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MICPA-ICAA EXAMINATION

TERM 2, 2013 (MAIN EXAMINATION)

Questions and Unofficial Suggested Answers and Examiners’ Report

ADVANCED STAGE EXAMINATION

TAXATION

Published by MICPA

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This booklet contains the questions, unofficial suggested answers for TAXATION of ADVANCED STAGE EXAMINATION for the Term 2, 2013 examination session. The unofficial suggested answers were prepared by The Malaysian Institute of Certified Public Accountants (MICPA). While every care has been taken to anticipate and satisfy the examiners’ requirements in the preparation of the suggested answers, these should not be regarded as the only solutions. Some of the answers set out are considerably more substantial than even the best candidate could achieve in the time available in an examination. It is felt, however, that longer, more detailed answers can be of great help for study purposes and that shorter answers would not always be as helpful.

ALL RIGHTS RESERVED : NO PART OF THIS PUBLICATION MAY BE TRANSMITTED IN ANY FORM OR BY ANY MEANS, ELECTRONIC, MECHANICAL PHOTOCOPYING, RECORDING OR OTHERWISE, WITHOUT THE PRIOR PERMISSION OF MICPA.

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THE MALAYSIAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS (INSTITUT AKAUNTAN AWAM BERTAULIAH MALAYSIA)

TERM 2, 2013

TAXATION

Main Examination

1. Time allowed: 3 hours (plus 15 minutes reading time) 2. This open-book examination consists of FOUR questions totalling 80 marks. 3. This paper contains 11 printed pages (including this page). 4. Answer ALL questions. 5. Any reference to "the Act" means the Income Tax Act, 1967 (as amended). 6. Workings that support the answer should be submitted with your answer.

© 2013 The Malaysian Institute of Certified Public Accountants The Malaysian Institute of Certified Public Accountants is the owner of the copyright for the material. The contents may not be reproduced or copied in whole or in part, in any form or by any means, without the prior written consent of the Institute

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Question 1 Watchout Sdn Bhd (Watchout), a Malaysian tax resident company, is engaged in the business of manufacturing and selling of watches, clocks and related accessories. It carries on the manufacturing activities in a factory located in Ipoh since 2001. Watchout owns the “Thime” brand name, which is registered in Malaysia and overseas. During the year ended December 31, 2011, Watchout embarked on a 3-year expansion programme with the view to increasing its production of watches, clocks and related accessories. Watchout prepares its accounts to December 31 annually, and the paid-up ordinary share capital of Watchout as at January 1, 2012 is RM5,000,000. Watchout’s Statement of Comprehensive Income for the year ended December 31, 2012 is as follows: Note RM’000 RM’000

Revenue 10,000 Less: Cost of sales 1 (6,000) ------------- Gross profit 4,000 Other operating income 2 300 Less: Administration expenses

Bank charges 3 130 Legal and professional fees 4 140 Repair and maintenance expenses 5 120 Salaries, bonuses and allowances 6 300 Utilities 70 Depreciation of property, plant and machinery 40 --------- 800

--------- Less: Selling and distribution expenses Advertising and promotion expenses 7 350 Bad and doubtful debts 8 100 Freight and insurance expenses 9 150 Salaries, bonuses and allowances 6 800 Travelling and entertainment expenses 10 200 Depreciation of property, plant and machinery 60 --------- 1,660

-------- (2,460) ----------

Profit from operations 1,840 Less: Finance cost 11 (1,000)

---------- Profit before taxation 840 ======

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Notes 1. Cost of sales includes: RM’000

Allowance for inventory obsolescence 380 Depreciation of property, plant and equipment 1,500 Inventories written off 30 Purchase of raw materials 3,500

2. Other operating income comprises the following: RM’000 Gain on disposal of investment in unit trusts held for long term investment 170 Gain on change in fair value of investments 45 Insurance claim received for plant and machinery destroyed during a fire 70 Profit from deposit with an Islamic bank in Kuala Lumpur 15 ___ 300 ===

3. Bank charges comprise the following: RM’000

Commission for outstation cheques 80 Stamp duty for cheque books 50 ______

130 ======

4. Legal and professional fees include: RM’000

Payment to a legal firm for the registration of trademarks in Malaysia 20

Payment to company secretary for corporate secretarial work 12 Payment to a financial advisor in relation to the acquisition of shares in a watch manufacturing company in China 100

5. Repair and maintenance expenses include: RM’000

Office cleaning expenses 60 Purchase of machinery 50

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6. Salaries, bonuses and allowances include: RM’000

Salaries 850 Bonus expenses (see note 12) 180 Allowances paid to marketing manager to defray expenses incurred

to entertain customers 24

7. Advertising and promotion expenses include: RM’000

Expenses for the provision of an internship programme approved by

Talent Corporation Malaysia Bhd (for 2 interns) 15 Expenses on participating in the International Trade Fair 2012

held in Malaysia (the trade fair is approved by the Ministry of International Trade and Industry) 50

Expenses for the registration of trademark in China 20 Cash contribution for the annual dinner of its holding company 18 Donation of 10 bicycles to 5 primary schools 4

8. Bad and doubtful debts include:

RM’000

Allowance for doubtful debts (general provision) 70 Bad debts written off 30 Recovery of bad debts (for which tax deduction was claimed

in the past when the bad debts were written off) (15)

9. Freight and insurance expenses include: RM’000 Freight charges incurred to ship finished goods to China 90 Insurance premium paid to a Malaysian export credit insurance company 40 10. Travelling and entertainment expenses include: RM’000

Expenses incurred on travelling to China for a proposed acquisition of shares in a watch manufacturing company 45 Expenses incurred on travelling to Thailand to purchase raw materials 30 Expenses incurred to entertain existing customers 50 Incentive trip to sales agents for achieving sales target 60 Expenses incurred by sales director for a 8-day trip to conclude a contract with a customer from China: - subsistence 1 - accommodation 2 - air fare (business class) 10

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11. Finance cost includes: RM’000

Interest expense on letter of credit and trust receipts 250 Interest expense on money borrowed to purchase shares in a

watch manufacturing company in China 400 Foreign exchange loss on payment for the purchase of

shares in the company in China 300

12. Other information (a) The following is the bonus expense account: RM’000 RM’000 Balance brought forward 200 Add: Bonus expenses during the year - accrual for contractual bonus 80 - provision for bonus __100__ ____ 180 Less: Payment for provision made in previous year (160) ______ Balance carried forward 220) ====== (b) Watchout is a wholly-owned subsidiary of Watchful Sdn Bhd. Watchful Sdn Bhd

has current year business losses of RM200,000 and it is unable to utilise the losses during the year 2012 due to inadequacy of aggregate income. The paid-up ordinary share capital of Watchful Sdn Bhd as at January 1, 2012 is RM5,000,000.

(c) The qualifying expenditure and tax written down value of the plant and machinery owned by Watchout as at January 1, 2012 are RM8 million and RM3 million respectively.

During the year, plant and machinery (qualifying expenditure as at July 1, 2007

of RM1,000,000) was destroyed in a fire.

(d) Fixed asset additions during the year: RM’000

(i) Plant and machinery for an additional production line 2,000 (ii) Computer equipment (used in the administration office) 100

(e) The annual allowance rate to be applied is 14% for all assets

Required: Compute the chargeable income of Watchout Sdn Bhd for the year of assessment 2012, showing all relevant tax adjustments including the capital allowance calculations. You are to consider all available incentives and reliefs applicable in your computation. (20 marks)

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Question 2 (a) Great Builders Sdn Bhd (GBSB) was awarded a contract for the construction of a 10

kilometer underground tunnel for the State Government of Terengganu for a sum of RM100 million in 2005. In the same year, GBSB in turn sub-contracted the construction of a portion of the tunnel on a turnkey basis to FB Contractors Sdn Bhd (FBC) for RM60 million to be completed within 5 years from the date of the contract.

In 2007, GBSB terminated the services of FBC on the basis that FBC did not abide by the terms of the contract. FBC took legal action against GBSB for wrongful termination. GBSB incurred RM50 million to finish the work not completed by FBC. GBSB reflected this cost as an amount recoverable from FBC in its balance sheet and sought to recover this cost from FBC. An arbitration between GBSB and FBC resulted in GBSB having to pay the RM60 million together with interest to FBC. At the same time, the arbitrator decided that GBSB is entitled to recover RM30 million from FBC. GBSB appealed to the High Court against the arbitrator’s decision. Pending the decision of the High Court, GBSB has yet to pay the RM60 million to FBC.

Required:

State your arguments for and against the deductibility of the RM60 million payable by Great Builders Sdn Bhd to FB Contractors Sdn Bhd arising from the arbitrator’s decision and the RM20 million on the net costs incurred by Great Builders Sdn Bhd to finish the tunneling work not completed by FB Contractors Sdn Bhd.

(4 marks) (b) Superior Properties Sdn Bhd (SPSB) carries on a mixed development project in Batu

Pahat, Johor. It submitted a master plan to the State Government which showed that a designated piece of land was for the construction of a petrol station for lease. This piece of land, together with the other parcels being developed, was reflected in the accounts of SPSB as “Property development expenditure” although it was intended to be leased out for construction of a petrol station and not for sale. SPSB entered into an agreement with a petrol station operator to lease this piece of land for 20 years and derived income from the lease of the land. The land was not reclassified to “Property, plant and equipment” in its accounts upon leasing it to the petrol station operator.

Required:

State your arguments for and against the applicability of Section 24(2) of the Act (relating to withdrawal of stock-in-trade) in respect of the lease of the land to the petrol station operator.

(4 marks)

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(c) Solar Industries Sdn Bhd (SISB) currently assembles solar panels at its rented factory in Penang using components imported from its parent company, Solar Inc, a company incorporated in the United States, for the export market. Due to increasing demand for its products, SISB intends to manufacture the solar panels in Malaysia with components sourced locally. SISB was informed by the Malaysian Investment Development Authority (MIDA) that the solar panels are a promoted product qualifying for pioneer status or investment tax allowance (ITA) for a period of 5 years. As the tax adviser, you have been asked whether SISB should apply for pioneer status or ITA with the financial projections given as follows:

Year 1 Year 2 Year 3 Year 4 Year 5 RM’000 RM’000 RM’000 RM’000 RM’000

Land 5,000 - - - - Factory 15,000 - - - - Plant & machinery 5,000 20,000 50,000 - - Adjusted income/ (loss) (10,000) 15,000 30,000 35,000 40,000

Assume the annual allowance rates for factory and plant and machinery for computing capital allowances are 3% and 14% respectively.

Required:

Assuming that Solar Industries Sdn Bhd will commence manufacturing operations in Year 1 upon the completion of construction of the factory and installation of plant and machinery, advise Solar Industries Sdn Bhd on the appropriate tax incentive that should be applied under the Promotion of Investments Act 1986 showing computations to support your answer.

(12 marks) (Total 20 marks)

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Question 3 (a) Peace Insurance Malaysia Berhad (PIM) is a Malaysian resident general insurance

company. The following information has been extracted from PIM’s accounts for the year ended December 31, 2012:

Other information: Marine

aviation & transit policies RM’000)

Fire, motor &

other policies RM’000

(i) Premiums Gross premium income 6,000 9,000 Reinsurance premiums paid/payable in Malaysia 1,250 500 Reinsurance premiums paid/payable outside Malaysia 750 50

(ii) Reserve for unexpired risks as at December 31, 2012 as determined by the relevant authority regulating the insurance industry

1,000

400

(iii) Reserve for unexpired risks as at December 31, 2011 for tax purposes was RM2,000,000.

(iv) Gross dividend income comprises: RM’000

Franked dividends 1,100 Exempt dividends 1,000 Foreign dividends 1,500

3,600

(v) Capital allowances for the year of assessment 2012 amounted to RM350,000.

Required

Compute the tax payable by Peace Insurance Malaysia Berhad for the year of assessment 2012.

(7 marks)

RM’000) Gross premiums 15,000 Gross dividend income 3,600 Interest income 335 Rental income 240 Gross proceeds from sale of shares 4,000 Net claims incurred 3,000 Commissions 900 Management expenses (assume fully deductible) 1,600 Cost of shares sold 2,100 Reserve for unexpired risks as at December 31, 2012 2,800

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(b) J Development Sdn Bhd, a property developer, has a three-phased development project in Ampang. Phase 1 was completed during the basis period for year of assessment (YA) 2012 with a net profit of RM5 million while phases 2 and 3 commenced development in YA 2012. The details of the three phases are set out below:

Phase 1

Double storey terrace houses

RM’000

Phase 2 Double storey

bungalows RM’000

Phase 3

Condominium RM’000

Estimated sale value - 20,000 30,000

Progress payments received and receivable

-

10,000

10,000

Estimated project cost - 18,000 35,000

Actual profit 5,000 - -

Profit taxed in previous year of assessments

2,000

-

-

Allowable operating expenses incurred during the year of assessment 2012 was RM500,000.

Required

Compute the adjusted income of J Development Sdn Bhd for the year of assessment 2012.

(5 marks) (c) James Cheah (James) inherited a piece of land from his father, Sam Cheah (Sam),

upon his father’s death on February 1, 2009. The land originally purchased by Sam for RM80,000 on April 1, 1970, was transferred by the executors of the Estate of Sam Cheah to James on March 1, 2010. The market value of the land as at February 1, 2009 and March 1, 2010 were RM3 million and RM3.2 million respectively.

On December 1, 2011, James transferred the land to Ace Sdn Bhd (Ace), a company whose shares were wholly owned by James and his wife, for a consideration of RM5 million. The consideration was satisfied by cash of RM1 million and 4 million shares of RM1 each in Ace. The land was acquired by Ace as a long term investment. James sold 2,000,000 shares in Ace on September 30, 2012 for RM5 million. On December 15, 2012, Ace transferred the land to trading stock at market value of RM5.5 million. Required (i) Compute the real property gains tax (RPGT) payable by:

(aa) the executors on the transfer of land to James Cheah (1 mark) (bb) James Cheah on the transfer of land to Ace Sdn Bhd (1 mark) (cc) James Cheah on the sale of shares in Ace Sdn Bhd (3½ marks)

(ii) State the tax implication to Ace Sdn Bhd on the transfer of the land to trading

stock, and compute the RPGT liability (if any). (2½ marks)

(Total: 20 marks)

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Question 4 (a) The group structure of AB Holding Sdn Bhd is as follows:

ABH is an investment holding company. ABH borrowed RM45 million from a bank to finance its investment in and to make advances to ABP and ABF as follows:

Share investment in/

Advances to Annual bank interest

payable by ABH RM’000

RM’000

Share investment in ABP 15,000 750

Share investment in ABF 10,000 1,000

Advances to ABF (interest free) 20,000 500

Total 45,000 2,250

ABP, a cash rich company with RM30 million in its bank account, has been the most profitable company within the group, operating a highly profitable palm oil plantation business in Sabah since 2005. It makes annual profits of between RM3 million and RM5 million and has been paying taxable dividends to ABH. ABP has exhausted its Section 108 credit balance and has moved into the single tier system. ABH will be receiving single tier dividends from ABP effective 2013. ABF is engaged in the business of fertilizer trading. It has been incurring losses for the past five years with unabsorbed losses brought forward of RM20 million. ABF is unlikely to turn around in the next three years.

ABL is involved in the business of breeder poultry farm and has been making profits of about RM500,000 annually from the export sales of chicken meat. ABC is 69.5% owned by ABL and the balance of the shareholding is held by an individual not related to the group. ABC is in the business of chicken feeds trading and it forecasts yearly losses of RM100,000 in the next few years due to the rising cost of maize and soybean meal.

AB Holding Sdn Bhd (ABH)

AB Plantation Sdn Bhd (ABP)

AB Livestocks Sdn Bhd (ABL)

AB Fertiliser Sdn Bhd (ABF)

100% 100% 100%

AB ChicFeed Sdn Bhd (ABC)

69.5%

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ABH intends to embark on a new business of trading crude palm oil (CPO) which is likely to be profitable. About 75% of the purchases would be sourced locally and 25% of the sales would be made to overseas customers. Transactions with foreign entities would be denominated in foreign currencies.

ABH also plans to undertake aquaculture business which has an investment cost of RM10 million. ABH understands that such an activity may qualify for two types of tax incentives. Firstly, the income derived from this activity may be tax exempt and secondly, the cost of investment may qualify for a tax deduction. The group has a policy which allows a new company to be set up to undertake a new business where necessary or an existing company may be used to carry out a new business.

All subsidiaries have a paid-up ordinary share capital of more than RM2.5 million except for ABC which has a paid-up ordinary share capital of RM2 million.

Required:

(i) State, with reasons, how the shareholding structure, financing structure and intercompany transaction(s) of the AB group of companies can be reorganised and how the new businesses can be structured to achieve greater group tax efficiency.

(15 marks)

(ii) State, with reasons, whether a Labuan company can be set up to undertake the CPO trading business.

(2 marks) (b) A daughter of one of the directors of ABH has just returned to Malaysia after residing

a number of years in London and is thinking of setting up an Italian restaurant in Bangsar. She understands that there may be service tax payable to the Malaysian Royal Customs and Excise Department.

Required:

Advise her on the services (in relation to the restaurant operations) that will be subject to service tax, the threshold and the rate of service tax applicable.

(3 marks) (Total: 20 marks)

.

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TERM 2, 2013 MAIN EXAMINATION

SUGGESTED ANSWERS

TAXATION Question 1 Chargeable income of Watchout Sdn Bhd for the year of assessment 2012

RM’000 RM’000

Profit before taxation 840 Depreciation (40+60+1,500) 1,600 Allowance for inventory obsolescence 380 Gain on disposal of investment in unit trusts (170) Gain on change in fair value of investments (45) Insurance claim received for plant and machinery destroyed during a fire (70) Profit from deposit (15) Payment for registration of trademarks in Malaysia 20 Payment for company secretariat work 12 Payment to a financial advisor 100 Purchase of machinery 50 Bonus expense provision 100 Payment for bonus (160) Entertainment allowances paid to the marketing manager 12 Expenses for the provision of an internship programme (double deduction – RM5,000 each) (10) Expenses incurred on participating in International Trade Fairs (double deduction) (50) Expenses for the registration of trademark in China (double deduction) (20) Cash contribution for holding company’s annual dinner 18 Donation of 10 bicycles 4 Allowance for doubtful debts (general provision) 70 Insurance premium (export credit insurance) (double deduction) (40) Expenses incurred on travelling to China for a proposed acquisition of shares 45 Expenses incurred to entertain existing customers 25 Double deduction for promotion of exports - subsistence (8xRM150 – limited to RM1,000) (double deduction) (1) - accommodation (8xRM300 – limited to RM2,000) (double deduction) (2) Interest expense on money borrowed to purchase shares 400 Foreign exchange loss on purchase of shares 300

---------- 2,553 ---------

Adjusted Income 3,393 Less : Capital allowances (Note) (1,741)

--------- Statutory Business Income 1,652 Less : Reinvestment Allowance (limited to 70% of SI) (1,156)

--------- 496 Add: Profit from deposit 15 --------- Chargeable Income 511 ===== OR

Statutory Business Income 1,652 Add: Profit from deposit 15 Less : Losses of holding company (limited to 70% of RM200,000) (140) --------- Chargeable Income 1,527 =====

√

√

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Note Capital allowance Qualifying Initial Annual Total Cost Allowance Allowance

RM’000 RM’000 RM’000 RM’000 Existing Assets: Plant and machinery 7,000 0 980 980 (8,000-1,000) (7,000 x 14%)

New Assets: Plant and machinery 2,000 400 280 680 (2,000 x 20%) (2,000 x 14%)

Computer 100 20 14 34 (100 x 20%) (100 x 14%)

Machinery 50 10 7 17 (50 x 20%) (50 x 14%)

-------------------------------------------------------------------- Total 1,711

Add: Balancing allowance (assets destroyed in a fire) RM’000

Qualifying cost 1,000 Less: CA claimed [ (20%+14%x5yrs)] (900) ------ TWDV 100 Insurance claims (70) ------ Balancing allowance 30 -------- CA available for set-off 1,741 =====

Reinvestment allowance (RA) claim RM’000

(i) Plant and machinery 2,000 --------- RA @ 60% : RA available for set-off 1,200 Less: RA utilised (1,156)

--------- RA c/f 44 =====

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Question 2

(a) Arguments for and against the deductibility of the RM60 million payable by Great Builders

Sdn Bhd to FB Contractors Sdn Bhd arising from the arbitrator’s decision:

Arguments for deductibility

- As GBSB is a construction contractor, the RM60 million is incurred in its ordinary

course of business to engage sub-contractors to undertake part of the work.

- It is an ascertained and accrued liability that has been determined by the arbitrator

notwithstanding that the amount paid has yet to be paid pending the decision of the

High Court.

Arguments for non-deductibility

- It is a provisional sum payable to FBC as the amount has yet to be ascertained pending

the decision of the High Court, i.e. the liability has not yet crystallised.

Arguments for and against the deductibility of the RM20 million on the net costs incurred by

Great Builders Sdn Bhd to finish the tunneling work not completed by FB Contractors Sdn

Bhd:

Arguments for deductibility

- represents actual costs incurred to complete the work. If this was not incurred, it may

result in a breach of contract with the State Government.

Arguments for non-deductibility

- represents capital expenditure as it is reflected as an amount recoverable in GBSB’s

balance sheet and not charged as an expense in its income statement.

(b) Arguments for and against the applicability of Section 24(2) of the Act (relating to

withdrawal of stock-in-trade) in respect of the lease of the land to the petrol station operator:

Arguments for Section 24(2) to apply

- SPSB is a developer and the land is reflected as “Property development expenditure”.

As such, it forms part of its stock-in-trade.

- The land is not sold but leased out and thus represents land withdrawn for SPSB’s

own use although not reclassified to “Property, plant and equipment” (PPE).

Arguments for Section 24(2) not to apply

- Section 24(2) is not applicable as the land was designated for construction of a petrol

station based on the master plan.

- no reclassification to PPE and thus not intended, that the land was to be withdrawn for

own use.

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(c)

Year 1

Year 2

Year 3

Year 4

Year 5

Adjusted income

Nil

15,000

30,000

35,000

40,000 Less: CA for the year

-3,650

-7,950

-20,950

-10,950

-10,950

CA b/f

-3,650

Statutory income

Nil

3,400

9,050

24,050

29,050

If Pioneer Status applies Statutory Income exempt from

tax (70%)

Nil

2,380

6,335

16,835

20,335 Pioneer loss utilised

Nil

-2,380

-6,335

-1,285

Nil

Credit to exempt account

Nil

Nil

Nil

15,550

20,335

Pioneer loss (current year/b/f)

-10,000

-10,000

-7,620

-1,285

Utilised

Nil

2,380

6,335

1,285

Pioneer loss c/f

-10,000

-7,620

-1,285

0

SI subject to tax (30%)

Nil

1,020

2,715

7,215

8,715 Tax payable at 25%

Nil

255

679

1,804

2,179

If ITA applies ITA for Year 1 - 20,000 x 60%

12,000 ITA for Year 2

- 20,000 x 60%

12,000 ITA for Year 3

- 50,000 x 60%

30,000 ITA c/f or b/f

12,000

12,000

21,620

45,285

28,450

12,000

24,000

51,620

45,285

28,450

Utilised

Nil

-2,380

-6,335

-16,835

-20,335 ITA c/f

12,000

21,620

45,285

28,450

8,115

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Statutory income

Nil

3,400

9,050

24,050

29,050

ITA set off 70% SI (exempt a/c) Nil

-2,380

-6,335

-16,835

-20,335

SI subject to tax

Nil

1,020

2,715

7,215

8,715

Less: Loss utilised

Nil

-1,020

-2,715

-6,265

Nil

Chargeable income

Nil

0

0

950

8,715

Tax payable at 25%

Nil

Nil

Nil

238

2,179

Current year/b/f loss

-10,000

-10,000

-8,980

-6,265 Utilised

Nil

1,020

2,715

6,265

Loss c/f

-10,000

-8,980

-6,265

0

Capital allowances - Factory - cost

15,000 IA (10%)

-1,500

AA (3%)

-450

-450

-450

-450

-450

- Residual expenditure

13,050

12,600

12,150

11,700

11,250

- P&M - cost

5,000 IA (20%)

-1,000

AA (14%

-700

-700

-700

-700

-700

3,300

2600

1900

1200

500

Additions

20000 IA (20%)

-4000

AA (14%)

-2800

-2800

-2800

-2800

13200

10400

7600

4800

Additions

50000 IA (20%)

-10000

AA (14%)

-7000

-7000

-7000

33000

26000

19000

Conclusion : SISB should apply for ITA as the total tax liability over the 5 year period is lower and there will be RM8,115,000 of unutilized ITA carried forward to the sixth year/thereafter.

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Question 3

(b) Adjusted income of J Development Sdn Bhd for the year of assessment 2012

RM RM Actual profit from Phase 1 5,000,000 Less: Profit taxed in previous YAs 2,000,000

3,000,000 Gross income of Phase 2 1 1,000,000 Less: Estimated loss of Phase 3 (restricted to estimated profit from Phase 2)

2

1,000,000

-

3,000,000 Less: Allowable operating expenses 500,000

Adjusted income 2,500,000

(a) Tax payable by Peace Insurance Malaysia Berhad for the year of assessment 2012

Note RM’000

Gross premiums 15,000 Add: Gross dividend income 2,600 Interest income 335 Rental income 240 Gross proceeds from sale of shares 4,000 Reserve for unexpired risks as at 31.12.2011 2,000 Less: Net claims incurred 3,000 Commissions 900 Management expenses 1,600 Cost of shares sold 2,100 Reinsurance premiums in Malaysia 1,750 Reinsurance premiums outside Malaysia 1 760 Reserve for unexpired risks as at 31.12.2012 2 1,409

Adjusted income 12,656 Less: Capital allowance 350

Statutory income = Chargeable income 12,306

Tax @ 25% 3,076.50 Less: Section 110 set-off (RM1.1 m x 25%)

275

Net tax payable 2,801.50

Note:

1. Reinsurance premiums outside Malaysia 95% x 800,000 = 760,000 2. Reserved for unexpired risks as at 31.12.2012

Marine, aviation and transit policies 25% x (6,000,000-1,250,000-760,000))

1,009

Fire motor and other policies 400

1,409

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Phase 2 RM

Phase 3 RM

Estimated sale value (A) 20,000,000 30,000,000 Estimated project cost (B) 18,000,000 35,000,000 Estimated profit/(loss) (C)=(A)-(B) 2,000,000 (5,000,000) Progress payments received/receivable (D) 10,000,000 10,000,000 Percentage of completion (E)=(D)/(A) 50% 33% Gross income/(estimated loss) for YA 2012 (F)=(E)x(C) (Notes 1, 2)

1,000,000

(1,650,000)

(c) Real Property Gains Tax (RPGT) payable by:

(i) The executors – Transfer of land to J Cheah

No RPGT gain or loss because the disposal price is deemed equal to the acquisition price for a transfer of asset to a legatee pursuant to a will (Para 3(a) Schedule 2).

James Cheah – Transfer of land to Ace Sdn Bhd No gain or loss because the disposal price is deemed equal to the acquisition price for the transfer of asset by an individual (J Cheah) to a company controlled by the individual for a consideration consisting substantially of shares in the company and the balance of a money payment (Para 3(b), Schedule 2). James Cheah - Sale of Ace Sdn Bhd shares

RM’000 RM’000 Disposal price 5,000 Less: Deemed acquisition price of shares on

1 December 2011

3,200

Less: Cash payment 1,000

50% x 2,200,000 Chargeable gain

2,200

1,100

3,900

Less: Exemption (10% of RM2.8 m) 390

3,510

RPGT payable @ 10% (disposed in the first year)

351

(ii) Ace Sdn Bhd – Transfer of land to trading stock

The transfer of land to trading stock is deemed to be disposal of a chargeable asset at the value of the land at the date of transfer.

The RPGT payable is computed as follows: RM’000 Market value of land on 15 December 2012 5,500 Less: Acquisition price of land on date of transfer from J Cheah to ASD

3,200

Chargeable gain 2,300

RPGT @ 10% 230

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Question 4 (a)(i) In order to achieve greater tax efficiency for the ABH group of companies, the following

can be considered:

(1) ABH should charge interest to ABF even though ABF is making losses. ABF would qualify for group relief and can surrender its current year losses of up to 70% to profitable companies (i.e. ABP and ABL). The unabsorbed losses can be carried forward to be utilised against the future business income of ABF.

(2) Interest expense on bank loan obtained by ABH solely for financing the share

investment in ABP and ABF will be a permanent loss as the single tier dividend income is tax exempt. To mitigate the tax inefficiency:

ABP (which is cash rich) can pay higher dividends to ABH so as to enable ABH to settle the loans. ABP can then borrow directly from the bank to fund its operations and the interest arising therefrom is tax deductible.

Alternatively, ABP could undertake a capital reduction exercise and return its surplus capital / cash to ABH. ABH can then utilise the funds to reduce its loans.

(3) ABL should increase its ordinary shareholding in ABC to 70% whilst the paid up

ordinary share capital of ABC should be increased to more than RM2.5 million so as to enjoy group relief in the future.

(4) ABF could undertake the new profitable business activity in CPO trading (with

commercial justification) so that the unabsorbed business losses and current year losses of fertilizer trading business can be used to offset the profits from the CPO trading business.

(5) A new company should be set up to undertake the aquaculture business activity.

ABP being the most profitable company within the group should be the holding company of the new company and ABP should invest by way of subscribing RM10 million ordinary share capital in the new company.

The RM10 million investment cost in the new company is eligible for a tax deduction

against the business income of ABP. The new company can enjoy tax exemption for 10 years commencing from the first

year of assessment it derives statutory business income from the aquaculture project. (a)(ii) A Labuan company cannot be used for the CPO trading activities because the majority of

the purchases and sales are:

transacted with resident companies; and

denominated in ringgit Malaysia which are generally prohibited under the Labuan Companies Act 1990.

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(b) Taxable services in relation to the restaurant operations include:

(a) provision or sale of food, drinks or tobacco products.

(b) provision of services in the form of “corkage”, “towel charge” or “cover charge”.

(c) provision of premises for meetings or for promotion of cultural or fashion shows.

(d) provision of parking spaces for motor vehicles where parking charges are imposed.

The threshold for a restaurant located outside a hotel to charge service tax is an annual sale turnover of more than RM3 million of taxable services.

The rate of service tax is 6% of the price or charge for the taxable service.

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THE MALAYSIAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS (INSTITUT AKAUNTAN AWAM BERTAULIAH MALAYSIA)

EXAMINER’S REPORT

TERM 2, 2013

TAXATION MAIN EXAMINATION

Question 1 Subject matter examined: Tax computation Generally, candidates performed reasonably well on the tax computation question. However, some candidates seemed to be unaware that reinvestment allowance and group relief are mutually exclusive. Question 2 Subject matters examined: (a) Deductibility, (b) Applicability of Section 24(2) of the Income Tax Act, 1967 and (c) Tax Incentives The following weaknesses of the candidates were observed : Part (a) : Most candidates stated “wholly and exclusively incurred” without any specific

reason being given. Part (b) : Candidates were asked about the applicability of Section 24(2) (for and against)

but most of them did not answer this part of the question. Some candidates got mixed up when arguing for and against applicability.

Part (c) : Candidates seemed to have little knowledge on pioneer status and investment

tax allowance (ITA). Examples are capital allowance to be deducted from adjusted income before exemption for pioneer status and ITA to be applied. Then the losses brought forward to be applied next. Candidates did not follow the proper sequence. However, a few candidates did well for this part of the question.

Some candidates were wrongly used ITA rate and not knowing setting off against 70% of statutory income.

Question 3 Subject matter examined: (a) Insurance; (b) Property Developer; (c) Real Property Gains Tax (RPGT) In general, Part (c), RPGT of the question were poorly attempted by candidates. Many candidates did not answer Part (b) and those who answered were poorly attempted.

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Question 4 Subject matters examined: (a) Tax Planning (b) Service tax The following weaknesses of candidates were observed :

(i) Weak in identifying areas of tax inefficiencies.

(ii) When question required candidates to state (with reasons) whether to set up a business

or not, candidates should provided answer with yes or no, and with reasons. Some candidates just stated the conditions without directly answering the question.

(iii) Lack of knowledge of Labuan Companies Act, 1990.