Hong Kong tax notes

Hong Kong's cheer is anything but nice for the Inland Revenue this Christmas

Last month, the Hong Kong Court of Final Appeal (CFA) delivered its landmark judgement in Commissioner of Inland Revenue v. Nice Cheer Investment Limited.

Issue

The central issue in Nice Cheer was this: if revaluation gains under an accounting standard result in an accounting profit hitting the taxpayer's profit and loss account, are those unrealised profits chargeable to profits tax under the tax law?

The CFA said, "no"; the word "profits" in the Inland Revenue Ordinance (IRO) connotes actual or realised profits (i.e., cold hard cash) and not potential or anticipated profits. The adoption of new standards of commercial accounting cannot overturn this principle.

It is no understatement to suggest that the CFA decision is a disaster for the Inland Revenue Department (IRD). The decision is in direct conflict with the IRD's published assessing practice on the relevant matters, in place for as long as 12 years (depending on the specific issue).

Tens of thousands of taxpayers who have filed their tax returns consistent with the IRD's view of the law should now be asking themselves what to do about the tax overpaid, which could amount to hundreds of millions of dollars.

The IRD has been quick to point out that a profits tax assessment becomes final and conclusive, and generally cannot be amended or revised, if the taxpayer fails to object to the same within one month of the date of the assessment. The IRD has said that a court judgment will not have retrospective effect on cases where the assessments have already become final and conclusive. That is true but it is only half of the story.

Our View
There is a provision in the IRO (section 70A) which enables a taxpayer to apply for correction of an assessment within six years after the end of a year of assessment or within six months after the date on which the relative notice of assessment was served (whichever is later), if the assessment was excessive because of an error or omission in a return or statement. The limited Board of Review authority around section 70A suggests that there can be no error or omission for the purposes of the provision where the returns lodged followed "practice generally prevailing" at the time.

Were most taxpayers' returns in respect of unrealised profits lodged in accordance with "practice generally prevailing" at the time? The answer is probably, yes. However, the interesting issue here is whether, by their unusually firm and very public views on the correct law and filing approach, the IRD in fact created the "practice generally prevailing". It remains an open question and one that a test case will almost certainly consider in due course.

Action Required

In light of the controversy taxpayers should, at the very least, review their position and determine the tax impact of filing a section 70A claim in accordance with the principles of the Nice Cheer decision. By filing a section 70A claim, taxpayers will at least preserve their right to a refund of tax (should they be due one) in light of the statutory time bar. Our tax team can assist with the review and with the application to the IRD.