THEORETICAL MODEL IN ACCOUNTING EDUCATION RESEARCH

TOPIC 5 CORPORATE TAXATIONGROSS INCOMEDEDUCTIBLE EXPENDITURESTAX PAYABLEMalaysian Taxation 21

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LEARNING OUTCOMETO DETERMINE THE GROSS INCOME OF A COMPANY (BUSINESS AND NON BUSINESS)

TO IDENTIFY DEDUCTIBLE EXPENDITURE

TO COMPUTE THE CHARGEBLE INCOME OF A COMPANY

Malaysian Taxation 22

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Malaysian Taxation 23 CHAPTER 5 (a)GROSS INCOME

Badges of TradeSUBJECT MATTERPERIOD OF OWNERSHIPFREQUENCY OF TRANSACTIONSSUPPLEMENTARY WORKS DONE PRIOR TO SALEORGANIZATION SET UP TO DISPOSE THE GOODSMOTIVE FOR THE TRANSACTIONSMalaysian Taxation 24

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Badges of Trade1. SUBJECT MATTER (nature of asset)Commodities could be bought as personal use of enjoyment - purchase of a bottle of Pepsi/cokeBUT if buying and selling Pepsi/coke even a single bottle will increase the trading stock clearly a trading transactionRutledge v IRC (1929) purchase 1m rolls of toilet paper, gained 10K profit The courts held the sum to be taxable although they claimed it was an isolated transaction Example: painting/jewellery once bought for pleasure but sold when its value had appreciated difficult to prove (adventure/concern in nature of trade) Malaysian Taxation 25

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Badges of Trade

2. PERIOD OF OWNERSHIPWisdom v Chamberlain (1968) an actor purchased some ingots of silver as a hedge against an anticipated devaluation. He sold within a year and made profits. The courts held the sum to be taxable adventure in the nature of trade.Mount Elizabeth v The Comptroller of Income Tax (1987) developed a block of high-rise apartment and disposed them with the exception of a few units. These units were retained for seven years and then disposed Profit arising still treated as trading profitsMalaysian Taxation 26

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Badges of Trade

3. FREQUENCY OF TRANSACTIONSTransaction in one series evidence of a systematic and methodical activity general pattern will constitute an adventure in the nature of trade.Pickford v Quirke (13 TC 251) a member of a syndicate which purchased the shares of a mill-owning company, then liquidate the comp. and sold the asset to another comp. The syndicate was specially formed for the purpose of buying asset (substantial profit). Taxpayer had engaged in 4 other transaction & made profit. The courts held that all the transactions constituted the carrying on a trade.

Malaysian Taxation 27

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Badges of Trade

4. SUPPLEMENTARY WORKS DONE PRIOR TO SALECape Brandy Syndicate v IRC (12 TC 358) 3 individuals form syndicate and purcahsed a quantity of Cape Brandy. This was shipped to England and blended with some French brandy, re-casked and sold to various buyer. The entire lot was sold over a period of 18 months and not involved in any other transaction. The courts held the profits were taxable (adventure in the nature of trade) although they claimed it was an isolated transaction.Malaysian Taxation 28

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Badges of Trade

5. ORGANIZATION SET UP TO DISPOSE THE GOODSMartin v Lowry (11 TC 297) Taxpayer (an agriculture merchant) acquired about 45 m yards of war surplus linen. He set up an organization and advertised the sale of linen and over a period of few moths the entire linen were sold. The courts held he was carrying on a trade - the profits were correctly assessed as arising from a business. Malaysian Taxation 29

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Badges of Trade

6. MOTIVE FOR THE TRANSACTIONS

Motive never an issue (the nature of transaction is clearly evident as one of trade)The courts will have to resort the indicators which point to the transaction as constituting a trading/business transaction)Malaysian Taxation 210

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Business activities (income) have to be distinguished from investment transactions (capital)Capital natured business receipt are not taxable (i.e. gains from disposal of fixedassets).

Malaysian Taxation 211Capital vs Income

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Section 22(1) and (2):Applies to revenue receiptIf the gross income resulted from past expenses and outgoings of revenue nature, it would then be treated as incomeMalaysian Taxation 212The Ascertainment of Gross Income

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Non-refundable Advance received S 22(2)Sum receivable by way of insurance, indemnity, recovery and reimbursement constitute gross business income.

For instance, such sum include insurance recoveries which are in respect of trading stock, defalcation by employees, repairs of assets as well as life and accidents insurance.

Insurance recoveries for replacement of assets are capital receipt, thus not taxable.Malaysian Taxation 213

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ExampleCARE Car Seat is an enterprise selling leather car seats. It obtained its leather from various suppliers in Europe. In 2012, several customers complained that their leather seats which had been supplied by CARE Car Seat had started to peel after only four months of use. The company traced the leather shipment which had been used for the defective car seats and replaced all the car seats made from the said shipment. It then made a claim against the leather supplier. After a period of lengthy negotiations and to maintain goodwill, the supplier paid CARE Car Seat a sum of RM45,000.

Malaysian Taxation 214

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Malaysian Taxation 215Answer..Discuss whether the RM45,000 is taxable.

Answer:

Compensation for Loss of Income Compensation for loss of income from a source is a revenue receipt and is taxable.This receipt exhibit one or more of the following attributes:The receipts must be filling a hole in profits.The receipt must not be in respect of physical damage or disposal of capital assets.The receipt must not relate to the restructuring of company.Malaysian Taxation 216

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Recovery of Trade Debt

The recovery of trading debt is taxable subject to key condition being satisfied.The debt previously written off as being bad and were allowed as deductions in arriving at the adjusted income from business.

Malaysian Taxation 217

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Waiver of Amounts Owing to CreditorsThe waiver of amounts owing to creditors (i.e. suppliers) is taxable.Example:Samad, is an owner of a provision shop. As at 31-12-2011, he had an amount of RM2,500 owing to one of his confectionary suppliers. In the middle of 2012, the supplier agreed to waiver the amount owed to him on the basis of the long-term relationship between him and Samad. Samad consequently debited the supplier account in his monthly accounts and credited the income statement account.Malaysian Taxation 218

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Malaysian Taxation 219Discussion:Issue: Advise Samad whether the waiver of RM2,500 is taxable.

CHAPTER 5 (b)

BUSINESS DEDUCTIONSMalaysian Taxation 220

Principles of DeductionRevenue versus capital expenditureExpenditure incurred by the taxpayers carrying on a businessQualifying deduction under the ITATiming of the expenditureExpenditure wholly and exclusively incurred in production of gross incomeMalaysian Taxation 221

General provisions for deductions Deductibility under Section 33 of ITA:Outgoings and expensesWholly and exclusivelyIncurredDuring that period; andIn the production of gross income

Malaysian Taxation 222

Example 1(WHOLLY & EXCLUSIVELY)Dhia Emas SB exports frozen prawn and fish to Japan and Singapore and also distributes its own products overseas through various distribution centers. Raffi Family holds 65% shares in DESB. For its business DESB leased refrigeration equipment, cold rooms and container from Raffi Family at the market rate RM2m per annum. The lease agreement provides that if the annual profits of DESB, above RM2m (before charging the lease rental), the lease rental would be increased accordingly. State with reason, whether the lease rental would be deductible for tax purposes.

Malaysian Taxation 223

Answer:Malaysian Taxation 224

Example 2(DIRECT PURPOSE FOR BUSINESS)Muazam Sawit Bhd, a plantation company incurred RM12,000 on a special audit of another company, Shah Rubber Bhd that it tends to acquire. State with reason, whether the expenses is deductible against business income of Muazam Sawit Bhd.

Answer:The amount in relation to special audit was not incurred for the direct purpose of the existing plantation business but connected to another source. Thus, the expenses is NOT deductible.Malaysian Taxation 225

Deductions ProhibitedSection 39(1)

Domestic & private expenses Expenditure not wholly incurredCapital withdrawn and any sums employed as capitalContribution to a non-approved schemeQualifying mining, prospecting and agriculturalInterest or royalties paid to a non-resident personPayment for timber license or permit(h)Bonus payment (now deleted)(i)Failure to remit deduction from contract payment(j)Failure to remit deduction from special classes of income(k)Lease rental(l)Entertainment(m)Leave passage costMalaysian Taxation 226

Example 3(LEASE RENTAL)MyMee SB produces instant noodles, for the YE 31/5/2011 the company has made lease rental in respect of the following vehicles:

Lease rental paid during the yearAccumulated leased rental 1/6/2010Cost of carWira 1.5RM25,00015,00085,000Van 15,00050,00012,000BMW45,00035,000210,000

Malaysian Taxation 227

Answer:Amount restricted to

Malaysian Taxation 228

Example 4(ENTERTAINMENT)Azura Salleh SB incurred RM100,000 on entertainment for the YE 31/7/2012. Details are as follows, compute the allowable entertainment;

Entertainment allowanceRM10,000Entertainment to supplier5,000Sponsorship cultural show at a sporting event open to members of the public50,000Gifts to customer for purchase above RM10015,000Launching a new product20,000

Malaysian Taxation 229

AllowableRemarksallowanceRM10,000supplier5,000cultural show 50,000Gifts to customer 15,000Launching a new product20,000100,000

Answer:Malaysian Taxation 230

Deductible & Non-deductible expensesSection 33(1)(a): interestSection 33(1)(b): rentSection 33(1)(c): repairs & renewalSection 33(1)(d): other deductionsEmpower Minister of Finance to prescribe relevant deductions from time to timeThe deduction sometimes not allowable under ordinary rules but in view of particular economic necessity

Malaysian Taxation 231

Section 33(1) (a)InterestInterest expenses on money borrowed would be allowed as deduction under the following 2 circumstances:The loan employed in production of gross incomeThe loan is laid out on asset used/held in that period for the production if business income.

Malaysian Taxation 232

Example (INTEREST)Azneel Sdn Bhd (ASB) entered into an agreement for the assignment of a timber concession. The consideration payable by ASB for the assignment has been by installment and ASB is also required to pay interest on the total consideration or such part outstanding. In computing the adjusted income, the DG did not allow deduction for the interest paid but the taxpayer argued that the interest has been paid for being allowed credit not for the use of license; However DG had contended that the interest is part of the selling price. Advise NSB.Answer: The payment of interest has been consideration for the credit given to the taxpayer for the outstanding debt and it could be deducted under s 33. (DGIR v RB Sdn Bhd (1984)Malaysian Taxation 233

Section 33(1) (b)RentWould be accorded a deduction if it was:Payable for occupying the land/building (immovable properties)Used in relation to the periodIncurred for the purposes of producing gross income of that source (i.e business must have commenced)

Malaysian Taxation 234

Example (RENT)a) Chen rented a shophouse in order to sub let for rental income. He also derives manufacturing income. Can rental be deducted from gross income of the manufacturing?Answer:Rental expenses incurred on shophouse used to produce rental income under s 4(d) cannot be deducted from gross income of the manufacturing source under s 4 (a). In order to get a deduction for the rental the source of rental must first exist, i.e. only deductible against rental income of shophouse.Malaysian Taxation 235

b) Ahmad SB is manufacturing company occupying a factory in Sg Buluh. Rental expenses were paid on 1/1/2012 to 31/12/2012. However the company commenced the manufacturing business on 15/4/2012. Can the company claim the entire rental to be deductible?Answer:Only rental expenses form 15/4/2012 31/12/2012 is deductible against gross income for the manufacturing business.Malaysian Taxation 236

Section 33(1)(c) - repairs & renewalREPAIR - Principle in case laws: Capital in nature (NOT deductible)Improvement on a an assetAcquisition repairReplacement on whole of the asset (entirety) Revenue in nature (deductible) repair of premises, plant, machinery or fixtures employed in the production of gross income;Replacement of part of assetRenewalMaintaining the commercial viability of an assets

Malaysian Taxation 237

Example (REPAIR and RENEWALS)A) Rubber SB is the owner of rubber estate. The drainage system is controlled by 10 Watergates. As a result of a leak in one of the Watergates, new gates was installed at the coast of RM15,000. Consider the deductibility of the sum expended installing the new Watergates.Answer:Malaysian Taxation 238

B) Mall Bhd owns a chain of retail outlet in Malaysia. In 2009, it acquired 2 dilapidated shop lots to expand its chain. Repair work was carried out in the same year in the 4 outlets including initial repairs on the newly acquired shop lots. State with reason, whether the repairs on the 4 outlets are tax deductible.Answer:Malaysian Taxation 239

Specific Business deduction- Bad debts - Employers contribution to an approved fund - Equipment for the disabled employees- Translation and National Language Publication- Library facilities (not exceeding RM100,000)- Community welfare- Child care centre- Managing musical or cultural groups -Sponsorship of arts and cultural activity (max: RM300,000)- Scholarships (wef YA2001)

(section 34 & 35)Malaysian Taxation 240

- Halal certification expenditure (wef YA2005: double deduction)-Practical training (wef YA 2002)- International standardization activities- Scientific research- Special deduction for scientific research expenditure (double deduction)- Contributions and payment to an approved research institute or an approved research company- Stock in trade Specific Business deduction(section 34 & 35)Malaysian Taxation 241

Example (bad debt)Runny is a building contractor. He has lent a sum without any security to Lee a family friend. Lee subsequently became bankrupt and Runny considered the sum lent to be a total loss and has sought to deduct it from his profit. He considered that the loan had been a bad debt incurred in the ordinary course of business and deductible under s 34(2). Advise Runny. Would your advice differ if Lee is a major supplier to the business?Answer:Malaysian Taxation 242

Example (Approved scheme)ZSB decided to improve the benefits offered to its employee. As a result, it set aside RM150k out its reserve for a pension fund. This is the initial contribution necessary to set up the fund. State with reasons, whether the expenditure is a tax deductible.Answer:Would be capital expenditure not deductible. The initial contribution is capital because it is made, not only once and for all, but with a view to bringing into existence an asset. However s 34(5) may allow the deduction for a such special contribution in respect of an approved scheme.Malaysian Taxation 243

Accountancy feesAdvances & loansAdvertising costs allowableBooks & periodicalsBusiness acquisition costsAcquisition of trading stock on takeover: deductibleTravelling expenses: non allowable

Deduction of outgoings & expenses [section 33(1)]Malaysian Taxation 244

Trade & club subscriptionIncome taxes: non allowableClothing & tools: non allowableCompany general meeting: non allowableTrade exhibition and travelling expenses Consumable aids: allowablecrop re-planting: allowable

Deduction of outgoings & expenses [section 33(1)]Malaysian Taxation 245

Deduction of outgoings & expenses [section 33(1)]DamagesDefending capital assets: allowableDevaluation losses: allowableFines & penalties: non allowableTerminating redundant employee: allowableLegal expenses in restructuring exercise: allowableAudit fees: allowableMalaysian Taxation 246

Interest on loan to small businessEmployment of disabled employeesInsurance premium for import of cargoTraining of an handicapped personsExport credit insurance premiumFreight charges (from Sabah & Sarawak)Research expenditureContribution to approved research instituteOverseas expenses for promotion of tourismExpenditure for approved trainingDouble DeductionMalaysian Taxation 247

Double DeductionExpenses incurred in international trade fairFees incurred in packaging design (wef YA2001)Advertising Malaysian brand productPromoting brand namesPromote export of servicesHalal certificationPromotion of higher education

Malaysian Taxation 248

Malaysian Taxation 249 CHAPTER 5 (c)TAX PAYABLE

FORMATMalaysian Taxation 250AddLessNet profit/(net losses)xx+) Any item/expenses not allowable for deductionxx-) Items allowed for double deduction(xx)-) Non business income / Non taxable income Sec 4(c) : dividend, interest and discount Sec 4(d): rent, royalty and premium(xx)Adjusted income/lossXX+) Balancing chargesxx-) Capital allowance/ balancing allowance(xx)Statutory IncomeXX

Malaysian Taxation 251Statutory IncomeXX(-) Loss b/f(xx)(+) Other incomexxAggregate incomeXX(-) Approved donation* Total Donation vs 10% from Aggregate income (Which is lower)(xx)Chargeable Income XXPaid up share capital (