Global Tax Alert | 18 November 2013

Hong Kong Court of Final Appeal rules unrealized revaluation gains on listed securities held for sale as nontaxable

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Executive summary

In a judgment of the Nice Cheer Investment Limited (NCIL)1 case, Hong Kong's Court of Final Appeal (CFA) ruled that year-end unrealized revaluation gains on listed securities held for sale were not taxable in Hong Kong while the deductibility of unrealized losses may in some instances still be unclear. This Alert highlights the Decision of the CFA.

Detailed discussion


NCIL carried on a business of trading in marketable securities quoted on the Stock Exchange of Hong Kong.

During the relevant years, NCIL duly recorded in its profit and loss accounts 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 on the balance sheet date.

The inclusion of the unrealized gains or losses in this manner was in accordance with Hong Kong's accounting standards.

In NCIL's tax returns for the relevant years, the unrealized gains were excluded as being nontaxable income but the unrealized losses were claimed as tax deductible.

The Commissioner of Inland Revenue (CIR) determined that both the unrealized gains and losses arising from revaluing the listed securities held at the year-end should be included in NCIL's profits tax computations. NCIL appealed to the lower courts which decided in favor of NCIL. The CIR then appealed to the CFA.

Decision of the Court of Final Appeal

The CFA held that the unrealized gains on the revaluation of listed securities held for sale on the relevant year-end date as reflected in the accounts of NCIL were not taxable in Hong Kong.

The judge of the CFA rejected the CIR's reliance on the Spanish Prospecting2 case as supporting the CIR's argument that unrealized profits were nonetheless taxable profits under the Inland Revenue Ordinance (IRO), based on the two cardinal principles of tax law as established by a long series of tax cases, namely that for income tax purposes: (i) the word “profits” connotes actual or realized and not potential or anticipated profits; and (ii) neither profits nor losses may be anticipated.

The CIR presented the second position that the amount of any profits or losses during the year of assessment must be ascertained by reference to the ordinary principles of commercial accounting unless these are contrary to an express statutory provision in the IRO, relying on the decision of the CFA in December 2000 in the Secan case.3

In response, the CFA concluded that the principles of commercial accounting must be adjusted to conform to the underlying principles of taxation, in particular profits are not taxable until they are realized and that profits must not be anticipated.

Further, the CFA reasoned in the judgment why the unrealized revaluation losses of trading stock are generally deductible; whereas unrealized gains are not taxable. Under the new accounting standards, securities held for sale at the end of an accounting period must be valued at fair market value (FMV). The CFA concluded that any decrease in FMV to be recorded as a loss would have to be material and likely to be permanent. Otherwise, auditors would not normally allow such a treatment. However, such a provision can be challenged by the Commissioner.


The CFA's reaffirming the two cardinal principles of tax law is welcome.

Companies should however note that it appears that only if the diminishing in value of trading stock is material and permanent in nature would it qualify for a tax deduction, but it may be subject to the Inland Revenue Department's challenge.


1. Nice Cheer Investment Limited FACV 23/2012.

2. Re Spanish Prospecting Co Ltd [1911] 1 Ch 92 CA.

3. Commissioner of Inland Revenue v Secan Limited (2000) 3 HKCFAR 411.

For additional information with respect to this Alert, please contact the following:

Ernst & Young Tax Services Limited, Hong Kong
  • Tracy Ho
    +852 2846 9065
Ernst & Young LLP, Hong Kong Desk, New York
  • Connie Chan
    +1 212 773 2661
Ernst & Young LLP, Asia Pacific Business Group, New York
  • Chris Finnerty
    +1 212 773 7479
  • Jeff Hongo
    +1 212 773 6143
  • Kaz Parsch
    +1 212 773 7201
  • Bee-Khun Yap
    +1 212 773 1816

EYG no. CM3972