Court applies “principle of agency” in determining source of profit

In a recent judgment, the Court of Appeal (CA) overturned a decision of the Court of First Instance (CFI) and the Board of Review (BOR). The CA ruled that the CFI and the BOR made an error of law for failing to recognize the role played by an agent outside Hong Kong in the sub-licensing arrangements (with the master license being obtained in Hong Kong) in determining that the royalty income was wholly sourced in Hong Kong.

The CA however upheld the decision of the BOR and CFI that a contractual lump-sum payment received by the taxpayer was a taxable revenue item sourced in Hong Kong.

While the CA remitted the case to the BOR to reconsider the source issue based on its ruling of the “principle of agency” and the implications of the TVBI case, the CA indicates that, based on the facts of the case, the source of the royalty income should be substantially offshore.

Depending on whether the Revenue would appeal against the CA’s decision on the remitter, this CA’s decision could open the door for an apportionment of at least royalty income derived from sub-licensing arrangements. Such an apportionment is apparently not currently envisaged by the practice notes issued by the Inland Revenue Department (IRD).

This alert discusses the issues involved in the case. Clients who wish to explore how the CA’s decision could impact their existing or potential future offshore claims can contact their tax executives.