Court of Final Appeal clarifies test for “change of intention” in respect of purpose for which property is held in determining whether profits tax is chargeable on disposal of property

In the recent judgment in Church Body of the Hong Kong Sheng Kung Hui and Hong Kong Sheng Kung Hui Foundation (the Church) v Commissioner of Inland Revenue (IRD), FACV 16/2015, the Court of Final Appeal (CFA) dismissed the IRD’s appeal to recover HK$180 million in profits tax from the Church.

The issue was whether the Church had changed their intention from holding their property as a capital asset to holding it for the purpose of trade, and if so, when that occurred. Profits tax under the Inland Revenue Ordinance (IRO) would only be chargeable as from the point in time when that change of intention occurred.

The key point to take away from the case is that where property was originally acquired as a capital investment, the owner can take steps to improve his property, or to engage in activities to enhance the value of it. This in itself might, but would not usually, convert the disposal into an adventure in the nature of trade. However, where on the facts, the steps and activities go beyond the mere realisation of capital, they would be regarded as evidence pointing towards the conclusion that there was a change of intention on the part of the landowner to embark on an adventure in the nature of trade, and may attract profits tax under the IRO.

Facts

Since the 1930’s, the Church had been the owners of a large estate in Tao Po (Old Lots). The Old Lots were acquired and held by the Church, not for the purpose of trading, but for investment or as a capital asset. The Old Lots were agricultural land with restricted building rights. As such, the Church needed to surrender and obtain a re-grant with associated changes to the lease terms on payment of a premium, before the land could be used for substantial residential development.

In the 1970’s, the Church began exploring the possibility of developing the Old Lots. From 1978 to 1989, there were different plans / proposals for the development, with varying degrees of institutional versus residential use of the Old Lots. By September 1989, there was no longer any institutional use in the plan / proposal. In December 1990, the Church’s architect applied for a surrender and re-grant.

In 1993, the Old Lots were surrendered to the Government in return for the New Lot, which could be used for substantial residential development. Shortly after, the Church entered into a joint venture agreement with Cheung Kong to develop the New Lot.

Under the joint venture agreement, the Church became entitled to some residential units and car parking spaces. Some of the properties were then sold and the proceeds were received by the Church. The Church was assessed for profits tax for the years 1998/99 to 2004/05 inclusive in the total sum of HK$180 million.

The main dispute concerned whether there was change of intention at all, and if so, the date when it occurred. This is important because the amount of profits tax payable would vary depending on the time of the change of intention.

The Church contended that there was no change of intention at all, or alternatively, that the change of intention only occurred in 1993 when they accepted Cheung Kong’s tender.

On the other hand, the IRD contended that the Church had changed their intention by September 1989 at the latest, alternatively, December 1990. The IRD contended that as from September 1989, the Church continued to market the Old Lots “in an organised and coherent way with a view to maximising the income from the development”. Alternatively, the intention was changed in December 1990, when the Church’s architect applied for a surrender and re-grant.

Law

Section 14 of the IRO provides that profits tax shall be chargeable on every person carrying on a trade in Hong Kong in respect of his assessable profits. Trade is defined in section 2 as including “every trade and manufacture, and every adventure and concern in the nature of trade.”

It was accepted by the parties that if the property was held as an investment, it would remain as such unless the owner changed his intention to that of trading. There must be evidence which establishes that change of intention. An investment does not turn into trading stock because it is sold.

The CFA held that whether there has been a change of intention is a question of fact and degree. An intention to trade is essential. The relevant time to consider intention is when the relevant asset is sold. If a change of intention is to be relied upon as the basis for a finding of an intention to trade, precision in the fact finding process is required.

Conduct of the taxpayer going beyond what a “non-trader” owner might have done in similar circumstances is such evidence, but if there is no such evidence, it is difficult to imagine a case where a finding of trading or intention to trade could be supported.

Decision

On the facts, the CFA found that the steps and activities taken by the Church were necessary for finding out the potential of the property concerned and ascertaining the maximum value it could fetch. It did not go beyond what a non-trader owner might have done in similar circumstances, and therefore, did not support a finding of a change of intention. The omission of this consideration by the Board of Review robbed the Board’s conclusion of any validity.

Although the CFA upheld the Court of Appeal’s decision, it differed on the reasoning. The Court of Appeal proceeded on the basis of an “enhancement for realisation principle”, namely, that if a change of intention is solely based on activities relating to the enhancement of value of the property, this would amount to an error of law. 

Mr. Justice Fok PJ in the CFA took the view that no such principle exists. Since a finding of an intention to trade must be a matter of fact and degree and depending on the extent of such expenditure, enhancement for realisation, if going beyond what might be expected of a non-trader preparing to sell a long term capital asset, may be sufficient to support a finding of fact that the landowner has formed the intention to sell the land in the course of a trade or business.

Conclusion

The important point to note is that if property was acquired as an investment, it may attract profits tax upon disposal if there has been a change of intention to sell the land in the course of a trade or business. The CFA’s decision provides some assurance that the finding of such a change of intention is not one to be made lightly. Precision is required and the findings must be supported by evidence. Merely enhancing the value of the property for sale might, but would not usually be sufficient, to support a finding of fact that the owner has changed the intention to sell the land as trader. It would depend on whether the activities done went beyond what might be expected of a non-trader, preparing to sell his investment property. Ultimately, a holistic approach taking into account all relevant circumstances would be applied.