Nice Cheer claimed the unrealized trading losses as tax deductible and the unrealized gains as non-taxable
CIR v Nice Cheer Investment Limited [CACV 135/2011] – the Court of Appeal upheld that unrealized gains on valuation of trading securities at their market value on balance sheet date are non-taxable
Nice Cheer Investment Limited (NCIL) was trading in securities and the securities were therefore its stock in trade.
During the relevant years, NCIL included in its profit and loss account realized gains or losses on the disposal of securities.
In addition, NCIL also included in its profit and loss account unrealized gains or losses arising from the valuation of its unsold securities at their fair market value on the balance sheet date.
The inclusion of the unrealized gains or losses in this manner was in accordance with the accounting standards SSAP 24 and HKAS 39.
In its tax returns, while claiming the unrealized losses as tax deductible, NCIL excluded the unrealized gains as being non-taxable income.
Not satisfied with the determination by the Commissioner of Inland Revenue (CIR) that the unrealized gains were taxable income, NCIL appealed to the Court of First Instance (CFI).
Decision of the Court of First Instance
The CFI held that the unrealized gains are not chargeable to profits tax on the following basis:
- Profits under section 14(1) of the Inland Revenue Ordinance (IRO) means real profits arising in or derived from actual buying and selling of commodities in commercial transactions between a taxpayer and his trading partners or supply of professional or other services by a taxpayer to another person and do not include notional or unrealized profits arising out of revaluation of a taxpayer’s stock in trade.
- NCIL has done nothing to attract liability to profits tax under section 14(1). It made no trading transactions from which the unrealized profits arose and it could not trade with itself. In respect of the unrealized gains, not only was there no trading between NCIL and a third party, there was no exchange, not even simple transfer by NCIL of the securities from itself in one capacity to itself in another or to its shareholders, directors or employees, or selling them at undervalue. There was a total lack of commercial activity.
Not satisfied with the decision of the CFI, the CIR appealed to the Court of Appeal (CA).