Trading or Investing? Court Draws the Line for Investors for Tax Purposes

Dr Zanariah Ramli v Ketua Pengarah Hasil Dalam Negeri

Court of Appeal

2013

Introduction

This case involved an appeal by the Inland Revenue Board (IRB) against the Special Commissioners of Income Tax (SCIT) decision, which held that profits made by Dr Zanariah Ramli from buying and selling bonds were capital gains not subject to income tax.

The IRB argued that the profits were income from bond trading and thus taxable under section 4(a) of the Income Tax Act 1967.

Dr Zanariah contended the profits were capital gains from investments not subject to tax.

High Court Decision

The High Court allowed the IRB’s appeal and held that the profits were income from adventures in the nature of trade, not capital gains.

In coming to this conclusion, the High Court relied on the following case laws:

• In Commissioners of Inland Revenue v Fraser, a one-time transaction was considered a trade as the taxpayer had acquired a large quantity of whisky greatly exceeding personal use and resold it shortly after through an agent.
• In International Investment Ltd v CGIR, it was held that trading can exist even from one single act and does not require repetition or continuity, although that generally indicates trade.
• In Pickford v Quirke, repetitive transactions became systematic and amounted to a trade.

Applying these principles, the High Court found that:

• Dr Zanariah completed over 400 buy and sell bond transactions over two years, averaging almost one transaction per working day. This pointed to systematic and repetitive trading rather than investment.
• The bonds were not held for long periods but rapidly turned over. This was unlike typical investor behaviour.
• Dr Zanariah appointed a portfolio manager to execute transactions on her instructions, showing she controlled and directed the bond trading activities.
• The intention of the taxpayer must be inferred from conduct, not self-serving testimony alone. Her trading pattern contradicted her stated intent to invest.

Given the badges of trade were present, the totality of evidence led to the irresistible conclusion that Dr Zanariah was carrying on a trade in bonds.

Court of Appeal Decision

On further appeal by Dr Zanariah, the Court of Appeal dismissed the appeal and affirmed the High Court’s decision.

The Court held that the badges of trade were present in Dr Zanariah’s activities, demonstrating an adventure in the nature of trade.

There was a lack of intention to hold the bonds as investments.

Advice for Investors

This case demonstrates that frequent buying and selling of securities can be considered trading rather than investment by tax authorities.

Buying and selling shares by stock market investors is a common investment activity.

However, frequent share transactions aimed at making profits can turn investors into traders for tax purposes, similar to this case involving bonds.

The principles from this case would also apply to stock market investors since income tax laws do not distinguish income from shares or bonds.

learned Justice Sharma J had laid down certain guiding principles in deciphering whether a specific action or actions would amount to an adventure in the nature of trade or otherwise.

In summary, 6 criteria needed to be considered in that process. These 6 criteria may be listed as follows:

1. The subject matter of the transaction;
2. The period of ownership;
3. The frequency of the transaction;
4. The alteration of the property to make it more saleable;
5. The methods for disposing of the property; and
6. The circumstances responsible for the resale of the property.

Income tax liability can arise once an adventure in the nature of trade exists, whether in bonds or shares. Therefore, stock market investors should know that systematic and repetitive trading could subject share profits to income tax, even if they view the activities as investments.

Holding periods and documented investment intentions are relevant. However, objective evidence of conduct will be decisive. Investors should seek tax advice when activity potentially crosses into trading.

In summary, this landmark case established principles for distinguishing between investment and adventures in the nature of trade. The badges of trade and taxpayers’ conduct will determine characterisation for tax purposes.

Reference:

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