TUTORIAL 25 Advanced Taxation / BAC 4644/Dr Nakha Ratnam Somasundaram FINAL REVISION
CUSTOMS AND EXCISE DUTIES
Question 1
What do you understand by ‘duty to declare’ and what are the particulars that should should be declared? Answer
It is the duty of the importer or exporter, whether personally or through his agent, to make a declaration of any goods imported or exported which is a full and true account of the particulars of which provisions provisions are made in the relevant forms. Generally, the following particulars must be submitted: (i) Number of packages (ii) Description of package (iii)Description of goods to be imported or exported (iv)Weight, (iv) Weight, measure or quantity (v) Value (vi) Country of origin.
Question 2
Mr. James recently visited visited Singapore and stayed there with his sister for a week. When he he departed Singapore, the sister gave him a small camera that she had been using for two t wo years. She bought it for SD400 when new but now worth only about SD30. His sister told him the item is not dutiable as it it is only a used used camera, and the model model is now discontinued. discontinued. Mr. James then placed it in his car boot and drove drove across the Causeway to Malaysia. At the Customs point he told the Customs officer that he has nothing valuable to declare. Required: (a) Explain whether the conduct of Mr. James is appropriate. (b) What do you think is the proper thing that he should have done? (c) Quote any case law that you think is appropriate.
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Answer
(a) Mr. James has a duty to declare dec lare the used article to the t he customs officer. Not declaring could be an offence. He could even be treated as attempting att empting to evade duty and commit commit fraud. (b) He should declare the article art icle to the Customs officer. If the set is not liable to any duty, it should be confirmed by the t he customs officer. And the exemption should then be claimed in a proper manner. (c) Case law: Regina v Hor How Choo – Choo – it it is the duty of the person to declare the goods and claim the exemption. exempt ion. Goods not declared could be liable to t o a duty of RM30% of the value of the goods (usually determined by the Customs unless you have sufficient documentation to assist with the value determination).
Question 3
How is classification of goods and tariff codes made suitable for international trade? Answer
Classification determines the t he tariff code of the product follows the established Har monized System. This system is co mplied with internationally by participating countries and t hereby ‘harmonizes’ the coding and valuation issues. In addition the system and assist with the following: The proper payment of the applicable app licable duty Facilitating trade Information gathering Statistical analysis
The system is sometimes further facilitated facilitat ed by multilateral arrangement among countries with enables the reduction or elimination of tariff on goods from or to participating countries.
Question 4
Explain the transaction value and how does it assist with international trade? Answer
Transaction value is the value after the t he following adjustment: adjustment: Add back 1) Commissions and brokerage 2) Cost of containers 3) Royalties and license fees 4) Marketing assistance charges 5) Value accruing to the seller on disposal
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Answer
(a) Mr. James has a duty to declare dec lare the used article to the t he customs officer. Not declaring could be an offence. He could even be treated as attempting att empting to evade duty and commit commit fraud. (b) He should declare the article art icle to the Customs officer. If the set is not liable to any duty, it should be confirmed by the t he customs officer. And the exemption should then be claimed in a proper manner. (c) Case law: Regina v Hor How Choo – Choo – it it is the duty of the person to declare the goods and claim the exemption. exempt ion. Goods not declared could be liable to t o a duty of RM30% of the value of the goods (usually determined by the Customs unless you have sufficient documentation to assist with the value determination).
Question 3
How is classification of goods and tariff codes made suitable for international trade? Answer
Classification determines the t he tariff code of the product follows the established Har monized System. This system is co mplied with internationally by participating countries and t hereby ‘harmonizes’ the coding and valuation issues. In addition the system and assist with the following: The proper payment of the applicable app licable duty Facilitating trade Information gathering Statistical analysis
The system is sometimes further facilitated facilitat ed by multilateral arrangement among countries with enables the reduction or elimination of tariff on goods from or to participating countries.
Question 4
Explain the transaction value and how does it assist with international trade? Answer
Transaction value is the value after the t he following adjustment: adjustment: Add back 1) Commissions and brokerage 2) Cost of containers 3) Royalties and license fees 4) Marketing assistance charges 5) Value accruing to the seller on disposal
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Deduct 1) Assistance after importation (e.g. maintenance) 2) Transport after importation (e.g. inland road or rail t ransport) 3) Duties and taxes of the importing country (e.g. import duties) This method gives a consistent or near consistent manner for the det ermination of the value for the goods passing the custom point and thus making the liability to duty a more systematic and predictable one.
Question 5
Mr. Ah Long was importing a container of sea-food from China. The agreed value with the importer was RM800,000. And And the duty payable payable on this at 20% was RM 160,000. He instructed his agent to declare on the t he relevant Customs Forms only RM80,000 when it arrives at Port Klang. Required: Discuss the action of Mr. Ah Long and explain are the actions that t he Director General of Customs can take. Answer
There is false declaration of the the value of the goods; goods; and falsification of documents to show an incorrect value. The fine can be up to t o RM500,000. Attempting to bring in goods without paying duty or insufficient duty could be treated as smuggling – smuggling – which which is a serious offence and a nd the penalty is 10 times the duty or RM500,000 whichever is the lower. The Director General of Customs could also confiscate the shipment of seafood i.e. Mr. Ah Long could lose the shipment of seafood sea food which may then be auctioned auct ioned off by the Customs.
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GOODS AND SERVICES TAX Question 1
How does GST works? Answer
GST is a multi-stage tax on domestic consumption. It is charged on all taxable supplies of goods & service in Malaysia except those specifically exempted. GST is also charged on importation of goods & services into Malaysia. Payment of tax is made in stages by the intermediaries in the production & distribution process. Although tax is paid throughout the production & distr ibution chain, it is ultimately passed on to the final consumer.
GST is accounted and paid by taxable persons. The taxable person pays GST or INPUT TAX on his business purchases. He then adds value to those goods & services. When the goods are sold or services provided, GST or OUTPUT TAX is collected based on the selling price. Tax itself is not a cost to the intermediaries & does not appear as an expense item in their financial statement. The registered person is required to charge GST (output tax) on his taxable supply of goods & services to his customers. He (the registered person) is allowed to claim input tax credit on any GST (input tax) incurred on his purchases which are inputs to his business.
Question 2
Explain the types of supplies under the Goods and Services Act 2014 (as amended). Answer
Three are three types of supplies (a) Standard rated supplies (b) Zero rated supplies (c) Exempt supplies
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Standard Rated Supplies. Standard rated supplies are taxable supplies of goods & services which are subject to GST Standard rate of 6%. A taxable person who is registered under GST has to collect GST on the supply and is eligible to claim input tax credit on his business inputs in making taxable supplies. Zero Rated Supplies Zero rated supplies are taxable supplies of goods and services which are subject to GST at zero percent. In this case, businesses do not collect any GST on their supplies but are entitled to claim credit on inputs used in the course or furtherance of the business. Exempt Supplies Exempt supplies are supplies of goods & services which are not subject to GST. In this context, the businesses do not collect any GST on their supplies and are not entitled to claim credit on his business inputs. Table 1 Types of supplies and GST implications for input and output taxes
Type of supply
Output tax
Input tax
Standard rated Zero rated Exempted
6% 0% GST not charged
Claimable Claimable Not claimable
Question 3
Discuss the concept and scope of a ‘taxable person’. Answer Meaning of person
Includes individuals, corporation, Federal Government, State Go vernment, statutory body, local authority, society, trade union, co-operative society, tr ust, partnership and any other body, organization, association or group or persons, whether corporate or unincorporated. Scope
Includes natural and juridical persons:
Individuals, sole proprietor and partnership Company, club, association, society, co-operative, trade union, non-profit body and unincorporated bodies Trust, trustee, executor, administrator and joint venture
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Federal Government, State Government, statutory body and local authority
Meaning of taxable person
A person who is, or is required to be, registered for GST
Question 4
Who is a person who is, or is required to be, registered for GST? Answer
Any person who makes a taxable supply of Goods and Services in Malaysia must register for GST. If a person makes a taxable supply exceeding RM500,000 (the prescribed t hreshold) then it is mandatory for that person to register. I f the turnover is below RM500,000 then the GST registration is voluntary (voluntary registration allows you charge GST and to recover the input tax credit). Calculation of taxable turnover for registration is based on tot al value of taxable supplies for 12 months period. The supplies include the following:
Standard rated supply Zero rated supply (includes goods exported) Deemed supply (disposal of business assets, business assets held on last day of registration, private use of business assets, supply o f services to connected persons without consideration, business gifts exceeding RM500). Disregarded supplies (supplies between members of t he same group).
“Person” includes: Individuals, sole proprietor, partnership, company, society, trade unions, club, association. Federal government, state government, statutory bo dy and local authority in the business of making taxable supplies in Malaysia
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Taxable turnover is determined in two ways:
The historical method o The annual turnover over the 12-months period ending at the end of the current month
Fig 1 Historical method of determination of threshold (backward)
Jan
Dec
The future turnover method (forward) The annual turnover over the 12 months period commencing from the o beginning of the current month Fig 2 Future method of determination of threshold
Jan
Dec
The turnover will exclude the following:
Exempt supplies. Disposal of capital assets of the business. Imported services. Supplies of imported goods made within a warehouse (warehousing scheme). Supplies made by a foreign principal or recipient, in accordance with Approved Toll Manufacturing Scheme. Out-of-scope supplies (i.e. a supply from a place outside Malaysia t o another outside Malaysia) Supplies made between designated areas. The GST component in the supply
In case of liability you must register within 28 days in the following month, of becoming liable. The effective date of registration is the 1st day of the month following the month in which registration occurred (see Fig 3).
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Fig 3 Date of registration
GST threshold reached
May
Register for GST by 28 June
June
GST effective date 1 July
July
2016
Question 5
Discuss the liability to register for GST (whether voluntary or mandatory) in the following instances: (a) Lim has invested in eight residential homes that are rented out. The total rent receivable per annum is RM600,000 (b) Lim has invested in five shop houses that are r ented out. The total rent receivable per annum is RM600,000 (c) Eswaran runs a motor workshop. His turnover is as follows: Service charges= RM200,000; Sale of spare parts = RM40,000 (d) Nasir runs a sundry shop in Shah Alam (annual turnover = RM300,000) and a satay restaurant in Bangi (annual turnover = RM400,000) (e) RapidJalan & Scenic Sdn Bhd is a transport company. It operates a stage bus service between Seremban and Kuala Lumpur (annual turnover RM300,000). It also operates a tour bus service covering the area Kuala Lumpur to Malacca (annual turnover = RM400,000) Answer (a) Residential premise are not subject to GST (b) The shop houses are business premises and liable to GST if the gr oss rent exceeds the threshold. (c) His threshold is below RM500,000. He need not register for GST (d) His combined turnover exceeds RM500,000 and must r egister for GST (e) The stage bus operation is exempted from GST but the tour operation would be subject to GST if the turnover exceeds RM500,000.
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Question 6
Who are the persons not required to register for GST? Answer
The following persons need not register:
Persons making wholly exempt supply Persons making a supply in designate areas Persons making supplies below the GST threshold Persons making out of scope supply (e.g. making a supply outside Malaysia).
Question 7
What are the types of registration that are covered under the GST rules? Answer
Types of registration would include the following: (a) Sole proprietors (b) Single taxable persons (c) Companies and group of companies (companies in a group and controlled by the holding of shares at least 50% in the second or other companies) (d) Partnership (e) Personal representative (f) Joint venture
Question 8
Discuss briefly the meaning of ‘Supply’ Answer
It is the concept of a ‘supply’ itself is the entry point into the GST system. ‘Supply’ has been statutorily defined as all forms of supply i.e. consisting of goods and services. Consideration is an element for supply to be present. There is no supply if there is no consideration – subject to exception (deemed supply – for example in case of supplies to connected persons in controlled situations). Definition of ‘Consideration’ (Section 2 Goods and Services Act 2014 (as amended) “Any payment made or to be made, whether in money or otherwise, or any act of forbearance, whether or not voluntary, in respect of, in response to, or for the inducement of, the supply of goods or services, whether by the person or by any other person” Consideration may be provided by third parties.
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ESTATE UNDER ADMINISTRATION
Question 1
How is the income allocated between the deceased individual and the estate of the deceased? Answer In the year the individual died, there will be two tax co mputations From the beginning of the basis year to the date of his death for the relevant year of assessment From the date of death to the end of the basis per iod for the year of assessment
The income is allocated as follows:
Business and rental income : On a time basis (sec 64(1) Interest and dividends: These income are assessed on a receipt basis
Note that for income tax purposes, an executor is not an individual (defined in the law as a ‘natural person’). Hence benefits available to an individual would not be available to an executor. (Case law: Harta Pesaka TSDSHA v Ketua Pengarah Hasil Dalam Negeri). Income arising from a source outside Malaysian and remitted to Malaysia and received by any person is exempt from tax (Para 28 Sch 6 effective from year of assessment 2004). Question 2 What are the special deductions allowable for an est ate under administration, in determining the chargeable income? Answer Sometime the will may provide for the payment of an annuity from the income of the estate under administration. This annuity is allowable as a deduction under section 64(3) against the aggregate income in arriving at the total income. The annuity is a taxable receipt on the recipient. It taxable on a receivable basis and therefore as soon as the rec ipient becomes entitled to the income, the amount will be assessed.
Payment of annuity must to be distinguished from a ‘distribution’ which is capital and therefore not deductible in arriving at the total income of t he estate under administration nor is it taxable in the hands of the recipient. Sometimes annuities arise on the surrender of an insurance po licy, or surrender of a fixed asset, in exchange for an annual payment. Such payments, when received would const itute an income and accordingly taxable. But annuities contract issued by a Malaysian insurance company under a contract of insurance is exempted (Para 38 Sch 6 effective from year of assessment 1995)
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Question 3
Mr. Alfred Lim was a successful Malaysian businessman. He died in 2011 leaving behind a wife and four children. In his will, written before his death, he had named his wife as the executor with his four children as the beneficiaries. The will also require that she continues the business after his death. Under the terms of the will, the income from the trust paid out or distributed to the beneficiaries for the year ended 31 December 2015 was as follows: No.
Recipients
1 2 3 4 5
Annuity to wife First child Second child Third child Fourth child (sum to be accumulated)
Amount (RM) 30,000 65,750 98,625 98,625 25,000
Under the will, payment to the first child would be one quarter of the distributable income, and paid at the discretion of the executor; whereas the sum paid to the second and third child shall be one half of the balance of the distributable income, after accumulation for the last child, who in 2015 was only two years old. The trust received income from some investments as follows during the year ended 31 December 2015: No.
Particulars
1 2 3 4
Rent from a property in Malaysia Interest from a fixed deposit in a local bank Dividends (Malaysia)(single tier) Dividend (Taiwan)(remitted in 2015)
Amount (RM) 20,196 5,358 8,910 12,679
Legal fee of RM20,093 was incurred to settle some third party claims regarding the trust and was settled with a lump sum payment of RM59,400. Mrs. Lim charged a management fee of RM29,700 for managing the trust. During the year, Mrs. Lim, made a donation of food packages to a temple valued at RM5,400. A cash donation of RM50,000 was made to a Malaysian approved charitable institution. These various expenditure (i.e. legal fees, settlement, management fees and donations) were charged to the trust business account under ‘EXPENSES’ and except for these charges, the tax agent has confirmed that the balance of the other expenses are wholly and exclusively incurred for the purposes of the business. The result of the trust business for the financial year ended 31 December 2015 was as follows: RM Gross income from business 683,130 Less: Expenses 292,587
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Net profit 390,543 For the year of assessment 2015, the trust is entitled to a capital allowance of RM58,518 and balancing allowance of RM29,258. It has a balancing charge of RM19,423. The trust business has a loss brought forward to the year of assessment 2015 amounting to RM7,367 and also an unabsorbed capital allowance brought forward of RM62,245. The trust distributable income for the year ended 31 December 2015 before accumulation of RM25,000 for the fourth child was RM288,000. Required Compute the chargeable income of the trust for the year of assessment 2015.
Note: Assume that the Director General of Inland Revenue has allowed the application of section 61(2) of the Income Tax Act 1967 (as amended) to the trust income. [40 marks] Question 4
Mr. James Tan, a resident and citizen in Malaysia, was a businessman operating two businesses – one in Malaysia and one in Singapore. He passed away suddenly on 30 September 2015, without a will. The businesses close the accounts to 31 December each year. For the year ended 31 December 2015, the trading results were as fo llows: RM Business Business 1 (Malaysia ) Business 2 (Singapore)
Adjusted income Adjusted income
97,200 16,000
Mr. James made a donation of RM500 to an approved Malaysian charitable institution in May 2015. Mr. James Tan had a rental source from a property in Kuala Lumpur, a single tier dividend from a public listed company, as well as interest from a fixed deposit in a Malaysian bank. The details are as follows:
Rental (year ended 31 Dec 2015) Dividend (Paid in October 2015) Interest (received in May 2015)
RM 19,440 7,623 3,267
Mr. James Tan left behind a wife, and a child aged 10 years old in 2015. At the time of his death, Mr. James Tan was domiciled in Malaysia. The administrator was Mr. James Tan’s close friend, one Mr. Kumar. He administered the estate till the financial year end 31 December 2015. He made an annuity payment of RM12,000 to the wife just before the estate was wound up. At the end of the year 2015, Mr.
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Kumar liquidated the estate and made a distribution of RM200,000 each to the wife and the child. Required: Compute the chargeable income for the year of assessment 2015, of: (i) Mr. James Tan [assume that the wife and child reliefs were claimed by him]; (ii) The estate of Mr. James Tan (deceased);
Note: In relation to the question above, the personal relief in respect of the year of assessment 2015 are as follows for: Wife RM3,000; Child RM1,000 Computation of chargeable income of Mr. James Tan Year of assessment 2014
Business 1 (Malaysia) Business 2 (Singapore) Add: Other income Rent Dividend - single tier (exempted Sch 6 Para 12B) Interest (section 109C) Aggregate income Less: Approved donation Total income Less: Personal relief Self Wife Child Chargeable income
RM 72,900 0
3/4 x 97,200
3/4 x 19,440
14,580 0 0 87,480 500 86,980 9,000 3,000 1,000
13,000 73,980
Computation of chargeable income of the estate of James (deceased) Year of assessment 2014
Business (Malaysia) Business 3 (Singapore) Add: Other income Rent Dividend (single tier) Interest
1/4 x 19,440
Aggregate income Less: Annuity to wife
1/4 x 97,200
RM 24,300 0 24,300 4,860 0 0 26,160 12,000
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Total income Less: Personal relief (domiciled in Malaysia) Chargeable income
17,160 9,000 8,160
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TRUST Question 1
Outline the computation format for a trust in the following circumstances: 1) The computation of the trust body itself 2) The computation of the beneficiary if the trust distributes its total income to the beneficiary (assume that there is only one beneficiary and the whole income is distributed).
Answer The computation of the trust body: format
RM Business income Net profit per PL account Add: disallowable expenses Adjusted income Less: Capital allowances Statutory income Less: Unabsorbed losses b/f Statutory business income after losses Other statutory income Interest Dividend Rent Aggregate income Less Annuities payable
Less: approved donations Total income / Chargeable income
RM 00 00 00 00 00 00 00
00 00 00
00 00 00 00 00 00
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Question 2
En. Tan Chong passed away on 30 October 1999. He left behind his wife and three children along with some properties and businesses. Under the terms of his will, a trust was created and his wife was named as the trustee and their four children as the beneficiaries. Under the terms of trust, one quarter of the trust body income is to be distributed to the first child at the discretion of the trustee. The balance must be distributed equally between the second and third child. A sum of RM 30,000 is to be accumulated for the fourth child until the child reaches the age of 18 years. The wife is entitled to an annuity of RM 50,000 per year. En. Tan Chong had two business and also several investments. The investments provided regular income by way of interest, dividend and rent. During the year, the trust paid a cash donation of RM 9,000 to an approved inst itution. It also donated hardware for repairs and renovation to t hree welfare and old folk’s home. The hardware supplied free of charge were worth RM 15,500. The trustee also paid legal fee of RM 24,000 to a lawyer for defending the will against some claims made by relat ives. Based on the trust distributable income of RM 300,000 ( before accumulation), the trustee made the following payments or accumulation to the beneficiaries for the year ended 31 December 2008: First child: RM 60,000 Second child: RM 90,000 Third child: RM 90,000 Accumulation for the fourth child: RM 30,000 The details of the business and the investment income for the year ended 31 December 2014 are as follows: Trust income Stationary Trading business : 1 January 2014 - 31 December 2014 Gross income Allowable expenses Capital allowances due Balancing charges Balancing allowances
RM 787,500 337,500 67,500 22,500 33,750
Hardware trading : 1 January 2014 to 31 December 2014 Gross income Allowable expenses Capital allowances due Adjusted loss b/f Capital allowances b/f
112,500 130,500 13,500 22,500 11,250
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Other income Rent Interest Dividends (Malaysia) (single tier) Dividends (Hong Kong)(remitted)
22,500 6,750 10,125 14,625
Required
Compute the chargeable income of the trust for the year of assess ment 2014 assuming that section 61(2) of the Income Tax Act 1967 (as amended) is applied. Answer Trust Year of assessment Stationary Trading business : 1 January 2014 - 31 December 2014 Gross income Less: Allowable expenses Adjusted income Add: Balancing charge
Less: Balancing allowance Capital allowance Statutory income Hardware trading : 1 January 2014 to 31 December 2014 Gross income Less: Allowable expenses Adjusted loss
33,750 67,500
Less: Annuity Less:
101,250 371,250
112,500 130,500 (18,000)
Statutory income Aggregate of statutory income from business Less: Unabsorbed loss b/f Other income from non-business sources Rent Interest Dividend (Malaysia-single tier) Dividend (Hong Kong) - exempted Para 28 Sch 6 Aggregate income Less: Current year adjusted loss (from Hardware trading)
787,500 337,500 450,000 22,500 472,500
0 371,250 22,500 348,750 22,500 6,750 0 0
29,250 378,000 (18,000) 360,000 50,000 310,000
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Donation in kind Donation in cash Total income Less: Payment to beneficiaries [sec 61(2)] First child Second child Third child Chargeable income
0 9,000
60,000 101,588 101,588
9,000 301,000
263,175 37,825
Distributable income of trust before accumulation Less: Accumulation for the 4th child Distributable income after accumulation
300,000 30,000 270,000
Deemed total income
301,000 x 270,000 / 300,000
270,900
Discretionary portion Non-discretionary portion Total
270,000 x 1/4 270,000 x 3/4
67,725 203,175 270,900
Amount paid to first child Amount due to first child Statutory income : Lower of the two
60,000 67,725
Second child 1/2 of 203,175 Third child 1/2 of 203,175 Total received by second and third child
60,000 101,588 101,588 203,175
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SETTLEMENT
Question 1 Why do you think a ‘settlement’ is of concern to the Revenue authorities? Answer A wealthy person (the settlor) on a high tax bracket may choose to transfer either properties or income or both to another person (the beneficiary) to benefit from the lower tax bracket of the beneficiary.
This essentially is a tax avoidance scheme that has no commercial or arm’s length consideration and therefore is generally disallowed for tax purposes under section 65. In this context one needs to understand the concept of settlement, settlor, relative and reciprocal settlement, and exceptions to the application of section 65(1) as well as a revocable settlement and its implication for tax.
Question 2 In the context of the Income Tax Act 1967 (as amended) explain the significance of the following terms for income tax purposes, in your own words: i) ii) iii) iv) v)
Settlement Settlor Relative Reciprocal settlement Revocable settlement
Answer
A ‘settlement’ includes any disposition, trust, covenant, arrangement or agreement and any transfer of assets or income but does not include – 1. A settlement which in the opinion of the Director General of Inland Revenue is made for valuable and adequate considerations 2. A settlement resulting from an order of a court; or 3. Any agreement made by an employer to pay to an employee or to the widow or any relative, dependents of an employee after his death such remuneration, pension, or lump sums as in the opinion of the Director General of Inland Revenue is fair and reasonable. ‘Settlor’ in relation to a settlement includes any person by whom the settlement was made or entered into directly or indirectly and any person who was provided or undertaken to provide funds or credit directly or indirectly for the purpose of the settlement or has made with any other person a reciprocal arrangement for that other person to make or enter into the settlement.
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‘Relative’ means a child of the settlor (including a step child of the settlor and a child over whom the settlor has custody or whom he maintains wholly or partly at his own expense), a child adopted by the settlor, or the husband or the wife of the settlor in accordance with any law and any person who is a wife, grandchild, brother, sister, uncle, aunt, nephew, niece or cousin of the settlor. A ‘reciprocal settlement’ is a settlement in which the two transactions are of a similar natur e. A ‘revocable settlement’ is one which, under section 65(2) provides that: 1. Any person has or may have power whether immediately or in the future and whether with or without the consent of any other person to revoke or otherwise determine the settlement or any provisions thereof; and 2. In the event of the exercise of the power, the settlor or a wife or husband of the settlor will or may become beneficially entitled to the whole or any part of the property then comprised in the settlement, or of the income arising from the whole or any part of the property so comprised., 3. All income arising from the settlement from the property comprised in the settlement shall be deemed to be income of the settlor and subject to section 45(2), and not income of any other person; 4. Provided that the subsection shall not apply by reason only of the fact that the settlor or a wife or husband of the settlor will or may become beneficially entitled to any income or property relating to the interest of any beneficiary under the settlement in the event of the beneficiary predeceasing him or her as t he case may be.
Question 3
En. Ahmad is a successful businessman and owns several properties from which he derives rental income. As he was getting old, he decided to sett le some of the properties and the income derived therefrom among his three children – two daughters and one son. Accordingly under the terms of the settlement: 1. The first daughter would receive a shop house and the rental income derived therefrom. The daughter is married and is currently sta ying with her husband. She has been diagnosed with cancer. Accordingly, the settlement terms provide for the property and the income to revert to En Ahmad should the daughter predecease him. 2. The second daughter, who is 25 years old as at the beginning of the year of assessment 2008, but unmarried, would receive an apartment and the rental income therefrom. 3. The last child, the son who is 19 years old as at 1 January 2008 would receive the bungalow and the rental income derived therefrom
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Required Explain with reasons, who will be assessed to income tax on the income derived from the various properties settled by En. Ahmad, for the year of assessment 2008. Answer
1. The first daughter will be assessed to t he income from the shop house – she is married and therefore the age factor is not important. The fact that the asset and the income would revert to the father should the daughter pre-decease him is not tantamount to a revocation and will not have any effect on the settlement . 2. The second daughter will be assessed to the income from the apartments – she is not married but is more than 21 years old. 3. The income from the bungalow would be assessed on En Ahmad since the son is below 21 years and is not married as at the beginning of the year of assessment in question.
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INVESTMENT HOLDING COMPANY
Question 1
What is an investment holding company? Answer
These are companies that hold investments and for financial purposes, they generally function as a holding company within a group of companies usually providing common user services with or without charges: in other instances they are used as a vehicle for listing purposes in the Malaysian stock exchange (Bursa Malaysia). With effect from the year of assessment 2006, one need to distinguish between an ordinary investment holding company, and an investment holding company listed in the Malaysian stock exchange, since the tax treatment are different. In other words, distinguish: (a) an investment holding company (IHC); and (b) a listed investment holding company (LIHC)
With effect from the year of assessment, an IHC is defined to mean a company whose activities consists mainly of investments, and not less than 80% of its gross income other than gross income from a source consisting of a business of holding an investments (whether exempt or not) is derived therefrom. A business of holding of an investment is defined as follows: It means the business of letting properties and the company also provides maintenance or support services in respect of the property. In other words, if the company: (a) does NOT provide any maintenance services in the letting of the property it is an investment income (b) if it provides maintenance services then it a business of letting of property – and the income will be excluded as an investment income for the purposes of t he 80% computation
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Example 1 Determination of IHC status Sources of income
Rent (Business) Rent (Non-business )
A
B
C
D
E
85,000 0
20,000 0
0 75,000
50,000 20,000
20,000 30,000
10,000 20,000 100,000
20,000 20,000 10,000 100,000
Dividend Interest Management fee Total income
5,000 10,000
50,000 30,000
100,000
100,000
10,000 5,000 10,000 100,000
% of income from holding of investment
15÷100 15
80÷100 80
90÷100 90
50÷100 50
70÷100 70
No
Yes
Yes
No
No
IHC: Yes/No
Once the 80% criteria is satisfied, and the company is now treated as an investment holding company or not an investment holding company, the rental income is still treated as a section 4(d) source income and NOT a section 4(a) income. The management income is then treated as a section 4(f) income and NOT a section 4(a) income Example 2
Source of income
2007
Year of assessment 2008 2009
2011
30,000 20,000 20,000 20,000 90,000
10,000 20,000 20,000 20,000 70,000
70,000 20,000 20,000 10,000 120,000
60/70 86
Rent (Business) Rent (Non-business) Dividend Interest Total income
60,000 10,000 10,000 20,000 100,000
% of income from holding of investment
40/100 40
50/100 50
60/90 66
No
No
No
IHC: Yes/No
50,000 20,000 10,000 20,000 100,000
2010
Yes
50/120 42 No
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Question 2
What do you understand by ‘Permitted Expenses’ within the meaning of section 60F (2)? Answer
An investment holding company listed in the Malaysian stock exchange will have its income from the holding of investments treated as a business income derived from a single source. This legal provision is not available to a company NOT listed in the Malaysian stock exchange. The investment holding company not listed in the Malaysian stock exchange would however be allowed a special deduction under section 60F (2) known as the ‘permitted expenses’. Revenue expenses in the case of an investment holding company are of two types: Expenses falling within the meaning of section 33(2) (see working in the above question) Expenses falling within the meaning of section 60F(2)
Expenses falling within the meaning of section 33(2) would be deducted directly against the relevant income. Expenses falling within the meaning of section 60F (2) are known as ‘permitted expenses’. These are specific expenses to be deducted as a proportion (i.e. a figure obtained from a formula computation) against the aggregate income. It is a comparative deduction – one needs to compute the permitted fraction and then compare this with 5% of the gross income consisting of dividends, interest and rent for t he relevant period – the deduction being the LOWER of the two. Permitted expenses consist of the following:
Director’s fee Wages, salaries and allowances Management fees Secretarial, audit and accounting fees, telephone charges, printing and stationary costs and postage charges Rent and other expenses incidental to the management of an office
Note that these listed expenses do not fall within the meaning of section 33(2). Also note that Public Ruling 6 of 2006 prohibits secretarial fees as a deductible expense in arriving at the adjusted income of a company. However, a secretarial fee is a llowed as a concession in determining the permitted fraction for deduction against the aggregate income of an investment holding company. The permitted fraction is deducted as a proportion and this is determined as follows: A x B/4C
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A=
total of the permitted expenses incurred for the basis period reduced by any receipt of a similar kind
B=
the gross income consisting of dividend, interest and rent chargeable to tax for the basis period for the year of assessment. Any other income for example, royalty, will be assessed under section 4(f) and will not be included under B
C=
the aggregate of the gross income consisting of dividend – whether exempt or not – interest, rent and gains from the realisat ion of investments for the basis period for the year of assessment.
The permitted fraction is compared with 5% of the gross income consisting of dividend, interest and rent (i.e. excludes exempt income): and only the LOWER amount is allowed as a deduction. Excess of permitted expenses cannot be carried forward to the subsequent year of assessment.
Question 3
List out the features of an investment holding company under the provisions of the Income Tax Act 1967 (as amended). Answer
Essentially the investment holding company treatment under the ITA can be tabulated as follows: Area
Investment holding company
Definition
It is a company whose activity consists in the making of investment. The income must consist of at least 80% from investment
Applicable section of the law
Section 4(c) Section 4(d) Section 4(e) Section 4(f)
Deductibility of expenses
Expenses are deducted in relation to each of the sources in respect of expenditure incurred wholly and exclusively in the production of gross income in arriving at the adjusted income from that source
dividend and interest rental annuity other income
Permitted expenses are deducted at the aggregate stage using a restrictive formula [A/B] x C = Permitted expenses This is compared to 5% of the gross income chargeable to tax and the lower is allowed a deduction at the aggregate stage
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Basis of assessment
The financial year is taken as the basis period for the relevant year of assessment Example Financial year ended 30 June 2015 = Year of assessment 2015
Treatment of losses
Does not arise as the expenses is limited to the gross income
Capital allowance
Not available
Investment related income
Need to distinguish between revenue income and capital income. Revenue income is brought to charge (except dividends paid under the single tier or tax exempted dividends) Income from the sale of investment is capital income and is not brought to charge.
Question 4
Lim Holdings Sdn Bhd is an investment holding company (‘the company’ ) (financial year end: 31 Dec) and derives its income mainly from investments. Investment consists of fixed deposit, shares and a shophouse for which no support or maintenance services are pro vided. For the year ended 31 December 2015, the company has produced t he following result: Lim Holdings Sdn Bhd Year ended 31 December 2015 Gross income Fixed deposit interest Rent - shophouse Dividends (single tier) Investment 1 Investment 2 Gains from realization of investment Total gross income Less: Expenses Director's remuneration Staff salary Accounting and secretarial Audit fees Interest charges (loan for investments) Printing and stationary Management expenses Office rent
RM
RM 65,037 54,198 156,588 78,296 79,200 433,319
47,998 28,799 9,601 19,199 38,399 1,920 26,878 47,916
26
Quit rent and assessment (shophouse) Entertainment Depreciation Net profit
1,920 2,879 4,800
230,309 203,010
The details of the cost of the investments are as follows: Investments costs Shop house Shares – Investment lot 1 Shares - Investment lot 2 Total
RM 600,000 700,000 800,000 2,100,000
The share investments lot 1 and lot 2 are in shares in a local company quoted in the Malaysian stock exchange, and which pays single tier dividends to shareholders. The shophouse from which the rental income is received is located in Putrajaya. Lim Holdings Sdn Bhd borrowed substantial funds from a local bank for these investments (shophouse and shares) and incurred interest charges as shown in the accounts. It’s paid up capital as at the beginning of the basis year for the year of assessment 2015 was R M3 million. Required: In respect of the year of assessment 2015, compute the following: i) chargeable income of Lim Holdings Sdn Bhd; and ii) the income tax liability of Lim Holdings Sdn Bhd .
Note: The corporate tax rate is 25%.
Answer
Lim Holdings Sdn Bhd Year of assessment 2015 Interest
Rent from shophouse Less: Expenses Prop of interest expenses 38,399 x 600,000/2,100,000 Quit rent and assessment Dividends - single tier Investment 1 Investment 2
RM 65,037 54,198
10,971 1,920
41,307
0 0
0
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Aggregate of statutory income Less: Fraction of permitted expenses Total income and chargeable income Income tax Income tax
Lim Holdings Sdn Bhd Computation of permitted fraction Permitted expenses Director's remuneration Employee's salary Accounting and secretarial fee Audit fee Printing and stationary Management expenses Rent
106,344 5,962 97,215 RM 24,303.75
97,215 at 25%
RM 47,998 28,799 9,601 19,199 1,920 26,878 47,916 182,311
A
Gross income chargeable to tax Interest Rent Gross income chargeable to tax
RM 65,037 54,198 119,235
B
Gross income whether or not chargeable to tax Interest Rent Dividend-investment 1 Dividend-investment 2 Gain from realization of investment
65,037 54,198 156,588 78,296 79,200 433,319
Fraction of permitted expenses allowable A x [B / (4 x C)] 182,311 x [119,235/(4 x 433,319] Or 5% of gross income chargeable to income tax 5% x 119,235
Lower of the two
C
RM 12,541 5,962
5,962
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LISTED INVESTMENT HOLDING COMPANY
Question 1
What is a listed investment holding company? Answer
With effect from the year of assessment 2006, a listed investment holding company is given a preferential treatment to have the income from the holding of investment be treat ed as a business source unlike in the case of just an investment holding company not listed in the stock exchange. This company is different from the IHC in that it is listed in the Malaysian Stock Exchange (or the Bursa Saham). Therefore the income from the holding of investment is treated as a source or sources consisting of business of the listed investment holding company. The applicable law for LIHC is section 60FA
Question 2
What is the treatment of expenses of a listed investment holding company? Answer
The overhead expenses of operating a LIHC such as director’s fees, wages, salaries and allowances, management fees etc. would be fully deductible against the gross income Example 1 LIHC
Gross income (from investments sources) Less: Expenses
RM 100,000 20,000
Adjusted income
80,000
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Question 3
What are the restrictions that are applicable to an LIHC that are ‘unusual’?
Answer
The income of a LIHC is treated as a business source under section 60FA(2) and 60FA(3) but the deductions for expenses are limited to the gross income from that source. If the source produces no income then no expenses relating to that source is allowed i.e. it is disregarded. Since the expenses are limited to the gross income (or is ignored if there is no income) losses does arise. Hence there is no current year loss or for that matter losses to be carried forward. Similarly capital allowance is available to be deducted from the adjusted income to arrive at the statutory income. But this too is limited to the adjusted income. Hence should the capital allowance exceed the adjusted income, the excess w ill not be carried forward to the following year of assessment and will be lost.
Question 4
A LIHC has provided the following accounts for the year ended 31 Dec 2014: Profit and Loss account Year ended 31 Dec 2014
Rental income Dividends (single tier) Interest Gain from realization of investment
RM 500 80 20 120
Less: Expenses Interest charges (on property loan) Quit rent Assessment Directors fees Salaries Wages and allowances Management fees Audit Secretarial fees Accounting fees Stationery Postage Travelling
53 3 5 105 85 21 27 15 11 16 3 1 17
RM
720
30
Entertainment Advertisement Net profit
25 5
392 328
Required Determine the aggregate and the chargeable income of the listed investment holding company. Answer Computation of listed investment holding company
RM Net profit per account Less: Interest Dividends (single tier) Gain from realization of investment Add: Disallowable expenses Travelling Entertainment Advertising Add: Other income Interest Dividend (single tier) Gain from realization of investment (capital) Aggregate/total/chargeable income
20 80 120
17 25 5
20 0 0
RM 328
220 108
47 155
20 175
31
UNIT TRUSTS and PROPERTY TRUST
Question 1
Outline the format of the tax computation for a unit trust in accordance with the requirements of the Income Tax Act 1967 (as amended). Answer Unit Trust Computation template
Interest Less: Allowable expenses Adjusted/statutory interest income
RM 10,000 3,000 7,000
7,000
Dividends (single tier) Less: Allowable expenses Adjusted/statutory dividend income
0 0 0
0
Gross rental income Less: Allowable expenses Less: Section 63A deduction Statutory rental income Aggregate income Less: Section 63B deduction Less: Approved donations Restricted to 10% of aggregate income Total income/ chargeable income
10,000 7,000 3,000 1,000 2,000
1,000 900
RM
2,000 9,000 3,000 6,000 900 5,100
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Question 2
Explain the conditions and restrictions under which the deductions under section 63B are allowed to a unit trust in respect of permitted expenses.
Answer to Question 4 In ascertaining the total income of a unit trust for the basis period for a year of assess ment, there shall be deducted before any deductions falling to be made under section 44(1) (c) i.e. donations to the government or an approved institution, an amount in respect of expenses incurred by that unit trust during that period which amount shall be determined in accordance with the formula prescribed in section 63B (1): The permitted fraction is deducted as a proportion and this is determined as follows: A x B/4C A=
total of the permitted expenses incurred for the basis period
B=
the gross income consisting of dividend, interest and rent chargeable to tax for the basis period for the year of assessment
C=
the aggregate of the gross income consisting of dividend – whether exempt or not – interest, rent and gains from the realisat ion of investments for the basis period for the year of assessment.
Note: 1) As regards income falling under B in the for mula, note that any other income for example, royalty, management fee etc. will be assessed under section 4(f) and will not be included under B 2) Also income that is not chargeable to tax e.g. exempted income will not be included in B. 3) Exempted income will fall in C because of the words ‘whether exempted or not’.
Permitted expenses consist of the following [Sec 63B (2)]
Manager’s remuneration Maintenance of register of unit holders Share registration expenses Secretarial, audit and accounting fees, t elephone charges, printing and stationary costs and postage charges
Note that these listed expenses do not fall within the meaning of section 33(1) i.e. they are not deductible under section 33. Also note that Public Ruling 6 of 2006 prohibits secretarial fees as a deductible expense in arriving at the adjusted income of a company. However, a secretarial fee is allowed as a concession in determining the permitted fraction for deduction against the aggregat e income of an investment holding company.
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The amount to be deducted shall not be less than 10% pf the total per mitted expenses incurred for that basis period. Where by reason of an absence or insufficiency of aggregate income for that year of assessment effect cannot be given or cannot be given in full to any deduction falling to be made to the unit trust under section 63B for that year, t hat deduction which has not been so made shall not be made to the unit trust for any subsequent year of assessment. In other words, excess of permitted expenses cannot be carried forward to the subsequent year of assessment.
Question 3
Pacific Unit Trust was formed in 1997 and managed by Premier Bhd. I t is not approved by the Securities Commission as a Real Estate Investment Trust or a Property Trust Fund, and has not distributed its total income. The trust invests its funds primarily in fixed deposits and shares. It also acquired a building which was rented out. Its profit and loss account for the year ended 31.12.2014 shows the following: Pacific Unit Trust Statement of accounts for year ended 31 Dec 2014
RM Income Gross Rent Gross Interest Malaysian dividends (single tier) Gain from realization of investments Less: Expenses Assessment and quit rent Fire insurance Property management fee Property management fee paid to Premier Bhd Share registration expenses Secretarial, audit and accounting fee Telephone, printing and stationery expenses Office rent and incidental expenses Trustee’s remunerations Net profit
RM
100,000 360,000 240,000 100,000 800,000
4,000 2,000 6,000 80,000 10,000 12,000 4,000 24,000 6,000 148,000 652,000
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During the year, Pacific Unit Trust installed a lift in the building. The cost of the lift, inclusive of installation cost, was RM 500,000 and the expenditure incurred on alteration of the building to install the lift was RM 100,000.
Required: Compute the tax payable by Pacific Unit Trust for YA 2014.
Answer Pacific Unit Trust Income Tax Computation Year of Assessment 2014
RM Rental (Sec. 4 d income) Less: Assessment and quit rent Fire insurance Property management fee Adjusted income Less: Special deduction under Sec. 63A (10% of 600,000)
4,000 2,000 6,000
RM 100,000
12,000 88,000 60,000 28,000
Add: Other income Interest Dividend (single tier) Aggregate income Less: Section 63B deduction Chargeable income
360,000 0 628,000 23,188 604,813
Income tax
151,203
604,813 x25%
35
RM 80,000 10,000 12,000 4,000
Permitted expenses Property management fee to Premier Bhd Share registration fees Secretarial, audit and accounting fee Telephone, printing and stationary
A
106,000 RM 100,000 360,000
Gross income chargeable to tax Gross rent Gross interest
B
460,000
C
RM 100,000 360,000 240,000 100,000 800,000
Gross income whether or not chargeable to tax and gains from realization of investment Gross rent Gross interest Dividends Gain from realization of investments
Permitted fraction A x B / 4C
RM 15,238
106,000 x 460,000/(4 x 800,000)
Or: 10% of permitted expenses
106,000 x10%
10,600
Whichever is the higher
23,188
Capital allowance Cost of lift Add: Installation cost Aggregate cost
500,000 100,000 600,000
Percentage of installation cost to aggregate cost (100,000 / 600,000) x 100
17 %
The percentage of installation cost is less than 75% The whole expenditure qualifies for capital allowance RM600,000 Capital allowance
600,000 x 10%
60,000
36
REAL ESTATE INVESTMENT TRUST and PROPERTY TRUST FUND
Question 1
What is your understanding of a real estate investment trust (REIT?)
Answer
A REIT is a special kind of unit trust that invests at least 50% in real estate i.e. land, building and in companies holding large properties (i.e. companies with large land banks). Also known as a Property Trust Fund (or PTF), the income is largely derived from rent. REIT/PTF must be approved and comply with rules of the Securities Commission. REIT and PTF are accorded special treatment for tax purposes under sect ion 61A. Question 2
What constitutes the basis year for a REIT and PTF Answer
Generally for companies the financial period is the basis period for a year of assessment. Example Year end 31 Dec 2014 (a) Basis period is ye 31.12. 2014 (b) Year of assessment is 2014 Year end 30 Sept 2014 (a) Basis period is ye 30 Sept 2014 (b) Year of assessment is 2014
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Question 3
What is the basis year for a REIT and PTF that commences business and does not close the first account to 31 December or closes the first accounts to a period of more than 12 months or less than 12 months from the date of commencement?
Answer
The law has been amended under section 21A (4) with effect from 2014 and the determination of the basis period and the relevant year of assessment are as follows: First accounts for less than 12 months
If the accounts are drawn for a period of less than 12 months ending on a day in that basis year, that period shall constitute the basis per iod for that year of assessment. Example Company A commences operations on 1 March 2013 and closes the accounts to 30 September The basis period for the year of assessment 2013 is the period 1 March 2013 to 30 September 2013
First accounts for more than 12 months
If the period of months ends on a day immediately following the basis year, that period (the second year of assessment) shall constitute the basis for the year of assessment immediately following the first year of assessment. In such a situation, there is no basis year for the first year of assessment Example Company A makes commences on 1 March 2013 the first accounts to 30 June 2014. The first year of assessment is 2014 and the basis period is 1 March 2013 to 30 June 2014. There is no assessment year for 2013 Example First accounts for more than 12 months and ends in the third year
For any period of months ending on a day immediately following the second year, that period (the third year of assessment) shall constitute the basis for the year of assessment immediately following the second year of assessment. There is no basis year for the first and the second year of assessment. Example
38
Company A commences operations on 1 December 2013 and closes the first accounts to 31 March 2015. The first year of assessment is 2015 and the basis period is 1 December 2013 to 31 March 2015 There is no assessment year for the years of assessment 2013 and 2014.
Question 4
Since a substantial part of a REIT’s income is from rental, what is the treatment accorded to such income under the Income Tax Act 1967 (as amended) Answer
The applicable law is section 61A. Rental income from the letting of real property is treated as a business source but only for purposes of section 61A and not section 4A. Thus all expenses relating to the rental source is fully deductible. However any excess of the expenses cannot be carried forward to the following year of assessment. The capital allowance are allowed under schedule 3 of the ITA (unlike for unit trust). In other words, the initial and annual allowance will be computed on the qualifying plant and machinery or industrial building based on the rates specified in the schedule 3 (unlike the flat 10% allowed for unit trusts). Again, any excess of capital allowances cannot be carried forward to the following year of assessment. Thus an income of a REIT is treated like a business but is not given the full effect of the treatment as is due for an income falling under section 4(a).
Question 5
In computing the income of a REIT would you allow any deduction under section 63A (for capital allowance) or under section 63B (capital allowance)? Answer As all the expenses relating to the earning of the rental income is allowed as a deduction against the rental income, section 63B permitted fraction would not apply. Similarly as capital allowance is given under schedule 3, the deduction under 63A is not applicable to the income of a REIT in arriving at the adjusted income and the statutory income.
39
Question 6
What is the special feature as regards the distribution of income of a unit trust? Answer
To make REIT and PTF an attractive vehicle for investment and to make Malaysia a financial hub, special treatment is given designed to distribute the income of a REIT to the unit holders. Thus under section 61A(1) there is no chargeable income to the REIT if 90% of the total income as computed for income tax purposes under the Act is distributed to the unit holders. But is a lesser percentage is distributed the whole of the total income would be brought to charge. Example Distribution exceed 90% of TI
Distribution 90%
exceeds
RM
Distribution less than 90%
RM
Total income of REIT Amount distributed
100,000 96,000
Total income of REIT Amount distributed
100,000 60,000
Chargeable income Tax charged
Nil Nil
Chargeable income Tax charged
100,000 25,000
Question 7
How is the distribution of income by a REIT treated for income tax purposes? Answer Under Part X Sch 1, REIT shall deduct taxes from the income distributed and pay only the balance to the unit holders. It can be tabulated as follows: Type of Unit holder
Foreign institutional investor [ pension fund, investment schemes] Non-resident company Others (e.g. resident individuals) Resident Malaysian company
%
10 25 10 0
The tax represents the final tax. Thus individuals receiving the income from a REIT need not report the income in their income tax return as it is already taxed at source by the REIT.
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But for resident companies since no taxes are deducted from the payments made, companies will report the income in their return and will be taxed according on that income according to the applicable rate. Ordinary companies whose paid up capital exceeds RM2.5million will suffer tax at 25% on the income received from the REIT. A SME will suffer tax at the appropriate bracket i.e. 20% on the first RM500,000 and 25 on the amount exceeding that amount.
Question 7
How would the REIT deal with the income tax deducted from the payments made to unit holders? And what are the penalties for non-compliance?
Answer
The tax deducted from the payments to the unit holders must be paid to the Inland Revenue Board within one month of the payment to the unit holders with an account of the payments and tax deductions made. In case of non-compliance, a penalty of 10% on the taxes remaining unpaid will be imposed. The taxes and the penalty becomes a debt due to the government and can be enforced via a civil suit. The penalties may be remitted if there is good cause shown by the taxpayer.
Question 8
How would expenses incurred by a REIT on legal fees, valuations and consultancy fees etc. incurred in setting up a REIT and before the commencement of the business be treated for income tax purposes? Answer
These are pre-operating expenses and legally speaking it does not rank for a tax deduction. As the government wants to promote REIT as an investment vehicle, a deduction is allowed under the Income Tax (Deduction for establishment expenditure of REIT or PTF) Rules 2006 as a concession.
Question 9
What is the position if a company that has incurred qualifying capital expenditure on an industrial building and has claimed capital allowanced on the asset, disposes that building to a REIT?
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Answer
A company’s disposal an industrial building where that company has previous claimed an industrial building allowance on that building will not have any balancing allowance or charge on the disposal [See Public Ruling 2/2015]. The situation is similar to a controlled sale.
Question 10
New REIT is a real estate investment trust operating since 2012. It closes the accounts to 31 December each year. For the year ended 31 December 2014, it has produced the following statement of accounts: New REIT Income Statement for the year ended 31 Dec 2014
RM Gross income Rent from shopping malls Rent from warehouses Rent from factories Interest from fixed deposits Dividends (Malaysian single tier) Total gross income Less: Expenditure Audit fee Accounting fees Depreciation Management fee Property upkeep Secretarial fee Trustee administration fee Approved donation Administration
RM 950,000 450,000 782,000 32,000 95,000 2,309,000
30,000 50,000 26,000 80,000 300,000 60,000 35,000 200,000 60,000
841,000 1,468,000
During the year the New REIT acquired a factory building costing RM4 million of which the land cost was RM1 million and let it out for rent. The income is included under ‘Rent from factories’ for the year ended 31 December 2014. Required:
(a) Compute the total income of New REIT for the year of assess ment 2014.
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(b) What is the income chargeable to tax, and the income tax liability for New REIT in the following instances for the year of assessment 2014: (i) The amount distributed is RM1.1 million (ii) The amount distributed is RM1 million (c) Assuming one of the factory buildings is disposed of during the year, within a period of 3 years from the date of acquisition; indicate the liability to real property gains tax if any. Answer
(a)
Computation of total income
New REIT Computation of chargeable income Year of assessment 2014
Rent from malls Rent from warehouses Rent from factories
RM 950,000 450,000 782,000
Less: Deduction allowed Audit fees Accounting fees Depreciation Management fee Property upkeep Secretarial fee Trustee fee Approved donation Administration
30,000 50,000 0 80,000 300,000 0 0 0 60,000
Less: Capital allowance Add: Other income Interest Dividends (Malaysian single tier) Aggregate income Less: Approved donation Restricted to 10% of aggregate income Total income
32,000 0
200,000 130,400
RM
2,182,000
520,000 1,662,000 390,000 1,272,000
32,000 1,304,000
130,400 1,173,600
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(b)
Income chargeable to income tax and the income tax liability
Taxability based on income distribution
Total income Amount distributed Percentage distributed Chargeable income
RM 1,173,600 1,100,000 94 Nil
Total income Amount distributed Percentage distributed Chargeable income Income tax at 25%
1,173,600 1,000,000 85 1,173,600 293,400.00
(c)
Real property gains tax
The real property gains tax liability arises as follows:
Disposal
With three years of acquisition Disposal in the 4t year Disposal in the 5t year t Disposal in the 6 and subsequent years
Rate of tax (%)
30 20 15 0
For New REIT the real property disposal would attract real property gains tax at 30% on the chargeable gain arising from the said disposal.
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LEASING
Question 1
What do you understand by leasing and what are the special features of the legislation relating to leasing?
Answer
Leasing is a form of financing for the acquisition of high cost capital assets. It is similar to renting and hire purchase with a variation in legal ter ms and conditions. Generally leasing helps: the acquirer to relief or improve his cash flow by way of deduction of lease payments; and The lessor achieves tax efficiency of capital as sets by way of capital allowance. However, in view of the possibility of tax abuses, special legislation was introduced in 1986 to streamline the industry. Special features
Under section 36(1) of the Income Tax Act 1967 (as amended) where the DGIR is satisfied that there is a need for some treatment in computing the gross income with respect to: A hire purchase transaction; A transaction under which a debt is payable by installments; A lease transaction in respect of movable property; Any other transaction involving a debt or stock in trade; or Such other transaction as may be prescribed. He may also prescribe the manner in which the adjusted income and statutory income from the business is computed, by giving directions and formula, rules, regulations for the special treatment with respect to any such transactions either in relation to a particular business or in relation to any business having any such transaction. As a result, the Income Tax Leasing Regulations 1986 were gazett e on 8 April 1986. Some of the special features are as follows: Meaning of lease:
A lease includes a sub-lease, a tenancy of three year or less and any agree ment for a lease or sub-lease (Sec. 2, Income Tax Act 1967 (as amended)). Under the Leasing Regulations of 1986, a lease is any kind of agreement or arrangement under which payments are made for the use of an asset.
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A controversy is that the definition is wide – and may cover both moveable and immovable asset while the Income Tax Act 1967 (as amended) under sect ion 36 talks of only the movable asset.
Separate business
A business which consists of leasing transactions and other activities will be deemed to have two businesses – one consisting of leasing transactions, and the other of the ‘other act ivities’. In other words, a leasing company which has leasing a nd non-leasing activities will be having two businesses.
Gross income of a lessor
The lease rental received or receivable (i.e. on an accrual basis) will be recognized as gross income charged to tax in the basis period for a year o f assessment in accordance with the financial period of the lessor. Under section 24(1) (c) of the Income Tax Act 1967 (as amended): ‘…where in the relevant period a debt owing to the relevant person arises in respect of the use or enjoyment of any property dealt at any time in the course o f carrying on a business, the amount of the debt shall be treated as gross income of the relevant person from the business for the relevant period’
Income accruing evenly
Regulation 3 of the Leasing Regulations provides that the total income of a lease is deemed to accrue evenly over the period of the lease ter m;
Special provisions for the treatment of lease income receivable
The full rental receivable in a basis period for a year of assessment may be treated as the gross income of the lessor where the DGIR considers such a treatments as being just and reasonable (proviso to regulation 3).
Deem sale transaction
Under the leasing regulations, there are six situations where lease agreement is deemed to be sale transaction. 1. The lessee is given an option to purchase the asset during or upon the expiry of the lease term; 2. The lessee is given the beneficial ownership of the asset 3. The lessee during the lease term or upon its expiry acquires the relevant asset at below the market value.
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4. 5. 6.
The asset is a special purpose asset The lessee has claimed capital allowance in respect of the asset prior to the lease The lessee is given the right to sell or dispose of the asset prior to the lease
The implication of this deemed sale is that t hat the lessee becomes the owner of the asset. Therefore, the lessor cannot claim any capital capita l allowance on the asset in question.
Treatment of terminal payments
Where any terminal payments are made by the lessee to the lessor as compensation for termination the lease, such payments would be deemed as taxable in the hands of the lessor.
Question 2
Heavy Plant Leasing Sdn Bhd. (‘HPL’) is a Malaysian incorporated company carrying on the business of leasing heavy plant, plant, machineries, and equipment to the building industry industry for several years. HPL’s accounts are c losed to 31 December each each year. During the year 2008, the company leased out a machine to Roadbuilders Sdn Bhd. (‘RSB’) under a stepped -up monthly payments payments arrangement. The arrangement was agreed upon to enable the lessee to ease its cash flow. Under this arrangement, arr angement, RSB will make lease payment to HPL over a period of two and a half years years as follows: Period July 2008 to 31 December 2008 January 2009 to 31 December 2009 January 2010 to December 2010 Total lease payments
Lease payments (RM) 200,000 300,000 400,000 900,000
Required: In the context of section 24 of the Income Tax Act 1967 (as amended) and Rule 3 of the Income Tax Leasing Regulations of 1986, advice the tax implications of this arrangement to Heavy Plant Leasing Sdn Bhd.
Answer
Section 24 of the Income Tax Act 1967 (as amended) provides that where in the relevant period a debt is owing owing to the relevant person arises in respect of the use or enjoyment of any property dealt with at any time in the course of carrying on a business, then the amount of the debt shall be treated as the gross income of the relevant person from the business for the relevant period. The lease rentals received and receivable rece ivable (i.e. the income is assessed on an accrual bas is) will be recognized as gross income charged to tax in the basis basis period for a year of assessment. Regulation 3 of the ITLR 1986 deems that the lease rental receivable in respect of a lease shall be deemed to accrue evenly throughout throughout the period of such lease term and the gross 47
income of the lessor in respect of that lease for the basis period for a year of assessment shall be a portion of the total sum receivable for the lease term being a portion which bears the same proportion to that total sum receivable as the number of days in the basis period for that year that falls within the lease t erm bears to the total number of days of the lease term- an anti-avoidance ruling designed to prevent the structuring of the lease payments to secure t ax advantage, especially in non-arm’s non- arm’s length length transaction. However, the full rental received in the basis period for a year of assessment may be treated tr eated as the gross income of the lessor for the basis period for that year of assessment assess ment where the Director General of Inland Revenue considers such tr eatment to be just and reasonable in the circumstances. Where in a transaction between independent person dealing at ar m’s length it could be established that the arrangement is in line with wit h commercial realities the DGIR would accept such an arrangement (e.g. in a case of o f a floating rate lease or o r a stepped up or stepped down lease) Based on the law, there are two t wo possible results: (a) If the company compan y is not able to satisfy sat isfy the DGIR that the arrangement is commercially justifiable, the lease payments would be spread out over the period period of the lease by virtue of Regulation 3, as follows: Period July 2008 -Dec 2008 Jan 2009 - Dec 2009 Jan 2010 - Dec 2010
YA 2008 2009 2010
Apportionment 900,000/30 900,000/3 0 x 6 mths 900,000/30 900,000/3 0 x 12 mths 900,000/30 900,000/3 0 x 12 mths Total
Amount 180,000 360,000 360,000 900,000
(b) If the Director General of Inland Revenue is satisfied that the arrangement is just and reasonable, then the lease rental would be treated as received in the relevant basis period for the year of assessment as follows:
Period July 2008 -Dec 2008 Jan 2009 - Dec 2009 Jan 2010 - Dec 2010
YA 2008 2009 2010 Total
Amount 200,000 300,000 400,000 900,000
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Question 3
SP Leasing Sdn Bhd (‘the company’) is a locally incorporated resident company and has been in business business for several years. It carries on the business of leasing heavy heavy construction machineries and the business of selling plant and machinery on hire purchase terms. The company closes its accounts to 30 th June each year. For the year ended 30 th June 2014 (the financial year) , the t he company had had provided the following information: (i)
The adjusted income from the leasing business was RM97,702 while that from the hire purchase business was RM99,473.
(ii)
In respect of the leasing business, the company is entitled to a capital allowance of RM73,968 for for assets used in that business i.e. on assets leased out;
(iii)
The capital allowance allowance on office equipment used in the leasing business is RM47,258
(iv)
The capital allowance for assets asset s used in the hire purchase business is RM58,190.
(v)
The company has office equipment and furniture and fittings that are used in both the leasing and the hire purchase business (‘the common user assets’). F or the year of assessment 2014, the capital allowance due on the common user assets is RM8,534. It is agreed with the Director General of Inland Revenue that 70% of the capital allowance should be allocated to the leasing business while 30% should be allocated to the hire purchase business.
(vi)
The company incurred a loss in respect of the leasing business in 2013 and the loss brought forward to the year year of assessment 2014 was RM21,574.
(vii)
The company owns a large warehouse that is let out. The adjusted rental income was RM24,461
(viii)
It has a fixed deposit deposit with a local bank that was placed as security for the company’s overdraft facilities. During the financial year, the interest earned from this fixed deposit was RM3,255.
(ix)
The company received a single tier dividend of RM5,500 from a Malaysian public listed company on 20 th November 2013.
(x)
During the financial year, the company made a cash donation of RM11,000 to a Malaysian approved charitable body.
(xi) Required Compute the chargeable income of SP Leasing Sdn Bhd for the year of assessment 2014 .
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Answer SP Leasing Sdn Bhd Year of assessment 2014 Computation of chargeable income
RM Leasing business Adjusted income Less: CA CA on leased assets CA on office equipment CA on common user assets (8,534x70%)
97,702 73,968 47,258 5,974 127,200 97,702 29,498
Less: Absorbed Balance CA c/f Statutory income Hire purchase business Adjusted income Less: CA Less: CA on common user assets (8,354x30%)
RM
0
99,473 58,190 2,560
Statutory income Agg. statutory business income from business Less: Unabsorbed loss b/f Aggregate of statutory business income (after losses) Add: Other income Dividend (single tier) Rent Interest Aggregate income Less: Approved donation Donation restricted to 10% of aggregate income Total income and chargeable income
60,750 38,723
38,723 38,723 21,574 17,149
0 24,461 3,255 11,000 4,486
27,716 44,865 4,486 40,379
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BANKING
Question 1
What is the scope of taxation of a bank? Answer
A banking business source is taxed on a world scope – in other words, on income wherever accruing or derived. The world scope applies only to the banking business and not the non business sources of income like rent. The business income of the overseas branch of a bank would be subject to Malaysian income tax at the point of accrual of the foreign income.
Question 2
What is the relief due to the bank for income subject to tax in the foreign jurisdiction? Answer
Where the foreign income suffers tax in the foreign jurisdiction, then tax re lief is due as follows: Where Malaysia does not have a double taxation agreement with the country in which the income arose, then a unilateral relief is due, i.e. a tax relief of a maximum of 50% of the foreign tax suffered would be allowed as a deduction in arriving at t he Malaysian income tax payable Where Malaysia has a double taxation agreement with the country in which the income arose, then a bilateral relief is due i.e. the tax relief would be the lower of the tax suffered in Malaysia on the foreign income or tax suffered in the fore ign country. Example MBB Bhd derives business income of RM1,000 in a foreign tax jurisdiction. The tax suffered was RM20,000. The Malaysian tax suffered on the same income is RM15,000. Required What is the tax relief due to MBB Bhd in the following situations? (a) The foreign tax jurisdiction does not have a double tax agreement with Malaysia. (b) The foreign tax jurisdiction does not have a double tax agreement w ith Malaysia.
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Answer In the case of (a) MBB Bhd would be entitled to a maximum relief of RM10,000 being half of the foreign tax suffered. In the case of (b) the relief e ntitlement would be RM RM15,000 being the lower of the foreign tax suffered (RM20,000) or t he Malaysian tax suffered (RM15,000) on the same income.
Question 3
ABB Bhd is a Malaysian resident bank and in line with its expansion program, opened its first branch in Chennai, South India in 2012. The bank closes its accounts on 31 December each year. For the year ended 31 December 2013, it received the following payments from the Chennai branch: (a) Interest of RM30,000 in respect of a short term loan extended to the Chennai branch in May 2013. The interest was accrued in November 2013 and remitted to Malaysia in January 2014. (b) Management fees of RM200,000 to assist with the setting up of the branch office in Chennai and putting in place a proper standard operating procedures that included complying with Indian banking laws. Answer The Chennai branch in South India would be tr eated as part of its banking business operations and would be taxed on a world scope under section 60C. The interest is therefore liable to tax as part of its business operations. It will be brought to charge when the payment accrued in November 2013, and will be taxed in the year of assessment 2013. The management fees, while it was received for assistance with the setting up of the Chennai branch, would still form part of its banking operations and would be liable to Malaysian income tax.
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Question 4
Malaysian Indian Bank Holdings Bhd (‘the Malaysia n bank’) is a local bank with operations in Malaysia and branches in India (‘the Indian branch’). For the year ended 31 December 2012, it received the following sums: a) RM40,000 being interest on interbank transfer – the Indian branches ran short of cash in September 2012 and the Malaysian Bank gave a short term loan to tide over the cash shortage. The interest was remitted to Malaysia. b) Interest of RM100,000 from a subsidiary in Malaysia for a loan extended to the subsidiary for the purchase of a building. c) RM3000,000 being interest on funds made available to another subsidiary for maintaining the net working capital funds of the said subsidiary as prescr ibed by Bank Negara. The Malaysian bank had also invested in bonds and this was realized during the year. The bank a profit of RM300,000 on the sale of the bonds; while it incurred a loss of RM85,000 on the disposal of a landed property acquired as a long term investment in a landed property. Required Discuss the taxability of the income received, including the treatment of the profit from the sale of the bonds and the loss arising from the sale o f the land property
Answer The RM40,000 from the interbank transfer would be liable to income tax as part of its banking operations. The RM100,000 would be liable to income tax also as part of its banking operations. The RM300,000 received would be liable to t ax as it was for maintaining the net working capital funds of the said subsidiary as prescr ibed by Bank Negara. The gain from the profit from the sale of the bonds would be liable to t ax as it forms part of the trading operations of the bank. The loss of RM85,000 incurred on the investment in a landed property would not be allowable as it is a capital loss arising from a long term investment, and did not arise in the course of the banking business. Note: One needs to make a distinction between a short term investment from surplus funds (the income or gains derived from its realization would be liable to income tax) and one made on a long term basis (the gains from its realization made, based on the circumstances, and would not be liable to in come tax. This is a tricky area and one needs to study the facts of the case carefully and apply the decisions of the courts to the case accordingly. The trend in recent times is for the courts to distinguish between a short term investment being treated as part of a business operations and long term investment the gains from the reali zation of which is treated as capital receipt not liable to income tax. For example, one needs to make a distinction between the Punjab Co -operative Bank Ltd v CIT (old school of thought) and Waylee Investment Ltd v CIR (the current trend in thinking on banking operations).
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Question 5
For the year ended 31 December 2012, MB Bank Bhd (‘the bank’), a Malaysian resident has an adjusted income of RM 250 million, and is entitled to a capital allowance of RM40 million. The bank has investments in a foreign country from which it rece ived a dividend of RM7.125 million after suffering an underlying tax of 25% and another 5% withholding tax on the dividends paid out to non-residents. The double taxation agreement between the two countries provided for a double taxation relief. Required Compute the tax payable by MB Bank Berhad after the bilateral relief due. Answer RM000 250,000 40,000 210,000 10,000 220,000
Adjusted business income Less: Capital allowance Statutory income Add: Dividend Aggregate/chargeable income Income tax at 25% Less: Bilateral relief - lower of Malaysian tax 10,000 x 25% Foreign tax 2,500 + 375 Tax payable after relief
55,000 2,500 2,875
2,500 52,500
The gross dividend income is computed as follows: Net dividend Add: 5% WHT (7,125/95x100x5%)
7,125 375 7,500
Add: 25% underlying tax (7,500/75x100x25%)
2,500 10,000
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INSURANCE
Question 1
How is the insurance categorized for income tax purposes? Answer
The insurance business is categorized into two major businesses: (a) The general insurance ; and (b) The life insurance.
Question 2
What is the distinction between the general insurance and the life insurance? Answer
The general insurance would include the business of insuring fire, property, motor vehicle, transportation, health, education, and general damages i.e. other than life. Life insurance is only focused on risk to life of t he assured.
Question 3
What are the sub-categories of insurance business under general and life business? Answer
A general insurance may also carry out inward re-insurance, off-shore insurance in addition to the general insurance. For income tax purposes, each of those businesses is treated as a separate business. Similarly, the life insurance business is deemed to have two sources of business income – one from the life fund and the other from the shareholder’s fund. A life insurance company can also carry on the business of life re-insurance business and an inward life re-insurance business. For income tax purposes, the life re-insurance and the inward life re-insurance are treated separately as general insurance business sources.
Question 4
What is the scope of charge of a resident life insurance business?
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Answer
The income of a resident life insurer is taxed on a world scope, and is taxed on the income derived from investments or sale of investments that are derived from investments made out of the life fund or shareholder’s fund of the business. As the resident insurer’s income would be taxed on a world scope, it is likely to suffer double tax and therefore relief may be available for any foreign tax suffered. The relief is set off against the Malaysian income tax charged. Para 28 Schedule 6 is not applicable to the income received in Malaysia from outside Malaysia in respect of insurance business.
Question 5
What is the scope of charge of a non-resident life insurance business? Answer A non-resident life insurer is taxable on the income from investment and sale of investment from the Malaysian life fund. The income from this fund is taxable notwithstanding that the particular investment income arose outside Malaysia.
The life fund refers to a special fund that the law requires life insurance companies to establish under section 38 of the Insurance Act 1996
Question 6
Identify the type of income and expense that will be considered for income t ax purposes in respect of the following:
Resident life insurance business Resident general insurance business A non-resident general insurance business
Answer Life insurance business
When a life insurer underwrites the life of an assured, the insurer undertakes to make payments to the insured upon death or upon maturity of the relevant policy. As there is a contingency event, the premium received is treated as not earned and therefore, not treated as income of the insurer. The amount of premium to be paid upon the life policy is carefully determined bas ed on actuarial computation. And if any surplus arises, for example on account of overestimates then such surplus is transferred to the shareholder’s account and this sum so transferred is liable to income tax.
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As the premium received for a life policy is not taxable, any claim paid out on a life po licy is also not deductible for income tax purposes. In the case of resident life insurance business, the following would constitute income and expenses for the purposes of Income Tax Act 1967 (as amended):
Gross income from commissions, interest, and dividends made out of life fund or the shareholder’s fund Gross proceeds from the realization of the investment or rights
The following are allowable expenses
Cost of acquiring and realizing investments this deduction is applicable to both the life fund and shareholder’s fund Amount transferred from the shareholder’s fund to set off the actuarial deficit for the relevant period arising from the life fund – this deduction is only applicable to the shareholder’s fund
General insurance – resident
In the case of resident general insurance business, the following would constitute income for the purposes of Income Tax Act 1967 (as amended):
Gross premium first receivable in the period (less returns) Gross income from general business, including commissions, interest, and dividends Gross proceeds from the realization of the investment held Amounts recovered under a contract of re-insurance Reserve for unexpired risk - opening balance
The following are allowable expenses
Claims incurred during the period Reinsurance premiums payable during the period – a 100% of the premium paid would be allowed if the reinsurance were with a res ident company; and only 95% if it is with a foreign company outside Malaysia. Commissions paid and discount allowed Management expenses Cost of acquiring and realizing investments Reserve fund for unexpired risk – closing balance
General insurance – non-resident
Gross premium first receivable in the period (less returns) – these are restricted to only Malaysian issued policies (i.e. derived from Malaysia) Gross income from general business, including commissions, interest and dividends these are restricted to only Malaysian derived income Gross proceeds from the realization of the investment held Amounts recovered under a contract of re-insurance Reserve for unexpired risk - opening balance
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The following are allowable expenses
Claims incurred during the period Reinsurance premiums payable during the period – a 100% of the premium paid would be allowed if the reinsurance were with a res ident company; and only 95% if it is with a foreign company outside Malaysia. Commissions paid and discount allowed Management expenses Reserve fund for unexpired risk – closing balance Cost of acquiring and realizing investments A proportion of head office expenses – this amount are computed as a proportion of the Malaysian gross premium as bears the world gross premium as a proportion of the head office Proportion of head office expenses is computed as follows: [Malaysian gross premium / world gross premium] x head office expenses
Question 7
What is the treatment of capital allowances and losses in respect of the life fund and the shareholder’s fund? Answer
The adjusted income of the shareholders fund (both resident and non-resident) is deemed to be the statutory income i.e. no capital allowance is deducted against the adjusted income from the shareholder’s fund. Capital allowance is allowed only against the adjusted income of the life business. Any unabsorbed capital allowance can be carried forward and allowed only against the life insurance business in the following and subsequent years of assessment. Losses arising from the life fund must be deducted only against the life fund. Any unabsorbed losses of the life fund would be carried forward and deducted against the adjusted income of the life fund. As for non-life fund (example, shareholder’s fund, general insurance etc.), the current year loss, and the unabsorbed loss from the non-life fund must be deducted from the non-life fund.
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Example
Adjusted income Less: Capital allowance Current year allowance Unabsorbed allowance b/f Statutory income Aggregate of statutory income Less: Unabsorbed loss b/f From life fund From SHF and GI business Chargeable income
(c)
LF RM000 60,000 26,278 15,000 18,763 18,736
Non-life fund SHF GI RM000 RM000 90,148 11,059 90,148
50 9 11,000
101,148
736 18,000
82,156 18,992
Question 8
What do you understand by ‘reserve for unexpired risk’ and what is the treatment accorded under the Income Tax Act 1967 (as amended)? Answer
This is a reserve fund created for unexpired risk, which is an estimate of future liabilities t hat may be incurred on existing general insurance policies. As the r isk has not expired, the premium received cannot be recognized as income for income tax purposes. Under section 60(9), the unexpired risk is ascertained as follows:
25% of the net adjusted premium in respect of marine, aviation ad t ransit policies the actuary’s computation of the net adjusted premiums of accidents, fire and other general insurance not covered in the above category – this amount must be in relation to the appropriate accounting principles approved by Bank Negara
The term net adjusted premium refers to situations where if reinsurance policies exist, to the difference between the gross premium receivable a nd the amount of the re-insurance premium payable [being the 95% or the 100% premium payable under section 60(7)]. In order to determine the reserve fund for unexpired risk take note that t he marine, aviation, and transit policies are aggregated as one business source under general insurance.
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Example Say ABC Insurance Company paid reinsurance premium as follows on the relevant policies: Reinsurance and net premiums paid for general insurance MAT FMO RM000 RM000
Gross premiums received Less: Reinsurance in Malaysia Reinsurance outside Malaysia
Net premium paid
Total RM000
(c)
8,800
7,700
16,500
(d)
700 350 1,050
350 175 525
1,050 525 1,575
(c-d)
7,750
7,175
14,925
MAT=Marine, aviation and transit policies; FMO=Fire, motor and other policies
The amount to be allowed in respect of the reinsurance and the reserve for the unexpired would be as computed as follows:
Reinsurance and net premiums paid deductible
MAT RM000
FMO RM000
Total RM000
Gross premiums received (c) Less: Reinsurance in Malaysia-allowed 100% Reinsurance outside Malaysia - allowed 95%) [Sec 60(7)] (d)
8,800
7,700
16,500
700 333 1,033
350 166 516
1,050 499 1,549
Net premium paid
7,768
7,184
14,951
600
2,542
(c-d)
Closing balance of the reserve for unexpired risk (expenditure deductible for income tax purposes)
MAT- computed at 25% of net premium paid [sec 60(9)(a)] [25% x 7,768] FMO - on actuarial basis [section 60(9)(b)] [ fully allowed as provided]
1,942
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Question 9
What is the treatment for income tax purposes of the following income? (a) foreign source income (b) dividend received under the imputation system (c) capital gains from the realization of investment Answer
(a) Foreign sourced income would be subject to tax and Para 28 Schedule 6 does not apply to such income. (b) Dividends issued under the imputation system and received by an insurance company would be treated as part of the business income of the insurance company, falling under section 4(a) of the ITA and would be charged to tax accordingly. However, any dividends issued under the single tier system would be exempted from income tax. (c) Capital gains from the realization of investment would be subject to tax and a deduction would be available for the cost of acquiring such investment.
Question 10
In respect of an inward re- insurance business falling under section 60A:
Explain the meaning of ‘re-insurance’ The tax adjustments in arriving at the adjusted income The steps in the computation of the chargeable income What is the tax rate applicable under schedule 1 of the Income Tax Act 1967 (as amended?) The treatment of the income for the determination of exempt dividends under schedule 7A of the Income Tax Act 1967 (as amended)
ANSWER TO QUESTION ‘Re-insurance’ refers to any risk that is re-insured with insurance. In this context, ‘inwardreinsurance’ for example means re-insuring the risk with a Malaysian company where the risk or the original policy was issued outside Malaysia. The re-insurance business is treated in a manner similar to that of the general insurance business. The chargeable income would be calculated as follows:
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General insurance
Inward reinsurance
100,000 30,000 70,000 (a)
20,000 2,000 18,000 (b)
Adjusted income Less: Capital allowance Statutory income Aggregate of statutory income (a) + (b) Less: Approved donation Chargeable income
88,000 8,000 80,000
The amount of chargeable income attributable to the inward re -insurance would be computed as follows: 80,000 x [18,000/88,000] = 16,363 The tax on the inward re-insurance business shall be c harged at the reduced rate of 5% on this computed chargeable income.
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Question 11
MGR Insurance Bhd is a resident insurance company carrying on the business of life insurance business and general insurance business. The company closes the accounts to year end 31 December. For the year ended 31 December 2012, the company’s financial statement in respect of its insurance business is as follows:
LF RM000
SHF RM000
GI RM000
(a)
60,516 396 795 4,770 5,565 6,899 3,711 670 83,322
0 5,565 3,711 26,504 37,105 129,872 51,730 838 255,325
20,809 221 773 0 0 0 0 699 22,502
(b)
7,421 1,362 1,855 4,241 5,863 2,384 16,927 585 40,638
3,876 1,362 708 10,601 111,319 42,419 13,398 754 184,437
5,302 1,387 663 0 0 0 1,575 4,484 13,411
(a-b)
42,684
70,888
9,091
Income Gross premium Interest income Rental income Gross dividend Sale of shares Sale of office building Sale of mining land Reserve for unexpired risk b/f Less: Expenses Net claims incurred Management expenses Commissions Cost of shares Cost of office building Cost of mining land Re-insurance premium Reserve for unexpired risk c/f
Profit
LF=Life fund; SHF=Shareholder’s fund; GI=General insurance
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The insurance company had also furnished t he following information in respect of the capital allowances, losses, reinsurance, and the reserves for unexpired risk.
Note 1 Capital allowances and losses
LF RM000
SHF RM000
GI RM000
648 200 800
23,258 17,000 0
249 300 658
Capital allowance for YA 2012 Unabsorbed capital allowance b/f Unabsorbed losses b/f
Note 2 Reinsurance and net premiums paid for general insurance MAT RM000
Gross premiums received Less: Reinsurance in Malaysia Reinsurance outside Malaysia
Net premium paid
FMO RM000
Total RM000
(c)
8,800
7,700
16,500
(d)
700 350 1,050
350 175 525
1,050 525 1,575
(c-d)
7,750
7,175
14,925
MAT=Marine, aviation and transit policies; FMO=Fire, motor and other policies Note 3 Reserve for unexpired risk for General insurance Section 60(9)(a) and (b)
RM000 554
Unexpired risk b/f from YA 2011 (aggregate) Unexpired risk c/f to YA 2012
Based on FRS 202 (company allows 50%) Actuarial basis per section 60(9)(b) ITA
MAT RM000
FMO RM000
Total RM000
600
4,484
3,884
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Answer
MGR Insurance Bhd Computation of income tax for year of assessment 2012
LF RM000
SHF RM000
GI RM000
(a)
0 396 795 4,770 5,565 6,899 3,711 0 22,136
0 5,565 3,711 26,504 37,105 129,872 51,730 0 254,487
20,809 221 773 0 0 0 0 699 22,502
(b)
0 0 0 4,241 5,863 2,384 0 0 12,488
0 0 0 10,601 111,319 42,419 0 0 164,339
5,302 1,387 663 0 0 0 1,549 2,542 11,443
(c)
9,648
90,148
11,059
648 200 8,800
90,148
249 300 10,510
Income Gross premium Interest income Rental income Gross dividend Sale of shares Sale of office building Sale of mining land Reserve for unexpired risk b/f Less: Expenses Net claims incurred Management expenses Commissions Cost of shares Cost of office building Cost of mining land Re-insurance premium Reserve for unexpired risk c/f
Adjusted income Less: Capital allowance Current year allowance Unabsorbed allowance b/f Statutory income
SI(LF)/Aggregate of SI(SHF+GI) Less: Unabsorbed loss b/f Life fund General insurance Chargeable income
8,800
100,658
800 8,000
658 100,000
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Workings Reinsurance and net premiums paid
MAT RM000
FMO RM000
Total RM000
8,800
7,700
16,500
Gross premiums received (c) Less: Reinsurance in Malaysiaallowed 100% Reinsurance outside Malaysia – allowed 95% [Sec 60(7)] (d)
700
350
1,050
333 1,033
166 516
499 1,549
Net premium paid
7,768
7,184
14,951
600
2,542
(c-d)
Reserve for unexpired risk
MAT- computed at 25% of net premium paid [sec 60(9)(a)] FMO - on actuarial basis [section 60(9)(b)]
1,942
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PROPERTY DEVELOPERS
Question 1
In the case of a property developer, what are the factors that you would consider in determining the date of commencement, including active development and booking date ? Answer
The property development industry is a specialized industry and therefore complicated in nature. The determination of the date of commencement of the business is therefore not a simple straightforward matter. One therefore has to resort to the general rules and case laws relating to commencement of business for guidance. Date of commencement could be determined as being the ear lier of the following:
The date the developer commenced active development of the land; or The booking of lots for sale.
Active development: this term is not defined and one has to take that it means a series of activities connected with the development of the land, like clear ing and leveling land etc. Note: Booking refers to the date the purchaser can pay a booking fee to purchase a property. This has to be distinguished from registering to buy a property, where no payment is made by th e potential buyer.
Date of commencement
The date of commencement for a property developer is very much dependent on the facts of the case. But generally it is accepted that the date of commencement would be indicated by the active development of the land or alternatively by the booking (which has to be distinguished from mere registration by potential buyers) of the units to be constructed. The earlier of these two activities would be accepted as the date of commencement. Where the property development consists of more than one project, then each project is treated as a separate and distinct source of income. The implication is that the capital allowance would be deducted in respect of each of the artificial separate business. Active development of the land
Active development of the land refers to the commencement and continuation of the works necessary for the development and completion of the development project. Such works would include excavation, filling and levelling as well as p iling prior to the actual erection of the relevant buildings
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Booking date
This refers to the date when the property developer invites the public either by personal invitation or by an announcement to the public in the media (e.g. the newspaper) to book the properties to be constructed. This is different from the registration of potential buyers for the purchase of the property. The two acts are distinguished by the fact that in the case of potential registration, no fees need to be paid. On the other hand in the case of actual booking, the buyer may have to pay a certain amount of towards the purchase price usua lly termed the down payment, followed by stage payments based on the development progress.
Question 2
Company T has a piece of land with total land area of 200 hectare. The company plans to build a block of luxurious condominium on 10% of the land area while reserving the balance of 180 hectare for bungalow houses in future. The total cost of the land was RM10 million. Required What is the applicable land cost t hat would be allocated to the condominium project? Answer
The cost of the whole piece of land is RM10 million. Hence the co st of land to be allocated to the condominium project is RM1 million being 10% of the total cost of cost [10% of RM10 million]. Where the development is ongoing and there are several phases, the a llocation would be apportioned based on the formula: Total development area of the relevant phase Total development area of all phases
x
common infrastructure cost
Question 3
How should common infrastructure be apportioned to the relevant projects of a developer for the purposes of determining the adjusted income? Answer
The accounting standards prescribe that common costs may be allocated using relative sales value or any other generally accepted method. For income tax purposes common infrastructure costs have to be apportioned in accordance with: (a) the area (acreage) method;
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(b) the relative sales value method; or (c) any method that is acceptable by the DGIR. A property developer who chooses to apply any of the method above need not apply to t he DGIR. He only needs to indicate it in the tax computation and ensure that the method used reflects a fair and reasonable allocation of the costs.
Question 3
What is the implication of determining the date of commencement for t he property developer? Answer
Expenditure incurred before the date of commencement is not allowable for tax deduction purposes, as it would be capitalized as development expenditure.
Question 4
How is the revenue for a property developer recognized? Answer
As the profit accrual period is a prolonged one (i.e. covering a long period), it is important that the profit recognition is reasonably matched to the expenses to give a ‘true profit’. The accounting rules have developed the ‘perce ntage of completion method’ to do this. And the tax authorities have adopted this method to compute the adjusted income of a property developer. Essentially the method falls in line with section 24 of the ITA 1967 (as amended) that requires income to be recognized on an ‘accrual basis’. Section 24(1) (1)
where in the relevant period a debt owing to the relevant person arises in respect of – a) any stock in trade sold (or part with on requisition or compulsory acquisition or in a similar manner) in or before the relevant period in the course of carrying on a business; b) any services rendered at any time in the course of carrying on a business; or c) the use or enjoyment of any property dealt with at any time in the course of carrying on a business
The amount of the debt shall be treated as gross income of the relevant person from the business for the relevant period.
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The accounting base for the percentage of completion method is based on cost, while the IRB’s base is founded on ‘ payment received and receivable’. Accounting base [Cost incurred to date / total cost] x estimated gross profit = estimated profit for the relevant year
IRB base [Payment received/receivable / total sales value of project] x estimated gross profit of the project = estimated profit for the relevant year
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SEA AND AIR TRANPORT
Question 1
What is the scope of charge under the Income Tax Act 1967 (as amended) in respect of income derived from shipping and airline o perations? Answer
Shipping and airline operations fall under the special industries and are assessa ble on a world scope under section 54(2) (a), i.e. from income ‘wherever accruing or derived’; unlike other income that are only assessed on a ‘derived, accr ued or received in Malaysia’ basis.
Question 2
What do you understand by the following terms? a)
‘Malaysian ship’
b)
gross income derived from Malaysia
c)
casual call
d)
transshipment
Answer Malaysian Ship
A Malaysian ship is defined under section 54A (6) to mean a sea going ship registered under section 11of the Merchant Shipping Ordinance of 1952. It excludes several types of vessels like tug boat, fishing boat etc. Gross income derived from Malaysia
Gross income derived from Malaysia is defined under sect ion 54(5) to means the total of all sums received or receivable in Malaysia by the operator in the basis period in respect of transporting by sea or air passengers or cargo embarked or loaded in Malaysia into ships or aircraft owned or chartered by the operator. It would exclude the following:
Goods transshipped Casual call Refund
A casual call
This is one where the ship owned or operated by an owner or charterer has not called at a Malaysian port in the last 24 months and will not probably call at a Malaysian port in the next 24 months. Essentially a ‘casual call’ would be an isolated call. 71
Transshipment
This refers to passengers and cargo brought into Malaysian solely to be transferred to transship to another ship or plane. Alternatively such transshipment is on a c asual call basis. The income from such activities would be excluded in determining the income of the operator derived from Malaysia.
Question 3
What are the conditions that must be satisfied before a ratio certificate is accepted by the Director General of Inland Revenue Malaysia? Answer
The following must be satisfied:
It must be issued by a revenue authority of the country of residence of t he sea or air transport operator The said revenue authority must compute and assess the full profits of t he nonresident operator from his shipping or airline operations The tax computation basis must be quite similar to the Malaysian basis of computation. The certificate must state the world gross freight earnings, the adjusted profits or losses, and the capital allowances due The certificate issued by most countries with which Malaysia has a double tax agreement is generally acceptable on a reciprocal basis.
Question 4
Orion Shipping Lines Ltd. is a Hong Kong based shipping company. For the year ended 31 Dec 2015 it has submitted to the Director General of Inland Revenue Malaysia the following adjustment to its accounts made by the Hong Kong tax authorities:
Net profits per accounts Add: Depreciation Less: Rent received from outside Hong Kong
RM 3,000 8,700 11,700 1,800 9,900
The company has produced an acceptable certificate from the Hong Kong tax authorities that indicates the following: RM Gross world income
86,000,000
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World adjusted income
80,000
World depreciation allowance
4,800,000
Gross income derived from Malaysia
4,300,000
Required: For the year of assessment 2015, compute the tax payable by the company using the following: a)
5% method;
b)
the acceptable certificate method
Answer The 5% method
Gross income derived from Malaysia
4,300,000
Deemed statutory income at 5%
215,000
Malaysian tax payable:
53,7500
215,000 @ 25%
The Acceptable Certificate Ratio Method
Deemed Malaysian derived income 4,300,000/86,000,000 x 80,000 Less: Deemed Malaysian capital allowances 4,300,000/86,000,000 x 4,800,000 Deemed Malaysian statutory income Malaysian tax payable
3,760 at 25%
4,000
240 3760 940.00
Note: The current rate is 25% for 2015.
Question 5
Transshipping Lines (‘the company’) is an Australian incorporated shipping company carrying on the business of transporting passengers and cargo by sea to various destinations. The company however does not have an office in Malaysia. Certain merchants who wish to ship their goods using the company’s ships would arrange with their agent in Port Kelang to
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ship their goods to Singapore in feeder vessels, which will take the goods to Singapore. The feeder vessels do not belong to the company nor are they chart ered by the company for this purpose. Once in Singapore, the goods will be loaded from the feeder vessels on to the ships belonging to the company and sent to their respective destinations. The payments for the services are made to the agents in Port Kelang. Required Discuss the taxability of Transshipping Lines to Malaysian income tax under the Income Tax Act 1967 (as amended) in respect of the payments received for the cargoes shipped from Port Kelang. Quote relevant case laws in support of your answer. Answer
The company will not be liable to any Malaysian income tax since the Austr alian shipping company was not operating in Malaysia. The goods were in fact loaded on to the Australian ship in Singapore and not in Malaysia. In the case of OOCL Ltd v Ketua Pengarah Hasil Dalam Negeri a shipping company resident in Hong Kong had no business operations in Malaysia – but Malaysian merchants wishing to ship cargo to Hong Kong would approach a local agent who acted for the Hong Kong shipping company. The cargoes were loaded from Penang, Kuching and Kota Kinabalu into feeder vessels and sent to Singapore where it was transshipped on to the Hong Kong vessel. The Inland Revenue Board charged the pa yments received as income derived from shipping operations Malaysia. On appeal as to whether the Hong Kong company has derived income from Malaysia the Special commissioners of Income Tax held that as the feeder ships on to which the cargoes were loaded on in the various ports were neither owned or charter ed by the Hong Kong company, the income derived from the transport of the Malaysian cargo is not derived from Malaysia.
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TRADE ASSOCIATION
Question 1
What do you understand by the term ‘mutuality’? Quote relevant cases in support of your answer.
Answer
The mutuality principle holds that a man cannot make a profit by trading with himself. Therefore, where a number of people have associated together for a common purpose and have contributed to a common fund in which all of the contributors are interested, the surplus of their contributions remaining after the fund has been applied to the co mmon purpose is the return of their own moneys (which they have overpaid) and is therefore not profit. Thus, when the mutuality principle applies, any de alings with members’ contributions or subscriptions will not give rise to a liability to t ax.
Case laws: Last v London Assurance Corporation Social Credit Savings and Loan Society Ltd v FCT Municipal Mutual Insurance Ltd v Hills
Question 2
How is the mutuality principle applied or not applied in Malaysia in respect o f mutual activities of trade associations?
Answer
In Malaysia, trade associations are generally organisations formed with the stated objective of safeguarding and promoting further the businesses of its members. As only members are involved in such organisations, the principle of mutuality exists and any gains arising from their activity should not give rise to a chargeable income. However, s.53 of the Income Tax Act 1967 effectively excludes the application of the mutuality principle by deeming a resident trade association to be carrying on a business and its gross income to be all sums receivable on revenue account, including entrance fees and subscriptions. These incomes are brought to charge. However, some exemption is available to the associations vide Income Tax (Exemption) (No.19) Order 2005 (PU(A) 190/2005), under which members’ subscription fees, less a proportion of common expenses and common capital allowances, are exempted from income tax.
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Note that the legislation does not provide for an outright exemption (i.e. a full exemption for subscription) but only a partial exemption being a proportion arrived at by disallowing certain proportion of common expenses and capital allowances. It can be represented as follows:
Subscription fees (say) Less: Proportion of common expenses (note 1) Proportion of capital allowances (note 2) Exempted income
Note 1:
RM 10,000 3,000 1,000
4,000 6,000
Proportion of common expenses
Common expenses x [ subscription fees / total gross income ]
Note 2:
Proportion of capital allowance
Capital allowances x [ subscription fees / total gross income ]
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Question 3
Assume you have the following information re: the Coffee Shop Association of Malaysia for the year ended 31 December 2015: Statement of income for year ended 31 December 2015: The Coffee Shop Association Accounts for the period 1 January 2015 to 31 December 2015 RM Income Membership subscription Seminar fees Lantern Festival contributions Dividend (single tier) Fixed deposit interest Total income Less: Expenses Salary and wages Rental of seminar hall Lantern Festival expenses Speaker fees Employee's Provident Fund Stationery Utility expenses Painting of premises Donation and contributions Assessment Quit rent Surplus of income over expenditure
143,826 71,913 42,552 20,425 1,702 280,418
73,000 10,000 17,872 5,000 8,000 7,000 6,000 3,000 2,451 1,500 500
134,323 146,095
Other information: Other information RM Dividend (single tier) Capital allowance Specific Common
5,106
0 900
Donation
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Approved Non-approved Total
1,000 1,451 2,451
Required: Compute the chargeable income of the Coffee Shop Association for the year of assessment 2015.
Answer Workings Gross income from business Members subscription Seminar fees Lantern Festival contributions Total gross income from business
Common expenses Salary and wages EPF Stationery Utility Painting of premises Assessment Quit rent Total common expenses
RM
143,826 71,913 42,552 258,291
RM 73,000 8,000 7,000 6,000 3,000 1,500 500 99,000
Common expenses allocation Common expenses attributable to memberships' subscription fees [Membership sub./Gross bus income ] x common expense 143,826 /258,291 x 99,000 55,127 Common expenses attributable to seminar fees [Seminar fees /Gross income ] x common expenses 71,913/258,291 x 99,000 27,563
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Common expenses attributable to Lantern Festival ['Deepavali Night' /Gross income ] x common expenses 42,552/258,291 x 99,000 16,310
Common capital allowance allocation Common capital allowance attributable to memberships' subscription fees [Membership fees/Gross income ] x Capital allowance 143,826 /258,291 x 900 501 Common capital allowance attributable to seminar fees [Seminar fees/Gross income ] x Capital allowance 71,913 /258,291 x 900 251 Common capital allowance attributable to 'Lantern Festival' [Lantern Festival/Gross income ] x Capital allowance 42,552 /258,291 x 900 148
The Coffee Shop Association Year of assessment 2015 Business income Membership subscription Less: Prop of common expenses Adjusted income Less: Prop of Capital allowance Statutory income (to be exempted) Seminar Seminar fees Less: Direct expenses Speaker fees Rental of seminar hall Prop of common expenses
Adjusted income Less: Prop. of capital allowance
Lantern Festival Lantern Festival contributions Less:
RM
RM 143,826 55,127
88,699 501 88,198
71,913 5,000 10,000 27,563
42,563 29,350 251
29,099
42,552
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Direct expenses Prop of common expenses Adjusted income Less: Prop. of capital allowance Aggregate of statutory income from business Less: Amount exempted (M'ship subscription) Aggregate of SI from business after exemption Other income Dividend - single tier Interest Aggregate income Less: Donation Chargeable income
17,872 16,310
34,182 8,370 148
8,222 125,519 88,198 37,321
0 1,702
1,702 39,023 1,000 38,023
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CLUBS AND SOCIETIES
Question 1
Explain what you understand by a ‘club’ and ‘so ciety’? Answer
These terms ‘club’ and ‘society’ are not defined in the Income Tax Act 1967 (as amended). Generally these entities are t aken to be some kind of loose association that exist not for a business purposes and if there is any business advantage it is certainly one of incidence than purpose. Case laws: Kowloon Stock Exchange Ltd v CIR v Fletcher v Income Tax Commissioners
Question 2
How does the principle of mutuality apply to a club? Answer
The principle of mutuality is that ‘a man cannot trade with himself’. Essentially it means that the contribution to the fund of the club and its participators in the surplus must be the same person. As such in a club any surplus of income over expenditure is treat ed as no income and therefore not liable to income tax. Question 3
How is a club assessed? Answer
As the income from the transaction with the members is not liable to tax, the following receipts of a club may not be taxed: (i) (ii) (iii) (iv)
Entrance fees Subscriptions Provision of services to the members Sale of goods to members
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Example of club computation:
Club Income and Expenditure account Year ended 31 Dec 2014
RM
RM
Income Subscription from members Entrance fees from members Malaysian dividends (single tier) Fixed deposit interest (Malaysian bank)
260,000 18,000 28,000 50,000
356,000
Less: Expenditure Salaries Utilities Repairs and maintenance Bank charges Depreciation of plant and machinery Approved donation
105,000 20,000 6,000 4,500 30,000 4,000
169,500 186,500
Surplus of income over expenditure
Computation of chargeable income of a club Year of assessment 2014
Subscription (members) Entrance fee (members) Dividends Fixed deposit interest Aggregate income Less: Approved donation Restricted to 7% of agg income Chargeable income
RM 0 0 0 50,000 50,000 4,000 3,500
3,500 46,500
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CO-OPERATIVE SOCIETIES
Question 1
Under what circumstances is the income of a co -operative society exempted from tax?
Answer
Under Para 12(1) (a) the income of any co-operative society is exempted in respect of a period of five years commencing from the date of registration of such co-operative society. Therefore, it would enjoy tax exemption for the first five years from the date of registration. Thereafter under Para 12(1) (b) the co-operative society would be liable to tax where the members’ fund as at the first day of the basis period for the relevant year of assessment is less than seven hundred and fifty thousand ringgit. Example 1 The members’ fund as at 1 Jan 2015 is:
Paid up share capital Subscribed capital Share premium account Statutory reserve fund Unappropriated profits
400,000 200,000 80,000 150,000 70,000
Members’ funds
900,000
In this case as the members fund as at the first day of the basis period is more than RM 750,000, then the co-operative society is subject to tax. Example 2 The members’ fund as at 1 Jan 2015 is: Paid up share capital Subscribed capital Share premium account Statutory reserve fund Unappropriated profits Members’ funds
200,000 100,000 80,000 150,000 70,000 600,000
As the members’ fund as at the first day of the basis period is less than rm750,000 the cooperative society is exempted on its income.
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Question 2
The Chicken Farmer’s Cooperative Society, which was registered in 2008, commenced operations on 1 August 2008 prepares its accounts to July 31 annually. Required: Determine the basis period of the for the first and second year of assessment for the cooperative society
Answer
Co-operative societies are allowed to prepare accounts to a date other than 31 Dece mber if it is a period of 12 months [Sec 21A (2)]. Sec 21A (2) Subject to sub-section (5) and (6) where a company, trust body or a co-operative society has made up the accounts of its operations for a period of twelve months ending on a day other than 31 December in the basis year, that period shall constitute the basis period for that year of assessment for any of its sources of income. In this case, as the accounts for the first period was for a period of 12 months, then that period is acceptable as the basis period for the relevant year of assessment. 1 2
Year of assessment is 2009: Basis period is 1 August 2008 – 31 July 2009 Year of assessment is 2010: Basis period is 1 August 2009 – 31 July 2010
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Question 3
The ABC Cooperative Society (‘the Society’) is a local cooperative society incorporated in 1980 in the state of Selangor. The accounts are closed to 31 December each year. The members are rubber planters from the stat e. For the year ended 31 December 2007, the society’s audited accounts showed the following:
Profits from rubber trading Gross Malaysian dividends Fixed deposit interest Less: Salaries and bonus EPF and allowances Traveling and accommodation Rental Depreciation Excess of income over expenses
RM '000
RM '000
4,000 700 2,185
6,885
600 65 45 25 150
885 6,000
Details of the members’ funds as at 31 December 2006 and 2007 are as follows:
Paid up capital Bonus shares (issued out of revaluation surplus of building) Share premium reserve Statutory reserve Unappropriated profit
31-Dec-06
31-Dec-07
RM '000
RM '000
4,000
3,500
800 3,000 7,000 4,500
500 3,500 9,000 6,000
19,300
22,500
Required:
Compute the chargeable income of the cooperative society for the year of assess ment 2007.
The tax computation will be as follows: Business: Excess of income over expenditure Less: Dividend income Interest income
RM '000 6,000 700 2,185
2,885
85
3,115 150 3,265
Add: Depreciation Adjusted and statutory income Dividends Interest Less:
700 2,185 Total income Deductions under section 65(A)(a) 25% of net audited profit Or Amount transferred to reserve account [9 m less 7 m] Whichever is the lower
Less: Deductions under section 65(A)(b) 8% of [4m +3m + 7m + 4.5m ] Chargeable income
2,885 6,150
1,500
2,000 1,500 4,650
1,480 3,170
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Question
Assume the following information is available in respect of the Kampung Jusa Co -operative Society for the year ended 31 December 2014: Kampung Jusa Co-operative Society Statement of income and expenditure for year ended 31 December 2014
Income Member's subscription Entrance fees Sale of fruits Rent Dividends (single tier) Interest on fixed deposit
Less: Expenditure Salaries and bonus Interest on member's loans Meeting allowances Travelling Entertainment Repairs and maintenance Donation to an approved institution Utilities Depreciation Audited net profit Less: Dividends paid to members Obligatory contributions Co-op education trust fund Co-op development fund Unappropriated profit for the year
RM000
RM000
110 35 3,869 2,310 4,245 279
10,848
121 47 35 45 45 62 86 20 23
484 10,364
217 133 184
534 9,830
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Member’s fund as at the beginning of the basis period: Member's fund at the beginning of the basis period
Paid up capital Bonus shares (from asset revaluation surplus) Statutory reserve fund Reserves Unappropriated profits Member's fund as at the beginning of the basis period
1-Jan-14 RM000 3,630 2,241 13,445 8,964 6,723 35,003
Other related information: Notes: Bonus shares issued out of revaluation surplus Unabsorbed capital allowance b/f Current year capital allowance on qualifying assets Unabsorbed loss b/f
RM000 2,241 440 220 330
Required:
Compute the chargeable income of the Kampong Jusa Co-operative society for the year of assessment 2014.
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Answer Kampung Jusa Co-operative Society Tax computation for year of assessment 2014
RM000 Audited net profit Less: Member's subscription Entrance fees Rent Dividends (single tier) Interest on fixed deposit
110 35 2,310 4,245 279
Add: Entertainment - disallow 50% Donation to an approved institution Depreciation
23 86 23
Less: Capital allowance Unabsorbed capital allowance b/f Current year capital allowance
440 220
Less: Unabsorbed loss b/f Add: Other income Rent Dividends (single tier ) Interest on fixed deposit Aggregate income Less: Approved donation Total income Less: Section 65A(a) deduction - lower of Contribution to statutory fund Co-operative education trust fund co-operative development fund Or 25% of audited net profit Less: Section 65A(b) deduction 8% of member's fund [8% x 32,762] Chargeable income
2,310 0 279
RM000 10,364
6,979 3,385
132 3,517
660 2,857 330 2,527
2,589 5,116 86 5,030
133 184 317 2,591
317
2,621
2,938 2,092
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Member's fund as at beginning of the basis period
Paid up capital Bonus shares (issued out of revaluation of property) Statutory reserve fund Reserves Unappropriated profits Less: Bonus shares issued out of revaluation of property Member's fund as at the beginning of the basis period
RM000 3,630 2,241 13,445 8,964 6,723 35,003 2,241 32,762
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GROUP LOSS RELIEF
Question 1
What do you understand by a surre ndering company, a claimant company and a related company? Answer
Surrendering company • A company having an adjusted loss in the basis period for a year of assessment t hat passes over its losses to another company. Claimant company • A company which is related to the surrendering company that claims the losses against its own income Related company Companies are related in the context of Section 44A, if at least: •
70% of the paid-up ordinary capital of the surrendering company is directly or indirectly owned by the claimant company, or
•
70% of the paid-up ordinary capital of the claimant company is directly or indirectly owned by the surrendering company, or
•
70% of the paid-up ordinary capital of both the surrendering company and the claimant company are directly or indirectly owned by another company resident and incorporated in Malaysia.
In the above context, ‘Indirectly owned’ means through the medium of o ther companies resident and incorporated in Malaysia.; and ‘Ordinary share’ means any share other than one carrying the right to a fixed percentage of the nominal value of the share or of the profits of the company. Question 2
When can a company claim loss relief
Answer
Entitlement to group relief is very restricted on account of the various conditions and limitations. A valid claim can be only made when all of the pre -conditions have been met.
Question 3
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In relation to question 3, what are the pre-conditions to claim loss relief? Answer
The following six requirements apply to both the surrendering company and the claimant company: 1. They must be related companies throughout the basis period for the year of assessment (of claim) and the 12 months preceding. 2. Both must have a paid-up share capital of more t han RM2.5m at the beginning of the basis period for the year of assessment (of claim). 3. Both must be resident in Malaysia for the basis per iod for the year of assessment (of claim). 4. Both must be incorporated in Malaysia. 5. Both must have a 12-month basis period ending on the same day. 6. Both must be subject to tax at the full company rate app licable (and not the reduced rate of 20%). Question 4
When would a company be excluded from making a claim for group loss? Answer
If any of the following apply in the basis period for the year of assess ment concerned, a company will be excluded from surrendering or claiming the losses: • • • • • • •
The company is a pioneer company, or has been granted approval for investment tax allowance. The company enjoys either a tax exemption in respect of a shipping operation, or a ministerial exemption. The company has made a claim for reinvestment allowance. The company has claimed a deduction for an approved food production project. The company has claimed a deduction for the cost of acquisition of proprietary rights. The company has been granted a deduction for the cost of acquiring a foreign-o wned company. The company has claimed a deduction under any rules made under s.154 (a PU Order) which prohibit the application of group relief.
The following requirements also apply: • • • •
The surrendering company must have an adjusted loss in the basis period for the year of assessment (i.e. in the year in which the loss is to be claimed). The claimant company must have a defined aggregate income for the year of assess ment (of claim). The residual assets and residual profits test must be satisfied. Both companies must make an irrevocable election to surr ender or claim an amount of adjusted loss in the return (Form C) furnished for the year of asses sment (of claim).
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Question 5
What are the factors and steps you would consider in arriving at the losses in a group relief?
Answer
Any eligible company having an adjusted loss may be a surrendering company. Current year loss relief must be applied first. The amount of loss eligible for surrender is 50% of the adjusted loss for the basis period for the year of assessment, after it is reduced by any aggregate income of the company for that year of assessment. The capital allowances of the surrendering company are not taken into acco unt. •
The aggregate income of a claimant company is defined as t he aggregate income as reduced by all of the items which qualify for deduction under Section 44 when calculating total income, except for group relief itself.
•
These items are: – current year loss – qualifying prospecting expenditure – qualifying pre-operational business expenditure (approved overseas expenditure) – monetary and other gifts, such as approved donations.
•
Aggregate income is computed as follows: – aggregate of statutory business income from all sources, r educed by unabsorbed losses brought forward – aggregate of statutory income from all other sources – claw-back of qualifying prospecting expenditure.
Example of the steps in arriving at the defined aggregate income:
Aggregate income (say) Less: sec 44(1) deduction Current year loss Prospecting expenditure Pre-operating business expenditure Approved donations Defined aggregate income
RM 100,000 10,000 13,000 12,000 5,000
40,000 60,000
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TRANSFER PRICING
Question 1
What do you understand by transfer pricing? And why is this an issue for the revenue authorities of the relevant jurisdictions
Answer
Transfer pricing [TP] describes the pricing of goods and services between related part ies. The pricing here may not be affected by market forces as in arm’s length transactions. General aim of TP is tax avoidance. This is achieved by shifting profits from a high tax jurisdiction to a low tax jurisdiction. The capital exporting countries fear reduced repatriation of inco me to the home country The capital importing countries see a tax base ero sion and reduction of tax revenue
Question 2
What are the areas where transfer pricing could be an issue?
Answer
TP affects the following transactions: Purchase and sale of goods Provision of management and technical services Financial assistance Use of intangible assets • • • •
Example (1) Company A Sdn Bhd is a subsidiary of Company B Private Ltd, a company incorporated in India. Company A borrows RM100m from Company B in 2014 and paid the following sum as interest debited to the PL account. (a) Interest at 15% (b) Interest at 8% What is the outcome of these rates for the derivation of commercial profit, and the tax consequences to jurisdiction where Company A is situated?
Answer Loan
RM'000 100
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Commercial interest rate Charged to subsidiary Charged to subsidiary
10% 15% 8%
Net profit before interest charges Less: interest at 15%
300 15
Profit
285
Net profit before interest charges Less: interest at 8%
300 8
Profit
292
Revenue adjustments for transfer pricing Net profit before interest charges Less: Interest at market rate (10%)
300 10 290
(2)
Assuming Company A Sdn Bhd is a loss making company and is a high credit risk, would you accept the interest rate of 15% charged by the parent co mpany when the commercial rate is agreed as 10%? Discuss.
Question 3
What is ‘contemporaneous documents’ and why is this required and by whom?
Answer
In line with section 140A, if a business transaction on the supply or acquisition of goods or services is made between related parties the DGIR may make appropriate adjustments to reflect the market value. Market value is the value obtainable in dealing between independent parties dealing at ar m’s length The taxpayer must prepare ‘contemporaneous documents’ to reflect the transact ion made in a controlled transaction in respect of acquisition of goods and services including financial services. This should be made available to the Revenue authorities to indicate the basis of the pricing of the goods and services. It covers a wide range of documents, including the following:
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(a) Organization structure and persons involved (b) Nature of the industry and market conditions (c) The details of the transaction (d) Marketing strategy and pricing policies (e) Comparability, function and risk analysis (f) Application of the relevant transfer pricing (g) Other related and connected information This information and the related documentation must be regularly updated to reflect t he current state of affairs as regards the transactions. Contemporaneous documents are not required in the following cases: (a) Not carrying on a business (b) Financial assistance is below RM50m (c) Gross income is below RM25m (d) Related party transactions is below RM15m
Question 4
What are the Transfer Pricing methodologies generally used by the Revenue authorities?
Answer
For income tax adjustment purposes there is no one single method. The method accepted must be chosen very carefully and supported by relevant acceptable documents. Essentially the methods chosen should give the most appropriate arm’s length price. There should be minimal adjustments required. It should be reliable to use to make the re levant adjustments. One needs to see the commercial reality of the transaction and examine whether in adopting the particular pricing and charges, the taxpayer has r esorted to transfer pricing with the intention to avoid tax in the relevant jurisdiction. The generally accepted methods are as follows: •
Traditional transaction method Comparable uncontrolled price Resale price Cost plus Transactional profit method Profit split Transactional net profit – – –
•
– –
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Question 5
In considering a transfer pricing issue, and with a view t o making a comparison, what are the factors that a taxpayer or a revenue authority should look at?
Answer
In the real world business transactions are not conducted in a uniform environment. Each company faces a different situation and prices are determined according to those particular circumstances and the business strategy adopted. For example, a new company that is entering the market may be willing to accept a loss in the sale of its goods or services for t he first three years in order to penetrate the market and gain market acceptance. The pricing may therefore be lower than its competitors. Generally the following factors are accept ed as important: (a) (b) (c) (d) (e) (f) (g) (h) (i)
Character of the goods and services Functions performed Assets used in the course of the operations Financing issues e.g. loans, interest and discounts Cost sharing e.g. advertising Risk assumed by the relevant parties Contract terms and conditions between the parties Business strategies adopted by the relevant entity (e.g. new company, old company, new market, expanding market etc.) Economic situations like recession or slow growth.
Question 6
Explain the CUP method in relation to transfer pricing.
Answer
The ‘CUP’ method makes a direct comparison of the price between a co ntrolled and an uncontrolled transaction. And adjustments are made for significant differences as in quest ion (5) above
Question 7
Alpha Sdn Bhd is a Malaysian company that manufactures tablets for the relief of headaches. These are sold for RM100 per pack of 50 tablets exclusively to an overseas company Beta Corporation in China which is a subsidiary of Alpha Sdn Bhd. Both companies are owned by India Pharmaceuticals Corporation Private Limited, a company incorporated in India.
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A similar product is sold by its competitor, Pfizer of t he United States to its subsidiary in China, Pfizer of China. The product is sold for the equivalent of RM130 per pack of 40 tablets. Both companies, Pfizer (US) and Pfizer (China) are o wned by The Pfizer of Switzerland. Question
(a) What is the issue that you would consider in this scenario? (b) Would you apply section 140 or a transfer pricing methodology in this case? (c) What are the factors that you would consider in determining whether the prices charged by the Malaysian company is a value reflective of the market price? (d) What are the documents that should be kept by the Malaysian company to support its pricing of the product? (e) What is the penalty for failure to keep or keep insufficient documents are required by the revenue authorities?
Answer
(a) A medication for the relief of headache is marketed by two different companies in China and the prices are different. The Malaysian revenue authorities may want to know why there is a pricing difference, and whether such difference is o n account of market forces or a shifting of profits i.e. a transfer pricing issue. (b) Section 140 is a specific law governing basically a nti-avoidance issues [i.e. the taxpayer has intentionally avoided or evaded tax in a particular circumstances] and is not transfer pricing issues. The onus is on the revenue to prove that there was an avoidance or evasion. There are 4 circumstances under which the Revenue may invoke Section 140(1) to disregard or vary a transaction. In other words, the Revenue must prove that they have reason to believe that the transaction had the direct or indirect effect o f altering the incidence of tax, relieving the company from any tax liability, evading or avoiding any liability, or hindering or preventing the operation of ITA. The application of section 140 or the transfer pricing methodology would depend on the particular facts of the case identified at the ground level. In real life this can be tedious and complicated requiring several verifiable information. (c) One could look at the following features carefully (t hese are a mix of business, commercial and technical nature) and could be discussed in deta il in the class. But generally one could consider the following matters: a. The particular product features (e.g. the packaging, dosage and effectiveness, plain compressed tablet or effervescent tablet) b. The brand name (established, new, market acceptance of t he brand) c. Sales volume (large, fast moving cf low and slow moving) d. Market risk assumed by the parties to the transaction e. The timing of the sale (winter season vs summer) f. Transaction mode (cash on delivery, credit terms, returns of unsold stock) g. Transportation (CIF or FOB etc.) h. Condition of sale (terms, conditions, liability for breach of terms) i. Intangible property issues (ownership of property, R&D cost, royalty charges)
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(d) The taxpayer should keep contemporaneous documents that identifies a nd address the following : a. Organization structure and persons involved b. Nature of the industry and market conditions c. The details of the transaction d. Marketing strategy and pricing policies e. Comparability, function and risk analysis f. Application of the relevant transfer pricing g. Other related and connected information h. Updates of these documents in line with changed circumstances (e) Penalties are imposed under section 113(2) as follows: (i) Documentation not available : 35% (ii) Documentation not conforming to revenue requirements: 25%
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TAX PLANNING
Question 1
What do you understand by ‘Tax Planning’? Answer
Tax planning is a combination of fiscal steps taken to eliminate, minimize or defer the tax liability of tax entity. These are done within the limits of the e xisting tax laws, rules and regulations. Sufficient tax competency and vast experience is required to do these planning that demand a skillful management of competing alternatives to achieve t he optimum financial effect. There is also a considerable risk of interpret ations going wrong or worse viewed by the revenue authorities as ‘avoidance or evasion’ with very serious consequences. Question 2
What are the factors to consider in relation to the mode of finance, the acquisition of assets to be used in the business? Answer
Financing has effect on the company’s cash flow and tax liability. In the acquisition of business assets companies need to consider the following modes:
Acquire for cash Loan and overdraft Hire purchase Leasing
Qualifying capital expenditure on plant and machinery and industrial building would be given an allowance that can be set off against the adjusted income. Allowances can be computed based on:
The Income Tax (Qualifying plant annual allowance) Rules 2000. Accelerated capital allowance rules. Reinvestment allowance rules (where expenditure is incurred after t he commencement of the business).
How the acquisition of the assets is financed would have an effect o n the tax liability. The manner of financing need to be considered carefully in the co ntext of the business performance i.e. whether the business is making a loss or a profit. A cash payment for the acquisition of an asset qualifying for capital allowance would allow the taxpayer to claim capital allowance on the full cost, reducing the adjusted income. However this may affect the cash flow for operational purposes.
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Acquiring the asset that qualifies for capital allowances vide a bank loan would ease any cash flow problems while entitling the taxpayer to claim a full allowance o n the asset so acquired. Bank loan interest paid would also be a deductible expenditure reducing the adjusted income accordingly. But obtaining a loan requires one to consider other issues like an acceptable co llateral or security as well as personal guarantee for the loan from the bank. Other cost would include legal fees, commissions, stamp duty etc. Repayment of such loans may not be flexible and might result in bank foreclosing the business in difficult t imes when the entity is unable to service or pay the loans in time and fall into arrears. Acquiring a qualifying asset under a hire purchase would limit t he claim of capital allowance to the amount paid under the hire purchase arrangement. But an added advantage is the hire purchase interest would be a deductible expense in arriving at the business adjusted income. Also, motor vehicle not used for commercial purposes (e.g. a car for the use of the director) would suffer a qualifying capital expenditure restriction, limiting the full benefit of the capita l expenditure for business purposes. Acquiring a qualifying asset under a lease arra ngement would be similar to renting the asset where the full lease or rental payments would be an allowable expenditure in arriving at the business adjusted income. The drawback is the asset would not belong to the taxpayer at the end of the lease term unlike the hire purchase arrangement where the asset wo uld be transferred from the vendor to the acquirer and can co ntinued to be used in the business maximizing the investment on the asset. Where assets are acquired from related parties one needs to consider the rent or lease payments made in the context of arm’s length values – i.e. it must reflect the market value for such payment and arrangements. One could be claiming accelerated capital allowance where this is available. Sometimes special rates may be prescribed for certain plant and machineries. These may also have a t ime frame within which it is available. Thus timing of the expenditure becomes equally critical. On the same note, the special rates are usually applicable to special industries and at specific times based on sectors that the government desires to promote. Tax advisors and tax planners must have an updated knowledge of the availabilit y of these incentives and allowances in order to maximize capital allowance claims, and the tax benefit, for the client.
Question 3
If a business choose to dispose of an asset what are the factors that one should be aware of in relation to the income tax law and what are its impact on the income tax liability of a taxable entity?
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Answer
Since the law provides for an allowance on the qualifying expenditure incurred on plant and machinery and industrial buildings that are used in the carr ying on of a business, the revenue is concerned that the facility should not be abused to gain an undue t ax advantage from its disposal. Some issues that should be considered could arise from a disposal within a per iod of two years from the date of acquisition and disposal within a context o f a controlled situation. These elaborated below: Disposal within two years: (a) The allowance previously given would be withdrawn - the effect being the adjusted income would be increased by the amount of the allowance withdrawn (it is equal to the allowance previously given) – or alternatively a loss may be reduced by an equal amount. (b) The Director General may exercise discretion in certain situations – and these are situations where there is commercial just ification or a business need. Example: a mini being sold within two years to buy a larger capacity lorry because business turnover has exceeded expectation.
Disposal after two years Factors that will impact the tax liability would be a combination of the following factors: (a) (b) (c) (d)
Residual expenditure Disposal price Balancing allowance Balancing charge
A balancing charge would increase the statutory income while a balancing allowance would reduce it. Depending on the profit or loss situation of the business, one could time the disposal of the asset to take maximum advantage from the balancing charge or allowance. Also disposal of assets to related parties would have to take into account the market value of the asset disposed. Balancing allowance or balancing charge would not be applicable to the disposer in the case of a related party disposal of an asset on which capital allowances have been claimed. The acquirer on the other hand would not be entitled to an initial allowance but only an annual allowance for the balance of the res idual value of the asset acquired.
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Question 4
Would a disposal to a related company or a disposal at a price not reflecting the market value has any impact for income tax purposes? Answer
As noted above, controlled provisions of the law apply to the disposal - assets are deemed to be disposed at the tax residual value. As such, no balancing charge or balancing allowance arises on the disposal to the disposer. The acquirer would be entitled to an annual allowance for the balance of the res idual expenditure. He would not be granted an initial allowance. This rule applies e ven to assets sold or transferred to a related non-resident company.
Question 5
Discuss the importance of distinguishing between a business income and an investment income.
Answer
For income tax purposes it is without doubt very important to distinguish between business income and investment income because of the entirely different tax treatment. Parking the category of income as between business income as opposed to non-business income the essential issue is whether to treat the gains received from a transaction as one arising from a business transaction or from a capital transaction. In one case it would be liable to income tax whereas in the other it would a capital and therefore not liable to income tax. Whether it falls into one or the other category needs to be carefully considered before the transaction could be done. In the case of a loss arising from a transaction, one needs to consider the following factors as regards the losses: BUSINESS •
Treatment of sources A business source is given several flexible treatments. A business can have a loss when the expenses exceed the gross income. This loss can t hen be set off in several ways against the business income and even non-business income. This may not apply in the case of a non-business source such as interest and dividend. Any losses arising from such non-business source is lost and are not available t o provide any tax shelter.
•
Business losses, current year losses and b/f losses
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A basic attractive attract ive feature of a business loss is that t hat a current year loss can be allowed a llowed all other sources of income. Any brought brought forward losses can be allowed against all business sources; and any balance of losses losses remaining can be carried forward to be deducted against the business income of the following year until such losses are fully absorbed. The losses are not distinguished by sources for deduction purposes.
•
Groups loss relief under certain conditions In certain situations, a company can claim a group re lief for losses – losses – in in this instance the loss is allowed against the income of another taxable entity. For this several conditions must be fulfilled as required under section 44A.
•
Capital allowance deductions In the case of a business, capital allowances are allowed for assets used in the business and these are deducted against the particular source of business business income. Unabsorbed capital allowances may be carried forward to be deducted against the same source of business income.
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•
Deductibility of expenses against t he income The scope is much wider in the case of a business source as compared to a non business source.
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INVESTMENT
•
Single and separate source Income falling under a non-business category is treated as separate sources and this could be limiting the scope of deduction and therefore the total tax liability.
•
Excess of expenditure and loss loss deductibility deductibility Losses would be ignored and therefore not available to shelter fro m tax other sources of income or against future tax liability. The losses may be then lost.
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Question 6
What is the income tax effect of the interest payment on a loan taken to finance business operations while an excess is temporarily t emporarily invested to produce a short term return?
Answer
Interest payments would be subject subject to a restriction restr iction depending on the fund fund usage – usage – and tax planning would would involve maximizing the deduction deduction or reducing the restriction . The money borrowed and used wholly wholly in the business operations would would be fully allowed. If the money is borrowed and used wholly wholly for investment purposes would would be fully disallowed. But where money is borrowed and used partly for the business purposes and partly for non-business purposes would be be subject to some interest restriction. The restriction is computed co mputed using the formula: [Investment/Borrowings] x interest charges charges = interest interest disallowed disallowed However the restricted interest which is disallowed in arriving at the adjusted income of the business would be now now available for deduction against the income income derived from the particular investment. Example: A commercial property is financed financed with a loan. The interest would be be allowed against the rental income . However if the property does not produce income, the interest cannot be used. Similarly if the interest exceeds the gross rental income, the excess would wo uld be lost.
Question 7
If a holding company provides management services to its related company, what are the factors that it should take into account acco unt to obtain the fullest benefit under the tax law for itself and for its related companies?
Answer
In providing management management fees between companies in the group, several factors need to be considered in these inter inter group transactions. One important element element is that the transactions must be at arm’s length and reflect market value for the consideration. consideration. The The charges for for work done or fees fees received should also reflect market value. value. In other words, the charges or fees fees must have a commercial basis and not an insert or padding in a series of transactions designed to reduce tax liability on the relate d parties.
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Question 8
Upon cessation of a business what are the factors that one needs to consider in relation to the outstanding debtors and stocks of the company ceasing business?
Answer
Transfer of stocks between companies in the group should essentially bear in mind that whatever transacted value should reflect the market value for the stocks. Where for example it is sold for a value less than the market value, sufficient documentation must be produced to substantiate the lower value (e.g. out of o f date items, deteriorated stocks, damaged or spoiled stocks, slow moving stocks etc.). Example Supermarkets may sell items close to the t he expiry date at 50% discount. Fruits and vegetables that are showing signs of decay could be disposed of at below normal price.
Question 9
A business group structure consists of Gabong Sdn Bhd which is the holding company with two wholly-owned subsidiaries. The three companies close the accounts to 30 December and have been in operation for many years. Gabong Sdn Bhd Bhd operates several retail ret ail stores for groceries. Gabong Manis Sdn Bhd is involved involved in the distribution of a branded health health drink which is popular among among university students. Gabong Lena Sdn Bhd operates a three star hotel in Cyberjaya. The group plans to expand and later become a public listed company. In achieving this goal, the expansion expansion exercise would require RM500 million million additional capital. The Board of Directors (BOD) plan to incorporate a new company, Gabong Baru Sdn Bhd that will bring under its fold the existing three companies. The new company will be listed in the Malaysia stock exchange later. Gabung Baru’s income will be mainly derived from its investments in the three subsidiaries and the provision of management services to them. t hem. The BOD also plans to open more retail stores and add in additional products for its retailing network. The existing outlets will be renovated and refitted with electrical fittings, plant and machinery and coolers.
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The hotel business would acquire additional buildings near airports and convert and refurbish these into a BBM (self-serviced bed and breakfast motel) to cater for budget travelers taking the low fare flights. The BOD is considering the following funding options: (a) Option 1: additional capital requirement for the expansion would be met by way of a loan from a commercial bank by each of the company (b) Option 2: the funds could be provided by way of loan from the directors of the company or (c) Option 3: by the issue of additional shares to existing shareholders if obtaining sufficient financial support from the bank is difficult or insufficient. To acquire the fixed asset, plant and machinery and building for the proposed expansion, the BOD is considering the following financing mode: (a) (b) (c) (d)
an operating lease a finance lease a hire purchase; or outright cash purchase
The BOD is not clear as to t he income tax implication of these matters such as the availability of deductions for leases payments, capital allowance claims and maintenance cost deductions, as well as the conditions that must be complied with to afford these deductions for income tax purposes for each of the businesses. The company’s lawyer has informed the BOD that the newly incorporated company will be initially an unlisted investment holding company. And after three years, it could be listed in the stock exchange and be a listed investment holding company. The wants the lawyer to clarify the difference between a listed and unlisted holding company, and the tax implications. The BOD wants a report on the recommended steps to be taken, and why such steps as recommended would be advantageous over competing alternatives. The present and proposed company structures are as follows: Fig 1 Existing company structure
Gabong Sdn Bhd
Gabong Manis Sdn Bhd
Gabong Lena Sdn Bhd 107
Fig 2 Proposed company structure
Gabong Baru Sdn Bhd
Gabong Sdn Bhd
Gabong Manis Sdn Bhd
Gabong Lena Sdn Bhd
Required:
Based on the information supplied, consider the relevant issues in relat ion to the Income Tax Act 1967 (as amended) and advise the company accordingly.
Answer
The issues to consider are the following: 1. 2. 3. 4.
Raising of capital Associated cost related to the raising of the capital Mode of financing the acquisition of capital assets for t he business Explaining to the BOD the difference between an investment holding company and a listed investment holding company
Raising of capital Based on the BOD there are t hree avenues: (a) Borrow from a commercial bank (b) Borrow from the directors (c) Borrow from the shareholders
Associated cost related to the raising of capital One needs to consider the cost of the borrowing where the fo llowing expenses would be incurred: (a) Legal fees to draw up the loan and charge documents (b) Professional fees e.g. accounting and secretarial fees to prepare the applications (c) Cost of valuations of properties to be charged to the bank
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(d) Stamp duty on the instrument of agreement, conveyance and charge or lien etc. (e) Miscellaneous and incidental expenses connected with these activities As all these cost are connected with the obtaining of a loan, it will not qualify for a tax deduction. These are capital cost of raising capital
Implication and consequences of borrowing from the three different sources of fund: (a) Borrow from a commercial bank (b) Borrow from the directors (c) Borrow from the shareholders
(a)
Borrow from a commercial bank The loan from the bank is used for the purposes of the business (and not investment) and would qualify for a tax deduction. This will reduce the adjusted income by the amount of the loan. The interest charges on the loan would usually vary with market rates and central bank directives. This may add or reduce the cost of the funds. And eventually affect the cash flow, and the deduction available for tax purposes in arr iving at the adjusted income. Borrowing from the bank would also require having sufficient collateral to secure t he loan and guarantors to guarantee the loan. Fees may be involved in securing these.
(b)
Borrow from the directors The amount of the borrowing and the interest rate charges on the borrowing could be determined by the BOD. But the interest charge must be at arm's length and reflect the market rate. Excessive charge would be disallowed for income tax purposes. As the interest is an expense to the company and deductible in arriving at the adjusted income, the sum would be an income in the hands of the directors, and accordingly, would be taxable in their hands.
(c)
Borrowing from shareholders Same rules as in the borrowing from the directors also apply to borrowing from the shareholders. If additional shares are issued to t he shareholders to obtain the additional funds, the cost of issuing the additional shares would be capital expenditure, and are not deductible in arriving at the company’s adjusted income.
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The dividends earned on these acquisitions of the shares would be income to t he shareholders. As these would be single tier dividends, these would not be taxable in the hands of the shareholders. Also, as dividends are distribution of income of the company after it has been earned, it is not an expense and not deductible in arriving at t he adjusted income (in other words these are not expenditure incurred in the course of carr ying on a business to earn profits).
Mode of financing the acquisition of capital assets for t he business The following are alternative mode of acquisition of t he assets: (a) Operating leases (b) Finance lease (c) Hire purchase (d) Cash purchase. The BOD could be advised as follows on the income tax implication of the different mode of financing the purchase of the company assets: (a) Operating leases In an operating lease the asset is legally owned and maintained by the lessor and is let to the lessee only for its use. The lease charges a similar to a rental payment and may not be flexible. For income tax purposes, the lease charges would be fully tax deductible. The lessee cannot claim any capital allowance. And as there is no maintenance charges a deduction for these do not arise.
(b) Finance lease In an operating lease the asset is legally owned but not maintained by the lessor. It is let to the lessee for its use. The lease charges are similar to a rental payment and are fully deductible in arriving at the adjusted income. Similarly t he maintenance charges incurred by the lessee would be also fully deductible. Any excess payment exceeding the gross income would create a loss that can be allowed against other sources of income or business sources in the following year of assessment . But in the case of a finance lease, the terms of the payment can be negotiated, and is therefore flexible and this is an added advantage for cash flow purposes. However the arrangement could be scrutinized by the revenue authorities – the impact of any disallowance being more for the lessor than the lessee.
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(c) Hire purchase In a hire purchase arrangement, the repayment has two parts – a capital payment for the asset acquired and an interest element being the use of funds. Upon completion of the payment schedules, the asset would be legally owned by the purchaser. The interest element is fully deductible in arr iving at the adjusted income. The capital portion paid would qualify for capital allowance – both initial and annual. The annual allowance is computed on the accumulated capital instalments paid. The capital allowance claim will be spread over the period of the installment payment and as such could be longer than if the asset had been bought for cash or with a loan.
(d) Cash purchase. If the asset is purchased for cash the full qualifying expenditure would be given an initial allowance in the first year and annual allowance thereafter until the asset’s residual value is zero. However the purchase of any private motor vehicle would suffer a qualifying capital expenditure restriction – and this applies even for other modes of acquisition of the said asset (e.g. loan, lease or hire purchase). Difference between an investment holding company and a listed investment holding company Very briefly, the summarized difference could be illustrated as follows:
Nature of the matter
Unlisted investment holding company
Income
Business income (e.g. management fees) and non-investment income (e.g. commission or fees) would be treated as ‘Other income’ Rental, interest and dividend would be treated as investment income according to the relevant classification
Direct expenses
Listed investment holding company
Business income (e.g. management fees) would be treated as ‘Business income’ Investment income such as rental, interest and dividend would also be treated as ‘deemed business’ income and all will form only one business source Non-business and non-investment (e.g. rent = sec 4(d) income; income (e.g. fees and commission) dividend and interest = sec 4c would be ‘Other income’ income) Each of these would be a separate source Expenses incurred in producing the Expenses incurred in producing the income are deductible income are deductible It is limited to the gross income It is limited to the gross income
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