There is no single concept of what constitutes income. It is not defined explicitly in the Income Tax Act. In practice, the meaning of income is largely determined with reference to decided cases (common law) in order to distinguish between income and capital gain as the former is taxable and the latter is not.
This article aims to provide some guidance on this area of complexity in tax. Although no infallible criterion has emerged from the decided cases, the following tests may be applied as a guide:
1. PERMANENT STRUCTURE VERSUS SUBJECT MATTER OF THE BUSINESS
Profits derived from the realisation of assets forming part of the permanent structure of a business would be regarded as capital in nature while those relating to transactions in the course of a business are liable to be taxed.
2. FIXED OR CIRCULATING CAPITAL
According to Lord Haldane in John Smith & Son v Moore (1921), “Adam Smith, in his book Wealth of Nations, described fixed capital as what the owner turns to profit by keeping it in his own possession, circulating capital as what he makes a profit of by parting with it and letting it change masters.” Receipts from the disposal of fixed capital would accordingly be capital in nature and receipts from the disposal of circulating capital would be revenue in nature.
3. THE TEST OF INTENTION
Possibly the most important test he test of intention laid down by the courts is the “purpose test” for which the asset was originally acquired. If an asset is acquired for resale with a view to profit, the proceed from the sale of such asset is generally revenue in nature. Conversely, if an asset is acquired with the object of deriving income from it and not for resale at a profit, the proceed from the sale of the asset is generally considered capital in nature.
Justice Andrew Phang explained in CIT v IA (2006) 4SLR (R) 161 that the “purpose test” provides an eminently appropriate starting point for any inquiry of this nature. Simply put, the purpose of the transaction must be considered in the light of the objective facts and not the subjective intentions of the taxpayer.
In addition, Sharma J also stated in NYF Realty Sdn Bhd v CIR (1974), “The focal point is the dominant purpose for which the particular property was originally acquired. If it is established that the dominant purpose was its resale at a profit, the presence of other purposes… does not remove any profit on ultimate sale from the taxable area.”
4. PERIOD OF HOLDING
In Reliance Land Investment Co (Pty) Ltd v CIR 1946 WLD (1971), it was held that “recurrence of a receipt or the holding period is not necessarily a decisive test… though it is an important element to be taken into consideration”. A profit derived
after a long holding period may suggest that the asset was held as a long-term investment whereas an asset disposed of shortly after acquisition may prima facie be regarded as an asset purchased for resale in the short term for a profit. This may not necessarily be the case and it must be considered in conjunction with all other factors.
5. FREQUENCY OF SIMILAR TRANSACTIONS
If any particular transaction is found to be one of a series and there is evidence of habitual and repetitious activity, then the transaction may fall into the general pattern which as a whole constitutes a trade. On the other hand, It may be argued that a number of desultory transactions over a number of years do not constitute a trade.
The test of frequency must be considered in relation to the subject matter as Rowlatt J stated in Pickford v Quike (1927), “It is very well known that one transaction of buying and selling a thing does not make a man a trader, but if it is repeated and becomes systematic, then he becomes a trader and the profits of the transactions not taxable so long as they remain isolated,
become taxable as items in a trade as a whole.”
6. SUPPLEMENTARY WORK MADE
In IRC v Livingstone (1926), the fact that material alterations were made to a cargo vessel to improve its character and to make it more marketable was significant in indicating a trading transaction, because there was an organised effort to obtain profit.
7. CIRCUMSTANCES RESPONSIBLE FOR THE SALE
In West v Phillips (1958), “If an asset is sold because of some unanticipated factors or a sudden need for ready money, such causative circumstances would indicate a presumption that the asset was not originally acquired for trading purposes.”
8. EXISTENCE OF A PROFIT-SEEKING MOTIVE
In Iswera Ceylon v CIT (1965), Lord Reid upheld that “if his acts are equivocal, his purpose or object may be a very material factor when weighing the total effect of all the circumstances”. However, the presence of a desire to make a profit is not conclusive either. As Lord Buckmaster observed in Leeming v Jones, “an accretion to capital does not become income because the original capital was invested in the hope and expectation that it would rise in value…”.
9. THE MANNER IN WHICH A DISPOSAL IS SECURED
In Martin v Lowry (1927), it was held that if special effort was made to find or attract purchasers (sales campaign by extensive advertising) or a business organisation was used to effect the sale, then there is a presumption of trade.
10. METHODS OF FINANCING
If the financing is from external borrowed funds, the obligation of having to repay the loan facilities periodically would point to the presumption of trade, for example, the need to realise income so as to repay the loan.
Applying any one of the above factors is not by itself conclusive. One has to consider all the circumstances and facts of each particular scenario. Nonetheless, the following five basic propositions could be said to have emerged from the decision of the Courts:
- Payments received for the sale of fixed assets of a business are prima facie capital;
- Payments received for the destruction of the profit-making apparatus of a business are generally capital;
- Payments in lieu of trading receipts are generally revenue;
- Payments in return for the imposition of substantial restrictions on the activities of a trader are generally capital, and
- Payments of a recurrent nature are more likely to be revenue.
In summary, in determining the liability to income tax in Singapore, it is necessary to draw a distinction between taxable income and non-taxable capital gains. This is not always an easy task. Applying the above factors will help to draw out the relevant facts and circumstances under which the receipt arose and enable a holistic picture to emerge as to the nature of the receipt so as to determine if the income is revenue or capital in nature.