News Flash Hong Kong Tax The IRD lost in the Aviation Fuel Supply case as a matter of procedural fairness January 2015 Issue 1 In brief The Court of Final Appeal (CFA) handed down its judgment in Aviation Fuel Supply Co v CIR on 15 December 2014. The substantive issue before the CFA, as raised by the Commissioner of Inland Revenue (CIR), was whether balancing charges should be imposed on the taxpayer in respect of certain assets transferred by the taxpayer. The issue of balancing charge was only raised by the CIR when the case proceeded to the Court of Appeal (COA) and the statutory six-year limitation period for the assessment in dispute had already expired. The CFA dismissed the CIR’s appeal and held that the assessment under appeal cannot be revised at this stage by imposing a balancing charge on the taxpayer as the CIR is too late in bringing up the issue in the litigation process. It is interesting to note that the CFA dismissed the CIR’s appeal not on the basis that there was no merits of the CIR’s argument on the balancing charge issue but because the CIR did not raise the issue as an alternative argument earlier enough during the proceeding. The CFA commented that there may be merits in the CIR’s argument on the balancing charge issue technically, but held that allowing the CIR to raise the balancing charge issue at such late stage would be unfair to the taxpayer. As in doing that, the taxpayer would be required to carry out extensive further fact finding and investigation of the relevant transactions that took place more than six years ago. Given the conclusion above, it is not necessary for the CFA to decide whether the COA was right in saying that no balancing charge was payable on the basis that the assets were transferred by way of succession. However, the CFA did express its views on this issue as invited by the CIR as obiter dictum. A key lesson to learn in this case is that it is crucial to include all possible alternative arguments at the early stage of a proceeding such that if one argument fails, the other fallback arguments (if any) can still be relied upon. Taxpayers should therefore be mindful of including all possible arguments in the case stated for a Board of Review hearing or in the submission to the court for a direct appeal to the court. The obiter dictum of the CFA also sheds some light on what is meant by “passed by way of succession” in the context of applying the balancing charge/allowance provisions for profits tax purpose with respect to transfer of plant and machinery. In detail A brief recap of the case Below is a brief recap of relevant facts of the case and the judgments of the lower courts. For a detailed discussion of the full facts of the case and the judgments of the Court of First Instance (CFI) and the COA, please refer to our Hong Kong Tax News Flash, January 2013, Issue 21. The relevant facts The case involved a sophisticated commercial arrangement whereby the taxpayer’s group entered into various agreements with the Airport Authority in Hong Kong (the Authority) in 1995 to develop and operate the aviation fuel supply system at the Hong Kong airport (the Facility) on a "Build-OperateTransfer" model. The diagram in the Appendix shows the relationships of the parties involved in the arrangement. www.pwchk.com News Flash — Hong Kong Tax As a result of an early termination of the various agreements between the taxpayer and the Authority in 2003 whereby the taxpayer’s business together with the Facility (which consisted of plant and machinery, prescribed fixed assets and industrial buildings) were transferred from the taxpayer to the Authority, a lump sum of around US$449 million was received by the taxpayer. The CIR sought to tax the lump sum as trading receipt received by the taxpayer in year of assessment 2003/04. The taxpayer lodged an appeal against the CIR’s assessment directly to the CFI, arguing that the sum should be regarded as a compensation for the surrender of its business and a payment made by the Authority to acquire its business and therefore, should be capital in nature and not subject to profits tax. The judgments of the lower courts The CFI held in favour of the taxpayer that the sum was not a receipt derived from the taxpayer's business but a payment made to acquire the taxpayer's business and resulted in a change of ownership of the Facility. As such, it should be regarded as capital in nature and not taxable. The CIR then lodged an appeal against the CFI’s judgment to the COA. A few weeks before the hearing in the COA in 2012, the CIR raised a point that had not been raised before the CFI, namely if the decision of the CFI was upheld, the original assessment should be revised to impose balancing charges (and also claw back of the deduction previously claimed on the capital expenditure on the prescribed fixed assets) on the taxpayer upon transfer of the Facility as depreciation allowances were previously granted to the taxpayer. The taxpayer submitted that the CIR should not at that stage be allowed to put forward this claim as it was an entirely new assessment basis. The COA did not agree that the CIR was attempting to make a new assessment on a different and wider basis than the original assessment and exercised its discretion to allow the CIR to raise the balancing charge issue. However, the COA dismissed the CIR’s balancing charge claim and held that no balancing charge should be made on the taxpayer as the Facility was passed from the taxpayer to the Authority by way of succession upon cessation of the taxpayer’s business2. The COA also held in favour of the taxpayer that the 2 lump sum received by the taxpayer was a capital receipt and not taxable. the sale proceeds to each individual asset concerned. This would require the taxpayer to investigate transactions that took place more than six years ago (e.g. the taxpayer would need to find out the value the assets back in 2003 when the assets were transferred). In the CFA’s opinion, it would be unfair to the taxpayer to require it to investigate these matters after the limitation period for a fresh assessment had expired, in particular that the CIR could have originally made an alternative assessment claiming a balancing charge. The judgment of the CFA The balancing charge issue In appealing to the CFA, the CIR no longer sought to argue that the lump sum was trading receipt subject to profits tax but only focused on the COA’s judgment in respect of the balancing charge issue. Although the CIR sought to appeal against the COA’s judgment on the merits that the Facility was passed to the Authority by sale rather than by succession, the CFA considered that the chief question was indeed whether the CIR should have been allowed to raise the balancing charge issue at the last minute before the hearing in the COA. The CFA dismissed the CIR’s appeal and held that the COA should not have entertained the CIR’s application on the balancing charge issue as doing so is unfair to the taxpayer. Below is the analysis of the CFA on this issue: The COA has all the authority to make any assessment that the CIR is empowered under the Inland Revenue Ordinance (IRO) and hence is allowed to exercise a discretion to increase the original assessment under appeal on a different basis (i.e. by imposing a balancing charge) as that is all part of the original assessment, however, the COA needed to consider whether it would be fair to do so before exercising such discretion. By the time the COA was invited to make the assessment (it was 2012), the statutory six-year limitation period for making an additional assessment (the assessment in dispute is for year of assessment 2003/2004) under section 60(1) of the IRO had already expired. Although the COA’s assessment is not an additional assessment within the meaning of section 60(1), the effect of making such assessment is to deprive the taxpayer of the protection of the limitation period against what may be in substance an entirely new claim. Imposing a correct amount of balancing charge on the taxpayer would require: (1) apportioning part of the lump sum received by the taxpayer as the sale proceeds of the Facility and (2) allocating Whether the assets were transferred by sale? Given the CFA decided that the CIR should not be allowed to raise the balancing charge issue, it was not necessary for it to decide whether the COA was right in deciding that no balancing charge was payable on the basis that the plant and machinery were transferred by way of succession instead of by sale. However, as invited by the CIR, the CFA expressed the following views on this issue as obiter dictum: There was clearly a sale of the plant and machinery. Although the Authority succeeded to the taxpayer’s business, the plant and machinery were not passed to the Authority by way of succession as the Authority did not get them for nothing. In addition, the plant and machinery were not transferred by operation of law upon termination of the lease. The termination of the lease was similar to a sale of the taxpayer’s residual interest as a surrender would have been. As between the Authority, the taxpayer and the CIR, the plant and machinery had been treated as owned by the taxpayer and depreciation allowances claimed by the taxpayer had been allowed. As such, the CIR would have been entitled to impose a balancing charge on the taxpayer upon transfer of the plant and machinery. The COA made a mistake in seemingly holding that its opinion (i.e. no balancing charge in the case of succession) also applied to prescribed fixed assets and industrial buildings as section 39D(3)2 only applies to PwC News Flash — Hong Kong Tax plant and machinery and there is no equivalent provision in the IRO for prescribed fixed assets and industrial buildings. The takeaway One key lesson to learn in this case is that it is crucial to include all possible alternative arguments at the early stage of a proceeding such that if one argument fails, the other fallback arguments (if any) can still be relied upon. In this case, the CIR would succeed in claiming a balancing charge from the taxpayer should he include the balancing charge argument early enough (i.e. at the hearing of the CFI in this case3). Taxpayers should therefore be mindful of including all 3 possible arguments in the case stated for a Board of Review hearing or in the submission to the court in case of a direct appeal to the court. The obiter dictum of the CFA also sheds some light on what is meant by “passed by way of succession” in the context of applying the balancing charge/allowance provisions in the IRO to transfer of plant and machinery. The term “succession” is not defined in the IRO. Apparently, the term implies “a process in which the assets are taken up by someone without consideration” and one of the limited circumstances in which this can happen as cited by the CFA is when someone receives the assets by a distribution in specie. Endnotes 1. Hong Kong Tax News Flash, January 2013, Issue 2 can be accessed via this link: http://www.pwchk.com/home/eng/h ktax_news_jan2013_2.html 2. Section 39D(3) of the IRO provides that a balancing charge or balancing allowance should not be applicable in the case where the plant and machinery are passed by way of succession upon cessation of a trade or business. 3. This case is a direct appeal to the CFI, passing the Board of Review. PwC News Flash — Hong Kong Tax Appendix: Commercial arrangement between the taxpayer’s group and the Hong Kong Airport Authority 4 PwC News Flash — Hong Kong Tax Let’s talk For a deeper discussion of how this issue might affect your business, please contact a member of PwC’s Hong Kong Corporate Tax Team: Reynold Hung +852 2289 3604 reynold.hung@hk.pwc.com Oscar Lau +852 2289 5603 oscar.lau@hk.pwc.com With over 2,200 tax professionals and over 140 tax partners in Hong Kong, Macao, Singapore, Taiwan and 16 cities in Mainland China, PwC’s Tax and Business Service Team provides a full range of tax advisory and compliance services in the region. Leveraging on a strong international network, our dedicated Hong Kong Corporate Tax Team is striving to offer technically robust, industry specific, pragmatic and seamless solutions to our clients on their Hong Kong, PRC and international tax issues. In the context of this News Flash, China, Mainland China or the PRC refers to the People’s Republic of China but excludes Hong Kong Special Administrative Region, Macao Special Administrative Region and Taiwan Region. The information contained in this publication is for general guidance on matters of interest only and is not meant to be comprehensive. The application and impact of laws can vary widely based on the specific facts involved. Before taking any action, please ensure that you obtain advice specific to your circumstances from your usual PwC’s client service team or your other tax advisers. The materials contained in this publication were assembled on 20 January 2015 and were based on the law enforceable and information available at that time. 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