Malaysian taxation -lecture 6 PDF

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BASIC TAXATION 6 – BUSINESS INCOME – 2012questallim INTRODUCTION Business income is chargeable to income tax under Section 4(a) of the Income Tax Act 1967. In order for the business income to be tax in Malaysia, the following conditions needs to be established: i) the existence of business; ii) the business transaction is income in nature; iii) the business income is deemed derived from Malaysia. 1 BUSINESS Section 2 of the Act defines a “business” to include profession, vocation and trade and every manufacture, adventure or concern in the nature of trade but excludes employment. It is important to distinguish whether the income is a business or employment as the following is only given to a person carrying on a business:a) Capital allowances. b) Certain deductions for expenses incurred. c) Current business losses can be deducted against aggregate income and any unabsorbed business losses can be carried forward to offset against statutory business income

1.1 DEFINITION a) PROFESSION Generally refers to a person who used their intellect or skills. Eg engineering, auditing, legal and medical firms. b) VOCATION A person who attends races and places systematical bets was held in a decided case law to be carrying on a vocation. The gains derived were chargeable to tax even if the vocation was unlawful. TRADE “Trade” normally consists of transactions where there is continuity and repetition of buying and selling or manufacturing. Where there is only one transaction, it can be held to be in the nature of trade as the definition of business includes “adventure or concern in the nature of trade” The “ badges of trade” may be used to determine whether the receipts or gains consist of an adventure or concern in the nature of trade. d) ADVENTURE OR CONCERN IN THE NATURE OF TRADE Malaysian income tax imposes tax on transaction that gives rise to “income”. An isolated transaction would be taxed as business income, if it fell into either “trade” or “adventure or concern in the nature of trade”. In the event an isolated transaction is seen as realising an investment, the surplus is a capital gain and thus is outside the ambit of income tax.

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BASIC TAXATION 6 – BUSINESS INCOME – 2012questallim It may be difficult to hold an isolated transaction to be trade but it is easier to establish such transaction as an “adventure in the nature of trade” and income tax applies. 1.2 BADGES OF TRADE The courts have laid down guidelines or tests to distinguish the following: a) gains arising from disposal of an investment; and b) gains from trade or an adventure or concern in the nature of trade. The mnemonic is PROFITS WIN P Purpose R Repetition O Organisation F Financing I Improvement T Timing S Surrounding factors W I N

Ways of disposal Interest in similar field Nature

a) Purpose / Intention The conduct of the taxpayer with regard to the subject matter would be examined to discover the true intention at the time of acquisition. Where an asset purchased for investment, was subsequently sold, the gain derived is not taxable. If there has been a change of intention, the gain derived would be taxable as the investor has changed his intention to be a trader. b) Repetition / Frequency of Transaction Where the same type of object or article is repeatedly bought and sold, it would generally lead to the presumption that there is trading in that article.

c) Organisation / Transaction by Companies In the case of a formation of a company, the nature of the company’s operation and the accounting treatment of the asset in the records will be examined.

d) Financing / Mode of Acquisition A person who borrows more than he could normally afford to purchase an item could indicate that he was involved in a trading adventure.

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BASIC TAXATION 6 – BUSINESS INCOME – 2012questallim e) Improvement / Supplementary Work Supplementary work such as modification, processing, packaging, improving, renovating of the item sold where the character or quality has been changed to make it more saleable would suggest that a trade is carried on. f) Timing / Length of Ownership Generally, if the period of ownership between acquisition and disposal of asset is long the less likely that such disposal would be considered to be a trade. Where there is a quick resale there will be an impression that a trade was conducted and the gain might be taxable. g) Surrounding Factors / Circumstances Responsible for Realisation A forced sale to provide cash in emergency indicates that the property was not acquired for the purpose of resale at a profit. However, this test does not apply to trading stock h) Ways of Disposal of an Article If activities are made to find or attract purchasers to dispose of an asset such as advertisement, setting up an office, employment of staff will indicate the presence of a profit making scheme.

j) Nature / Subject matter There are 3 reasons for purchasing an article: i) ii) iii)

for the purchaser’s own use or the use of his family or friend; or for investment which yield income or gives pleasure; or for resale at a profit.

Purchasing of large quantities of articles is obviously not considered to be for personal use or for investment. For example gain from disposing a million rolls of toilet paper, large quantity of whisky greatly in excess of what could be used by himself, his family and friends.

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BASIC TAXATION 6 – BUSINESS INCOME – 2012questallim a. CAPITAL / REVENUE RECEIPTS Receipts that are capital in nature do not fall within the ambit of income tax. It is therefore important to distinguish whether a receipt is capital or revenue.

CAPITAL RECEIPT

REVENUE RECEIPT



Relate to fixed capital



Relate to circulating capital



Loss of a source of income



Loss of income / loss of use of an asset



Cancellation of a contract which substantially the whole structure of the organisation or framework of the business or destruction of profit making apparatus



Sale of part of profit making apparatus

 

Imposition of substantial restriction

Cancellation of trading contract in the ordinary course of business

Examples (a) Receipts that are revenue in nature Compensation for cancellation one of the several agency contracts / business contracts Compensation from insurance on stock destroyed in a fire; Interest charged on trade debtors for late payments for goods sold / services rendered; Recovery of bad debts (trade debts) Compensation for ‘loss of business profit’ Sale of trading stock / circulating stock (b) Receipts that are capital in nature Compensation for cancellation of the major agency contract / business contract Sale of only business patent, secret formula, secret process, know-how, business license Payment for goodwill Compensation received from a competitor for restriction on business activity Compensation from insurance on machines stolen by thieves; Sales of building, factory, plant and machinery Sales of investments (shares)

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BASIC TAXATION 6 – BUSINESS INCOME – 2012questallim 2

BUSINESS INCOME DERIVED FROM MALAYSIA Section 12(1) provides the circumstance business income is derived or deemed derived from Malaysia. a. Gross income from a business, which is not attributable to the operation of the business carried on outside Malaysia, is deemed derived from Malaysia. Profits attributable to operations outside Malaysia is taxable only when it is received in Malaysia, based on remittance basis. However, it is exempted under the Schedule 6 par 28. The following would determine whether business income is deemed derived in Malaysia i) ii) iii) iv) v)

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Contract concluded in Malaysia. Stocks are maintained in Malaysia of which orders fulfilled. Passing of ownership and risk in Malaysia. Sale proceeds received In Malaysia Services rendered in Malaysia.

GROSS INCOME FROM A BUSINESS 3.1 Section 22: Gross income from a business shall include any sums receivable or deemed to have been received by way of a. Insurance, indemnity, recoupment, recovery, reimbursement or otherwise i ii

Where such sums are in respect of outgoing and expenses deductible in ascertaining the adjusted income; or Under a contract of indemnity.

b. Compensation for loss of income from that source. Examples of receipts are insurance recoveries, compensation received for breach of contract, discounts and commission. The amount received must relate to working capital. If the amount received is resulted from past expenses and outgoing of revenue expenditure, it would be treated as gross income. Where the amount received relates to fixed capital, it would not be subject to income tax as it is a capital receipt.

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BASIC TAXATION 6 – BUSINESS INCOME – 2012questallim 3.2 Section 24(1): A debt in respect of the following shall be treated as gross income for a business a. any stock in trade sold; b. any services rendered; or c. use or enjoyment of any property.

} } in the course of carrying } on a business

The effect of this section, business income is assessed on an accrual basis. Section 24(2),(3): Where any stock in trade of a business is drawn for the personal use of the proprietor, the market value of the stock at the time of withdrawal shall be treated as the gross income of a business.

Section 30(1): Recovery of bad debts, which has previously been allowed as a deduction in ascertaining the adjusted income, the amount recovered, shall form the gross income of a business.

Question State with reason whether each of the following is taxable (to be included as gross income from business a) b) c) d) e) f) g) h)

goods taken for private use good donated compensation from insurance on stock destroyed in a fire compensation from insurance on machines stolen by thieves interest charged on trade debtors for late payments recovery of bad debts (trade) sales of investments compensation for loss of business profits

Answer (a) The market value of goods (on the date of withdrawal) to be included as gross income as required under s.24(2)(a). (b) The market value of goods (on the date of donation) to be included as gross income as required under s.24(2)(b) where goods were withdrawn without consideration. (c) Taxable as the compensation was for trading stock/circulating asset. (d) Not taxable as the compensation was for the loss of fixed assets. (e) Taxable; revenue receipt in the ordinary course of business. (f) Taxable; revenue receipt in the ordinary course of business. (g) Not taxable; the shares were not the trading stock / circulating asset of the business. (h) Taxable; receipt for loss of profit is revenue receipt.

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