TAX CASES

Apportionment of Common Expenses Between Leasing and Non-Leasing Business
House Transferred to a Company's Director - Whether Should be Taxed as Employment Income
Driving Training Ground Qualified as a Plant for Capital Allowances
Applicability of Service Tax on Shared Management Services
Costs of Efficiency Study and Retrenchment
Gains from Compulsory Acquisition Not Subject to Tax
Bank Guarantee Fee Not Deductible
Rider Attached to Life Policy and Withholding Tax on Charges Paid to Head Office of an Insurer
Deductibility of Leave Passage for Directors
 




1. Apportionment of Common Expenses Between Leasing and Non-Leasing Business

In DL Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri (Civil Appeal No. R1-14-7-97), the taxpayer was in the business of providing leasing, factoring and hire purchase financing facilities. Under the Income Tax (Leasing) Regulations 1986, income from leasing business was required to be separated from income derived from non-leasing business from the year of assessment 1986 onwards. However, there were no provisions in either the Act or the Income Tax (Leasing) Regulations 1986 providing for the formula for computing the amount of common expenses attributable to the leasing and non-leasing businesses.

While the parties agreed on the method upon which the common expenses ought to be apportioned, the taxpayer made the apportionment on the basis that only the interest component earned in its leasing portfolio was income of its leasing business. The DG disagreed, and took the view that the gross income of leasing portfolios comprised total rentals which in turn is made up of principal plus interest, while the gross income of non-leasing portfolio would include interest not connected with the leasing business.

On appeal to the SCIT, the SCIT ruled that the formula adopted by the DG was to be followed. However, the High Court reversed the decision of the SCIT and allowed the appeal made by the taxpayer. It was held that revenue expenditure should only be deducted against income revenue which was based on accepted principles and was not at cross purposes with the provisions of the Act. Accordingly, the formula for the apportionment of the common expenses for lease financing shall not take into account the element of principal. The method of apportionment for common expenses between the leasing portfolio and the non-leasing portfolio shall be in accordance with the ratio between :-


a.   the "non-capital" income from the leasing portfolio which consists of the interest element of the lease rentals plus the incidental income; and
     
b.   the "non-capital" income from the non-leasing portfolio which consists of the interest income plus the incidental income.


The DG has appealed to the Court of Appeal.

< top >


2. House Transferred to a Companyís Director - Whether Should be Taxed as Employment Income

In DM vs Ketua Pengarah Hasil Dalam Negeri [(2001) MSTC, 3215], the taxpayer and her husband were the only two directors of E Sdn Bhd ("the Company"). The taxpayer was not a service director and was not paid any wages or any other remuneration by the Company. The Company owned a residential house in which the taxpayer and her husband resided. The house was transferred by the Company to the taxpayer for a consideration of RM1.

The DG argued that the taxpayer was regarded as an employer under Section 2 of the Act and that the transfer of the house was a form of remuneration. The DG took the market value of the house to be RM730,000 and sought to tax the amount of RM729,999 as a perquisite received by the taxpayer having exercised an employment under Section 13(1)(a) and chargeable to tax under Section 4(b) of the Act.

The taxpayer argued that she was not an employee of the Company and hence the transfer of the house was not a perquisite in respect of having or exercising an employment and further, that she has been appointed director of the Company in order to fulfill the requirements of the Companies Act, 1965.

On appeal, the SCIT held that the taxpayer was not paid wages, salary, remuneration, leave pay, fee, commission, bonus, gratuity or allowance within the meaning of Section 13(1)(a) of the Act. There was no service contract between the taxpayer and the Company and there was no offer or promise or resolution of any kind to pay the taxpayer any form of remuneration for her services.

The taxpayer was appointed a director to satisfy the requirements of Section 122 of the Companies Act, 1965. The consideration of RM1, albeit seemingly inadequate, was sufficient consideration to make the transaction a valid sale and purchase.

< top >


3. Driving Training Ground Qualified as a Plant for Capital Allowances

In Ketua Pengarah Hasil Dalam Negeri v. MSDC Sdn Bhd (Civil Appeal No. R2-14-6-1999), the taxpayer was licensed to carry on the business of driving school for motorcars, motorcycles, lorries, tractors and all other motor vehicles instructing, teaching, guiding and rendering services of all kinds which the company thought fit.

In complying with the conditions of the permit issued for its driving school, the taxpayer had incurred expenditure in constructing a training ground and buildings necessary for the business. The taxpayer claimed capital allowances in respect of the buildings and the training ground as qualifying building expenditure and qualifying plant expenditure under Schedule 3 of the Act. The DG was of the view that the training ground and the school buildings were settings and therefore did not qualify for capital allowances.

The SCIT agreed that the buildings were merely part of the setting in which the business was carried on. The buildings had no function to perform other than to shelter the trainees who were given instructions on theory. As such, the buildings were only the structure within the function of educating the trainees and therefore did not qualify as plant.

As regards the training ground, the SCIT held that it was prepared specially for carrying out the business of a driving institute. It played an essential part in the business and satisfied the functional test as an apparatus used in the conduct of the activities of the trade based on various case laws. Thus, it constitutes qualifying plant and is eligible for capital allowances.

On appeal to the High Court by the DG, the judge upheld the decision of the SCIT and pointed out the training ground which is specially prepared for carrying out the business of a driving institute is in fact an integral part of the taxpayerís business and is therefore a plant. It is obvious that without the training ground, the taxpayer would not be able to carry on their business of a driving institute.

< top >


4. Applicability of Service Tax on Shared Management Services

In Sarawak Shell Bhd v Menteri Kewangan (Civil Appeal No. R2-25-118-1999), the applicant and its other joint venture partners were in the business of exploration and production of crude oil and natural gas, the refining of crude oil and manufacture of petroleum products. They were not carrying on the business of providing management services. Under a production sharing contract of arrangement pursuant to a joint venture agreement, the cost for management services are shared between the production sharing contractors without any mark-up or profit levied.

Section 7 of the STA provides that service tax shall be charged on and paid by any taxable person who carries on the business of providing taxable service. Such persons providing management services (i.e. a taxable service) are required to levy service tax at 5% on management fees with effect from 1st January, 1998. The issue was to determine whether management services provided under a cost sharing arrangement where the service provider is not in the business of providing management services should be chargeable to service tax under the STA.

For service tax to be chargeable upon the applicantsí cost sharing arrangement under its joint operating arrangements, the essential statutory requirement under the STA is that the applicants must carry on business of providing taxable service within the scope of the enabling provision i.e. Section 7 of the STA.


In this case, the applicants were in the business of exploration and production of crude oil and natural gas and the management services were only rendered to other joint venture partners under the joint operating agreements. It was held that the applicants merely provided incidental management services and were not carrying on the business of providing management services. Section 7 of the STA only operates where there is a distinct business of providing taxable service and not where the ëserviceí is a component feature of some other business. To be eligible for service tax, a person must carry on a business of providing those services, which then becomes taxable if such services are prescribed in the Service Tax Regulations.

Thus, the management services provided under the production sharing contract to the joint venture partners which were incidental to the applicants' business of exploration and production of crude oil and natural gas should not be subject to service tax.

The case has been referred to the Court of Appeal.

< top >


5.Costs of Efficiency Study and Retrenchment

In the High Courtís case of Ketua Pengarah Hasil Dalam Negeri v IF Sdn Bhd (Civil Appeal No. R2-14-9-98), the parent company of the taxpayer has engaged a company to conduct an efficiency study of its subsidiaries including the taxpayer. The efficiency study was carried out on the taxpayer for the period between 25th June, 1985 to 31st December, 1985. The assets, business and employees of the taxpayer were transferred to the related company on 1st December, 1985 and thereafter the taxpayer was voluntarily liquidated on 31st December, 1985. The retrenchment exercise was carried out on 15th December, 1985. The taxpayer made a claim for the costs of the efficiency study and the retrenchment costs to be deducted against its business income.

The SCIT allowed the appeal of the taxpayer. They found that the efficiency study increased the speed time in production, reduced non-productive time and improved plant maintenance. The costs of the efficiency study, and the retrenchment costs were thus held by the SCIT to be incurred in the production of income and hence deductible expenses. The DG appealed to the High Court.

In consideration of the facts and circumstances of the case, the High Court allowed the appeal by the DG stating that the taxpayer company was a different legal person from the other subsidiary companies and with the liquidation of the taxpayer, it was impossible to accept the contention that the efficiency study was meant for the benefit of the taxpayer, whose business was taken over by a related company with the taxpayer being voluntarily liquidated soon thereafter. The costs of the efficiency study were therefore not wholly and exclusively incurred in the production of income.


As regards the retrenchment costs, from the facts it was an irresistible conclusion that the retrenchment exercise was done for the benefit of the successor company of the taxpayer. The timing of the retrenchment exercise was very close to the takeover of the business of the taxpayer and the liquidation of the taxpayer. Further, the application to the Foreign Investment Committee to amalgamate the companies was made before the efficiency study was conducted in June 1985 indicating that the efficiency study and the retrenchment exercise were meant more to facilitate the takeover of the taxpayer's business. As such, the costs of the retrenchment exercise were similarly not incurred in the production of the taxpayer's income.

< top >


6. Gains from Compulsory Acquisition Not Subject to Tax

In P. Construction Sdn Bhd v DG, the appellant was in the business of housing development in Perak. It purchased the subject land in 1975. In 1980, the land was capitalised in the accounts as fixed asset. No subdivision was done and no developerís licence was obtained in respect of the land.

On 5th October, 1995, the Government gave notification for acquisition of the land. The official notification document was dated 10th June, 1997. Compensation was received for the compulsory acquisition. The issues for determination were whether the gains from the compensation received were subject to income tax and if positive, whether the tax should be for the year of assessment 1996 as held by the Inland Revenue. The SCIT have ruled that the gains were subject to income tax and since the compensation was paid in 1995, the tax should be raised for the year of assessment 1996.

On appeal to the High Court, both the above decisions of the SCIT were reversed. It was held that the subject land was capital and did not form part of the stock in trade of the company and that the relevant year of assessment should be 1998 since the acquisition document (Borang K) was issued in 1997. The date of payment of the compensation was held to be irrelevant.

The DG has withdrawn its appeal to the Court of Appeal.

< top >


7. Bank Guarantee Fee Not Deductible

In F. Sdn Bhd v DG, the appellant company involved in investment holding, in order to facilitate the purchase of certain shares, had entered into a guarantee facility agreement with a group of banks to secure an irrevocable bank guarantee for the purchase price of the shares. A commission of 1.2% per annum was payable for the bank guarantee secured. The company received dividend income from the shares purchased.

The company argued that the commission incurred on the bank guarantee facility was analogous to an operating cost or the cost of maintaining its business. The DG treated the commission as a capital expenditure prohibited from deduction under Section 39(1)(c) of the Act. On appeal to the SCIT, it was held that the commission payments were capital in nature citing Seabanc Credit (1998) / CLJ 349 in support.

The company has appealed against the decision to the High Court.

< top >


8. Rider Attached to Life Policy and Withholding Tax on Charges Paid to Head Office of an Insurer

In AIA Co. Ltd vs KPHDN [(SCIT)(PKCP (R) 15/99)], the taxpayer is a non-resident insurer carrying on life and general insurance business. Among others, the issues of dispute with the DG were :-

a.   whether riders attached to the life policy are to be treated as part of the life business or as part of the general business; and
     
b.   whether certain charges (i.e. American International Data Centre [AIDC] charges) paid to the Head Office in Hong Kong fall under Section 4A(ii) of the Act.


The other two issues of dispute were settled by way of agreement in accordance with Section 101(2) of the Act.

On the riders issue, the taxpayer argued that riders are a part of its life business and not part of its general insurance business. As such, the tax treatment should be in accordance with Section 60(4) of the Act in respect of the life fund of a non-resident insurer. On the other hand, the DG contended that the riders should be classified as part of the taxpayer's general insurance business and income tax on riders should be computed pursuant to Section 60(6) of the Act in respect of the general business of a non-resident insurer.

The SCIT held that the DG has not been invested by any power to reclassify riders from life business to general business and therefore riders should be treated as part of life business.

As regards AIDC charges issue, the taxpayer incurred expenses in respect of services provided by i.e. AIDC which was part of the taxpayer's Head Office in Hong Kong. The taxpayer argued that the AIDC charges were allocated by the Head Office on an actual cost basis in respect of routine office administrative services rendered and as such, it is not an income falling under Section 4A(ii) of the Act which is subject to withholding tax. Further, the AIDC charges were wholly and exclusively incurred in the production of income which should be allowed under Section 33(1) of the Act.

Based on the facts submitted and the Service Agreements between the taxpayer and American International Data Centre Ltd, it was held that the services rendered are technical in nature and therefore the AIDC charges fall under Section 4A(ii) of the Act and subject to withholding tax under Section 109B of the Act. The claim for AIDC charges are thus denied in accordance with Section 39(1)(j) of the Act for non-compliance with the requirement under Section 109B of the Act to deduct and remit the withholding tax applicable to the DG.

The DG has appealed to the High Court against the decision of the SCIT on riders issue whereas taxpayer has appealed on the issue of AIDC charges. However, both the DG and the taxpayer have discontinued with the cross appeals subsequently.

< top >


9. Deductibility of Leave Passage for Directors

In KHK Advertising Sdn Bhd v KPHDN (Civil Appeal No R1-14-4-99), the issue of dispute was whether the cost of leave passage provided to certain directors under the service agreements and claimed by the company for years 1983 to 1986 was tax deductible. The SCIT denied the claim on the ground that the expense was of private and vacational nature and not incurred wholly and exclusively in the production of income.

On appeal to the High Court, the learned judge pointed out that the view of the SCIT that the cost of leave passage was private and vacational and hence not wholly and exclusively incurred in the production of gross income was wrong. The wrong emphasis was placed by the SCIT on how the directors expended their compensation received from the employer. The proper issue was what compensation (salary, benefits-in-kind, free leave passage) was given for the services rendered by the directors. The free leave passage was one of the components of the salary package and was a cost to the employer in respect of services rendered.

The High Court allowed the cost of the leave passage reversing the decision of the SCIT.

< top >


A service brought to you by MIR Communications Sdn Bhd in cooperation with
Deloitte KassimChan Tax Services Sdn Bhd and Deloitte Touche Tohmatsu Tax Services Sdn Bhd.
© October 2001