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The case of Nice Cheer has been decided by the Court of Final Appeal in favour of the tax payer.
The Court of Final Appeal held that accounts drawn up in accordance with the ordinary principles of commercial accounting must nevertheless be adjusted for tax purposes if they do not conform to the underlying principle of taxation enunciated by the courts even if these are not expressly stated in the statue. In particular, principles of commercial accounting must give way to the core principles that profits are not taxable until they are realized and that profits must not be anticipated.
This means that unrealized profits are not taxable.
We are of the view that clients can claim under Section 70A to correct prior years’ tax returns, where unrealized gains have been taxed. This question has already been asked in the Legislative Council and in a written reply, the IRD has stated that they will not accept such claims. Presumably that was on the basis of the wording of the proviso to Section 70A, which states that a correction cannot be made if the assessment in prior year was based on the prevailing practice at that time.
However, we have reservation about the IRD’s stance. The reason is that Section 70A only prohibits reopening of prior years on the basis of prevailing practice, but not on an error of law.
In the present case, the Court of Final Appeal has firmly established that unrealized profits are not taxable. That is law, and not practice. Therefore in our opinion, there are strong grounds for making a claim to re-assess back years’ returns.
However, since the IRD has already made public their stance, it is very unlikely that such a claim will be accepted by the IRD itself. This means that the case must at least go to the Board of Review before there can be a resolution.
Be that as it may, as a matter of protection of your own interest, we think that there is no harm to lodge Section 70A claims now and if later it is determined to be not worthwhile, to withdraw the claim, since there is no downside risk to lodging such a claim.
The reason is that there is a time limit to Section 70A claims. It only applies to the previous six years of assessment. At this time, the year of assessment 2007/2008 will no longer be claimable after 31 March this year. Therefore as a tactical move, client should seriously consider lodging Section 70A claims before 31 March of this year.
