The problem of income

Sri Lanka’s Income Tax Law: General Principles – Module 2

1. As judges have often said, the object of the income tax is to tax income and nothing else, but the legislation here as well as elsewhere nowhere indicates with certainty and comprehensiveness what income is.

2. The definition in section 217 provides that “profits” or “income” means the net profits or income from any source for any period calculated in accordance with the provisions of the Act. “Income” is thus left undefined. 

3. Section 3 attempts a classification of “profits and income” or “profits” or “income” by specifying identified sources in paragraphs (a) to (j) but provides in the latter paragraph a reference to “income from any other source whatsoever not including profits of a casual or non-recurring nature.” Thus, Parliament has contemplated the possibility of there being items of income not included in the paragraphs preceding paragraph (j) and the necessity to tax such income provided such income is not of a casual or non-recurring nature. Here again, income is left undefined. 

4. Webster’s Third New International Dictionary (1993) defines income as “…a gain or recurrent benefit that is usually measured in money and for a given period of time, derives from capital, labour or a combination of both…”

5. In economics, income is the monetary or non-monetary return from land, labour, capital or enterprise.

6. In tax cases the word “income” has been much discussed by judges of eminence. Most of them have said much of quotable value for the reader but I will cite just two of them.

In AG of British Columbia v Ostrum (1904, A.C. 144, 147) the Privy Council observed: “Their Lordships are of opinion that there is no ground for cutting down the plain and ordinary meaning of the word ‘income’. 

In their view the expression was intended to include, and does include, all gains and profits derived from personal exertions, whether such gains and profits are fixed or fluctuating, certain or precarious, whatever may be the principle or basis of calculation.” 

Justice Pitney of the US Supreme Court (Eisner v Macomber, 1919, 252 U.S. 189, at 206-207) has observed: “Here we have the essential matter: not a gain accruing to capital, not a growth or increment of value in the investment; but a gain, a profit, something of exchangeable value proceeding from the property, severed from the capital, however invested or employed, and coming in, being ‘derived’ that is received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal; that is income derived from property. 

Nothing else answers the description.” The italics were used by the judge for emphasis.

In Thornhill v CIT (1940, CTC Vol. I p 180 at 188,189) the SC of Ceylon briefly cited the criteria of income as expressed in Tennant v Smith (1892, 3 TC 158 – income must be money or something capable of being turned into money), AG of British Columbia v Ostrum (see above), Eisner v Marcomber (see above) and applied the criteria mentioned in an early treatise, ‘Land and Income Tax Law and Practice’ by Cunningham and Dowland: “The essential characteristics appear to be the following:

a. It must be a gain.

b. It must actually come in, severed from capital, in cash or its equivalent.

c. It must be the produce of property or/and the reward of labour or effort.

d.It must not be a mere change in the form of, or accretion to, the value of articles in which it is not the business of the taxpayer to deal.

e.It must not be a sum returned as a reduction of a private expense.”

Speaking for the Court, Soertsz J. said “This statement, if I may say so, provides adequate tests by which to ascertain whether a particular receipt is income or not…”

In the Thornhill case, the taxpayer who owned tea and rubber estates received tea and rubber coupons issued under the Tea and Rubber Control Ordinances. 

The coupons entitled him either to obtain export licences for the export of his agricultural produce or to refrain from cultivation and sell the coupons to other growers who could utilise the coupons to cultivate extents of land in excess of the permitted maximum. 

The taxpayer sold the coupons. The sum realised on sale was assessed to tax. He appealed on the main ground that the sum realised was capital and not income. The Court upheld the assessment.

n The sum represents a gain.

n It has come in severed from capital.

n It is the produce of property, being the sale of coupons issued under the respective ordinances to cover his produce, real or hypothetical.

(The writer is a tax consultant and past President of the Sri Lanka Institute of Taxation. He has taught taxation to the professional students of the institute and served as an examiner for the professional examinations. He is a writer on tax topics and his articles have been published locally in some newspapers as well as the Sri Lanka Tax Review journal. His specialised articles have been published internationally in the Reports of the Annual Congresses of the International Fiscal Association based in The Hague, The Netherlands. He is the Immediate Past Chairman of IFA – Sri Lanka Branch.)