8 January 2007
In the case of the Commissioner of Inland Revenue v Franco Tong Sui Lun HCIA 2/2006, an employee was required to indemnify his employer whenever a client which he had introduced failed to honour debts due to the employer. The High Court decided that the indemnity payments deducted from the employee's remuneration were not deductible for the assessment of salaries tax because they were not expenses "wholly, exclusively and necessarily incurred" in the production of his assessable income.
Mr Franco Tong was employed as a dealer's representative by stockbrokers Kingsway SQ Securities Limited. Mr Tong's remuneration consisted of a basic monthly salary of $10,000 plus a commission. Mr Tong was required to indemnify Kingsway whenever a client which he had introduced failed to honour debts to Kingsway. Following a number of clients failing to pay Kingsway, Mr Tong entered into 3 Indemnity Agreements with Kingsway. Such Indemnity Agreements provided that the amount of loss suffered by Kingsway should be deducted from Mr Tong's future remuneration.
The Revenue assessed Mr Tong on an estimated basis of $1,676,225 for 2000/2001 with a payable tax of $251,433 and $1,673,321 for 2001/2002 with a payable tax of $250,998.
Mr Tong objected to the above assessments. For 2000/2001, Mr Tong agreed that his income was $1,676,225 but claimed an identical deduction (i.e. $1,676,225) in respect of the payments under the 3 Indemnity Agreements. His net income was therefore, he claimed, nil. For 2001/2002, Mr Tong sought to have a further sum of $866,726 deducted from his annual income in respect of payments under the 3 Indemnity Agreements.
The Revenue refused to accept that the Indemnity Agreements payments were deductible. Mr Tong therefore requested a review of his tax liability.
The Board of Review considered section 12(1)(a) of the Inland Revenue Ordinance, which provides that "all outgoings and expenses... wholly, exclusively and necessarily incurred in the production of the assessable income..." shall be deducted for the purpose of ascertaining the net assessable income of a person.
The Board held that the deduction from Mr Tong's remuneration due to the Indemnity Agreements payments were necessarily incurred in the production of Mr Tong's assessable income. The Board took into account that Mr Tong earned a high level of commission because he took the risk that his clients would not pay their outstanding accounts and he would have to indemnify Kingsway for his client's failures.
The Commissioner for Inland Revenue appealed.
The Appeal To High Court
The High Court decided in favour of the Commissioner and held that Mr Tong's payments under the Indemnity Agreements are not deductible from his assessable income because they do not exactly fulfil the requirements of section 12(1).
Although the payments under the Indemnity Agreements are referable to Mr Tong's earning of salary (and its computation), the High Court decided that they are Mr Tong's personal contractual obligations to Kingsway. Such payments are therefore not wholly, exclusively and necessarily incurred in Mr Tong's performance of duty and are not deductible from assessing Mr Tong's salaries tax liability.
The appeal decision would appear to be correct. However, it is interesting to note that the question of the legality (under section 32 of the Employment Ordinance) of the Indemnity Agreement deductions from wages was never raised.
For further information, please contact:
Name: Duncan A. W. Abate
Position: Partner, Head of Employment and Employee Benefits Group
Phone: +852 2843 2203
Fax: +852 2103 5066
Name: Hong Tran
Position: Senior Associate
Phone: +852 2843 4233
Fax: +852 2103 5070