Gill CJ (Malaya):

The respondent is a timber merchant carrying on business under the firm name of Guan Lee of which he is the sole proprietor. In 1968 he obtained from the Government of Kedah a permit to extract timber from a forest area in the State. In the same year, two other persons named Encik Ismail bin Mohamed Noor and Encik Mahmood bin Haji Abdullah (hereinafter referred to as the "permit-holders") also obtained similar permits. Condition 1 of the permits issued to them stipulated that the permit-holder shall not transfer any of his rights, obligations or liabilities under the permit to any other person or persons by power of attorney or in any other manner, except with the permission in writing of the State Forest Officer.

By agreements dated 19 May 1968 the permit-holders agreed and undertook to "sub-contract" out the forest lands comprised in their respective permits to the respondent, together with the right to collect, extract and take delivery of timber therefrom. In return the respondent agreed to pay the permit-holders $1 for every ton of timber extracted. Under further agreement dated 26 May 1968 the respondent agreed to pay on behalf of the permit-holders all royalties, premiums and any fines which might be imposed by the Forest Department. During the basis year for the year of assessment 1970, the respondent paid the permit-holders a total sum of $5,586 by way of commission, and he paid the Government of Kedah, in the names of the permit-holders, the sums of $36,600 and $42,000 respectively as royalties. In computing the respondent's adjusted income for that year of assessment, the Director-General of Inland Revenue (the appellant) disallowed those sums as items of expenditure.

On an appeal by the respondent against such disallowance by the appellant, the Special Commissioners of Income Tax held those items of expenditure to be deductible under s. 33(1) of the Income Tax Act, 1967 as expenses wholly and exclusively incurred in the production of the respondent's gross income, and made an order for the respondent's income tax to be amended accordingly. On a further appeal by the appellant by way of case stated to the High Court, Chang Min Tat J decided that the commission paid by the respondent to the permit holders was not deductible, but that the royalties which he paid to the Government in the names of the permit-holders were allowable deductions under s. 33(1) of the Act. It is from the latter part of the learned Judge's decision that the appellant has appealed to this Court.

At the hearing before the Special Commissioners, it was contended on behalf of the appellant that the Department of Inland Revenue and the Forest Department were not bound by the agreements between the permit holders and the respondent, as they were entered into in clear breach of the terms of the permits. The Commissioners rejected that contention as they formed the opinion that, although the agreements might not be valid as against the Government of Kedah, they were not illegal as between the respondent and the permit holders. The learned Judge in the High Court, however, took the view that there could be no doubt of the illegality of the agreements, whether viewed in relation to the Government or as between the parties.

The question to be determined in this appeal is whether the learned Judge was right in holding that the royalties paid by the respondent are allowable deductions from the gross income which he made in extracting timber under the agreements with the permit holders. The determination of this question, as rightly pointed out by the learned Judge, depends on the interpretation of ss. 33 and 39 of the Act. Section 33(1) deals with deductions which are allowed. Section 39 refers to deductions which are not allowed. The deductions specified under s. 39(1)(a) to (f) are not relevant to this appeal. What is relevant is s. 39(1)(g) which speaks of "any sum, by whatever name called, payable (otherwise than to a St