September 21, 2018
By Saiful Anuar Sabarudin
It can be very frustrating indeed after spending a lot of your precious time to come up with a good tax planning scheme , only to find out later it is being treated as a tax evasion or avoidance by the Inland Revenue Board (IRB) under Section 140 of the Malaysian Income Tax Act, 1967.
Section 140 provides wide and general powers to the Director General of the Inland Revenue (DGIR) to combat tax avoidance by disregarding certain transactions and computing or re-computing tax liability of a taxpayer.
The power given to IRB under Section 140 is very wide such that as long as the IRB has reason to believe that the transaction caught under Section 140, whatever tax planning scheme of the tax payer would be ignored regardless of the fact that such tax planning could be a genuine case . In this regard, it is essential that any tax planning sheme should take into consideration the effect of Section 140 to ensure there would be no subsequent dispute with the IRB.
It seems that tax planning in Malaysia is a risky business. Expert legal opinion in Malaysia are of the view that if the tax planning process is transparent and is within the meaning and letter of the law, then such tax planning is acceptable. Perhaps, as long as the principle of “ substance over form” exists, then the chances of such tax planning sheme being challenged would be very slim. In other words, a company may not reduce its income taxes by labelling a transaction as something it is not. It is the substance, not the form, of the transaction that determine its taxability. Surprisingly, this is not the case in one of the Court’s decision involving Section 140 ( SB Sdn Bhd v KPHDN(1999) which I will deliberate further in this article.
However, there have not been many cases where the IRB has invoked the anti-avoidance provisions of the Act. In any event, tax plans which are within the provisions of the Act are not generally set aside by the IRB. However, transactions that lack commercial substance would be challenged by the IRB where the only objective is the avoidance of tax.
The Good
Section 140 would identify those transactions that are not commercially justified and have the sole intention of avoiding taxes such as in the case of Sabah Berjaya Sdn Bhd (SB) v Ketua Pengarah Hasil Dalam Negeri ( 1999) 3 CLJ 587. This is a case whereby SB Sdn Bhd a subsidiary of Sabah Foundation ( a charitable trust) donated from 96% to 121% of its net profit to the Sabah Foundation for 8 years consecutively. The tax effect of this transaction is such that Sabah Foundation being a charitable trust would be exempted on the donations received from its subsidiaries and in return, SB Sdn Bhd would be able to claim the donation as approved donation under Section 44(6) , hence reducing its taxable income.
Based on the above transaction, we can safely assume that such a transaction has no regard for economic reality because other companies would not donated almost all of its net profit or for that matter, more than its net profit to a charitable body. As such the IRB invoked Section 140 simply because the donation was abnormal, illogical and ridiculous as a few of the reasons. As a result, the IRB had raised additional assessment for 8 years which amounted to approximately RM16 million.
The case went to the Special Commissioner and the IRB’s decison was upheld by virtue of the deeming provision of Section 140(6) of the Act which deals with related parties. Subsequently, the case went to High Court and finally Court of Appeal.
Surprisingly, in the Court of Appeal, it was held that anti-avoidance provision under Section 140 does not apply as this is a tax mitigation scheme and not a tax avoidance scheme because of the following:
- There was an actual donation made by the company to an approved instituition ( Sabah Foundation)
- The payments made reduced the company’s income under section 44(6) where the Act clearly afford such reduction in tax liability; and
- Anti-avoidance provisions does not apply to tax mitigation where the tax payer obtains a tax advantage by reducing his chargeable income or by incurring expenditure in circumtance in which taxing statute affords a reduction in tax liability.
Why Section 140(6) was not being considered in the above court’s decision remains as a mystery as this clearly contradicted the Sp Comm ‘s decision which put much emphasis on transactions between related parties. Instead , the judge adopted the “ form over substance” approach by considering every entity on its own without considering the relationship with another entity.
Now you might be wondering why I put this under the heading of “the good” . This decision has given more options to companies in a tax mitigation scheme without worrying about the transaction being commercially justified or regarded as ordinary business transactions between independent parties. Tax payers can always depend on the above court decision if it is being questioned by the IRB on transactions which are similar in nature . Hence, the heading is “ the good”.
However, please take note that the Act now has restricted the deductibility of approved donation against the aggregate income ( i.e 10% of Agg.Inc) probably because of the court decision which favours the tax payer. Hence, this has resulted in limiting the option for a tax mitigation scheme.
The Bad.
Another case worth mentioning involving Section 140 is the case of Sungai Batu Perlombongan Sdn Bhd (SBP) v Director General of Inland Revenue ( 1988) 1 MSTC 243, 2053 decided in favour of the Revenue by the Special Commissioners. The SBP case is the first challenge made by the IRB under the general anti-avoidance provisions of Section 140 of the Income Tax Act, 1967. Since this is the first case concerning Malaysian anti-avoidance case law, it deserves careful analysis for this would indicate the IRB’s stand in future challenges under Section 140 of the Act.
The facts of the SBP case may be summarised as follows:
- SBP, a mining company ceased operations in 1974 with substantial agreed tax losses being recorded.
- Mr Chin, the sole proprietor of another profitable mining operation, injected his profitable mine into SBP for consideration.
- Mr and Mrs Chin acquired the shares in SBP ( having owned no shares in SBP previously) for 20 sen a share.
- The remaining two directors resigned from the SBP board, leaving Mr and Mrs Chin the sole shareholders and directors of SBP.
- SBP claimed relief for the tax losses brought forward from its previous mining operation against the profits from the newly injected mine.
The IRB, and subsequently the Special Commissioner is of the view that the only intention that can be assumed from the above arrangement was to relieve Mr Chin from paying taxes on the profits from his sole proprietorship operation. SBP had disposed all its mining assets ( a shell company) at the time of its shares being acquired by the Chin’s, except for its tax loss asset and there could therefore be no commercial motive behind the arrangement; thus, the Director General ‘s view is that the IRB has good reason to invoke Section 140 ( the Privy Council approach in Newton’s case applied). The case went to the High Court and the Court held that the decision of the Special Commissioner is correct in law.
However,it is interesting to note that in the case of SB Sdn Bhd vs DGIR (1999), the Court of Appeal has taken a different view whereby a taxpayer is only engaged in tax avoidance when he does not reduce his income, suffer a loss or incur expenditure, but nevertheless obtains a reduction in his tax liability as if he had. Similarly, if a taxpayer invests in a business which enjoys tax incentives and reduces his chargeable income , such is not tax avoidance. In this regard, can we similarly say that the Chin’s has invested in a company which enjoys tax losses and reduces their chargeable income is in line with the Court’s findings in the SB case hence, not a tax avoidance scheme under Section 140 of the Act?
One of the taxpayers argument in the SBP case is that the take over of SBP is purely business transaction whereby it is common for a sole proprietor to sell his business to a company of which he is a substantial shareholder . Perhaps this argument might be acceptable if the taxpayer has become shareholder long before he transfers his own business to his company as his company has suffered losses prior to the tranfer of his own profitable business to the company.
Unfortunately the SB case was decided years after the SBP case otherwise the SB case might have been taken into consideration by the judges in reaching their decision for the SBP case which may result in favour of the taxpayer (SBP). Furthermore, in the case of I.R. Commrs v. Duke of Westminster (1936). Lord Tomlin states that “ Every man is entitled if he can to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be”. This statement implies that it is not wrong for a taxpayer to arrange his affairs in such a way that may result in avoidance or reduction in the incidence of tax.The leading UK anti-avoidance cases make interesting reading but do not necessarily influence the Malaysian scene. The reasons used by the Director General in invoking Section 140 must still muster a pass with the Special Commisioner and the Malaysian Courts.
Even though it seems that this whole arrangement in the SBP case was not specifically prohibited in the Act but unfortunately due to the wide power given to the IRB under Section 140, it was considered as tax avoidance scheme. Hence, this is bad for taxpayer. However, all is not lost for taxpayers considering the impact of Section 140(5) on IRB’s power under Section 140.
The impact of Section 140(5) on IRB’s power under Section 140.
In the case of Bandar Utama City Corp Sdn Bhd V Director of Inland Revenue (1999)MSTC 3725, the High Court has somehow restricted the wide power given to the IRB under Section 140 by virtue of Section 140 (5). Section 140(5) clearly imposes a duty on the IRB to give particulars of the adjustments or assessments as the case may be to the taxpayer. The High Court held that “ the IRB’s failure to provide the particulars would not only be a breach of its statutory duty under Section 140(5) but also of the rules of natural justice. The rules of natural justice must be observed and the taxpayer ought to know particulars of the case made against him so as to provide an answer to the case”.
It was stated that where there is an abuse of power by the IRB, then an order can be made against the IRB. Nevertheless, the taxpayer should bear in mind that the order does not determine the case once and for all but merely requires the IRB to give particulars of the assessments to facilitate an appeal by the taxpayer to the Special Commissioners.
Another case worth mentioning is DGIR V HCT (L) Sdn Bhd (1985) 2 MLJ 322 whereby the Supreme Court judgement is such that “the IRB had no recourse to Section 140 of the Act because it did not issue particulars of adjustment under Section 140(5). Consequently the IRB has no basis to disregard purchase agreement to disallow a portion of the purchase price of stock-in-trade which is deductible under Section 33(1) of the Income Tax Act, 1967”.
The abovementioned Court’s decisions have somehow put extra burden to the IRB in the sense that the IRB is under a statutory duty to provide ‘ reasons and basis of computations’ , or in other words ‘ particulars’ to the taxpayers. As such, it is hoped that the IRB would not be so quick to invoke Section 140 which give them wide power as they only “need reason to believe” Section 140 is applicable . Consideration must be given to Section 140(5) as well which require them to provide particulars to the taxpayers.
The Ugly
Needless to say the ugliest part of Section 140 is the fact that if taxpayers have been assessed under the said Section, tax must be paid notwithstanding that an appeal is made unless the IRB agreed for a stand over order of tax payment. However, based on past experiences, it is not that easy to apply for a stand over order as it would depend on merits of each case.There is nothing much the taxpayer can do because such law is provided under Section 103(1) and (2) of the Act. As the Court cases may take years to come to a conclusion, this would affect the cash flow of the taxpayers as some cases could reach huge amount of tax outstanding. Another option available to the taxpayer is to apply to the High Court for a stay of execution as has been decided in Kerajaan Malaysia v Jasanusa Sdn bhd (1995) . However , the granting of stay must be based on special circumtances, notwithstanding that the tax is due and payable under Section 103(1) of the Act.
Conclusion
To ensure the successfulness of tax planning sheme, it is crucial for taxpayers to constantly update and educate themselves of the legal and accounting developments around them. Those who fail to do so might put themselves in a difficult position in the form of greater taxation and legal sanction due to technical imperfections of their tax planning scheme. In this respect, it is worth the effort to refer to the Public Rulings and Guidelines issued by the IRB despite the fact that these references are not legally binding. If such scheme is not in line with the IRB’s Public Rulings, then taxpayers must be able to justify the reason for taking such an approach considering the fact that the IRB is ever ready to invoke Section 140 as and when it feels necessary to do so.
