The ING Baring Case

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ING Baring Securities (Hong Kong) Ltd was part of a subgroup of companies within the Barings group and was involved in the agency brokerage business. It traded securities in global stock markets on behalf of clients of the subgroup. The clients were in Hong Kong and outside Hong Kong.

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The Board of Review did not decide the issue of source and simply held that the taxpayer had not discharged its onus of proving that the determination appealed against was excessive or incorrect. The Court of Final Appeal had to decide whether there was sufficient evidence to hold that the commission income was derived outside Hong Kong.

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The Court of Final Appeal held that the commission income was derived outside Hong Kong. Millet NPJ said the Board of Review was misled by the evidence given and the market jargon employed by the taxpayer's witnesses. Chan PJ held the view that there was just sufficient evidence to draw the conclusion that the commission income was derived outside Hong Kong. Ribeiro PJ recoiled from the idea of a remitter and resolved the source issue by putting weight on the successful execution of clients' orders on foreign stock markets.

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The case confirmed the factual nature of source of profits. While the Court of Final Appeal concluded that the commission income was derived outside Hong Kong, it also confirmed as correct two previous cases relating to commission and rebates earned from overseas securities transactions.

Millet NPJ agreed that the decision in the Kim Eng case was correct because the commission and related income were derived from an arrangement set up in Hong Kong to free transactions from overseas regulations. Ribeiro PJ agreed that the decision in the Wardley case was correct because the rebate commission was derived from the performance of fund management services in Hong Kong.

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The Court of Final Appeal decision in the ING Baring case does not represent a change of law: the law remains that "one looks to see what the taxpayer has done to earn the profit in question and where he has done it". What the decision represents is a particular way of looking at the facts, though limited, in stockbroker cases where the profits in issue arise from commissions or similar incomes.

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All along, the Department has focused on the effective causes or proximate causes, ignoring antecedent or ancillary matters. In the Kwong Mile case, the Court of Final Appeal agreed with the Department that the conclusion of the underwriting agreement in Mainland China was the antecedent or incidental activity. The underwriting agreement would not bring in the profit and what actually earned the profit were the exertions to market the property in Hong Kong. Equally, the Department will neither leave out of sight the initial stages nor fasten the attention exclusively on the final stage in the derivation of the profits. The Court of Final Appeal decision in the ING Baring case should not be read as concentrating on the very last act that produced the profits.

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Some contend that the "totality of facts" approach, approved by Litton VP in the Magna Industrial Case, was rejected by the Court of Final Appeal in the ING Baring case. Such a contention is not correct. It is perfectly proper to use the term "totality of facts" to describe the process of enquiry about source. The final decision will become wrong only if it relies on impermissible factors. In profits tax, the term "totality of facts" should mean no more than having regard to all the relevant factual "operations" of a transaction to decide the locality of the source of profits.

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When examining the business of stockbrokers, Millet NPJ said that it was not necessary to establish that the transaction, which produced the profits, was carried out by the taxpayer or his agent in the full legal sense. It was sufficient if a person acting on his instruction carried out the transaction on his behalf and for his account. Millet NPJ did not say that the act of any person carried out overseas should be readily attributed to a taxpayer in Hong Kong in transactions other than those in securities in an overseas market. He rejected the proposition that "commercial reality" dictated that the source of profits of one member of a group of companies could be ascribed to the activities of another.

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In an import processing arrangement, goods are normally purchased from a subsidiary situated in the Mainland and sold overseas. Some argue that the profits should be assessed on a 50:50 basis on the ground that the goods are manufactured by the subsidiary on behalf of the Hong Kong taxpayer in the Mainland. Such an argument would not be accepted by the Department because of the Court of Final Appeal's rejection that the activities of one member of a group of companies could be ascribed to another member.

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The process of identification of the locality of source of profits may differ, depending on the nature of the transaction in question. The context in which the transaction takes place provides an indication of the source of profits. Bokhary PJ ruled in the Kim Eng case that the "presence and activities in Hong Kong" of a taxpayer is not wholly irrelevant to the question of source though not conclusive.

The Assessor has been given power under section 51(4) to seek full information in regard to any matter which may affect any liability, responsibility or obligation of any person. The information seeking power entrusted to the Assessor under section 51(4) has not been restricted or reduced in any way after the ING Baring case. In most cases, the reasons why the Assessor asks for a piece of information should be apparent. In any event, a taxpayer should be ready to prove in his return, with supporting documentary evidence, that a profit from a transaction was derived outside Hong Kong.

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The Department has expressed to HKICPA its views about the Court of Final Appeal's decision in the ING Baring case. The Department contributed an article on the ING Baring case to APlus in June 2008. The Department has revised Departmental Interpretation and Practice Notes No. 21 on locality of profits to reflect the decision in the ING Baring case and other court decisions.