Tax, Trade & Customs Update: The Income-Capital Distinction and DGIR’s Powers

In the recent case of Upayapadu (M) Sdn Bhd (“Taxpayer”) v Ketua Pengarah Hasil Dalam Negeri¹, the Taxpayer was successful in its judicial review application against the Director General of Inland Revenue’s (“DGIR”) decision to subject certain sums received by the Taxpayer pursuant to a settlement agreement (“Settlement Agreement”) to income tax even though the Settlement Agreement was entered into in consideration for the relinquishment of certain rights and licences held by the Taxpayer to the relevant authorities (“the Rights”).

Under the Settlement Agreement, the parties agreed that specified sums be paid to the Taxpayer as compensation for loss of income, exemplary damages and damages for loss of goodwill and reputation respectively (collectively “the Settlement Amount”).

However, the DGIR subsequently issued assessments and additional assessments for the Years of Assessment 2020 to 2023 (“Disputed Assessments”), purportedly on the basis that the entire Settlement Amount was subject to income tax, despite only a portion thereof being attributable to compensation for loss of income. Additionally, the DGIR also imposed penalties under section 113(2) of the Income Tax Act 1967 (“ITA”).

The High Court allowed the Taxpayer's application for judicial review and quashed all the Disputed Assessments, including the penalties imposed, for the following reasons.

The Court held that the Settlement Agreement had clearly identified and distinguished the nature of the respective payments, and only the amount corresponding to the compensation for loss of income constituted taxable income, for which tax had already been paid. Further, it was held that the exemplary damages and damages for loss of goodwill and reputation were capital in nature and not subject to income tax, being awarded not to generate profit for the Taxpayer but to punish the wrongdoer. Similarly, the Court also held that damages awarded for the loss of goodwill and reputation were in the nature of compensation for the impairment of a capital asset of the Taxpayer.

Further, the Court also held that the DGIR had acted inconsistently and arbitrarily. While an earlier tax investigation conducted by the Inland Revenue Board (“IRB”) on the Taxpayer had been concluded without any additional tax or adjustment, less than two years later, another audit was conducted by a different branch of the IRB taking a diametrically contrary position from the first investigation though covering the same years of assessment. Relying on the Federal Court decision in Kind Action (M) Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri², the Court held that the DGIR could not be permitted to act inconsistently or to "approbate and reprobate".

Accordingly, the Court quashed the Disputed Assessments, including the penalties imposed, and held that only the compensation for loss of income was taxable.

The Taxpayer in this matter was represented by Anand Raj (Partner), Irene Yong (Partner), Chantal Barnabas (Associate) and Srriya Nithiananda Jawahar (Associate), from our Tax, Trade & Customs Practice Group.

Note: The DGIR has filed an appeal against the High Court’s decision to the Court of Appeal, and the matter is currently pending before the Court of Appeal. 

Footnote:

1. [Judicial Review No.: NA-25-3-07/2024].

2. [2024] 5 MLJ 130.

THIS UPDATE IS ISSUED FOR THE INFORMATION OF THE CLIENTS OF THE FIRM AND COVERS LEGAL ISSUES IN A GENERAL WAY. 

THE CONTENTS ARE NOT INTENDED TO CONSTITUTE ANY ADVICE ON ANY SPECIFIC MATTER AND SHOULD NOT BE RELIED UPON AS A SUBSTITUTE FOR DETAILED LEGAL ADVICE ON SPECIFIC MATTERS OR TRANSACTIONS.