Tax case and argument point - Li & Fung (Trading) Ltd

In Li & Fung (Trading) Limited (LFT) v Commissioner of Inland Revenue (CIR) [HCIA 3/2010], the Court of First Instance upheld the Board of Review’s decision, finding in favour of LFT that the source of commission income were offshore and so not chargeable to profits. Background The taxpayer, LFT, a member of the Li & Fung Group, provides sourcing services to its customers in connection with the manufacture, sale and purchase of goods. Such services include locating suppliers, arranging manufacturing and then sell goods to LFT’s customers. LFT monitors the suppliers’ production schedule and to ensure satisfactory goods are supplied to its customers. In most cases, LFT’s services are provided outside Hong Kong through local offices, and they were affiliates of LFT. LFT engaged these local affiliates in performing the services which LFT has contracted to provide to its customers. Upon delivery of the finished goods to its customers, LFT is usually paid a commission of 6% of the total FOB value of the customer’s export sales and paid the affiliates 4% of the total FOB value of the customer’s export sales for their services. Issues Whether LFT’s profit relating to goods sourced from suppliers located in places other than Hong Kong were offshore and hence not chargeable to Hong Kong profits tax? The Commissioner’s argument The Commissioner suggested that LFT operated a “supply-chain management business” and argued that LFT’s profit was the difference between the 6% which it received from its customers and the 4% which it paid to its affiliates, and argued that the management supervises its overseas activities and its affiliates from LFT’s Hong Kong headquarters. In consequence, such commission were related to services rendered in Hong Kong and should be apportioned on the basis that activities were carried out both in Hong Kong and overseas. The Board of review decision The Board rejected the Commissioner argument and held that LFT sold services for commission, where the activities were carried out through their overseas affiliates. The affiliates companies (acting on behalf on LFT), render the services to LFT customers. The affiliates companies assisted LFT’s customers in placing orders with offshore sellers, supervised the manufacturer to the specifications of LFT’s customers, and arranged for the shipment of the finished goods to LFT’s customers. It was these activities that directly led to the payment of a gross commission, and these activities took place outside Hong Kong. Without those activities, no commission of 6% could have been earned. The Court’s decision The Court noted that it was true that LFT maintained back-up or support services for its affiliates at its Hong Kong headquarters. But the Board was entitled to disregard the antecedent activities which although they were commercially essential to the operations and profitability of the taxpayer s business, these activities do not provide the legal test for ascertaining the geographical source of profits. Conclusion The Court’s decision reiterates the approach that to determine the source of income, one must first identify the transaction which directly gives rise to the profit. If that transaction takes place in Hong Kong, then the profit generated may be charged with profits tax under IRO s.14. Otherwise, the transaction will have taken place offshore and profits tax will not be chargeable. The latter will be the result even though a taxpayer is present or normally resident in Hong Kong at the time when the transaction takes place. In a case like the present, to determine the source of a profit one must first identify the transaction which gives rise to the profits and not by where the taxpayer’s business is administered or where commercial decision is being taken. Disclaimer: The publication contains information in summary form and is therefore intended for general guidance only. This publication is not intended as legal, accounting or other professional advice and should not be relied upon as such. If legal, accounting or other professional advice or expert assistance is required, the services of a competent professional should be sought. Neither Reanda Lau & Au Yeung nor any related entity shall have any liability to any person or entity that relies on the information contained in this publication.