The Wiramuda Case – Landmark Federal Court Ruling That Compensation Is Not Taxable
Recently, the Federal Court led by the Chief Justice unanimously ruled in favour of the taxpayer by ruling that Section 4C of the Income Tax Act 1967 (ITA) is unconstitutional.
The taxpayer was successfully represented by the firm’s tax practice together with its instructing solicitors. This alert discusses the key points argued in the case.
In 1987, the Selangor state government alienated parcels of land (the Land) to the taxpayer. Somewhere in the early 1990s, the taxpayer commenced quarry activities which continued until 2011. From 2011, the taxpayer remained a dormant company. In 2016, the state government compulsorily acquired the Land for the SUKE Highway Project. The taxpayer was awarded compensation for the compulsory acquisition pursuant to the Land Acquisition Act 1960.
The Director General of Inland Revenue (DGIR) raised a notice of assessment imposing income tax and penalty for about RM 52 million against the taxpayer by subjecting to income tax the compensation received from the compulsory acquisition of the Land. The DGIR invoked Section 4C of the ITA to do so.
Being aggrieved by the notice of assessment, the taxpayer commenced judicial review proceedings to challenge the notice of assessment raised by the DGIR. Amongst others, the taxpayer argued that Section 4C was unconstitutional and was liable to be struck down on the ground that it deprives the taxpayer’s right to receive adequate compensation for the compulsory acquisition of land guaranteed by Article 13(2) of the Federal Constitution. Article 13(2) reads:
“No law shall provide for the compulsory acquisition or use of property without adequate compensation”
The History Behind Section 4C
Prior to the introduction of Section 4C of the ITA, the Court of Appeal in Ketua Pengarah Hasil Dalam Negeri v Penang Realty Sdn Bhd  3 MLJ 597 held that compensation received by the taxpayer for compulsory acquisition of land is not subject to income tax. The Court of Appeal adopted the principle enunciated by the Supreme Court in Lower Perak Cooperative Housing Society Berhad v Ketua Pengarah Hasil Dalam Negeri  2 MLJ 713 which held that the element of compulsion vitiated the intention to trade. The decision in Penang Realty was subsequently followed by the High Court in Metacorp Development Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri (2011) MSTC 30-024. The Federal Court subsequently affirmed the High Court’s ruling in the Metacorp Development case.
Consequent to these court ruling, the DGIR introduced Section 4C through the Finance Act 2014. Section 4C reads:
“For the purpose of paragraph 4(a), gains or profits from a business shall include an amount receiveable arising from stock in trade parted with by any element of compulsion including on requisition or compulsory acquisition or in a similar manner”
The crux of the taxpayer’s submission was that Section 4C violates the fundamental right afforded under Article 13(2) of the Federal Constitution on the following basis:
(i) The concept of “adequate compensation" as envisaged under Article 13(2) is the sum that would place the taxpayer in the same financial position as he would have been if there was no question of the subject land being compulsorily acquired. This is known as the principle of equivalence which was applied by the Federal Court in Semenyih Jaya Sdn Bhd v Pentadbir Daerah Hulu Langat and another  3 MLJ 561.
(ii) Section 4C was enacted to subject the compensation received for the compulsory acquisition of land under the Land Acquisition Act 1960 to income tax. It effectively takes away and reduces the amount of compensation received by a person whose land is compulsorily acquired. This defeats the protection afforded by Article 13(2).
(iii) Section 4C had the effect of eroding the enshrined fundamental right to “adequate compensation” under Article 13(2), thus, making the protection guaranteed by the Federal Constitution illusory.
The crux of the Revenue’s submission was the issue of the adequacy of the compensation in light of Article 13(2) of the Federal Constitution does not arise as the taxpayer has already been adequately compensated on the following basis:
(i) The word “law” in Article 13(2) should be read to be referring to the Land Acquisition Act 1960 and not the ITA. The Revenue argued that the judicial power to award adequate compensation for the compulsory acquisition of land lied solely on the High Court Judge. As such, the taxpayer was estopped from raising any contention on the adequacy of compensation in the Federal Constitution.
(ii) Section 4C was consistent with the Federal Constitution as Article 13(2) does not restrict the legislative powers of Parliament but merely requires adequate compensation to be awarded for the compulsory acquisition of land.
(iii) Section 4C does not conflict with Article 13(2) as the provision was duly legislated by Parliament.
High Court’s Decision
The High Court dismissed the taxpayer’s judicial review application on the basis that the DGIR was empowered to tax the compensation. Amongst others, the High Court held that Section 4C was a provision which was duly inserted by Parliament to the ITA and thus, it cannot be said to be in contravention of the Federal Constitution. Article 96 of the Federal Constitution gives the power to the DGIR to impose taxes on the taxpayer in accordance with the law.
Court Of Appeal’s Decision
Being dissatisfied with the High Court’s decision, the taxpayer filed an appeal to the Court of Appeal. The Court of Appeal also unanimously dismissed the taxpayer’s appeal on the grounds that there was a strong presumption of constitutionality in relation to Section 4C. As Section 4C was enacted vide the Finance Act 2014 and was passed by Parliament, the Court of Appeal held that Section 4C conformed to Article 13(2) and Article 96 of the Federal Constitution.
Federal Court’s Decision
The taxpayer subsequently filed a notice of motion to file an appeal to the Federal Court under Section 96 of the Court of Judicature Act 1964. In August 2022, the Federal Court allowed the taxpayer’s motion on the basis that there are questions of public importance to be determined.
In December 2022, in a unanimous decision, the Federal Court held that Section 4C of the ITA was unconstitutional as it contravened Article 13(2) of the Federal Constitution by depriving the taxpayer of adequate compensation arising from the compulsory acquisition of the land.
This is a landmark ruling as this is the first time where the apex court ruled that the tax provision in the ITA to be unconstitutional. It is a good decision by the Federal Court to uphold the supremacy of the Federal Constitution over legislations passed by Parliament. This ruling serves a good reminder that Parliament does not have the power to enact law including tax law that erodes the fundamental rights guaranteed by the Federal Constitution.
Authored by Yap Wen Hui, an associate with the firm’s Tax, SST and Custom practice.
22 March 2023