Court of Appeal decides on the constitutionality of Section 4C of the Income Tax Act 1967

The Court of Appeal had the opportunity of determining whether Section 4C of the Income Tax Act 1967 (“the Act”) (and the corresponding Section 24(1)(aa) of the Act) is constitutional in the recent case of Wiramuda (M) Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri (Civil Appeal W-01(A)-513-10/2020).

In short, the Court of Appeal held that Section 4C was rightly enacted by Parliament and was hence, constitutional. The appellate court further held that the matter was something to be determined by the Special Commissioners of Income Tax and ought not to have been ventilated via judicial review. The taxpayer has appealed and the matter is now pending before the Federal Court.

Facts:

In 1987, Selangor State Government alienated 5 parcels of land (‘the Land”) for development projects to the taxpayer. From 1993 to 1994, the taxpayer had carried out quarry activities on certain parts of the land. From 1996 to 2011, the quarry activities were continued by a third-party company and the taxpayer received income from the sale of the quarry rocks. The quarry activities ended in 2011 and the taxpayer remained dormant since then.

In 2015, the State Government of Selangor compulsorily acquired certain parcels of the Land. The taxpayer was offered compensation pursuant to the compulsory acquisition. Vide a tax audit, the Inland Revenue Board (“IRB”) subjected the compensation received from acquisition taxable under Section 4C and Section 24(1)(aa) of the Act and a notice of assessment amounting to the arrears of RM52 million was raised against the taxpayer.

The taxpayer applied for judicial review and leave was granted. However, the Learned High Court Judge dismissed the substantive judicial review application. The taxpayer then appealed to the Court of Appeal and posed the following questions:

1. Whether Section 4C of the Act is unconstitutional for contravention of Article 13(2) of the Federal Constitution;
2. Whether the taxpayer in the present case can bypass the alternative remedy of appeal to the SCIT under Section 99(1) of the Act; and 
3. Whether the taxpayer’s compulsorily acquired land is stock in trade as envisaged under Sections 4C and 24(1)(aa) of the Act.

Constitutionality of Section 4C of the Act

It was argued that Section 4C of the Act is unconstitutional by reason of contravention with Article 13(2) of the Federal Constitution which reads:

“No law shall provide for the compulsory acquisition or use of property without adequate compensation.”

The reason for such is that Section 4C violates the cardinal principle regarding “adequate compensation” as held by Federal Court in the case of Semenyih Jaya Sdn Bhd v Pentadbir Daerah Hulu Langat and Another [2017] 3 MLJ 561:

“[198] But what is adequate compensation for a person who has been deprived of his or her property? The term ‘adequate compensation’ is not defined in the Act. In Pentadbir Tanah Daerah Gombak lwn Huat Heng (Lim Low & Sons) Sdn Bhd [1990] 3 MLJ 282, the Supreme Court held that ‘the basic principle governing compensation is that the sum awarded should, as far as practicable, place the person in the same financial position as he would have been in had there been no question of his land being compulsorily acquired’ (see Compulsory Acquisition and Compensation by Sir Frederick Corfield QC and RJA Carnwath).”

Section 4C, which reads as below, taxes any compensation pursuant to compulsory acquisition:

“For the purpose of paragraph 4(a), gains or profits from a business shall include an amount receivable arising from stock in trade parted with by any element of compulsion including on requisition or compulsory acquisition or in a similar manner.”

Section 24(1)(aa) of the Act taxes the compensation receivable in the relevant basis period:

“24. (1) Where in the relevant period a debt owing to the relevant person arises in respect of—

(a)…

(aa) any stock in trade parted with by any element of compulsion including on requisition or compulsory acquisition or in a similar manner, in or before the relevant period;”

By subjecting the compensation payment to tax under the Act, it is therefore not placing the taxpayer in the same position as if the land was not compulsorily acquired as a portion of the compensation would be taxed.

The Court of Appeal first held that there is presumption that laws are constitutional. This was similarly held in Semenyih Jaya (supra.).

The Federal Court in Arumugam Pillai v Government of Malaysia [1975] 2 MLJ 29 which held that as long as method of recovery is prescribed, the constitutionality of the matter cannot be challenged:

“…Taxation is an independent power of the State. The result is that whenever a competent Legislature enacts a law in the exercise of any of its legislative powers, destroying or otherwise depriving of a man of his property, the latter is precluded from questioning its reasonableness by invoking Article 13(1) of the Constitution, however arbitrary the law might palpably be … So long as the method of recovery is laid down by the law, I do not see how it can be challenged.”

Section 4C was correctly legislated by Parliament by reason that the taxpayer was not deprived of his right to adequate compensation by way of land reference to the High Court under Section 37 of the Land Acquisition Act 1960.

Issue of Alternate Remedy

Where a taxpayer is aggrieved by the decision of the Director General of Inland Revenue (“DGIR”), the law prescribes a remedy vide Section 99 of the Act to appeal to the Special Commissioners of Income Tax (“SCIT”).

It is trite that judicial review can be allowed where there is an alternative remedy but such judicial review should only be allowed in “exceptional circumstances”.

The Court of Appeal held that since Section 4C of the Act does not contravene the Federal Constitution, there is no special or exceptional circumstance that entitled the taxpayer to bypass the SCIT under Section 99(1) of the Act. The notice of assessment was validly issued pursuant to the DGIR’s powers under Sections 91(1), 91(3), and 96 of the Act.

Whether the land compulsorily acquired falls under Section 4C of the Act

It was contended that land compulsorily acquired does not fall under the Act as the land was not the taxpayer’s stock in trade. Therefore, even if the compensation was to be taxed, it should be taxed under the Real Property Gains Tax Act 1976.

The Court of Appeal held that the determination of whether an asset is a stock in trade or investment is a question of fact that is to be determined by a court of law.

Comments:

This is the first reported case by an appellate court that determines the question of whether Section 4C of the Act is constitutional or otherwise. Article 13(2) of the constitution canvassed the right of the taxpayer to receive adequate compensation but the same was held to not preclude the Parliament from enacting Section 4C of the Act.

If the Court of Appeal’s decision is upheld by the Federal Court, the question of whether taxes imposed under Section 4C of the Act ought to be taken into consideration when determining the amount of compensation awarded comes into the picture under Section 37 of the Land Acquisition Act 1960. The decision, whether right or wrong, would be determined by the Federal Court in the near future.

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Court of Appeal clarifies the definition of “engaged in agriculture”

In a recent grounds of decision given by the Court of Appeal (accessible here), the Court of Appeal reversed the decision of the learned High Court Judge who decided in favour of the taxpayer. In essence, the Court of Appeal ruled that although the taxpayer was eligible to claim industrial building allowance, the taxpayer was not allowed to claim reinvestment allowance as the taxpayer was held to not be “engaged in” agriculture.

Facts:

The taxpayer, Classic Japan (M) Sdn Bhd, (“Taxpayer”) was engaged in the collection, processing and shipment of cut fresh flowers for export to Japan since 2006. The Taxpayer purchases fresh flowers from several contract growers.

Additionally, the Taxpayer had claimed increased export allowance under the Income Tax (Allowance for Increased Export) Rules 1999 (“the Rules”).

Upon a tax audit, the Inland Revenue Board (“IRB”) disallowed the allowance claimed under the rules, the industrial building allowance on the Factory and imposed penalty.

When the matter was heard before the Special Commissioners of income Tax (“SCIT”), the SCIT’s decision was as follows:

• The Taxpayer was not allowed to claim the increased export allowance allowance under the Rules;
• The Taxpayer was allowed to claim the industrial building allowance for the Factory: and
• The penalty was correctly imposed.

Both the Taxpayer and IRB appealed to the High Court.

At the High Court, the learned Judicial Commissioner’s decision was as follows:

• The Taxpayer was allowed to claim the increased export allowance under the Rules;
• The Taxpayer was allowed to claim the industrial building allowance for the Factory; and
• The penalty should not be imposed.

The IRB appealed to the Court of Appeal whereby the following questions of law were posed:

(i) whether the decision of the Judicial Commissioner of the High Court in deciding that the respondent is entitled to claim the increased export allowance under the Rules was correct in law and facts;

(ii) whether the Judicial Commissioner was correct in law and facts in deciding that the Factory is an industrial building as defined under paragraph 63 Schedule 3 of the ITA 1967; and

(iii) whether the Judicial Commissioner was correct in law and facts in deciding that the Revenue has no legal or factual basis to impose the penalty under section 113(2) of the ITA 1967.

1. Whether the Taxpayer should be entitled to claim increase export allowance under the Rules

The relevant provisions of the 1999 Rules provide as follow:

“Rule 2:

For the purposes of these Rules- “agricultural produce” means fresh and dried fruits, fresh and dried flowers, ornamental plants, and ornamental fish;

Rule 3:

Allowance for increased exports Subject to rules 4 and 5, where a manufacturing company or a company engaged in agriculture, resident in Malaysia, exports manufactured products or agricultural produce in the basis period for a year of assessment, there shall be given to the company an allowance to be determined in the manner as prescribed in rule 4.

Provided that an exemption on exports of manufactured products is only given to manufacturer.

Rule 4:

Determination of allowance

The allowance mentioned in rule 3 refers to-

(a) …

(b) …

(c) 10 percent of the value of increased exports of agricultural produce by the company”

To be eligible to claim increased export allowance, the following conditions ought to be met:

• The taxpayer must be a company engaged in agriculture;
• The taxpayer is resident in Malaysia; and
• The Taxpayer exports agricultural produce.

In coming to the determination of whether the taxpayer was “engaged in agriculture”, the Court of Appeal extensively relied on the dictionary definitions of the words “engaged” and “agriculture” of is reproduced as follow:

No.	Dictionary	Engaged	Agriculture
1	Black’s Law Dictionary	To employ or involve oneself, to take part in, to embark on.	The science or art of cultivating soil, harvesting crops, and raising livestock. Agriculture is a broader meaning than ‘farming’; and while it includes the preparation of soil, the planting of seeds, the raising, and harvesting of crops, and all their incidents, it also includes gardening, horticulture, viticulture, dairying, poultry, bee raising, and ranching.
2	Oxford English Dictionary	Become involved in.	The science or practice of farming, including the growing of crops and the rearing of animals.
3	The Longman Dictionary of Law 7th Edition	To be engaged in an occupation is to be occupied therein. It connotes such a degree of employment as occupies the whole or at least a substantial part of the time.	Includes horticulture, fruit growing, seed growing, dairy farming and livestock breeding and keeping, the use of land as grazing land, meadowland, osier land, market gardens, and nursery grounds, and the use of land for woodlands where that use is ancillary to the farming of land for other agriculture purposes.
4	Osborn’s Concise Law Dictionary 12th Edition		Includes horticulture, fruit growing, seed growing, dairy farming and livestock breeding and keeping
5	Words, Phrases & Maxims – Legally and Judicially Defined (Anandan Krishnan) (Lexis-Nexis)	To employ oneself in.	Agriculture connotes the raising of useful or valuable products which derive nutriment from the soil with the aid of human labour and skill, 43 MLJ 191. The term ‘agriculture’ has much wider import than the term ‘cultivation’. Consequently, a purpose may be connected with agriculture, such as, grazing on the lands of the holding but not necessarily ancillary to cultivation. Agriculture, in the Board of Agriculture Act 1889 (52 & 53 Vic C 30), s 12, includes horticulture The ordinary meaning of ‘agriculture’ is the raising of annual or periodical grain crops through the operation of plowing, sowing, etc. The term ‘agriculture’ is of wider import than the term ‘cultivation’. As is pointed out in the Oxford Dictionary, ‘agriculture’ means the science or art of cultivating the soil including the allied pursuits of gathering in the crops and rearing livestock; tillage, husbandry, farming (in the widest sense).
6	Jowitt’s Dictionary of English Law, 2nd Edition by John Burke	–	Includes horticulture, fruit growing, seed growing, dairy farming and livestock breeding and keeping, the use of land as grazing land, meadowland, osier land, market gardens, and nursery grounds, and the use of land for woodlands where that use is ancillary to the farming of land for other agriculture purposes.
7	Judicial Dictionary 14th Edition by KJ Aiyar	The word ‘engaged’ would not mean an isolated act or transaction. What it contemplates is that the person carries on the business as a continuous process of purchase, sale, and storage for the sale of the food grains. In order that a person is engaged in the business of purchase and sale of the foodgrains, it is necessary to show that he was carrying on business as a continuous process as normal trading activity.	The primary sense in which the term ‘agriculture’ is understood is ‘ager’, a field and ‘cultural’ – cultivation i.e. the cultivation of field and the term as understood only in that sense, agriculture would be restricted only to the cultivation of the land in the strict sense of the term meaning thereby, tilling of the land, sowing of the seeds, planting and similar operations on the land. [Commissioner of Income-Tax v Benoy Kumar Sahas Roy AIR 1957 SC 768, (1957) SCJ 740, (1957) 2 Mad LJ (SC) 145]. Agriculture is the art or science of cultivating the ground especially in fields including the preparation of soil, the planting of seeds, the raising, and harvesting of crops, management of livestock; village; husbandry, and farming.

In arriving at the conclusion that the Taxpayer was not “engaged in agriculture”, the salient points of the Court of Appeal’s decision are:

• Rule 3 of the Rules has the connotation of involvement in the planting or growing of the fresh flowers and the mere act of purchasing the flowers does not satisfy this;
• These flower growers were independent growers and not the Taxpayer’s employees
• In the terms of the agreement, there is nothing to indicate that the Taxpayer was involved in the agriculture activity;
• The Taxpayer’s main activity is collecting and exporting cut flowers and in its ‘cost of sales’ and there was nothing indicative that the Taxpayer was “engaged in agriculture”; and
• the photographs and invoices tendered before the SCIT by the respondent do not show that the respondent was engaged in agriculture activity.

The Court of Appeal opined that the Taxpayer must display direct involvement such as planting the said flowers in order to fall under the Rules.

2. Whether the Taxpayer was eligible to claim industrial building allowance for the Factory

In echoing the sentiments of the SCIT and the High Court, the Court of Appeal ruled this in the affirmative and held that the Factory is an industrial building under Paragraph 63 Schedule 3 of the Income Tax Act 1967.

The Court of Appeal held that even the act of repacking carried out in the factory constitutes a “process”. Reliance was placed on the case of Kilmarnock Equitable Co-operative Society Ltd v IRC 42 TC 675 whereby Lord Clyde held that “the breaking of bulk coupled with the separating out of the dross by screening and subsequent packaging of the coal into paper bags involves a “process” within the meaning of Section 271(1)(c)” in deciding that the taxpayer in that instant case was also a factory.

3. Whether the penalty was correctly imposed?

The Court of Appeal affirmed that the IRB’s discretion in imposing the penalty of 45% was correct in law.

Comments and Conclusion:

In contrast to the grounds of decision given by the High Court, the High Court had adopted a more liberal approach in deciding what amounts to agriculture by holding that the law ought to evolve with modern modes of agriculture:

“I disagree because the science for agriculture has grown by leaps and bounds and we should not be shackled by such an ancient concept when farms can now be housed in multi-storied buildings or vertical farms instead of being merely on open land. This can be done without even the need for the use of soil as in hydroponics which is defined by the Concise Oxford English Dictionary (Thumb Index Edition) as “the process of growing plants in sand, gravel or liquid with added nutrients but without soil”. (emphasis added and see also https://www.winsightgrocerybusiness.com/fresh-food/worlds-largest-hydroponic-farm-open-dubai)

…..

Alternatively, the other reasonable construction would be that Parliament has deemed it fit that the 1999 Rules have served their purpose of increasing exports of agricultural produce and that such a restriction is now put in place to better exploit the land whereby the party with the technical know-how would have to apply for land or team up with the landowners for purposes of obtaining such an exemption. “

However, the Court of Appeal was not with the High Court on this as the Court of Appeal considers that as the Taxpayer failed to prove a direct nexus with the act of agriculture i.e. itself was not engaged in the planting of the flowers, the Taxpayer could not be “engaged in agriculture”.

This point of law, whether right or wrong, remains to be the law until a case on the same question is posed before the Court of Appeal or the Federal Court.