revenue recognition

(i) Realised and unrealised gains and losses on trading investments

Realised gains and losses on trading investments are recognised on conclusion of sales contracts. Unrealised gains and losses on trading investments are recognised on the basis set out in note 2(b).

(b) Trading investments

Trading investments are stated at fair value at the balance sheet date. Fair value represents the quoted market price for investments which are listed or actively traded in a liquid market. For investments which are unlisted …

At each balance sheet date, the net unrealised gains or losses arising from the changes in fair value of trading investments are recognised in the profit and loss account. Profits or losses on disposal of trading investments, representing the difference between the net sales proceeds and the carrying amounts, are recognised in the profit and loss account as they arise.”

6. With effect from 1 January 2005, the Taxpayer adopted another standard, Hong Kong Accounting Standard 39 (“HKAS 39”), issued by the HKICPA under which both unrealised gains or losses arising out of revaluation of trading securities were also treated as profits or losses in the profit and loss account. For the purpose of this appeal, that change is immaterial. Note 2(d) and (i) of the Notes to the Financial Statements attached to the Taxpayer’s accounts for the year ended 31 March 2006 contained the following statement of its accounting policies:

“(d) Trading securities

Trading securities are stated at fair value at the balance sheet date. Fair value represents the quoted market price for securities which are listed or actively traded in a liquid market.

Regular purchases and sales of investments are recognised on trade-date, the date on which [the Taxpayer] commits to purchase or sell the asset. Transaction costs are expenses in the income statement.

At each balance sheet date, the net unrealised gains or losses arising from the changes in fair value of trading securities are recognised in the income statement. Profits or losses on disposal of trading securities, representing the difference between the net sales proceeds and the carrying amounts, are recognised in the income statement as they arise.”

“(i) Revenue recognition

(i) Realised and unrealised gains and losses on trading securities

Realised gains and losses on trading securities are recognised on conclusion of sale contracts. Unrealised gains and losses on trading securities are recognised on the basis set out in note 2(d).”

7. Profits tax is chargeable under Part IV of the Ordinance. Section 14(1) is the charging section for profits tax. In computing the adjusted losses or assessable profits, the Taxpayer excluded the unrealised gains from the assessments but claimed deduction of the unrealised losses on trading investments/securities at year end. The assessor was of the view that the unrealised gains and losses arising from revaluing the unsold listed securities held at the year end should be included in the profits tax computation for the year of assessment in which the unrealised gains were credited and the unrealised losses were debited in the Taxpayer’s accounts. Accordingly, the assessor issued computations of loss for the years of assessment 1999/2000 to 2002/03 and profits tax assessments for the years of assessment 2003/04 to 2005/06. The differential between the profits tax thus assessed over the years and that calculated by the Taxpayer without taking into account the unrealised gains was very substantial, being in the region of $250 million.

The accounting experts’ opinion

8. There were no substantial disputes between the Taxpayer’s accounting expert and the Commissioner’s. There were no disputes that the Taxpayer’s accounts for the various financial years were prepared in accordance with the then prevailing accounting practice.

9. By way of background, up until 31 December 1998, the common accounting practice in Hong Kong in reporting listed securities was to follow the International Accounting Standard 25 Accounting for Investments issued in March 1986, by using the lower of cost or market value of the investment. The diminution in value of investments (unrealised losses) was recorded as a provision and charged to profit and loss account, while the increase in value of investments (unrealised gains) were not reflected in the balance sheet or the profit and loss account.

10. The Council of HKICPA developed and issued its own financial reporting standards, including SSAP 24 which became applicable to accounting statements for periods beginning on or after 1 January 1999 until its replacement by HKAS 39 with effect from 1 January 2005.

11. SSAP 24 departed from the conventional practice of measuring financial instruments at the lower of historical cost or market value in the financial statements. It introduced the concept of fair value, holding gains and holding losses for trading stocks. Trading stocks were carried at fair value at the balance sheet date and holding gains and losses were included in profits or losses for the period. The holding gains and losses were not the result of actual trading but movements in fair value due to market conditions. In practice, the increase or decrease in fair value was included in other operating income and other expenses respectively on the face of the income statement; while detailed descriptions such as unrealised holding gains on investment securities were disclosed in the notes to the financial statements.

12. HKAS 39 which replaced SSAP 24 with effect from 1 January 2005, introduced more detailed accounting treatment, classification of investments and measurement of financial instruments at fair value. The accounting treatment for trading stocks under HKAS 39 is as follows. On initial recognition, trading stocks are measured at their fair value in the balance sheet. Recognition is defined as the process of incorporating an item in the balance sheet or income statement. After initial recognition, trading stock are measured at their fair value without any deduction for transaction costs which may be incurred on sale or disposal. Such measurements are usually done on balance sheet date. Gains or losses arising from a change in fair value are recognised in profit or loss account. Profit or loss is defined in the Glossary of HKAS 39 as the total of income less expenses, excluding the components of other comprehensive income. As with the...

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