September 30, 2018
By Saiful Anuar Sabarudin
Section 140 of Malaysian Income Tax Act 1967 (the Act) provides that the Director General of the Inland Revenue (DGIR) has the power to disregard or vary any transaction to counteract its intended effect if the transaction is believed to produce the effect of altering the incidence of tax, releiving from a tax liability, evading or avoiding tax, or hindering or preventing the operation of the Act (Malaysian Income Tax Act 1967). The provision of wide and general powers to the DGIR under Section 140 of the Act is nobly intended to combat tax avoidance. However, it can be very frustrating for taxpayers to spend a considerable amount of time to come up with a good tax planning scheme, but later find out the scheme is deemed a tax evasion or avoidance by the DGIR under Section 140 of the Act. In this regard, it is essential that the taxpayers take into consideration the effect of Section 140 of the Act when developing a tax planning scheme to avoid any subsequent dispute with the Inland Revenue Board (IRB).
While tax planning in Malaysia may seem a risky business, legal experts in Malaysia are of the view that if the tax planning process is transparent and is within the meaning and ambit of the law, then such tax planning should be acceptable. As long as the principle of “substance over form” is met, the chances of such a tax planning scheme being challenged is arguably very minimal. It is unlikely that a company will reduce its income taxes by labeling a transaction as something it is actually not. It is the substance, not the form, of the transaction that determines its taxability.
Accordingly, there have not been many cases where the IRB invoked Section 140 of the Act despite the existence of the anti-avoidance provision. Transactions that lack commercial substance with the perceived objective of avoiding tax would be vehemently challenged by the IRB. However, genuine tax planning schemes that are within the provision of the Act are generally not set aside under Section 140 of the Act by the IRB.
Section 140 of the Act is indeed an anchor provision concerning tax avoidance. However, this particular section is far from perfect to deal with tax avoidance issue. In the remaining parts of the article, I will discuss examples of cases that would highlight the good, the bad and the ugly of Section 140 of the Act.
The Good
Section 140 of the Act 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 where SB Sdn Bhd, a subsidiary of Sabah Foundation (a charitable trust), donated more than 70% of its net profit to Sabah Foundation from 1980 through 1984. In the three subsequent years (i.e. 1985 – 1987), the amount of donation was further increased to more than 100% of SB Sdn Bhd’s net profit. The tax effect of this transaction is 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 an approved donation under Section 44(6) of the Act, hence reducing its taxable income.
Based on the above transaction, it can be assumed that such a transaction has no regard for the economic reality. Commonly, companies would be remotely likely to donate almost all of its net profit to a charitable body. This case is much more peculiar as the donation made to Sabah Foundation has reached a level of exceeding the net profit amount. As such, the IRB invoked Section 140 of the Act simply because the donation was abnormal, illogical and ridiculous. As a result, the IRB had raised additional tax assessment for SB Sdn Bhd for 8 years which amounted to approximately RM16 million.
The case was brought to the Special Commissioners and the IRB’s decision was upheld by virtue of the deeming provision of Section 140(6) of the Act which deals with related parties transactions. Subsequently, the case went to the High Court and finally, the Court of Appeal.
Surprisingly, in the Court of Appeal, it was held that anti-avoidance provision under Section 140 of the Act was not applicable in this case as this is a tax mitigation scheme and not a tax avoidance scheme. The decision was based on the followings arguments:
- There was an actual donation made by the company to an approved institution (Sabah Foundation)
- The donations made reduced the company’s income under section 44(6) where the Act clearly affords such reduction in tax liability; and
- Anti-avoidance provisions do not apply to tax mitigation where the taxpayer obtains a tax advantage by reducing his chargeable income or by incurring expenditure in circumstance in which taxing statute affords a reduction in tax liability.
The reason why Section 140(6) of the Act was not being considered in the above Court of Appeal’s decision remains a mystery as this clearly contradicted the Special Commissioner‘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.
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. Taxpayers can always depend on the above court decision if they are questioned by the IRB about transactions similar to those of the above case. However, it is important to take note that the Act has restricted the deductibility of approved donation to a maximum of 10% of the aggregate income and hence, limiting the option for a tax mitigation scheme.
The Bad
Another case relating to Section 140 of the Act is the case of Sungai Batu Perlombongan Sdn Bhd (SBP) v Director General of Inland Revenue ( 1988) 1 MSTC 243, 2053, of which the decision was in favor of the IRB by the Special Commissioners. The SBP case was the first challenge made by the IRB under the general anti-avoidance provision of Section 140 of the Act. Since this is the first case concerning Malaysian anti-avoidance case law, it deserves a careful analysis as this would be the precedence for the IRB’s stand in future challenges under this Act.
The facts of the SBP case can be summarised as follows:
- SBP is a mining company which had ceased operations in 1974 with substantial agreed tax losses being recorded.
- Chin, the sole proprietor of another profitable mining operation, injected his profitable mine into SBP for consideration.
- 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 Commissioners are 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 Chins, except for its tax loss asset and there could, therefore, be no commercial motive behind the arrangement. Thus, the DGIR‘s view is that the IRB has good reason to invoke Section 140 of the Act. The case went to the High Court and the court held that the decision of the Special Commissioners is correct in law.
However, it is interesting to note that in another case of SB Sdn Bhd vs Director General of Inland Revenue (1999), the Court of Appeal has taken a different view whereby a taxpayer is only involved 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 considered as tax avoidance. In this regard, can we commonly say that the Chins 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 taxpayer’s argument in the SBP case is that the take over of SBP is purely business transaction in nature. Acceptably, 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 the shareholder long before he transfers his own business to his company which has suffered losses prior to the transfer 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 favor 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 the tax. The leading UK anti-avoidance case makes an interesting reading but does not necessarily influence the Malaysian scene. The reasons used by the DGIR in invoking Section 140 of the Act must still muster a pass with the Special Commissioners and the Malaysian Courts.
Even though it seems that this whole arrangement in the SBP case was not specifically prohibited in the Act, unfortunately, due to the wide power given to the IRB under Section 140 of the Act, it was considered as tax avoidance scheme. Hence, this is bad for the taxpayer.
However, all is not lost for taxpayers considering the impact of Section 140(5) on IRB’s power under Section 140 of the Act.
The impact of Section 140(5) on IRB’s power under Section 140 of the Act
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 of the Act 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 Director of Inland Revenue V HCT (L) Sdn Bhd (1985) 2 MLJ 322 whereby the Supreme Court judgment 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 the 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 eager to invoke Section 140 of the Act which gives them wide power as they only “need a reason to believe” in doing so. 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 of the Act is the fact that if taxpayers have been assessed under the said section, the 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 the 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 a 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] 2 CLJ 701 (SC). However, the granting of stay must be based on special circumstances.
Conclusion
To ensure the success of tax planning scheme, it is crucial for taxpayers to constantly update and educate themselves on 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 and Guidelines, 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 of the Act as and when it feels necessary to do so.
