HONGKONG INTERNATIONAL TERMINALS LTD v. COMMISSIONER OF INLAND REVENUE
15024088g
Wong Mau Shek
Summary of facts[1]
Hutchison Whampoo group (“HW”) had performed a group restructuring in 1994 by selling the terminal and ports assets from HIT Holdings Limited (“HIT”) to a newly subsidiary HONGKONG INTERNATIONAL TERMINALS LTD (taxpayer or “HITL”). The shares of HIT had been transferred to HIT Investment Limited (“HITI”). The total proceeds is USD1,345 million which is financed by a loan made by HIT Finance Ltd (“HITF”), the wholly owned subsidiary of HIT Holdings. HITF issued notes with floating rate (“the Notes”) listed on the Luxembourg Stock Exchange with the amount of USD1,735 million. Paribas Asia Limited (“PAL”) would underwrite the full amount, however, the adverse market conditions led PAL could raise USD 587miilion only. HW instructed PAL to underwrite the full amount and then HW acquired a BVI shelf company Strategic Investments International Limited (“Strategic”) to subscribe the 2/3 Notes amount.
The transaction was summarized as followed:
- PAL paid HITF the Notes with interest at 0.85%+LIBOR and HITF lent the USD1,721million to HITL with interest at 1%+LIBOR
- HITL paid HIT USD1,345million for the consideration of asset acquisition
- HIT paid USD1,255million to HITI as dividend, HITI made the USD1,255million interest fee loan to Strategic
- Strategic paid USD1,148million to PAL to subscribe the loan notes (“Strategic Notes”).
From the above transaction, HW group would obtain the following tax benefit:
- For HITL: Taxpayer claimed the deduction of interest payment according to s.16(1)(a)
- For HITF: The interest expense was deductible since the Notes was listed in Luxembourg stock exchange and s. 16(2)(f) was applied. Hence, only the interest amount derived from the difference between 1%+LIBOR and 0.85%+LIBOR (ie. 0.15%) was subject to Hong Kong tax.
- For Strategic and HIT: The interest income of Strategic Notes was not taxable since the Notes was listed on Luxembourg stock exchange. Moreover, there was no Hong Kong tax exposure for the interest free loan and dividend paid by HIT.
- Since the s.16(2B) and 16(2C) were not yet enacted, only the interest at 0.15% was taxable and the total interest expense (1%+LIBOR) suffered by HITL was deductible. The net tax benefit was 0.85%+LIBOR for HW group.
The potion of HITL’s interest deduction was challenged by CIR since the interest was ultimately pay back to Strategic. CIR raised the following reasons: (1) the tax deduction was not allowed under s16(1)(a) and 17(1) since the loan was not for the purpose of producing profits. (2) The circularity of the movement of funds was not reasonable and the borrowing was an “artificial or fictitious” transaction (3) the transaction was the sole or predominant purpose of enabling that tax benefit to be obtained subject to the challenge of 61A.
Taxpayer made the further appeal to Court of Appeal (COA) subsequently.
Deductible under s.16(1)(a) and s.17(1)?
S.16(1)(a) and s.17(1) emphasize that the expense is deductible only if the expense is for the purpose of producing chargeable profits.
COA rejected CIR’s argument on not allowing the tax deduction of interest expense under s.16 and s.17. The interest payment from taxpayer was related to the loan for financing the acquisition of profit making asset in operation. Since the loan was made for the purpose of producing profits from the targeted assets, the related interest expense was fulfilled s.16(1)(a) and s.17(1) . Also it complied with s16(2)(c) since the interest income received from HITF was also taxable under s.15(1)(f). As a result, the interest payment from taxpayer was deductible under s.16 and s.17.
Argument on s.61
s.61 stated that any transaction reduces the amount of tax payable which is artificial or fictitious, the taxpayer may be involved in fraudulent acts. [2]
In this case, Board of Review (BOR) held there was no real money involved to the extent of USD1,148million due to the circularity of the movement of funds. Hence the transaction was both artificial and fictitious. Taxpayer had appealed to COA. Since the taxpayer’s liability on asset acquisition was real and the Notes was offered to public, COA could not agree the transaction was artificial and fictitious.