A curious play on 3 time-barred provisions

The Special Commissioner of Income Tax (SCIT) recently published a judgment on the case of R v KPHDN (unreported) which pertains to three time bar provisions in the Malaysian Income Tax Act 1967 (MITA), namely Section 91(2), Section 91(3), and Section 111(2). The SCIT dismissed the appeal and concluded that the taxpayer was not entitled to a tax refund due to the operation of Section 111(2) MITA, and the Inland Revenue Board (IRB) was authorized to issue the 2nd Notice of Assessment beyond the time bar limitation under Section 91(3) MITA.

Facts:

The taxpayer is an investment holding company that failed to file their tax returns for the Years of Assessment (YAs) 1994 – 2000 due to negligence on the part of the previous management. However, the company rectified the situation by filing the missed tax returns, including the returns for YA 1994 to 2000, in January 2007. As a result, the IRB issued a CP.63 Notice of Computation of Repayment dated 24.3.2008 (“1st Notice of Assessment”), which granted tax credits of RM842k from dividend income received by the taxpayer under Section 110 of the MITA for YA 1996. The IRB later issued a computation table to the taxpayer, indicating that the tax credit had been utilized against tax payable for other years of assessment.

In February 2015, the IRB claimed that the taxpayer should not be allowed to claim the tax credit due to failure to submit the original dividend voucher and other reasons. After a series of correspondences, the IRB revoked the dividend credit by issuing another Notice of Assessment dated 27.2.2015 (“2nd Notice of Assessment”) and citing non-compliance with Section 111(2) of the Income Tax Act 1967. This provision requires that dividend credits be claimed within 6 years from the year of assessment.

Questions to the SCIT

• Whether there is any basis in law for the DGIR to invoke Section 91(3) MITA and issue the 2nd Notice of Assessment to withdraw the tax credit issued under the 1st Notice of Assessment
• Whether the DGIR is precluded under Section 91(2)(b) MITA from reclaiming the income tax credit approved under the 1st Notice of Assessment
• Whether the Appellant had the right to claim the repayment of tax 6 years after the end of YA 1996 under Section 111(2) MITA

Both parties called a witness to testify on the matter, and after hearing their testimony and reviewing written submissions, the SCIT made the following decision:

Issue 1: Section 91(3) and Section 91(2)(b)

The SCIT determined that the taxpayer was negligent because they failed to file their tax returns on time, which was seven months after the end of the financial year for the relevant year of assessment. The use of the word “shall” in Section 77A made it mandatory for the taxpayer to file their tax returns on time, and this negligence was admitted during cross-examination. As a result, the IRB was legally authorised to raise the assessment despite the time bar provision under Section 91(3).

The Court acknowledged that Section 91(2) is a separate provision from Section 91(3). However, it does not specify the application in circumstances of the taxpayer’s negligence in the current appeal.

Issue 2: Section 111(2)

Section 111(2) states that a taxpayer cannot claim a tax refund more than six years after the relevant year of assessment or six years after an assessment if charged. When the taxpayer filed their tax returns for YA 1996 in January 2007, they essentially made a “claim” under Section 111(2). The delay of 11 years violated Section 111(2) of the MITA because it was much longer than the statutory six years.

Commentary

With all due respect, the SCIT had flawed in its judgment on numerous points.

Firstly, the SCIT included provisions of the MITA that were not applicable to the current matter, such as Section 111(1A) and Section 111(1B) of the ITA, which only applied from YA 2003 onwards.

Secondly, it is possible that the DGIR’s attempt to retrieve the tax credit by issuing the Second Notice of Appeal may be invalid due to lack of jurisdiction under Section 91(1). The Singapore Court of Appeal has previously ruled on the matter in the case of Comptroller of Income Tax v AQQ and another appeal [2014] SGCA 15 [2014] 2 SLR 847, where such actions were beyond powers conferred under the Singapore Income Tax Act 1947 (“SITA”):

“[151] In the light of the consistently narrow meaning assigned to the word “assess” to refer to the determination of the amount of liability to tax under the Act, we do not think that the Comptroller has the implied power under s 74 to assess for tax a sum that had previously been refunded or repaid to a taxpayer. We recognise that this leaves an asymmetry in the positions of the Comptroller and the taxpayer – under ss 93 and 93A, a taxpayer may recover tax in excess of the amount payable under the Act or overpaid tax by reason of an error or mistake in a return filed.”

Note : Section 74 SITA bears similar wordings to Section 91 of the MITA.

Section 74 SITA may only be invoked where “the amount of tax assessed under the Additional Assessments was less than the amount of income tax assessed under the corresponding Original Assessments for each year.” The Comptroller therefore acted ultra vires s 74(1) as AQQ had not been previously “’assessed at a less amount than that which ought to have been charged’ and the trigger event for enabling the Comptroller to issue an additional assessment had not occurred.” The reason being that under the “tax assessed” line below, the amount under the additional assessment is actually less than the original assessment:

Therefore, the Additional Assessment was issued without any authority since there was no tax undercharged.

In the current appeal, the tax assessed and chargeable income in the 2nd Notice of Assessment is the same as in the 1st Notice of Assessment (see below). As a result, the power of the DGIR to “make an assessment or additional assessment … in respect of that person in the amount or additional amount of chargeable income and tax” under Section 91(1) MITA is not applicable.

Finally, the Judge did not provide any explanation as to why Section 91(2) of the MITA does not apply. It is a well-established principle that the court or executive should not add any additional requirements or conditions where they do not exist in the statute (as stated in Multi-Purpose Holdings Berhad and Success Electronics). While it is not disputed that the taxpayer was negligent in their tax affairs by failing to file the tax returns on time, they promptly took action to rectify the situation upon discovering the omission by the previous management. However, there is nothing in Section 91(2) that indicates that if the taxpayer was negligent, the time limit for the DGIR to reclaim tax refunds does not apply. It is regrettable that the SCIT did not address this issue in greater detail.

In relation to the Comptroller’s options for recovering the tax, the Singapore Court of Appeal briefly discussed the possibility of the Government of Singapore initiating a civil action to recover the refunded tax. The taxpayer in this appeal raised this point, but the SCIT did not address it. As the time limit set out in Section 91(2) MITA was not met and no common law civil action was commenced, the IRB was not entitled to reclaim the taxes.

A point not ventured by neither parties nor the court was the application of the second limb of Section 111(2) which allows for a claim to be made where there is a repayment of tax charged by an assessment within 6 years. Following the Court’s line of reasoning and if we consider the tax returns filed as a claim which was granted by virtue of the 1st Notice of Assessment, the taxpayer could still benefit from “repayment of tax charged by an assessment”. As the tax refund was immediately used to set off against other years’ tax payable, there was no unclaimed tax refund.

Note: the case is currently pending appeal before the High Court.

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Top 3 tax cases in 2022

The year 2022 was a noteworthy one for tax law, characterized by three pivotal cases resolved by the Federal Court, as well as the briefest budget announcement that lasted only one day prior to the dissolution of Parliament. This post aims to shed light on the three cases that presented the Federal Court with the chance to render decisions on intriguing and unprecedented legal matters.

1. Ketua Pengarah Hasil Dalam Negeri v Bar Malaysia

The highly anticipated legal case involving the Federal Court’s evaluation of Section 142(5) of the Income Tax Act 1967 (ITA) and its potential abrogation of Section 126 of the Evidence Act 1950 (EA) has reached its final verdict. The Inland Revenue Board (IRB) attempted to utilize the ITA to scrutinize potential tax evasion by law firms through the examination of client accounts. Nevertheless, the High Court and Court of Appeal both upheld the sacrosanct nature of client accounts, with the distinction made between “practitioners” and “advocates and solicitors” in the ITA indicating that Section 142(5) did not encompass the latter.

On July 20, 2022, the Federal Court rejected the IRB’s appeal and upheld the sanctity of client accounts. The Chief Justice declared that the contents of a client’s account are the property of the client, not the solicitor, and as such, the solicitor cannot divulge the information without the client’s consent. The IRB was also proscribed from utilizing the ITA for a “fishing expedition” to determine potential tax evasion. In summation, client accounts in Malaysia are considered sacrosanct and are protected from disclosure without the client’s consent, in contrast to the laws in New Zealand. In summary, unlike the law in New Zealand, client accounts are privileged and cannot be divulged without consent by the clients.

* No reported decision has been made on the matter in question. Additional details regarding the case can be obtained at the following link: www.theedgemarkets.com/article/apex-court-denies-irb-access-client-accounts-law-firm.

2. WSB v KPHDN

In a seminal ruling, the Federal Court declared that Section 4C of the ITA, which purports to impose taxation on income received from compulsory acquisitions, is unconstitutional and in contravention of Article 13(2) of the Federal Constitution, which enshrines the principle of “adequate compensation” for properties compulsorily acquired. In a departure from the decision reached by the Court of Appeal, the Federal Court asserted that the Parliament must not enact legislation that infringes upon fundamental rights, as evidenced by the provisions of Section 4C of the ITA. Prior to the inclusion of this section, compensation received from compulsory acquisitions was exempt from taxation under Paragraph 3(1) Schedule 2 of the Real Property Gains Tax Act 1976 (RPGTA), as established in judicial precedent such as the 2006 case of Ketua Pengarah Hasil Dalam Negeri vs Penang Realty Sdn Bhd and Metacorp Development Sdn Bhd vs Ketua Pengarah Hasil Dalam Negeri.

The judicial review application, which was initially dismissed by the High Court and Court of Appeal, held that Section 4C of the ITA was properly enacted and that any grievances should be addressed through the appropriate channels, such as the Special Commissioners of Income Tax route.

* No reported decision has been made on the matter in question. Additional details regarding the case can be obtained at the following link:https://www.theedgemarkets.com/article/compensation-forcefully-acquired-properties-should-not-be-subject-income-tax-rules-apex

3. KPHDN v MEMB

The IRB previously disallowed expenses totaling RM190 million claimed by MEMB on the grounds that the expenses had been accrued but not disbursed. MEMB subsequently launched a judicial review, which was initially denied by the High Court but later overturned on appeal by the Court of Appeal.

The IRB’s subsequent appeal to the Federal Court prompted the examination of two key legal questions:

1. Whether the argument of an alternate remedy is to be considered only during the substantive stage of judicial review, rather than at the leave stage.
2. Whether Section 103B of the Income Tax Act 1967 (ITA) precludes a court from granting a stay order.

The taxpayer argued that judicial review was appropriate in cases where tax assessments were raised in an erroneous and arbitrary manner, and that nothing in the ITA prevented the granting of a stay order. The case was ultimately remitted back to the High Court for further proceedings to address the substantive issues at hand. Thus, despite the existence of an alternate remedy, taxpayers are still entitled to use judicial review as a means of seeking resolution for their grievances.

* No reported decision has been made on the matter in question. Additional details regarding the case can be obtained at the following link: https://www.theedgemarkets.com/article/muhibbah-engineering-gets-nod-challenge-tax-assessments-imposed-irb

Taxes do not rank first during a winding-up

Taxes are a form of unsecured debt which ranks after secured debt when a company is being liquidated. Under Section 527 of the Companies Act 2016, payment of taxes ranked 6th in the list of priorities of unsecured debt after:

• Payment of liquidator fees;
• Wages owed to employees of the company;
• Workers compensation;
• Remuneration payable to employees; and
• Contributions payable.

In the recent high court case of Carotech Berhad (in liquidation) v Government of Malaysia and others (Civil Appeal AA-28PW-2-01/2022), the High Court held that taxes do not take priority over other unsecured debt even if the same is paid. The High Court boldly held that payment under protest is a common law right of ancient origin and the mere fact that the liquidator paid the taxes under protest does not mean that there is no debt accruing and arising.

The matter is now pending before the Court of Appeal.

Facts

Carotech Berhad (“Applicant”) had owned a few pieces of land (“Land”) which were charged as security to Maybank International (L) Ltd in this case. The Applicant was ordered to be wound up on 30.11.2012. The Land was subsequently ordered to be vested in Malayan Banking Berhad on 11.10.2013.

The Land was sold through public tender for RM24 million on 10.1.2020. As required under Section 21B (1) of the Real Property Gains Tax Act 1976 (“RPGTA”), the purchaser must remit 3% of the purchase price (a sum of RM729,000) to the Director General of Inland Revenue (“DGIR”) within 60 days of the disposal. If the taxes are not paid within the period, they will be increased by 10% and collectively as a debt owing to the Government of Malaysia.

After the taxes were paid, the Applicant requested a refund of the entire sum of tax. Instead of effecting the refund, the Applicant was required to pay a further sum of RM686,090.40 as the balance of the RPGT payable vide a notice of assessment by the DGIR. The Applicant paid the same under protest.

Arguments

The Applicant argued that the provisions of the CA dictate specifically the order of distribution of the Applicant’s assets. Under the statutory list of priority of payments, in which the Government of Malaysia is bound by Section 434 CA, taxes, including RPGT, rank 6th after secured debts are paid.

Following the case of Director of Customs Federal Territory v Ler Cheng Chye (Liquidator of Castwell Sdn Bhd (In Liquidation)) [1995] 3 CLJ 316, the Supreme Court held that mechanisms for recovery of taxes under the taxing legislation “merely directs the setting aside of moneys sufficient to provide for taxation but does not provide that Government debts shall rank in priority to all other secured debts.”

The Respondents argued that the RPGT is regulated by the RPGTA instead of the CA and hence does not bind the Respondents. Specifically, the Respondents assert that the CA only applies if the tax due as a debt arises before the winding up of the Applicant or was assessed before the time fixed for the proving of debts has expired. In this case, the debt arose vide a notice of assessment after the Applicant was ordered to be wound up.

Kerajaan Malaysia v. Mudek Sdn Bhd [2017] 10 CLJ 159 was cited in support of this, where the Federal Court held that taxes are due and payable upon service of a notice of assessment. If the taxes are a form of debt which requires proof of debt, it does not sit well with Section 523(3) of the CA, whereby the description of debts are those “which the company is subject at the date of the winding up order”.

Decision of the High Court

1. Whether payment of taxes is governed under the CA or RPGTA

The High Court agreed with the Applicant that the RPGT is subjected to the CA; hence, they ranked 6th as a form of unsecured debt as canvassed by the Supreme Court in Ler Cheng Chye (supra.). The RPGTA only provides when RPGT is payable but does not set out the order of priority of payment when the RPGT as assessed is payable by a company in winding up or liquidation. Instead, the specific section housed under Section 527 CA and the maxim specialia generalibus derogant imbues the Court to conclude that the payment of RPGT in the case of a company under liquidation is under the CA.

2. Whether the fact that payment of the RPGT has been effected gives rise to a debt

In response to this, the High Court held that the Applicant’s payment was made under protest in response to an illegal demand and paid for purposes of avoiding being mulcted. The Applicant is entitled to seek recovery by condictio indebiti, which is described as “where money is illegally demanded and paid, the payer adding to his act of payment a more or less formal declaration to the effect that the money so paid is wrongfully exacted”.

3. Whether the RPGT assessed after the date of winding up order is provable under Sections 523(3) and 527(1)(f) CA

In another case of Priority Artificial Lift Services, Llc v. Eastern Energy Services Sdn Bhd [2021] 1 LNS 637, the Learned Judge held that the Respondents do not need to submit proof of debt under Section 523(3) CA. They may still lodge a proof of debt if they wish to claim it.

The High Court found that Section 523(3) CA is wide enough to encompass future and contingent liabilities as legislated below:

“(3) Save as provided in subsections (1) and (2), all debts and liabilities present or future, certain or contingent, to which the company is subject at the date of the winding up order, or the resolution, or to which the company may become subject before dissolution by reason of any obligation incurred before the date of the winding up order, shall be deemed to be debts provable in winding up.”

In this case, the debts and liabilities include the Applicant’s banking facilities which have yet to be repaid. Any gains from the sale of the lands would subject the Applicant to the future or contingent liability of being assessed for RPGT. Section 523(3) of the CA 2016 expressly provides that such future or contingent liability shall be deemed provable in winding up.

The fact that the RPGT was assessed after the winding-up order and hence is not governed by the CA is untenable as Section 527(1)(f) CA stipulates “all federal tax assessed … or assessed at any time before the time fixed for proving of debts has expired”. The time for proving debts has not expired. The case of Mudek (supra.) does not apply as the Applicant is not challenging the RPGT save for the Respondents’ priority.

Federal Court upheld solicitor-client privilege pertaining to clients’ accounts by law firms.

A 7-member Federal Court bench held on 20 July 2022 that law firms’ clients’ account are protected by solicitor-client privilege under Section 126 of the Evidence Act 1950 (“EA”) and that Section 142(5) of the Income Tax Act 1967 (“ITA”) does not permit disclosure of the same. The Federal Court upheld the decision of the Court of Appeal and High Court (analysis of the Court of Appeal Judgment can be read here).

Without regurgitating my earlier blog post, the Director General of Inland Revenue (“DGIR”) requested for law firms to disclose details of their clients’ accounts circa 2016. The Malaysia Bar had protested, expressing its objections as they were protected by solicitor-client privilege. The DGIR’s reason for requiring disclosure of the clients’ accounts were to ensure tax compliance by law firms to determine quantum of taxes to be imposed on the respective law firms.

Chief Justice Tengku Maimun Tuan Mat held that “the content of the client’s accounts belongs to the clients of the solicitor and not the solicitor” and that Section 142(5) of the ITA does not oust Section 126 EA. The only person who can waive that privilege is the client.

This is a landmark ruling by the Federal Court on solicitor-client privilege in Malaysia. This decision entails that unlike New Zealand, there is no provision in the ITA or the EA which accords the tax authority to audit the clients account and such authority cannot be implied vide the rule of strict interpretation. The sanctity of client solicitor privilege can only be divulged through waiver by the client and no one else.  

High Court allows judicial review for misapplication of Section 140A of the ITA

The High Court had recently, in the case of Petronas Trading Corporation Sdn Bhd v KPHDN (Civil Appeal WA-25-17-01/2021), allowed leave for judicial review by finding that questions of illegality, unlawful treatment, error of law and failure to adhere to legal principles warrant intervention by way of judicial review. The grounds of judgment are accessible here.

This was one of the first few cases I handled as counsel whilst in RDS, where the taxpayer challenged the novel question of the application of Section 140A to a reassignment of income and expenses. 

Facts

The taxpayer was principally engaged in marketing and trading natural resources, i.e. crude oil. Vide an Undisclosed Agency Agreement, the taxpayer was appointed as an agent by its subsidiary, PETCO Trading Labuan Company Ltd (“PTLCL”). 

(Read: Undisclosed Agency Agreement is where an agent negotiates with a third party who does not know that the agent is acting on behalf of a principal.)

In 2011, PTLCL was invited to join the Global Incentive for Trading (“GIFT”) Programme. Subsequently, the taxpayer’s board of directors approved the reassignment of business activities and human resources from the taxpayer to PTLCL progressively. 

The DGIR disallowed the reassignment by invoking Section 140A of the ITA by stating that the income and expenses belonged to the taxpayer instead of PTLCL. The DGIR then raised notices of assessment amounting to RM 33 million to the taxpayer. 

Arguments 

Counsels for the taxpayer argued that leave for judicial review should be allowed given the following reasons: 

– Judicial review remains available as long as the taxpayer shows that it has an arguable case and that the application is not frivolous; 

– Availability of domestic remedy is a matter to be raised at the substantive stage;

– The DGIR disregarded the assignment without taking into account the commercial structure and activities of the companies;

– As a Labuan company, PTLCL is governed by the Labuan Business Activity Tax Act 1990 (“LBATA”) where Section 17D of the LBATA did not come into force before 1.1.2020; and

– Section 140A of the ITA does not empower the Respondent to disregard and re-characterise the transactions, especially when there was no related party transaction between the parties.

As for the Respondent, the Attorney General Chambers and the DGIR argued as follows: 

– Section 140A of the ITA does not empower the Respondent to disregard and re-characterise the transactions, especially when there was no related party transaction between the parties.

– The taxpayer cannot bypass the SCIT and the correct avenue is to file a notice of appeal under Section 99 of the ITA; and

– The basis for invoking Section 140A of the ITA was that the income derived and expenses incurred belonged to the taxpayer, not PTLCL.

Decision of the Court

In allowing leave for judicial review, the Learned High Court Judge was conscious of the fact that the DGIR’s powers under Section 140A of the ITA are limited in that it only allows the DGIR to adjust the arm’s length price:

“It is therefore clear that section 140A ITA only permits the Respondent to substitute the price in respect of the transaction to reflect an arm’s length price for the transaction. It does not permit the Respondent to disregard and re-characterise the UAA in this matter.”

Secondly, whether the DGIR’s failure to invoke Section 140 of the ITA is a question of law to be answered in the judicial review action. As alluded by the Supreme Court in National Land Finance Co-operative Society Ltd v Director General Inland Revenue [1993] 4 CLJ 339, both Section 140 and 140A of the ITA must be subject to the principle of strict interpretation, and every exercise of statutory power must conform with the express words of the statute and implied legal requirements. 

Finally, the Learned High Court Judge was categorical in finding that the threshold for leave to commence judicial review is low and that nowhere within Order 53 of the Rules of Court 2012 held that the existence of domestic remedy is a bar to judicial review. 

The DGIR had appealed to the Court of Appeal and the matter is now pending hearing. 

Federal Court to answer the position of domestic remedy in a judicial review application

The Court of Appeal in Muhibbah Engineering (M) Bhd v Ketua Pengarah Hasil Dalam Negeri (Civil Appeal W-01(A)-349-08/2020) had overturned the decision of the High Court in dismissing the taxpayer’s application for leave to commence judicial review against the Director General of Inland Revenue Board (“DGIR”). The DGIR then appealed to the Federal Court and the Federal Court had granted leave to appeal by finding that the questions framed by the DGIR warrant the apex court’s attention determination. 

The case is now pending before the Federal Court for the substantive hearing of the appeal. 

Facts: 

The taxpayer is in the business of providing oil and gas, marine, infrastructure, civil and structural engineering work. Pursuant to a tax audit conducted, the DGIR disallowed the taxpayer’s treatment of the Project Accrued Expenses deductions because they are provisional in nature. Consequently, the DGIR adjusted the losses surrendered by the taxpayer to its related company and issued notices of assessment for the years of assessment (“YA”) 2015 and 2016 and notice of non-chargeability (“NONC”) for YA 2017.

The taxpayer filed a judicial review application and protested the notices of assessment and NONC issued by the DGIR on two main grounds:

1. The Project Accrued Expenses are deductible under Section 33(1) of the Income Tax Act 1967 (“ITA”); and
2. The DGIR does not have any basis in law to invoke both subsections of Section 44A(9) of the ITA. 

The High Court dismissed the taxpayer’s application for judicial review. The salient points of the High Court’s reasons are as follow:

1. There is a dispute on facts and the matter should be referred to the Special Commissioners of Income Tax (“SCIT”); and
2. There are no exceptional circumstances that would warrant the grant of leave as there is a statutory appeal provided under Section 99 and Section 44A(9)(b) of the ITA.

At the Court of Appeal 

The Court of Appeal reversed the decision of the Learned High Court Judge and allowed the appeal. In upholding the principle in Majlis Perbandaran Pulau Pinang v Syarikat Bekerjasama-Sama Serbaguna Sungai Gelugor Dengan Tanggungan [1999] 3 CLJ 65, the Federal Court held that judicial review should be available where the applicant can demonstrate illegality or unlawful treatment, as the case was in this instant.

Although there is no hard and fast rule in determining when should the argument of alternate remedy be ventilated in a judicial review application, the Court of Appeal upheld the principles in QSR Brands Bhd v Suruhanjaya Sekuriti & Anor [2006] 2 CLJ 532 and Chin Mee Keong & Ors v Pesuruhjaya Sukan [2007] 6 MLJ 193 where the issue of the existence of an alternate remedy should be decided during the substantive stage. In coming to this decision, the Court of Appeal held that:

“It is to prevent the merits of the substantive application from being dealt with at the early stage of the leave application wherein the Applicant is merely required to show on arguable case as to any error of law, excess of jurisdiction or procedural irregularity committed by the public body concerned.”

Furthermore, the Court of Appeal was categorical that the threshold for judicial review is low. Since the Learned High Court Judge did not find that the judicial review application was frivolous or vexatious, the refusal to grant leave for judicial review is flawed. 

Appeal to the Federal Court 

The DGIR had subsequently applied for leave to appeal to the Federal Court and proposed three questions to be answered by the apex court: 

1. Whether the issue of domestic remedy may only be canvassed and decided at the substantive stage?
2. Whether any dispute relating to the merits of an assessment raised under a taxing legislation involving question of law or mixed question of law and facts may be determined by way of Judicial Review?
3. (Subsequently added)Whether a stay order granted by the Court of Appeal after allowing the leave application is contravene with the tax recovery scheme pursuant to Section 103 and 106 of the Act?

It is further understood that the jurisdiction of the newly enacted Section 103B of the Act will be ventilated before the Federal Court as part of the question canvassed in Question 3.  

The Federal Court had allowed questions 1 and 3 but dismissed question 2. This is the first tax case post-Bintulu Lumber to proceed to the highest court in Malaysia in close to two years and should be worth giving attention to. 

High Court rules on the application of Section 4(f) of the ITA

In the recent grounds of decision in the case of Keysight Technologies Malaysia Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri (Civil Appeal WA-14-4-03/2021), the High Court held that the sale of intellectual property from the taxpayer to its related company was revenue in nature and taxable under Section 4(f) of the Income Tax Act 1967(“ITA”). 

This case is perhaps the first written grounds in Malaysia regarding the application and interpretation Section 4(f) of the ITA. Whether right or wrong, the decision does deserve special attention on the application of Section 4(f) in the Malaysian judiciary. The case is now pending before the Court of Appeal.

Facts: 

The taxpayer was incorporated under the name Hewlett-Packard Microwave Products (M) Sdn Bhd in 1998. The taxpayer changed its name to Agilent Technologies Microwave Products (M) Sdn Bhd and again to Keysight Technologies Malaysia Sdn Bhd in 1999 and 2014 respectively, following two spin-offs by the taxpayer’s group of companies. 

The taxpayer had pioneer incentive status and was mainly in the business of manufacturing and marketing activities. Incidental to its principal activities, the taxpayer had developed technological know-how. 

In 2008, the taxpayer ceased to be a full-fledged manufacturer and converted into a contract manufacturer under a Manufacturing Services Agreement dated 1.3.2008 between the taxpayer and Agilent Technologies International s.a.r.l. At the same time, the taxpayer had sold, transferred and assigned all beneficial rights of protected and unprotected knowhow including manufacturing processes and intangible property rights (“Intellectual Property”) to Agilent Technologies Inc according to an Intellectual Property Transfer Agreement dated 1.3.2008 between the taxpayer and Agilent Technologies Inc. Agilent Technologies Inc paid the taxpayer RM821,615,000 in exchange for the Intellectual Property. 

This RM821 million was the subject of litigation. The Inland Revenue Board (“IRB”) had raised a notice of assessment for the Year of Assessment (“YA”) 2008 with penalty amounting to RM311 million. The main question was whether the sum of RM 821 million was taxable under Section 4(f) of the ITA. 

The Respondent was of the view that the sum of RM 821 million should be subjected to tax under Section 4(f) of the ITA for the following reasons: 

1. The transfer of technical knowhow was not an outright sale as the evidence should that the taxpayer was still using the technical knowhow in the manufacturing of its product after 1.03.2008; and

2. The gain on the transfer of technical knowhow for the payment on the loss of income was related to the change of the Appellant’s function from a full-fledged manufacturer to a contract manufacturer, which resulted in a reduction of profit margin for the taxpayer after the change of the function. 

The taxpayer appealed on the following grounds: 

1. The time bar under Section 91(1) of the ITA does not apply as the assessment was made 5 years after the expiration of the YA 2008 and the IRB had failed to establish negligence on the part of the taxpayer under Section 91(3) of the ITA;

2.The proceeds from the sale of the Intellectual Property are not revenue in nature and hence ought not to be taxed under the ITA; and

3.The IRB ought not to impose a penalty under Section 113(2) of the ITA.

The taxpayer was unsuccessful in its appeal before the Special Commissioners of Income Tax (“SCIT”) and they appealed to the High Court.

Decision

The Learned High Court Judge dismissed the appeal and upheld the decision of the Special Commissioners of Income Tax. 

If the 23-page judgment is too long for you to read, the TLDR is that the Learned High Court Judge found there was no outright sale of the Intellectual Property. It was reasonable for the IRB to raise the assessment under Section 4(f) of the ITA, impose a penalty under Section 111(2) of the ITA and that there was negligence by the taxpayer under Section 91(3) of the ITA.

The Learned High Court’s reason, as spanned across 12 out of the 23 pages of the grounds of judgment, focused on one finding of fact – there was no outright sale of the IP rights by the taxpayer. Amongst others, the taxpayer relied on 3 areas to prove that there was a transfer of IP rights:

1. Clause 3.4 of the Intellectual Property Transfer Agreement dated 1.3.2008 

“3.4 Except as expressly provided in this agreement and to the fullest extent permitted by law, assignor hereby disclaims any and all warranties, express or implied, with respect to the technology, including but not limited to, any implied warranties or merchantability, fitness for a particular purpose, or non-infringement, and the parties agree that the technology is being transferred “as is”.”. 

2. Clause 7.1 of the Manufacturing Service Agreement 

“7.1     Intellectual Property Rights Contractor hereby acknowledges that the Company or its licensor it the owner, or authorized licensee, of all rights in and to all of the Intellectual Property Rights, and Contractor shall acquire no rights whatsoever in or to any of such Intellectual Property Rights, except as specifically provided in this Agreement. Contractor shall not take any action that might impair in any way right or interest of Company in or to any of the Intellectual Property Rights”. 

3. Note 17(b) of the Statutory Financial Statements for the financial year ended 31.10.2008 which disclosed the sum of RM821,615,000 as “Transfer out of technical knowhow to a related corporation”. 

According to the Learned High Court Judge, the taxpayer’s witness had failed to support that there had been a transfer of intellectual property when put under cross-examination. 

“Respondent: … Can you show the court the documents which finally the IP rights has been registered in the name of Agilent Technology?

Appellant witness: I don’t have them.” 

This was also one of the grounds on which the Special Commissioners of Income Tax in coming to the finding that there was no outright sale: 

“We agree with the Respondent’s Submission… (the Appellant had failed) to support the claim that the gain from the transfer of technical knowhow (i.e. the marketing and manufacturing intangibles) by the Appellant to Agilent Technologies International totalling of RM821,615,000.00 is an outright sale.”

Commentary

1. Was there an outright sale of the IP rights? 

I’m not going to delve into the nitty-gritty, but the taxpayer submitted that what is being transferred from the taxpayer to Agilent Technologies was “technical know-how”, which is non-registrable or patentable. As such, some rights are only protected by contract. 

From the grounds of judgment, it appears to me that the Learned High Court Judge was not satisfied that there was an outright sale as there was no legal transfer of the IP Rights, but although it agreed that beneficial ownership has passed.

If it is not an outright sale, the question then begs as to the purpose of the sum of RM821 million. For a consideration valued at RM821 million, surely it must be for something valuable? Unfortunately, neither the Special Commissioners of Income Tax nor the Learned High Court Judge dealt with this in detail. However, it is the Respondent’s case that the amount relates to loss of income based on badges of trade as the valuation is the projection of the taxpayer’s net income. The SCIT and the High Court upheld this reasoning; hence I’ll assume this to be their reason. 

2. Is the sum of RM821 million representing the “loss of income” revenue?

Relating to the badges of trade, is “loss of income” one of the badges? Although the categories of the “badges of trade” are not closed, it does not appear that “loss of income” is a clear category. Even if there is no outright sale, the sum is not revenue because the payment is nevertheless depriving the taxpayer of a permanent “loss of income” that it would’ve received if it had continued to own the beneficial ownership of the asset. 

Two cases are worth considering and contrasting here: Burmah Steam Ship Company, Limited v The Commissioners of Inland Revenue 16 TC 67 vs The Glenboig Union Fireclay Co, Ltd v The Commissioners of Inland Revenue 12 TC 427. 

In Glenboig Union, the taxpayer carried on business as manufacturers of fireclay goods and as merchants of raw fireclay. Subsequently, there was a dispute between the taxpayer and the railway company, and the taxpayer was interdicted from working under the railway. The railway company lost in the action, and the House of Lords exercised its statutory powers to require a part of the fireclay to be left unworked on payment of compensation. It was immaterial that the compensation was computed by the loss of expected profit from the inability to but that the compensation was ‘the price paid for sterilising the asset from which otherwise profit might have been obtained’.

Lord Dundas held as follows: 

“In the first place, what we must consider is not the measure by which the amount of compensation was arrived at, but what it was truly paid for, and, as already indicated, I think the compensation was paid for the loss of a capital asset. In the second place, and this is perhaps just another way of stating the same thing, the sum can surely not be described as profits arising from the Appellants’ trade or business; for it arose not from the exercise of that trade but in respect that the Appellants were prevented from dealing in their business with, and earning any profits from, a portion of their mineral estate.”

Lord President (Clyde) also held:

“It was argued that the compensation payable to the Company, being measured by the present value of the profits which the Company might, and in all reasonable probability would, have made if the leasehold had not been interfered with, was really a consideration or substitute But, even so, it is a consideration or substitute, not for profits earned or capable of being earned, but for profits irretrievably lost and incapable of being ever earned. The taxing acts deal with profits made, not with profits lost – with actual, not with hypothetical profits – and it is by the words of the taxing acts that we are bound. As paid to and received by the Company, the compensation was the equivalent of a destroyed portion of one of its fixed assets: I do not think it was a profit which arose from the Company’s trade or business at all.”

In the case of Burmah Steam Ship, the taxpayer bought a vessel and sent it for overhaul. The time stipulated for the overhaul exceeded the agreed timeline, and the taxpayer claimed from the repairers damages based on the estimated profit which would’ve been earned had the vessel. In finding that the compensation was taxable, Lord President Clyde distinguished the case of Glenboig Union and this instant by holding that: 

“Now, in the present case, the injury inflicted on the Appellant by the repairer’s failure to make timeous delivery of the vessel is obviously not an injury to the Appellant’s capital assets. Time sounds in money no doubt, but the loss to the Appellant by the late delivery was in the form of loss of trading opportunities, not in the form of the loss of fixed capital….

It is true that the measure by which the amount of damages or compensation is ascertainable is no criterion of the capital or revenue character of the sum recovered for the purpose of adjusting an Income Tax account of profits and gains (Glenboig Union Fireclay Coy. v Inland Revenue 1, 1921 S.C. 400, 1922 S.C. (H.L.) 112)… In the present case there can be no doubt that, when the Appellant entered into the contract with the repairers, the consequences of a failure by the latter to deliver punctually, which were in the contemplation of both parties at the time, were that the Appellant would be deprived of the opportunity of putting the vessel to immediate profitable use in his business. It was in respect of this deprivation that the damages were recovered. The contemplated “hole” in the Appellant’s profits was unfortunately made, and in my opinion the damages recovered must go, as a matter of sound commercial accounting, to fill that “hole”, and therefore constitute a proper item of profit in the Appellant’s profit and loss account.”

If the compensation given is due to permanent damage to a capital asset, TLDR is capital in nature. In contrast, if the compensation is due to temporary disturbance, it is revenue. If the argument goes along the lines that there was no outright disposal and the compensation is for “loss of income”, it is nevertheless not revenue in nature. Either way, the sum of RM821 million should not be taxed under Section 4(f) of the ITA for the reasons below. 

3. Is the sum of RM821 million taxable under Section 4(f) of the ITA?

It is unfortunate that neither the High Court nor the Special Commissioners of Income Tax dealt with this question in detail and overly focused on whether the taxpayer sold IP rights. Section 4(f), the “catch-all” provision, was meant to be a receptacle into which various revenue receipts wished to be added but did not belong elsewhere. 

In the leading case of Leeming v Jones [1930] 1 K.B. 279, Rowlatt J held that gains falling under Case VI Schedule D, the pari materia of our Section 4(f), must be revenue in nature. In this instant, the taxpayer was invited and agreed to join a syndicate to acquire an option over a rubber estate. The estate was not large enough for re-sale, and the syndicate acquired a further option to purchase an additional estate. The two estates were sold at a profit for which the taxpayer was assessed to tax.

Rowlatt J. held as follow in this instant case: 

“.. and although you may have cases which fall properly within Sch. D and in respect of which case VI. may be usefully applied, yet if you are to apply Case VI. it must be in respect of something to which Sch. D applies; it must be something in the nature of profits or gains in contradistinction to capital, and I think that the words which are used by Atkin L.J. in Cooper v. Stubbs (1), to which I have already referred, are of assistance here, for he made it plain that he regarded Case VI.”

His Lordship further expanded on what would not be caught under Case VI:

“We have to bear in mind what I think Rowlatt J. has rightly said in Ryall v. Hoare (2): “Two kinds of emolument may be excluded from Case VI. First, anything in the nature of capital accretion is excluded as being outside the scope and meaning of these Acts confirmed by the usage of a century. For this reason, a casual profit made on an isolated purchase and sale, unless merged with similar transactions in the carrying on of a trade or business is not liable to tax. ‘Profits or gains’ in Case VI. refer to the interest or fruit as opposed to the principal or root of the tree.”

Leeming v Jones had referred to and distinguished the previous case of Cooper v. Stubbs [1925] 2 K. B. 753. Cooper had earlier alluded to the possibility of taxation of capital accreditation under Case VI. Still, subsequent cases interpreted this as giving rise to trading rather than miscellaneous income depending if the activity was speculation or organised as a trade.

“I think both the judgments in Cooper v. Stubbs (1) which are relied upon clearly indicate that the learned judges in dealing with Case VI. were definitely holding that there must be some profits or gains in the nature of revenue, as contradistinguished from a profit arising upon capital.”

Based on the analysis above, for an income to fall under Section 4(f) of the ITA, the income must be first and foremost revenue in nature. It is the fruit rather than the tree. For a corporation mainly involved in the manufacturing industry and had developed technical production know-how, that technical know-how should be a capital asset of the corporation. Hence, the subsequent disposal is capital in nature. 

3. Inconsistencies in the application of the law

Say that the income is taxable under Section 4(f) of the ITA, the IRB should’ve made appropriate adjustments according to the taxpayer deductions under the ITA. The deductible expenses, in this case, would be labour, research and development expenses and miscellaneous in developing the technical know-how. However, the IRB did not allow deductions, and neither did the SCIT and the High Court similarly hold, which to my mind, is flawed. 

Furthermore, the IRB reasons that because the taxpayer had continued to use the Intellectual Property which it had sold in the course of business, the income is revenue don’t equate well. The principle that is well settled is that the IRB doesn’t have the power to command how taxpayers ought to carry out their business (Port Dickson Power). Hence, if the sale was superficial, it ought to make the necessary adjustments under Section 140A of the ITA, which would be reflective of arm’s length transactions. The utilisation of Section 4(f) of the ITA was, to my mind, inappropriate in this case. 

Section 140 and 140A Income Tax Act 1967 Part 2

In the previous post accessible here, I touched upon the relationship between Section 140 and Section 140A of the Income Tax Act 1967 (“ITA“) and how the lines may be blurred due to the newly enacted Section 140(3a) and (3b). Briefly, Section 140 of the ITA is the anti-tax avoidance provision where the Director-General of Inland Revenue (“DGIR“) is given authority to ignore a certain tax transaction if there is no commercial sense in the arrangement other than to avoid tax. However, the cousin Section 140A is the transfer pricing provision where the DGIR is authorised to make an adjustment to a transaction if it considers that the transaction was not conducted at arm’s length.

The difference in the powers is imperative as it delineates the powers of the DGIR and illegal or without jurisdiction invocation of the said sections will be susceptible to intervention by a court of law.

The High Court had recently made a few landmark decisions on this which provide useful guidance on the jurisdiction of the two sections and the applicability of the same. 

In Ensco Gerudi (M) Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri [2021] MLJU 1229 (“Ensco Gerudi 2021“), the DGIR invoked Section 140A to make the adjustment between Ensco Gerudi (M) Sdn Bhd and Ensco Labuan Limited (“ELL“). The DGIR dismissed the taxpayer’s use of the transactional net margin method (“TNMM Method”) as the transfer pricing methodology and insisted on the application of the transactional profit split method (“Profit Split Method”) instead.

It is apposite to note that in a previous decision of Ensco Gerudi (M) Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri (Application for Judicial Review No.: 25-101- 05/2013) (“Ensco Gerudi 2013“), the DGIR invoked Section 140 on the exact same transactions which were the subject matter of dispute in the case of Ensco Gerudi 2021. The only difference is that the DGIR in this instant case was invoking Section 140A instead of Section 140. Ensco Gerudi 2013 was a matter that went up to the Court of Appeal where the Court of Appeal held that the DGIR did not have any jurisdiction to invoke Section 140 of the ITA on the taxpayer’s transaction with ELL. 

Aggrieved, Ensco Gerudi initiated judicial review against the DGIR for, amongst others, a declaration that the DGIR’s invocation of Section 140A was illegal and void. Counsel for Ensco Gerudi canvassed the following arguments: 

(a) The DGIR acted in excess of its jurisdiction when it failed to act in accordance with previously decided cases by the High Court and the Court of Appeal in Ensco Gerudi 2013; 

(b) The DGIR had unlawfully invoked Section 140A of the ITA when it is clear that the taxpayer and ELL are not ‘associated persons’ with one another within the definition of the ITA (for the relevant years of assessment); and

(c) The DGIR had breached its duty to provide reasons when it issued the notices of assessment without providing any clear reasons and/or justifications as to how the taxpayer and ELL are associated persons or that the transfer pricing methodology was incorrect. They are aggrieved by the DGIR’s failure to perform even the most perfunctory transfer pricing analysis in coming to its incongruous decision. 

The DGIR refuted the points below:

(a) The taxpayer ought to ventilate the matter via appeal to the Special Commissioners of Income Tax; 

(b) The ITA provisions relied upon by the DGIR are different in Ensco Gerudi 2021 and Ensco Gerudi 2013; and 

(c) The reliefs sought in the two cases are different.

Both leave and judicial review applications were allowed. In arriving at the decision, the Learned High Court held as follows:

1. The taxpayer and ELL are not associated persons as they do not possess or are entitled to acquire the greater part of the share capital or voting power because to be able to have control under Section 139 ITA, the taxpayer has to be at least 51% owned. The only justification that the DGIR had provided in relation to this issue is that the transactions are carried out between the parties within the same group but that is not a requirement under s 140A ITA.;
2. The Respondent had exceeded its jurisdiction and acted unlawfully when it fails to give due consideration to the earlier decisions of the Superior Courts of Malaysia.
3. Not only the taxpayer but the Court are deprived of knowing the DGIR’s version of what the transfer pricing report ought to be.
4. An appeal to the SCIT is not a blanket approach and does not shut out an aggrieved taxpayer from coming to Court seeking for the remedy of judicial review on the premise that there exists an internal appeal process.

In another case of S v KPHDN, the taxpayer had entered into several intragroup services with the taxpayer’s related companies. It was the DGIR’s contention that several of these services provided were duplicative and hence certain services ought to be disallowed deductions. The DGIR invoked Section 140A by alleging that the “duplicative services” were not at arm’s length hence no deductions should be claimed.

Counsel for the taxpayer argued that the DGIR had inappropriately invoked section 140A of the ITA which does not allow the DGIR to disallow the expenses. Only section 140 of the ITA allows the DGIR to make such adjustments. If the DGIR was of the view that a certain transaction was entered to reduce the incidence of tax, the DGIR ought to invoke Section 140 of the ITA and not Section 140A. Section 140A only allows the DGIR to make an adjustment that would be reflective of an arm’s length transaction but not to disregard it completely.  

The DGIR on the other hand argued that the matter includes a dispute of facts that ought to be ventilated with the SCIT and this instant judicial review application is an abuse of the court process. Consequently, contemporaneous documents and examination would be required in order to determine if the services rendered were duplicative or otherwise.

Upon hearing the parties’ submissions, the learned high court had allowed the taxpayer’s application for leave. The matter is now pending for the substantive stage.

Conclusion 

Section 140 and 140A has their distinctive difference and operates independently. With the presumption that the Parliament does not legislate laws in vain, Section 140 and Section 140A are not to be used interchangeably. Section 140A of the ITA only allows the DGIR to make an adjustment that would be reflective of arm’s length transaction but not to disregard the same whereas Section 140 gives the DGIR broader powers but not without its restrictions under as held in Port Dickson Power and as stated in Section 140(9).

How to prepare for interviews for law firms in Malaysia

Maybe you’re just starting out a job or maybe you have just completed your CLP and/or Bar and are seeking out employment to start your pupilage in order to be called to the Bar, either way, this post may be useful for you in order to kick start your career.

(Disclaimer: This post may be relevant only to pupilage and junior associate-level positions in Malaysia and I’m merely speaking from experience from the interviews I’ve personally been to.)

A. The screening process

The interview process differs from law firm to law firm. Some may have case studies, others may have aptitude tests and some do have preliminary questions and answers. It’s best to always be prepared for all. The preliminary screening is mostly modelled after the firm’s expertise as well as your personal preferred area of practice.

When I was applying for pupillage, I did apply for a number of firms. Some of my experiences can be summarised as follow:

• Firm A had a case study test. The test required you to analyse a given situation and how the relevant statutory provisions may apply. The test also requires you to suggest the best possible implementation route. My strategy to answer this test was to angle it from not only a commercial point of view but also the tax considerations which are relevant (obviously because I was going for the tax practice of the firm but also… arbitration was an option too).

• Firm B had a questions and answers test. Prior to the interview, I was given a sheet of paper with about 20 questions. The questions included legal questions and also IQ questions (i.e. why is a pothole cover round. Legit). The best is don’t return all your legal knowledge to your lecturer after completing your CLP / Bar haha. Most law firms adopt this test to assess your legal knowledge. 

• Firm C had a “drafting” test. The test consisted of a scenario and the candidate is required to draft the necessary cause paper(s) (i.e. statement of claim/statement of defence/affidavit) asked by the test. This is mainly to assess the candidate’s drafting skills. 

B. The interview

Sometimes, the interview comes once you’ve passed the screening process whilst others it is together with the screening process. For most of the interviews I’ve attended for pupilage, I was interviewed by 2 partners of the firm. Additionally, due to rising competition between law firms, do expect that you’ll be required to attend 2 or more interviews.

It is very important that you indicate at the outset on your cover letter your intended area of practice so that the interviewers chosen for you are the partners of your preferred practice area. They are often very reluctant to interview and select a candidate that is not for their own practice group, i.e. an IP partner would not choose a pupil for the Banking practice.

Other than the common interview questions i.e. “why did you apply here”, “tell us about yourself”, and “what are your strength and weaknesses”, there is an emphasis on your area of preferred practice and choice of the law firm. It is pertinent that you do research on each and every firm prior to applying in order to fully understand the practice areas of the firm. Please do not apply to a litigation firm and inform the interviewers that you would like to do corporate practice where the latter practice is minimal in the firm.

(Brownie points: prior to your interview, familiarize yourself with the partners of your preferred area of practice. Also, ask for their name cards before the interview so you’ll know who interviewed you in the future)

Most interviews are 15 – 60 minutes long, depending on the interests of the partners. For interviews which were only 15 minutes, I had already sensed that they were not interested in my application and would be mentally prepared to be rejected. For litigation firms, one common question is to discuss a case and assessed the correctness of the decision. I would recommend that should you be interested in applying for litigation roles, be well-versed with some novel and trite cases of the practice.

(Warning: for your choice of case for discussion during interviews, have clear reasoning as to why you chose the case, your views and the facts (clearly and precisely). It is better that you do not choose a case that involves your interviewers as the main aim is to facilitate discussion instead of praising how correct they are in the case. Also, be sure to have two sides of the coin in mind).

Remember when I said that some interviews may come right after the screening process? More often than not, the interviewers will go through your answers given in the tests and question you during the interview. Be prepared to be interrogated on some of the answers.

Last of all, although this should be common sense, don’t be late for your interview and dress appropriately and in proper attire. The first impression lasts a long time 😉

C. Starting your pupilage / new job

Once you’ve passed parts A and B and have landed yourself an offer from the firm, congratulations!! And if you’ve received more than 1 offer, double congratulations on the first world problems you’ll have to face.

When it comes to choosing your pupilage, be very careful and know that your pupilage will last for 9 months uninterrupted. Yes, that means no leaves are to be taken during the entire 9 month period. Therefore, it is very important that you are well prepared to enter the workforce with ample mental preparation.

Personally, it’s best to speak to seniors or your circle of friends who did pupilage in the firms you were offered to fully understand the job scope and expectation of the legal industry (Read: 2am deadlines, 5 hours of sleep and admin work to do). The remuneration of the firm, travelling time and house rent are factors you may want to consider when choosing your choice of firm.

Last comments

As someone who had joined (and left momentarily with the possibility of rejoining) the legal industry, the only advice I can part with is that the work is demanding and deadlines are constantly looming. Good mentorship and guidance are something I personally desired in personal growth and development. Do not be shy and do reach out to people on Linkedin who are in the firm to understand more as if you’re starting out your pupilage, you do want to know what you’re getting yourself into.

With that being said, stay strong soldier.

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.