In the recent case of Moulin Global Eyecare Trading Limited (in liquidation) v The Commissioner of Inland Revenue FACV 5/2013, the Hong Kong Court of Final Appeal provided welcome clarification on whether the fraudulent knowledge of directors can be attributed to a company.
The majority of the Court of Final Appeal upheld the Court of Appeal’s decision and ruled that the fraudulent knowledge of Moulin Global Eyecare Trading Limited’s former directors regarding inflation of profits should be attributed to the company. Accordingly, the fraud exception did not apply and the liquidators of the company could not rely on provisions of the Inland Revenue Ordinance to claim repayment of excess tax payments made to the Inland Revenue.
The former directors of Moulin Global Eyecare Trading Limited (the “Company”) fraudulently inflated the profits of the Company and paid almost HK$89 million in inflated profits tax to the Inland Revenue. When the Company was subsequently wound up, and provisional liquidators appointed, the liquidators attempted to reclaim the tax paid on the basis that the Company had not made any taxable profits in the relevant years.
The liquidators applied for:
- An extension of time for objecting to the Inland Revenue’s tax assessments under section 64(1)(a) of the Inland Revenue Ordinance (“IRO”); and
- Correction by the Commissioner of Inland Revenue (the “Commissioner”) of the tax assessment under section 70A of the IRO by reason of an error in the tax return submitted.
The Commissioner rejected these applications and resisted any repayment of excess tax paid.
The question for the Hong Kong courts was whether the Company should be attributed with the former directors’ knowledge of the fraudulent profits when it filed the tax returns, or whether the fraud exception applies to exclude such attribution. At first instance, the Court of First Instance decided in favour of the liquidators and remitted the matter to the Commissioner. On the Commissioner’s appeal, the Court of Appeal reversed the Court of First Instance’s decision and held that the relevant knowledge should be attributed to the Company. The Liquidators appealed that decision to the Court of Final Appeal.
In a majority judgment of the Court of Final Appeal delivered by Lord Walker of Gestingthorpe NPJ, the Court restated the law of attribution and the limits of the fraud exception by reference to the recent English Court of Appeal decision Bilta (UK) Ltd v Nazir  1 All ER 168. The Court of Final Appeal held that context is crucial, such that questions of attribution are always sensitive to the factual and statutory background and the nature of the proceedings in which they arise. In applying Bilta and considering previous case authorities, the Court drew a distinction between:
- ‘Redress’ cases, where a company takes action against its directors and employees for wrongdoings causing loss to the company, in which case the fraud exception applies and knowledge is not attributable as it would be “absurd and unjust to permit a fraudulent director or employee to be able to use his own serious breach of duty to his corporate employer as a defence“; and
- ‘Liability’ cases, where the issue is whether the company is liable to a third party for the fraudulent conduct of a director or employee, in which case the fraud exception will not apply, on the basis that the company must take responsibility for such fraudulent conduct even if it is in some sense a victim.
In the present case, the Court of Final Appeal found that the liquidator’s claim did not fit comfortably into either category. The Commissioner was not itself an accomplice to a fraudster and, if the fraud exception was to apply, it would frustrate the statutory purpose of the IRO, which was to allow the Commissioner to be able to make assessments on the basis of the returns submitted. Further, the Court of Final Appeal confirmed that the proper role of the fraud exception is a limited one; to bar an unmeritorious defense in claims by corporate employers against dishonest directors or employees, or accomplices who have conspired with them.
Accordingly, in dismissing the liquidators’ appeal the Court of Final Appeal held that the knowledge of the directors of their fraudulent inflation of profits should be attributed to the Company and that the liquidators could not then rely on either:
- Section 64(1)(a) of the IRO, because the Company was not prevented from lodging an objection in time, it chose not to do so; or
- Section 70A of the IRO, as the Company must be taken to have known that its returns were false and a deliberate lie was not an “error” for the purposes of that section.
Mr Justice Tang PJ dissented on the issue of attribution, finding that section 70A was applicable. His view was that justice and common sense should prevent the directors’ knowledge from being attributed to the Company, if the liquidators could prove that the profits had indeed been inflated and that the Company had paid more tax than was properly chargeable.
The decision of the Court of Final Appeal provides helpful clarification of the law of attribution and the limits of the fraud exception. It also has wide implications for companies which, even in liquidation, will have to bear the consequences of the fraudulent actions of their directors and employees in cases involving attempts to recover tax paid on the basis of false profits or liability of the company against a third party.