Chapter 5 corporate tax stds (2)

TOPIC 5 CORPORATE TAXATION

GROSS INCOMEDEDUCTIBLE EXPENDITURES

TAX PAYABLE

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LEARNING OUTCOME• TO DETERMINE THE GROSS INCOME

OF A COMPANY (BUSINESS AND NON BUSINESS)

TO IDENTIFY DEDUCTIBLE EXPENDITURE

TO COMPUTE THE CHARGEBLE INCOME OF A COMPANY

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CHAPTER 5 (a)GROSS INCOME

Badges of Trade

1. SUBJECT MATTER2. PERIOD OF OWNERSHIP3. FREQUENCY OF TRANSACTIONS4. SUPPLEMENTARY WORKS DONE PRIOR

TO SALE5. ORGANIZATION SET UP TO DISPOSE THE

GOODS6. MOTIVE FOR THE TRANSACTIONS

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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/coke

- BUT if buying and selling Pepsi/coke – even a single bottle – will increase the trading stock clearly a trading transaction

- Rutledge 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)

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Badges of Trade

2. PERIOD OF OWNERSHIP- Wisdom 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 profits

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Badges of Trade

3. FREQUENCY OF TRANSACTIONS- Transaction 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.

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Badges of Trade

4. SUPPLEMENTARY WORKS DONE PRIOR TO SALE- Cape 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.

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Badges of Trade

5. ORGANIZATION SET UP TO DISPOSE THE GOODS- Martin 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.

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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)

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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 fixed

assets).

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Capital vs Income

Section 22(1) and (2):◦ Applies to revenue receipt◦ If the gross income resulted from past expenses

and outgoings of revenue nature, it would then be treated as income

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The Ascertainment of Gross Income

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.

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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.

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Answer…..

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.

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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.

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Waiver of Amounts Owing to Creditors The 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”.

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Discussion:

Issue: Advise Samad whether the waiver of RM2,500 is taxable.

CHAPTER 5 (b)

BUSINESS DEDUCTIONS

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Principles of Deduction

Revenue versus capital expenditure Expenditure incurred by the taxpayers

carrying on a business Qualifying deduction under the ITA Timing of the expenditure Expenditure wholly and exclusively

incurred in production of gross income

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General provisions for deductions

Deductibility under Section 33 of ITA:◦ Outgoings and expenses◦ Wholly and exclusively◦ Incurred◦ During that period; and◦ In the production of gross income

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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. 

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Answer:

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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.

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Deductions Prohibited

Section 39(1)

(a) Domestic & private expenses (b) Expenditure not wholly incurred(c) Capital withdrawn and any sums employed as capital(d) Contribution to a non-approved scheme(e) Qualifying mining, prospecting and agricultural(f) Interest or royalties paid to a non-resident person(g) Payment 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 cost

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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

1/6/2010

Cost of car

Wira 1.5 RM25,000 15,000 85,000

Van 15,000 50,000 12,000

BMW 45,000 35,000 210,000

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Answer:Amount restricted to

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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 allowance RM10,000Entertainment to supplier 5,000Sponsorship – cultural show at a sporting event open to members of the public

50,000

Gifts to customer for purchase above RM100 15,000Launching a new product 20,000

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Allowable Remarksallowance RM10,000supplier 5,000cultural show 50,000Gifts to customer 15,000Launching a new product

20,000

100,000

Answer:

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Deductible & Non-deductible expenses

1. Section 33(1)(a): interest2. Section 33(1)(b): rent3. Section 33(1)(c): repairs & renewal4. Section 33(1)(d): other deductions

Empower Minister of Finance to prescribe relevant deductions from time to time

The deduction sometimes not allowable under ordinary rules but in view of particular economic necessity

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Section 33(1) (a)Interest

- Interest expenses on money borrowed would be allowed as deduction under the following 2 circumstances:1. The loan employed in production of gross

income2. The loan is laid out on asset used/held in

that period for the production if business income.

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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)

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Section 33(1) (b)Rent

- Would be accorded a deduction if it was:1. Payable for occupying the land/building

(immovable properties)2. Used in relation to the period3. Incurred for the purposes of producing

gross income of that source (i.e business must have commenced)

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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.

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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.

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Section 33(1)(c) - repairs & renewal- REPAIR - Principle in case laws:– Capital in nature (NOT deductible)

(a)Improvement on a an asset(b)Acquisition repair(c)Replacement on whole of the asset (entirety)

– Revenue in nature (deductible)a. repair of premises, plant, machinery or fixtures

employed in the production of gross income;b. Replacement of part of assetc. Renewald. Maintaining the commercial viability of an assets

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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:

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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:

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Specific Business deduction

- Bad debts - Employer’s 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)

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- 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)

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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:

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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.

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Accountancy fees Advances & loans Advertising costs – allowable Books & periodicals Business acquisition costs Acquisition of trading stock on

takeover: deductible Travelling expenses: non allowable

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

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Trade & club subscription Income taxes: non allowable Clothing & tools: non allowable Company general meeting: non allowable Trade exhibition and travelling expenses Consumable aids: allowable crop re-planting: allowable

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

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Deduction of outgoings & expenses [section 33(1)] Damages Defending capital assets: allowable Devaluation losses: allowable Fines & penalties: non allowable Terminating redundant employee: allowable Legal expenses in restructuring exercise:

allowable Audit fees: allowable

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Interest on loan to small business Employment of disabled employees Insurance premium for import of cargo Training of an handicapped persons Export credit insurance premium Freight charges (from Sabah & Sarawak) Research expenditure Contribution to approved research institute Overseas expenses for promotion of tourism Expenditure for approved training

Double Deduction

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Double Deduction

Expenses incurred in international trade fair Fees incurred in packaging design (wef YA2001) Advertising Malaysian brand product Promoting brand names Promote export of services Halal certification Promotion of higher education

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CHAPTER 5 (c)TAX PAYABLE

FORMAT

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Add Less

Net profit/(net losses) xx

+) Any item/expenses not allowable for deduction

xx

-) 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/loss XX

+) Balancing charges xx

-) Capital allowance/ balancing allowance (xx)

Statutory Income XX

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Statutory Income XX

(-) Loss b/f (xx)

(+) Other income xx

Aggregate income XX

(-) Approved donation*

Total Donation vs 10% from Aggregate income (Which is lower) (xx)

Chargeable Income XX

Paid up share capital (<=RM2million)

Tax on the 1st 500,000 @ 20%

Tax on the balance _____@ 25%

Tax Payable XX

THANK YOU

Q & A

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