The Li & Fung (Trading) court case fuels speculation of a change in Hong Kong’s corporate-tax law.
The Inland Revenue Department (IRD) has decided not to appeal against the Court of Appeal’s decision in Li & Fung (Trading) Limited (LFT) to the Court of Final Appeal (CFA). The decision by the CA that the sourcing commission earned by LFT is non-taxable offshore profit in Hong Kong is therefore now final.
Decision does not signal change of tax law
However, the IRD takes the view that, due to the approach adopted by the IRD at the tax tribunal level, namely the Board of Review (BOR), the courts did not have the opportunity to consider the entire facts of the case.
The IRD is apparently of the view that had the courts been given the opportunity to consider the entire facts of the case, their decisions may have been different. Regardless, the IRD considers that the court decisions were based on the facts of the case, and those decisions do not amount to a change of law or the overturning of any judicial precedents. As such, the IRD’s view is that the decisions by the courts may not have wide application to other source cases.
Factors that swayed the court
The significance of the LFT case is that, in upholding the BOR’s decision, the courts firmly rejected that contractual arrangements or commercial relationships with customers were relevant factors in determining the source of the commission income.
Instead, the courts upheld that the relevant rules which determined the source of the income were the place where the underlying sourcing and agency services were performed. Furthermore, the courts also upheld that the underlying services can be performed either by the taxpayer itself, or by its agents, or by someone acting on its instructions.
LFT case takes liberal legal approach
Contrary to what the IRD is apparently prepared to accept, the LFT case indicates that this more liberal approach to attributing the activities of others to a taxpayer in determining the source of commission income under an agency arrangement is of wide application.
Source of profits is nonetheless by its nature a complicated issue and clients should consult their professional tax advisors where appropriate.
LFT was sourcing for overseas customers
LFT acted as a sourcing agent for its overseas customers charging as its commission 6% of the value of goods sourced for the customers from overseas suppliers. Most of the sourcing and agency services were actually performed outside of Hong Kong by the overseas affiliates of LFT on instructions from LFT. LFT paid the overseas affiliates 4% for the services so rendered.
The BOR held that the direct profit-producing transactions generating the commission income were the sourcing and agency services performed outside of Hong Kong by the overseas affiliates and that what LFT did in Hong Kong was merely ancillary or incident activities.
The BOR therefore held that the 2% (i.e., 6% - 4%) net commission earned by LFT was non-taxable offshore income in Hong Kong. The Court of First Instance (CFI) and the Court of Appeal (CA) both upheld the BOR’s decision of the case. Now that the IRD has decided not to appeal against the CA’s decision to the CFA, the CA’s decision is therefore final1.
However, last Friday the IRD indicated on its webpage that, due to the approach adopted by the IRD at the BOR level, the courts did not have the opportunity to consider the entire facts of the case. The IRD is apparently of the view that had the courts been granted the opportunity to consider the entire facts of the case, their decisions may have been different.
1 For more detailed analysis of the decisions of the CFI and CA, please refer to our Hong Kong Tax alert issued on 29 March 2012.