Nice Cheer Investment Ltd. v Commissioner of Inland Revenue (CIR) (CACV 135-2011)

On 19 June 2012, In Nice Cheer Investment Ltd. v Commissioner of Inland Revenue (CIR) (CACV 135-2011), the Court of Appeal (CA) dismissed the CIR's appeal and upheld the decision of the Court of First Instance that unrealized gains arising from fair value revaluation of the taxpayer's trading securities are not regarded as "profits" for the purposes of section 14 of the Inland Revenue Ordinance (IRO).


The taxpayer is a Hong Kong incorporated company with investment trading as its principal activity. Under the accounting standards, any unrealized gains or losses arising from change in fair value (i.e. quoted market price) of the trading securities were recognized in its profit and loss account.

In computing the company's assessable profit or allowable losses for the year of assessment, the company treated the unrealized gains as non-taxable, whilst claimed a deduction for the realized losses.

The Commissioner's argument

The commissioner's argued that unrealized gains are profits of the company since profits have been established in accordance with ordinary commercial accounting principles and section 14 of the IRO does not prevent the charging of profit tax in respect of realized gains from revaluation.

The Court's decision

The CA dismissed the commissioner's appeal and held in favour of the taxpayer that the unrealized gains from the revaluation are not taxable.

The CA noted "the fact that the financial statement should reflect the fluctuation in the fair value of these trading ... securities ... did not mean that unrealized gains are "profits" for the purpose of the IRO. There is clearly a difference between what is required by way of accounting standards in a financial statement so that a full picture may be presented on the financial position of the company and what is profit for the purpose of profits tax under the IRO."

The unrealized gains disclosed in the financial statements merely reflect a full picture of the economic performance of a company, and not the tax position. According to the CA, the established principle that profits must be received, accrued or earned but not anticipated is in accordance with the structure and intent of the IRO. To tax the unrealized gains offends the principle that profit must be realized and not anticipated.

On realized losses, the court allowed deduction as the loss from a decrease in market value is an aspect of the cost of an asset, which is actually incurred by the act of purchase (an undertaken transaction), whereas a profit is earned by an act of disposition (which has not yet happen).


The CA decision is clear and well reasoned, the assess ability of profits recognized in the financial statements must be calculated in accordance with the statutory provision of the IRO.

Since unrealized gains are not taxable, the accounting value is no longer the tax cost of the securities. Furthermore, there will be timing difference on unrealized gains and realized gains from disposal. This difference will need to consider for provision for deferred tax in the financial statements.