INLAND REVENUE BOARD OF REVIEW DECISIONS
Case No. D'70/90
Profits tax - claimed expenses - whether income or capital - whether
application of taxable profits.
Panel: Robert Wei QC (chairman), Frank Pong Fai and Andrew W a g Wei Hung-
Date of hearing: 30 November 1 9 .
Date of decision: 1 February 1 9 .
The taxpayer claimed that certain repayments of unsecured loan
capital or transfers of shareholder's funds or reserves should be
deducted in computing the assessable profits of the business. The
assessor disallowed the payments because they were of a capital nature.
The taxpayer appealed to the Board of Review.
The payments were of a capital nature and therefore not deductible.
Alternatively the payments were the application of profits and not
expenses incurred in earning profits.
Cases referred to:
CIR v Lo & Lo (CA) [l9821 HKLR 503
CIR v Lo & Lo (PC) 2 HKTC 34
Mersey Docks and Harbour Board v Lucas 2 TC 25
Chiu Kwok Kit for the Commissioner of Inland Revenue.
Taxpayer represented by a Mr Y.
This is an appeal by the Taxpayer trading as X Company against
the determination of the Deputy Commissioner of Inland Revenue dated
12 September 1 8 confirming the profits tax assessments raised on her
for the years of assessment 1 8 1 7 and 1 8 1 8 on the grounds that
certain sums claimed to be repayments of unsecured loan capital or
alternatively transfers to shareholders funds/reserves should be deducted
in computing the assessable profits.
2. The Taxpayer did not appear at the hearing, but was represented
by a Mr Y. No witness was called. The documents produced by Mr Chiu,
the Commissioner's representative, were not in dispute. The primary
facts, so far as material to this decision, are as follows:
INLAND REVENUE BOARD OF REVIEW DECISIONS
(a) The Taxpayer commenced business in February 1985 as a sole
proprietress and carried on the business until it ceased in
February 1 8 . In her profits tax returns, the business was
described as 'trading and design service'.
(b) Annual accounts were filed together with profits tax returns
for the three years of assessment 1985186, 1986187 and 1 8 1 8
None of the balance sheets contains any item for capital as
such. Instead there is an item 'Loans (unsecured) and
obligations amounting to $85,108.16 in the balance sheet as at
the end of the year 1985186, and $ 2 0 0 in the balance sheet
as at the end of the year 1 8 1 7 . On the other hand, the
profit and loss account for 1 8 1 7 shows a deduction of
$24,422.47 described as 'Repayments of unsecured loan capital'
while that for 1987188 shows a deduction of $ 8 0 0 described
as 'Repayment of capital of unsecured loans'.
(c) The profits tax return for 1985186 disclosed an adjusted loss
of $28,329 which was accepted by the assessor. As for 1 8 1 7
and 1 8 1 8 the profits were assessed in the sums of $56,231
and $122,627 respectively.
(d) Subsequently in her correspondence with the Commissioner of
Inland Revenue, the Taxpayer revised her profit and loss
accounts for 1 8 / 7 and 1 8 1 8 by describing the deduction of
$24,422.47 and that of $68,000 as sums 'transferred to
(e) The Taxpayer explained the revision in her letter to the
Commissioner of Inland Revenue dated 2 June 1 8 in the
In answer to this aspect it is obvious I received the
funds (loans), that is the principal from the
shareholders, otherwise I could not have commenced my
business. I have not treated the transfer of funds
(loans) as expenses, but as a reserve fund (loan) to meet
liabilities incurred in setting up my business. The funds
raised therefore are or equate to a share value or
shareholders fund, which was required as a reserve in
order to commence my business.'
(f) In her notice of appeal, the Taxpayer stated that the loans
were not repaid and that the capital was not withdrawn but held
in reserve. The sums reserved, she stated, were equal to the
original 'principal' put into the business to enable her to
commence; without this original 'principal' there could have
been no production of profits.
3 The assessor disallowed the two deductions; the Taxpayer
contends that he was wrong.
INLAND REVENUE BOARD O REVIEW DECISIONS
4. The a u t h o r i t y f o r making deductions i s s e c t i o n 1 6 ( 1 ) of t h e
Inland Revenue Ordinance, which was paraphrased by Leonard VP i n C I R v -
Lo & Lo (CA) [l9821 HKLR 503 a t 509 a s follows:
'In order to a s c e r t a i n t h e taxable p r o f i t s you s h a l l deduct from
t h e t o t a l of r e c e i p t s and sums deemed t o be r e c e i p t s all
outgoings and expenses t o t h e e x t e n t t o which they a r e incurred
in t h e production of such p r o f i t s . '
In t h e same case Lord Brightman observed i n t h e Privy Council ( 2 H T 34
a t 71) :
'Sections 16 and 17 provide exhaustively f o r deductions i n t h e
sense t h a t permitted deductions a r e confined t o outgoings and
expenses incurred i n t h e production of p r o f i t s i n respect of
which t a x i s chargeable; t h a t such permitted deductions
expressly include those s p e c i f i e d i n ( a ) t o (h) of section
16(1), and expressly exclude those i n s e c t i o n 17. '
Furthermore, i n t h e Court of Appeal it was held t h a t an expense was
incurred because it was assumed; t h a t t h e f a c t t h a t t h e l i a b i l i t y was
contingent did not prevent t h e expense from being 'incurred' (per Leonard
V-P a t 509); t h a t t h e word 'incurred' 'includes t h e acceptance of a
l i a b i l i t y a s well a s t h e meeting of t h a t l i a b i l i t y a s and when it
matures' (per Cons, J A a t 511). Section 1 7 ( l ) ( c ) expressly excludes from
deduction l o s s o r withdrawal of c a p i t a l and expenditure of a c a p i t a l
4.1 Withdrawal of capital. and expenditure of a c a p i t a l nature
I n so f a r a s t h e two claimed deductions a r e 'repayment of
c a p i t a l ' , w think they f a l l within t h e meaning of 'withdrawal
of c a p i t a l ' and t h e r e f o r e a r e not deductible. I n so f a r a s
they a r e sums ' t r a n s f e r r e d t o shareholders funds/reserves ' ,
they a r e expenditure (not including a c t u a l payment) of a
c a p i t a l nature and t h e r e f o r e a l s o not deductible.
Alternatively, we t a k e t h e view t h a t repayment of c a p i t a l and
t r a n s f e r t o shareholders funds/reserves a r e merely instances of
applying t h e p r o f i t s a f t e r they have been produced r a t h e r than
outgoings o r expenses incurred i n producing them. e
support f o r t h i s view i n Mersey Docks and Harbour Board v Lucas
2 TC 25, c i t e d by M r Chiu. I n t h a t case a harbour board w sa
empowered by Act of Parliament t o levy dock dues, e t c , t o be
applied i n maintaining t h e concern, and i n paying i n t e r e s t on
moneys borrowed; any surplus income remaining a f t e r meeting
t h e s e charges was d i r e c t e d t o be applied i n forming a sinking
fund to extinguish t h e debt incurred i n t h e construction of t h e
docks, It was held t h a t t h e surplus was p r o f i t assessable t o
income tax. Lord Selborne LC s a i d a t page 28:
INLAND REVENUE BOARD O REVIEW DECISIONS
'The t a x is t o be charged upon t h e p r o f i t s
be charged "on t h e amount of t h e produce o r value
... and it i s t o
thereof". What i s "thereof"? Of t h e concern which t h e
corporation c a r r i e s on. If we had nothing more than that,
I should have thought t h a t we were t o consider not t h e
a p p l i c a t i o n of t h e moneys which t h e Mersey Board received
when they had received them, but t h e " p r o f i t s of t h e
concern" i n t h e sense of t h e "produce or value" which
could properly be described as " p r o f i t s of t h e concern",
and that s u r e l v could be all t h e n e t ~ r o c e e d s of t h e
concern a f t e r deducting t h e necessary outgoings without
which those proceeds could not be earned o r received. But
... t h e ~ c tdoes not s t o p there, it goes on and says t h a t
t h i s charge i s t o apply "before paying, rendering, o r
d i s t r i b u t i n g t h e produce o r t h e value e i t h e r between t h e
d i f f e r e n t persons o r members of t h e corporation, company,
o r s o c i e t y engaged i n t h e concern" ... "or t o any c r e d i t o r
o r o t h e r person whatever having a claim on o r o u t of t h e
said profits" ... y
To m mind it i s exactly t h e same thing
as if t h e r e had been a d e c l a r a t i o n t h a t , a f t e r paying t h e
current expenses and all o t h e r necessary outgoings,
without which nothing could be earned, t h e c l e a r surplus
p r o f i t s and gains of t h e undertaking should be applied i n
a c e r t a i n manner, t h a t i s t h e substance of it. The mode
of t h e a p p l i c a t i o n makes no d i f f e r e n c e whatever t o t h e
question of what i s "profitt' and what is "gain".'
Lord Blackburn s a i d a t page 33:
'There i s nothing i n t h e nature of things, t h e r e i s nothing
i n t h e words of t h e Act, t o say t h a t when an income has
been a c t u a l l y earned, when an a c t u a l p r o f i t upon which t h e
t a x i s put has been earned and received by any person o r
corporation, Her Majesty's r i g h t t o be paid t h e t a x out of
it i n t h e least degree depends upon what they a r e t o do
with it afterwards, unless t h e r e is an express enactment,
which I t h i n k t h e r e i s i n some cases, t h a t they a r e t o
apply it t o c h a r i t i e s o r o t h e r purposes. I f t h e amount
t h u s received i s t o be applied a t t h e i r pleasure, they
must pay t h e tax. I f it i s t o be paid over t o
shareholders o r t o c r e d i t o r s , o r t o anybody else, t h e
Queen is s t i l l t o have her tax. '
The words underlined by u s i n t h e above c i t e d passages show t h a t
instances of a p p l i c a t i o n of p r o f i t s , such as payments t o c r e d i t o r s are
not deductible whether t h e r e i s express l e g i s l a t i o n t o exclude them o r
not. The United Kingdom l a w and t h e Hong Kong l a w d i f f e r i n scope i n
t h a t t h e UK deductions a r e confined t o expenditure necessary t o earn t h e
receipts, while i n Hong Kong they a r e expenditure 'incurred' i n t h e
production of p r o f i t s , which i s considered t o be wider in scope
(~rofessor Willoughby's Hong Kong Revenue Law, v01 2, 2-241). However,
t h i s difference, notwithstanding t h e d i s t i n c t i o n drawn i n Mersey Docks
INLAM) REVENUE BOARD OF REVIEW DECISIONS
and Harbour Board v Lucas between ascertainment of profits and
application of ascertained profits, is in our view equally applicable in
5 For all these reasons, we are of the view that the two claimed
deductions were rightly disallowed.
6. With regard to the adjusted loss of $28,329 for 1985/86, the
Deputy Commissioner's determination is in the following terms:
'The Taxpayer elected to be personally assessed under part V11
of the Inland Revenue Ordinance for the year of assessment
1985186 and her loss of $28,329 should be deducted from her
total income in her personal assessment for the same year. As
a result, no loss was available in accordance with section
lg~(1) of the Inland Revenue Ordinance for set off against the
amount of her assessable profits from the business for the year
of assessment 1 8 / 7 '
In her notice of appeal the Taxpayer alleged that she was forced by
intimidation to elect to be personally assessed and was 'bombarded' with
forms requesting her to opt for personal assessment. These are serious
allegations and call for the clearest evidence before they can be
established. Since the Taxpayer chose not to give any evidence, the
allegations fail and the election must be taken to be valid and
effective. Mr Chiu while categorically denying the allegations, stated
that the Taxpayer was welcome to withdraw her personal assessment if she
so wished. However, Mr Y was not ready to take up the offer; he had to
seek advice. Therefore, so far as this appeal is concerned, the personal
assessment is in force, and there is nothing we can fault in the words of
the Deputy Commissioner quoted at the beginning of this paragraph.
' It follows that this appeal is dismissed and that the profits
tax assessments for the years of assessment 1 8 / 7 and 1 8 / 8 are