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02 November 2011
SOURCE OF AGENCY PROFITS - LI & FUNG (TRADING) LIMITED AND COMMISSIONER OF INLAND REVENUE
The judgment of the Court of First Instance in the case of Li & Fung (Trading) Limited v Commissioner of Inland Revenue was delivered by the Hon Reyes J on 18 April 2011. Reyes J found in favour of the taxpayer, Li & Fung (Trading) Limited (“LFT”). The case concerned the location of the source of LFT’s profits.
LFT had entered into agency agreements with its clients to provide manufacturing-related services that included locating suppliers, arranging for the manufacture of the client’s products, placing orders on behalf of the client, overseeing production and quality control, arranging shipment, dealing with any production issues etc. As remuneration for providing these services, LFT received a commission of 6% of the FOB price of the goods purchased by the client.
LFT entered into agency agreements with its affiliates under which the agents provided the services specified under LFT’s own agency agreement with its clients. LFT paid the affiliates a commission of 4% of the FOB price.
Before the Court of First Instance, Counsel for LFT argued that the Board had been correct in determining that those services directly responsible for earning the said profits had been rendered offshore, either by LFT or by these affiliates acting as LFT’s agents.
At the Board of Review, the Commissioner of Inland Revenue had argued that LFT’s
gross profit was in fact 2% of the FOB price, which represented LFT’s profit
from operating a “supply-chain management business”, the activities of which
were conducted by senior management from Hong Kong. Mr Benjamin Yu SC, counsel for the
Commissioner of Inland Revenue, did not pursue this contention but argued that
the Board of Review should have looked at the totality of LFT’s business activities,
determined which had been undertaken outside Hong Kong and which had been
undertaken in Hong Kong, and then apportioned the assessable profit accordingly.
Reyes J, in finding for the taxpayer, rejected the contention that the Board of Review should have considered the totality of the facts, including the importance of the administrative and management function of LFT in Hong Kong. He concluded that it was pointless to investigate every facet of LFT’s business, the correct approach being to focus only on those activities that directly gave rise to the profit in question. Reyes J was of the opinion that the activities undertaken in Hong Kong were merely incidental or antecedent to those activities undertaken offshore for which the commission was paid.
Reyes J concluded that “there was ample evidence on which the Board could come to the conclusion which it did… For the Board to have embarked on the investigation indicated by Mr Yu would have been to engage in what the CFA described in ING Baring as a “legally irrelevant” exercise. It was not the Board’s function to investigate every facet of LFT’s operations and then decide which matters were qualitatively the most important towards making a profit. What instead had to be done was what the Board actually did. That was to discern in a practical manner those activities of LFT that directly (as opposed to indirectly) led to the production of profits.”
In my view, the Board’s findings and conclusions on the source of LFT’s profits are unassailable. There is no basis for saying that the Board ought to have apportioned the 6% commission in the way Mr Yu suggests. Nor can it be said that the Board acted irrationally or that its conclusions were unsupported by the available evidence.
The Commissioner of Inland Revenue has appealed the judgment to the Court of Appeal.