The trading activities of charities could fall within the tax net

On 27 January 2010, the Court of First Instance (CFI) handed down its judgment on the Church Body of the Hong Kong Sheng Kung Hui and Hong Kong Sheng Kung Hui Foundation (SKH) v The Commissioner of Inland Revenue (CIR). It confirmed the decision of the Board of Review (BOR) that the profits the SKH derived from a residential development project were taxable.

The SKH are charitable bodies exempt from tax under section 88 of the Inland Revenue Ordinance (IRO). They had owned certain lands (Old Lots) since the 1930s, and part of the Old Lots had been occupied by an orphanage. The SKH planned to redevelop the Old Lots in the 1970s, including using land adjacent to the orphanage as a retirement village for clergy. However, this plan was later shelved and never revived.

In 1990, the SKH obtained town planning permission for a residential development on the Old Lots. In November 1993, the Old Lots were exchanged for a new piece of land (New Lots). The SKH and the Cheung Kong group entered into a joint venture agreement in December 1993, under which the New Lots would be developed into a private residential area (Deerhill Bay).

The CIR raised assessments for 1998/99 to 2004/05, charging tax on the SKH's share of the profits on the sale of Deerhill Bay. The SKH appealed to the BOR and the CFI, but failed on both occasions. They are now appealing to the Court of Appeal.

The two issues in this case were:
1. Whether the SKH carried on a trade in the Deerhill Bay project; and
2. If so, whether the SKH were exempt from tax on the profits so derived under section 88 of the IRO.
The SKH argued that they did not carry on a trade, as the redevelopment was a one-time event to maximise the capital sum they received, in accordance with the duties of their trustees and the objects of the SKH. In particular, the constitutions of the SKH expressed a “desire” to exemplify the teachings of Christ, which infer that the SKH are prevented from entering into trade or business. The Court did not agree. It considered that the existence of such a “desire” did not mean that the SKH were curtailed from carrying on a trade. Whether or not a trade was carried on was a question of fact.

The Court concluded that the SKH had changed their intention to hold the Old Lots for a trading purpose in 1990 at the latest (when their application for redevelopment permission was made) instead of 1993 (when the Old Lots were exchanged and the change of intention became irrevocable).

Even if the SKH were traders in the Deerhill Bay project, they could still be exempt from tax under section 88 if they could prove that the trading profits were applied solely for charitable purposes, and that they were not expended substantially outside Hong Kong. However, the SKH failed to present evidence about how the sale proceeds had been used.

The decision demonstrates that the trading activities of charities could fall within the tax net. To safeguard their exemption status, charities should keep proper records – including accounting records – showing a clear distinction between donation receipts and trading profits, as well as documents to prove the trading proceeds were used in Hong Kong for charitable purpose. Moreover, they should always ensure that their trading or business activities are in line with the objects stated in their constitutional documents or their service objectives.