Compulsory Acquisition of Land

SEMINAR ON TAX CASES & CRITICAL ISSUES

31 MAY 2006

TOPIC:

COMPULSORY ACQUISITION OF LAND

FRANCIS L.K. TAN

AZMAN, DAVIDSON & CO.

Suite 13.03, 13^th Floor

Menara Tan & Tan

207 Jalan Tun Razak

50400 Kuala Lumpur

COMPULSORY ACQUISITION OF LAND

1. When a person or company sells a piece of land, at a profit, the immediate question in terms of liability to tax is whether the gain is taxable and if so, whether it is to be taxed pursuant to the Income Tax Act 1967 (“ITA”) or the Real Property Gains Tax Act 1976 (“RPGT”). The rate of tax is different. Also, if the sale is a realization of an investment or capital, the ITA has no application since it is concern with the taxation of income. An individual, as against a corporation, who disposes off land more than five years after the land is acquired, is not liable to tax on the gain.

2. Under paragraph 3(f) of the Second Schedule to the RPGT, where an asset is compulsorily acquired, the disposal price is deemed to be equal to the acquisition price. In other words, there is no gain on the disposal and therefore no liability to tax. The tax position under the RPGT in connection with compulsory acquisition is therefore straightforward.

3. Under S.22(b) of the ITA, it is provided that compensation for loss of income from a source is to be treated as gross income. In relation to compensation received for “loss” of land as a result of compulsory acquisition, the question which arises is whether the compensation is for loss of income. If it is for the loss of a capital asset, then the compensation is a capital receipt and therefore not taxable. This question brings into focus whether the land acquired is capital or stock in trade. Consequently, when it is sold, whether the receipt is of an income or capital nature. In Ferguson v. CIR 33 TC 15, it is stated that:-

“There is so far as we are aware, no simple infallible test for settling the vexed question whether a receipt is of an income or capital nature. Each case must depend upon its particular facts: one has to look to all relevant circumstances.”

4. When there is a dispute whether a receipt is of an income or capital nature, the first place where the dispute is determined is the Special Commissioners of Income Tax. It cannot be over emphasized that all evidence, including accounting evidence must be introduced to show that the asset in question is not stock in trade and the taxpayer does not have a trading intention. It is also important to bear in mind that finding of facts by the Special Commissioners cannot be overturned by the appeal courts unless there is no evidence to support the finding or the decision is one which no reasonable body of commissioners could have been reached. Making a finding that the surplus from a sale of land in a transaction designed to raise finance falls into this category (Lim Foo Yong Sdn Bhd v. Comptroller General of Inland Revenue [1986] 2 MLJ 161.

In Simmons v. IRC [1980] STC 350 Lord Wilberforce laid down the law on trading intention as follows:-

“Trading requires an intention to trade; normally the question to be asked is whether this intention existed at the time of the acquisition of the asset. Was it acquired with the intention of disposing of it at a profit, or was it acquired as a permanent investment? Often it is necessary to ask further questions: a permanent investment may be sold in order to acquire another investment thought to be more satisfactory; that does not involve an operation of trade, whether the first investment is sold at a profit or at a loss. Intentions may be changed. What was first an investment may be put into the trading stock, and, I suppose, vice versa. If findings of this kind are to be made precision is required, since a shift of asset from one category to another will involve changes in the company’s accounts, and, possibly, a liability to tax (cf Sharkey (Inspector of Taxes) v Wernher). What I think is not possible is for an asset to be both trading and permanent investment at the same time, nor for it to possess an indeterminate status, neither trading stock nor permanent asset. It must be one or the other, even though, and this seems to me legitimate and intelligible, the company, in whatever character it acquires the asset, may reserve an intention to change its character. To do so would, in fact, amount to little more than making explicit what is necessarily implicit in all commercial operations, namely that situations are open to review.”

Intention can be determined in several ways. In the case of a company, it has been held that if its business is or includes trading, it prima facie begins to trade as soon as it embarks upon the first transaction of a trading nature. See International Investment Ltd v. Comptroller General of Inland Revenue [1979] 1 MLJ 4. If a land dealing company or housing development company begins to trade, it is difficult to then say that its land is not stock in trade and accordingly if the land is compulsorily acquired, the surplus is income.

5. On the other hand, if a company is able to demonstrate that its original intention was not to trade in the land it has acquired and the asset is shown as fixed asset, then the asset cannot in law be regarded as stock in trade. This is the position in Perak Construction Sdn Bhd v. KPHDN [2001] MSTC 3866. The taxpayer was in the business of constructing houses and in 1975, acquired some properties which was subsequently acquired by the government. The High Court, reversing the Special Commissioners findings held that the surplus arising therefrom was not income. The Court attached special weight to the fact that the land was capitalized and shown as fixed assets in the balance sheet. This is an instance where appropriate accounting entry can play an important role.

6. It is important to note, however, that it is settled law that accounting evidence can never be conclusive evidence. See EDLCH Sdn Bhd v Ketua Pengarah HDN [1996] MTSC 2798. The accounts treated the acquired land as a fixed asset but the other features in the accounts revolt against such a classification. As it was established that land was purchased with the dominant intention of using it as a current asset for development purposes, the Special Commissioners dismissed the appeal of the tax payer. It is the proposition of this case that in income tax cases, one must look at the substance of the thing and not merely at the manner in which the account is stated. See also Alf Properties Sdn Bhd v. KPJHDN [2005] 5 MLJ 717. Note however the dissenting judgment of Abdul Aziz Mohamad JCA.

7. In F Housing Sdn Bhd v. DGIR [1976] 2 MLJ 183, the rubber land of approximately 93.8 acres owned by the taxpayer was compulsorily acquired. The question which arose was whether the difference between the acquisition price or cost and the compensation received was liable to income tax. The High Court held on the facts of the case, the isolated transaction although it concerned compulsory acquisition, should lawfully be regarded as a trading transaction and the gain was income or profit and taxable under S.4(a) of the ITA. In so deciding, the Court paid due regard to the finding of the Special Commissioners that the land which was purchased by 5 persons supposedly as agent of the taxpayer was for the purpose of conducting a housing development. The Court also refused to draw a distinction between the business of land development and land dealings particularly as the issue was not pursued before the Special Commissioners.

8. The fact that a company may change its business direction or character was recognized in Simmons. In other words, an asset which is stock in trade, may be converted into fixed asset with the result that the profit realized therefrom from a subsequent sale is not subject to income tax. A change of business direction should however be manifested in some form. An appropriate board resolution and accounting entry are the obvious things to do.

9. The Special Commissioners and the Courts have also consistently held that if there is a change in the character of an asset, i.e. from stock in trade to fixed asset, then the provision of S.24(2) of the ITA has to be complied with. See M Development Sdn Bhd v KPHDN [1995] MSTC 2202 and the case of Yoon Lian Realty Sdn Bhd v. DGIR (Ipoh High Court Tax Appeal 14-1929, unreported and referred to in M Development). The result is that there is an acceleration in the recognition of income and unless there is a prospect of further appreciation in the value of the asset, there is no real advantage in reclassification.

10. In conclusion, the following propositions may be made:-

(a) In the case of a company incorporated for carrying on business for profit, there is a presumption that any gainful use to which it puts any of its asset amounts to the carrying on of a business. Accordingly, the assets it acquires for resale are stock in trade.

(b) The presumption may be rebutted by cogent evidence such as the absence of any step to make the asset more saleable and the asset is capitalized before commencement of business or upon its acquisition. In such a case, the asset will be treated as capital.

TLK/jl/2006