In Moulin Global Eyecare Trading Limited (in liquidation) v The Commissioner of Inland Revenue, FACV 5/2013, the Court of Final Appeal held that the guilty knowledge of the fraudulent directors should be attributed to the company in a claim by the liquidators under  section 64 or 70A of the Inland Revenue Ordinance to claim a refund of profits taxes paid.

Background

The profits of Moulin Global Eyecare Trading Limited (“MGET”) had been fraudulently inflated over the tax years 1998/1999 to 2003/2004 by its then management.  Assessments of profits tax were made pursuant to the returns prepared based on such inflated profits and were therefore excessive.  MGET was wound up on 5 June 2006.  The liquidators claimed a refund of the profits taxes paid under sections 64 and 70A of the Inland Revenue Ordinance (Cap. 112) (“IRO”).

Under section 64(1)(a) of the IRO, a taxpayer has 1 month after the date of the assessment to give notice of objection thereto with the possibility of an extension, if the Commissioner of Inland Revenue is satisfied that owing to some reasonable cause the taxpayer was prevented from giving the said notice within the 1-month period.

Under section 70A, a taxpayer may obtain tax repayment if, upon application made within 6 years after the end of a year of assessment, it is established to the satisfaction of an assessor that the tax charged for that year of assessment is excessive by reason of an error or omission in any return or statement submitted in respect thereof.

The Commissioner of Inland Revenue rejected the claims of the liquidators.  The liquidators applied for judicial review where Justice Reyes decided in favour of the liquidators and ordered the Commissioner to reconsider her decisions.  The Court of Appeal allowed the Commissioner’s appeal and set aside Justice Reyes’s orders.  In essence, the Court of Appeal decided that the fraudulent knowledge of MGET’s management that the profits had been inflated should be attributed to MGET such that MGET had not been prevented from giving notice of objection within time nor was there any error within the meaning of s 70A.  The Court of Final Appeal granted leave to appeal so that the law relating to attribution could be considered.

Attribution of Knowledge

Rules of Attribution

Since a company is an entity existent solely because of legal creation, the conduct or state of mind of one or more natural persons is to be attributed as that of the company for the purpose of determining the company’s legal liability or rights in civil proceedings.  The Court of Final Appeal in the present case took the opportunity to discuss the rules and exceptions on such attribution.

The Court of Final Appeal endorsed the tripartite classification of rules of attribution in Meridian Global Funds Management Asia Limited v Securities Commission [1995] 2 AC 500 (“Meridian”).  First, primary rules of attribution are to be derived from company law statutes and the articles of association of the company concerned.  Second, there are general rules of attribution which are equally available to natural persons, namely, the principles of agency.  And third, special rules of attribution are to be fashioned by the court by determining the intention of the legislature from the statutory language, purpose and context.

The Fraud Exception

On the other hand, previous authorities show that the fraudulent state of mind of directors and employees will in certain cases not be attributed to the corporate employer.  This is to avoid the injustice and absurdity of directors or employees relying on their own awareness of their own wrongdoing as a defence to a claim against them by their own corporate employer (“redress” category).  But the exception does not apply to protect a company where the issue is whether the company is liable to a third party for the dishonest conduct of a director or employee (“liability” category).

Attribution in the Present Case

In the present case, by applying the primary rules of attribution, the fraudulent directors should be the obvious persons whose knowledge should be attributed to MGET, unless the fraud exception applies to exclude such attribution.

The liquidators’ claim against the Commissioner of Inland Revenue was held less capable of fitting comfortably into either of the “liability” and “redress” categories, after the Court of Final Appeal considered the Commissioner’s role and responsibilities.  The Commissioner is not the accomplice of a fraudster.  The Commissioner is a third party from whom a corporate employer hopes to recoup, indirectly, part of a loss that it has suffered as the result of a director’s or employee’s misconduct.  But the Commissioner cannot be expected to make inquiries about a taxpayer’s business in such a way as to become well acquainted with it.  Furthermore, the Commissioner’s functions, powers and obligations are to be found wholly in the sphere of public law, and in particular in the IRO.  An essential part of the scheme of the IRO is that the Commissioner should be able to make assessments on the basis of the taxpayer’s returns.  It would frustrate this statutory purpose if the fraud exception were to intrude into this scheme.

The liquidators cannot therefore rely on the proviso to section 64(1) of the IRO, because MGET was not prevented from lodging an objection within time; it chose not to do so.  Nor can the liquidators rely on section 70A, because MGET must be taken as having known that its returns were false, and a deliberate lie is not an “error” for the purposes of that section.

Interpretation of Sections 64 and 70A

Further to the above analysis on attribution, the Court of Final Appeal held that sections 64 and 70A of the IRO would not be applicable in the present case.

The Court of Final Appeal noted in Monro v HMRC [2009] Ch 69 that the state has a legitimate interest in ensuring finality in fiscal transactions.  Against this underlying policy, the Court of Final Appeal held that the legislature regarded it as inconceivable that a reasonable extension of the short period of 1 month under section 64 of the IRO could ever amount to years.  Further, there must be a clear causal connection between the reasonable cause and the prevention.  Even in the absence of attribution to MGET of the guilty knowledge of the fraudulent directors, the Court of Final Appeal found it difficult to regard MGET as having been “hijacked” and quoted Lord Hoffmann in Meridian that “There is in fact no such thing as the company as such, no ding an sich, only the applicable rules”.

For section 70A, it was held that its scope is restricted by the need for an error in a return or an accompanying statement.  Even if the guilty knowledge of the fraudulent directors is not attributed to MGET, the Court of Final Appeal found it difficult to view the proposed substitution of an entirely new return and set of statements, as correction of a specific error; everything would have to be rewritten.

Conclusion

The Court of Final Appeal authoritatively decided against the application of the fraud exception in a claim for refund of excessive taxes paid because of inflated profits caused to be reported by fraudulent directors.  In recouping the excessive profits taxes paid in such circumstances, the liquidators could not claim against the Commissioner of Inland Revenue; but they could possibly claim against the auditors (in negligence) apart from the fraudulent directors themselves (in breach of service contract, breach of fiduciary duty and/or deceit).

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Important: The law and procedure on this subject are very specialised and complicated. This article is just a very general outline for reference and cannot be relied upon as legal advice in any individual case. If any advice or assistance is needed, please contact our solicitors.

Published by ONC Lawyers © 2014