Hong Kong Tax Alert: 14 November 2013
Nice Cheer Investment Limited (NCIL) carried on a business which consisted of trading in marketable securities quoted on the Stock Exchange of Hong Kong.
Before the application of the new accounting standards (i.e., SSAP 24 and HKAS 39), the trading stock of NCIL in the form of marketable securities was valued at the lower of cost and net realizable value on the balance sheet date. This approach mirrored that adopted by traders of goods in general and resulted in unrealized increases in the value of its listed securities during an accounting period not being reflected in its profit and loss account or tax computation.
The relevant new accounting standards however required that securities held for sale at the end of an accounting period had to be valued at their fair market value on the period-end date. Under the new accounting standards, any unrealized revaluation gains or losses had to be credited or debited to the profit and loss account for the relevant accounting period.
Adopting the new accounting standards for the years of assessment 1999/2000 to 2005/06, NCIL duly recorded in its profit and loss accounts for the relevant years not only profits or losses which it had realized by the sale or disposal of its listed securities, but also unrealized gains and losses arising from the revaluation of its listed securities held at the end of the relevant years.
In its tax returns for the relevant years, NCIL excluded the unrealized gains from assessment but claimed deductions for the unrealized losses.
The Commissioner of Inland Revenue (CIR) however determined that both the unrealized gains and losses arising from revaluing the listed securities held at the year end should be included in NCIL profits tax computations.
The differential between the profits tax thus assessed over the years and that calculated by NCIL without taking into account the unrealized gains was very substantial, being in the region of HK$250 million.
NCIL appealed against the CIR’s determination directly to the Courts, bypassing the Board of Review. The lower Courts decided the case in favor of NCIL. The CIR then appealed to the Court of Final Appeal (CFA).