Gazette Orders MALAYSIAN DEVELOPMENTS INTERNATIONAL DEVELOPMENTS

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1 TAX nsights An Occasional Series 3/ 2009 MALAYSIAN DEVELOPMENTS Gazette Orders Labuan Public Rulings East Coast Economic Region (ECER) Administrative matters Stamp duty Double Tax Agreements (DTAs) Case Law INTERNATIONAL DEVELOPMENTS Bangladesh China Greece Hong Kong India New Zealand Singapore Taiwan United States of America (U.S.A) Association of South East Asian Nations (ASEAN) OECD The road to global recovery remains sluggish and uncertain, although there are hints of an improvement. The economic results for Malaysia for the second quarter of this year show a slight improvement, with a slower pace of economic contraction of 3.9% as compared with 6.2% in the first quarter. The improved result was largely due to increased domestic spending in the second quarter. Overall, most sectors recorded a modest improvement, and although the domestic economy is expected to reflect better results for the second half of the year, this will largely be dependent on the global economy which still has some way to go on the road to recovery. The forthcoming 2010 Budget which is due to be announced on 23 October 2009 will prove a real challenge for the Government in its efforts to boost the economy, cut its operational spending, increase revenues and meet the needs of the rakyat. The question as to whether the long anticipated Goods and Services Tax (GST) will be introduced continues to be raised. Whether or not the Government will have the political will to announce this is left to be seen. In the last few months, we have witnessed a move to make Malaysia more attractive to investors, with the announcement of liberalisation measures. As many as 27 services subsectors were fully liberalised to foreign investors. Among the service sectors which have been liberalised are the information technology (IT) and related services sector, the health and social services sectors, the tourism and recreational services sectors, the transportation sector, the business services sector, etc. Additionally, the 30% Bumiputera equity requirement for newly listed companies has been removed. This move has been widely welcomed both domestically and by potential foreign investors, who have found the previous local equity requirements restrictive. There have been some interesting tax developments both domestically and internationally over the last few months which are summarised below. Malaysian Developments Gazette Orders Income Tax (Deduction for Cost of Training for Employees) Rules 2009 The Income Tax (Deduction for Cost of Training for Employees) Rules 2009 allows a double deduction for the cost of providing the following types of training courses to employees for the purpose of upgrading and developing employees technical skills: (a) post graduate courses in information technology and communication, electronics or life sciences; (b) post basic courses in nursing or allied healthcare; or (c) approved aircraft maintenance engineering courses It should be noted that the employer must be resident in Malaysia and that the rules have effect for the years of assessment 2009 to Further, the double deduction will not be given where the employer has made a claim to the Human Resource Development Fund. 1

2 Income Tax (Exemption)(No.3) Order 2009 This Order takes effect retrospectively from 30 August 2008 and is effective until 31 December The Order operates to exempt non-resident persons from tax in respect of fees derived from the training courses specified in the Income Tax (Deduction for Cost of Training for Employees) Rules 2009 (above). Such training fees which would otherwise fall within the ambit of Section 4A(ii) where the training courses are customised, will not be subject to withholding tax. Income Tax (Request for Information) Rules 2009 These Rules were recently gazetted to provide competent authorities from countries with which Malaysia has entered into double tax agreements, the right to request information from the Director General of the Inland Revenue Board. This also extends to requests for information from banks which have to be made via the Director General. Where such requests are made to the Director General, the competent authority would be required to indicate the purpose for which the information is required as well as to indicate the requisite information clearly (e.g. name and identification of the person in respect of whom the information is sought, their bank account details where bank information is required, etc). Income Tax (Exemption)(Amendment) Order 2009 This Order has been enacted to amend and incorporate changes to the Income Tax (Exemption) (No.11) Order 2005 (which provides a tax exemption for venture capital companies). The details of the changes are as follows: - Previously, in order to obtain a tax exemption for ten years of assessment or for the years of assessment equivalent to the life of the Venture Capital Company (VCC), whichever is the lower, the VCC had to invest at least seventy per cent of its invested funds in venture companies or where the investment is in the form of seed capital at least fifty per cent of its invested funds in seed capital. The change now requires that at least seventy percent of the funds must be invested in a venture company at the point of the first investment or at least fifty percent of the funds must be invested in the form of seed capital at the point of the first investment. - An exemption is also now available for five years of assessment or the years of assessment equivalent to the life of the VCC, whichever is lesser, provided at least thirty percent of the funds invested in venture companies takes the form of seed capital, start-up financing, early stage financing or a mixture of the three. Further the application for exemption should be made to the Securities Commission between 30 August 2008 and 31 December It should be noted that if a VCC has been granted an exemption under the provisions of the original order issued in 2005 then such exemption shall continue to apply notwithstanding the amendments made via this order. Otherwise, the changes are deemed to be effective from the year of assessment Promotion of Investments (Promoted Activities and Promoted Products)(Amendment) Order 2009 This Order widens the list of promoted products /activities for the purposes of the pioneer and investment tax allowance incentives to include the additional products/activities in relation to the categories set out below. As can be seen in the table below, the widening of the promoted products activities takes effect retrospectively. Category of Activity Processing of agricultural produce Manufacture of wood and wood products Manufacture of machinery and machine parts Free Zones Act Amendment Effective from 1 June 2009, the districts of Senai, Kulai, Johor Bahru and the Sultan Ismail International Airport have been gazetted as Free Industrial Zones. The Second Schedule of the Free Zones Act 1990 has been amended to reflect this. Labuan Widening of promoted products/activities to include: Food additives, flavoring, coloring, etc. This takes effect from 31 January 2008 Design and development and production of wooden furniture. This takes effect from 28 June 2007 Equipment for water treatment, waste water treatment and sewage treatment. This takes effect from 9 November 2006 Changes are expected to the legislation in relation to Labuan offshore companies, following the introduction of the following Bills: - Labuan Offshore Financial Services Authority (Amendment) Bill Labuan Offshore Trusts (Amendment) Bill

3 - Labuan Limited Partnerships and Limited Liability Partnerships Bill Labuan Offshore Business Activity Tax (Amendment) Bill Labuan Foundations Bill Offshore Companies (Amendment) Bill 2009 With respect to the Bill to amend the Labuan Offshore Business Activity Tax Act, 1990 ( LOBATA ), an offshore company has been redefined as a Labuan company and accordingly, an offshore business activity has been redefined as a Labuan business activity. The tax treatment of such companies remains unchanged, i.e. these companies are taxed at 3% of their net profits or can elect to pay RM20,000. The Bill also contains new provisions allowing for Advance Rulings to be sought in respect of the LOBATA as well as new provisions concerning the disclosure of information. Public Rulings Public Ruling 3/2009 -Professional Indemnity Insurance A new public ruling (PR) has been issued to replace the earlier PR 5/2006. Essentially, the new PR widens the scope for the deduction for professional indemnity insurance (PII) premium expenses. Previously, such expenses were only deductible where a professional person was required to have professional insurance under the laws or by-laws applicable to the respective profession. The new PR now allows a deduction for PII premiums to professionals who are not under an obligation to purchase PII, but who nonetheless choose to do so, provided the professionals carry on the business of their respective professions. The new PR also specifies that in the event a deduction has been allowed, any proceeds received thereof are taxable, regardless of whether the proceeds are paid directly to the professional or to the claimant. Where the proceeds are paid to the professional and the latter subsequently compensates the claimant from the proceeds received, such a payout would not be deductible to the professional. with the IRB. Addendum to PR 6/ Trade Associations This addendum to PR 6/2005 which is effective from year of assessment 2009, widens the definition of a trade association to include an association formed with the main object of developing and advancing the profession of its members, such as professional associations. The addendum provides an example of the computation of chargeable income for trade associations which clearly shows that adjusted losses/unabsorbed capital allowances in respect of member s subscriptions will be disregarded. Third Addendum to PR 1/ Perquisites from Employment This addendum widens the scope of tax exempt meal allowances to include meal allowances provided to employees when working overtime or during overseas/outstation trips as well as per diem allowances which are intended to cover the cost of meals. However, it should be noted that the employer must have a formal meal allowance/per diem policy pursuant to which such allowances are paid. This warrants further analysis as such payments are analogous to compensation payments/warranty costs incurred by a manufacturer for instance in respect of faulty products. The latter payments would be tax deductible to the manufacturer. By the same token, such payments should be tax deductible to a professional. It is understood that this matter is being raised by the professional bodies 3

4 East Coast Economic Region (ECER) Timing of disclosure Penalty Rates The ECER initiative was first launched in 2007 to spearhead growth in the states of Kelantan, Terrenganu, Pahang and the Mersing district of Johor. More recently, the Government has announced that a Special Economic Zone (SEZ) will be launched within the ECER. The SEZ will comprise 6% of the ECER s prime land area which is expected to create 80% of the economic wealth and 50% of jobs in the ECER. The SEZ will comprise new townships, tourism sites, knowledge innovation zones, four ports and two airports. Within the SEZ, four free zones will be set up alongside the Kemaman port, Kuantan Port City, Tanjung Agas and Kuantan airport. Tax incentives including a ten year tax exemption, 100% investment tax allowance and exemptions from import duties will be given for qualifying activities within the SEZ. Additionally, it is understood that the incentives will be customised for qualifying investors. Administrative Matters Benefit of Free Petrol Since the enactment of the 2009 Budget proposals to exempt employees from tax in respect of travel allowances of RM2,400 for travel to and from work, and travel allowances of RM6,000 for official travel, there has been some confusion as to the exemption and the tax treatment of benefits in kind for free petrol. The IRB has liaised with the Ministry of Finance (MOF) on this matter following a dialogue between the IRB and the professional bodies in May 2009 and has provided the following clarification: Employees who are provided with free petrol by their employers can elect to be taxed at the prescribed values under Appendix 2 of the Public Ruling No. 2/2004 OR claim an exemption of RM2,400 and RM6,000 respectively on petrol used from home to work and vice versa and for official travels. Where the employer is not able to segregate between petrol used from home to work and for official travels, then only the RM6,000 exemption will be given. Tax Audit Framework The IRB has recently issued a new Tax Audit Framework which is effective from 1 January 2009 (to replace the earlier framework issued in January 2007). The new Framework includes a change to the penalty rates in respect of voluntary disclosure made within 6 months from the filing date. The penalty rates are as follows: Within 60 days More than 60 days but within 6 months Within 6 months to 1 year Within 1 year to 3 years More than 3 years After taxpayer is informed but before tax audit visit 10% 15.5% 20% 25% 30% 35% It should be noted that this framework is not applicable where the tax audit involves Sections 140A and 138C of the Income Tax Act, 1967 (ITA) (i.e. transfer pricing, thin capitalisation and advanced pricing arrangements). New Withholding Tax Forms [CP37E and CP147] New withholding tax forms have been issued as follows: Form CP37E this form is for deductions made pursuant to Section 109E of the ITA in relation to family funds, family re-takaful funds or general funds. Form CP147 (Pin 5/2009) - this form is to be completed for payment of the increase in tax arising from noncompliance with withholding tax provisions. (Note that this supercedes the earlier version of the form.) Tax Return Forms for the Year of Assessment 2009 for Non-Companies The IRB has issued the following tax return forms together with guidebooks and explanatory notes: Form TR 2009 for Real Estate Investment Trusts/Property Trust Funds. Form TC 2009 for Unit Trusts. Form C for Co-operative Societies. Guidelines Information Required When Making Tax Payments (GPHDN 1/2009) The IRB has issued guidelines which stipulate the information required when making payments for income tax, real property gains tax and withholding tax. The guidelines set out the details of the relevant payment codes, the types of forms to be used, payment methods, etc. Issuance of Tax Clearance Letters for Companies (GPHDN 2/2009) The IRB has issued guidelines in respect of applications for tax clearance letters for dormant companies, companies 4

5 under members voluntary liquidation and companies under liquidation by creditors. The IRB has clarified that a director of the company is required to formally write to the IRB to seek such tax clearance. In order to obtain tax clearance, the company should have submitted its tax returns (Forms C and R including R31 if required) up to the latest year of assessment. However, companies who have yet to file their last tax returns can use the returns of the immediately preceding year of assessment. It should be noted that, apart from submitting the Form C and the Form R, several other documents should also be submitted for each of the cases mentioned above. The list of additional documents that needs to be submitted is stated in the guidelines. Application to Leave the Country Temporarily under Section 104 of the ITA (GPHDN 3/2009) Generally taxpayers are required to fully settle their outstanding tax liabilities before leaving Malaysia. However the IRB has recently issued guidelines which provide that a taxpayer with unpaid taxes may apply to leave Malaysia temporarily for a specified period of time. The guidelines stipulate several criteria that the taxpayer is required to meet, including the payment of 50% of the outstanding taxes and an agreement to settle the remaining taxes in a series of instalment payments which the IRB must approve. Companies and Co-operative Societies Prescribed Forms for Self-Amendment of Tax Returns The IRB has recently issued the prescribed forms for selfamendment of the Form C for companies and the Form C1 for co-operative societies. The new forms are the Forms CP6 and CP6A respectively. Pursuant to Section 77B of the ITA, companies and co-operatives should use these forms when amending their tax returns for the year of assessment 2009 and onwards. It should be noted that self-amendment of tax returns can only be submitted after the tax filing due date and within six months of that date. Construction Industry The construction industry raised concerns about the application of stamp duty on main contracts as well as on subsequent subcontracts of the same. The MOF has taken their concerns into consideration and has announced that with effect from 15 July 2009, a stamp duty remission would be granted in respect of such multi-tier contracts as follows: Government contracts where the main contract is with the Government, the Government is exempted from stamp duty. The ad valorem duty will therefore be imposed at the next stage, i.e. on the contract between the main contractor and the sub-contractor. If the subcontractor were to enter into further sub-contracts, the latter would only be subject to stamp duty of RM50 each. A remission will be given for the remaining stamp duty (based on the ad valorem rate). Non-Government contracts only the main contract will be subject to ad valorem duties and subsequent subcontracts will be subject to RM50 stamp duty respectively. Again, this means that the ad valorem stamp duty will be remitted in respect of the subsequent sub-contracts. Services Industry Service agreements now fall within the ambit of Item 22 as well. The MOF has reviewed the application of stamp duty to service agreements and has confirmed that service agreements entered into between 15 September 2009 and 31 December 2010 will only be subject to stamp duty of RM50. A remission will be granted in respect of the balance of stamp duty which would otherwise be payable. However, with effect from 1 January 2011, ad valorem duty will apply to service agreements. It is advisable therefore to segregate (Note: The relevant forms and guidelines, etc reported above can be obtained from the IRB website at Stamp duty Since the 2009 budget proposals involving a change in the Stamp Act 1949 to widen the ambit of Item 22 of the First Schedule, there has been ambiguity over the application of the ad valorem stamp duty for various industry sectors. In addition, there has been an outcry about the increase in costs due to the imposition of the stamp duty. 5

6 Case Law MI (Malaysia) Berhad v Ketua Pengarah Hasil Dalam Negeri [(2008) MSTC 3,741] This case involved the question of whether the sum received upon the maturity of fixed deposits constituted a realisation of investments. In this case, the taxpayer was a resident life insurance company and in its tax computation, it had treated the sum received upon the maturity of its fixed deposits as a gain from the realisation of investments in computing its deductible management expenses (based on the formula prescribed by Section 60(3) of the ITA). the service portion of such agreements from any other elements, e.g. the supply of raw materials, etc. where this would otherwise be integrated in the service project. In both instances, it should be noted however that until the stamp duty remission referred to above is gazetted as law, an application for remission from stamp duty must be made pursuant to Section 80(1A) of the Stamp Act, 1949 for each case. This, however, places an administrative burden on both the contractors as well as the Government. Double Tax Agreements (DTAs) Malaysia Iran The IRB s website indicates that the DTA between Malaysia and Iran which was signed several years ago is now effective, with the effective dates for income tax /withholding taxes being any year of assessment beginning on or after 1 January 2006 and for petroleum income tax, for a year of assessment beginning on or after 1 January The withholding tax rates applicable are as follows: Royalties 10% Technical fees 10% Interest 15% Malaysia Brunei Malaysia and Brunei signed a DTA on 5th August 2009, the details of which are not available as yet. The DTA has yet to be gazetted. Malaysia United Kingdom (U.K) Malaysia and the U.K have signed a protocol to the Malaysia U.K DTA on 22 September 2009 which will have the effect of bringing the Exchange of Information Article of the current DTA in line with the OECD requirements. The Special Commissioners held that a fixed deposit does not involve an element of risk, in that the principal is secured. Further, upon maturity, the return is payable in cash without the need to convert or sell the asset. Therefore, a fixed deposit does not carry the typical characteristics of an investment and its maturity would not amount to a realisation of an investment within the meaning of Section 60(3)(a) and (b) of the ITA. Mengawarti Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri [(2009) MSTC 4414] This case involved the deductibility of costs (i.e. land premium and other related costs) associated with land alienation. The taxpayer was a company involved in the business of housing development. In connection with this activity, state land was alienated to the taxpayer for a premium of RM858,000. The taxpayer subsequently entered into a joint venture agreement with another developer, whereby the latter was given the right to develop and sell the completed units in return for which the taxpayer was paid a sum of RM900,000. The RM900,000 was paid in two instalments, comprising RM831,340 which was paid upon receiving approval from the state authority and the balance of RM68,660 upon completion of the development. Additionally, the developer agreed to pay the taxpayer an additional RM0.50 per square foot upon completion of the project. The tax authorities brought the RM900,000 to tax as income and disallowed a deduction for the land premium and related costs. The Special Commissioners did not allow a deduction for the land alienation costs as the Special Commissioners found there was insufficient evidence to prove that this amount was actually paid. On appeal, the High Court dismissed the taxpayer s appeal and went on to find that the land alienation costs were capital in nature (although this was obiter). On further appeal by the taxpayer, the Court of Appeal 6

7 dismissed the taxpayer s appeal primarily on the grounds that there was insufficient evidence that the land alienation costs had been paid. Ketua Pengarah Hasil Dalam Negeri v Perbadanan Kemajuan Ekonomi Negeri Johor [(2009) MSTC 4,399] The issue in this case involved the question of whether income in the context of a tax exemption meant gross income or chargeable income. The taxpayer was a statutory body which was involved in several activities. The taxpayer had been granted an exemption from tax pursuant to Section 127 of the ITA on all its income except dividend income. During the years in question, the taxpayer made some approved donations, for which it sought a deduction against its taxable dividend income. The IRB however, restricted the deduction, by apportioning the donations against the other exempt income and the taxable dividend income. The taxpayer appealed on the basis that the donations should not be apportioned and should be fully deductible against the dividend income. The Court of Appeal held that an exemption can only arise in respect of chargeable income and not gross income. However, the Court held that although not expressly provided for, the power to apportion expenses is implied in Section 33(1) of the ITA, and therefore, it held that the IRB was not incorrect in apportioning the donations made against the exempt income and the dividend income. Reference was made to the previous decisions of Lower Perak Co-operative Housing Society Bhd v.kphdn [(1994) 2 MLJ 713] and Daya Leasing Sdn Bhd v KPHDN [(2005) MSTC 4,124]. TWR Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri (Rayuan PKCP 18/2004)) This case involved the age-old question of whether a gain arising from the disposal of land should be subject to income tax under Section 4(a) of the ITA or real property gains tax ( RPGT ). The taxpayer was a corporate entity which was set up to acquire land on which a group company, OEC Malaysia was supposed to set up a steel mill. Approval was obtained from the Malacca State Government to set up the steel mill at the proposed site. Although the land was classified as agricultural land, the intention was to convert this to industrial land. Another pertinent fact is that the vendor of the land in question insisted that the land be sold together with two other parcels of land. The taxpayer agreed to purchase the two other parcels of land with the intention of building accommodation for the steel mill workers and building houses for sale. Subsequently, the Malacca State Government requested OEC Malaysia to locate the steel mill to an alternate site. When this occurred, the taxpayer attempted to get the vendor of the land to rescind the agreement but was unsuccessful and therefore the taxpayer was left with the land. Thereafter the taxpayer successfully obtained the necessary approvals for conversion and subdivision of the land. No further work was carried out on the land and three years subsequently, the taxpayer sold the land and filed a RPGT return. The IRB contended that the sale of land was subject to income tax rather than RPGT. The Special Commissioners held that the gain was subject to income tax. The facts which gave rise to this decision were as follows: - based on the taxpayer s objects in its memorandum of articles of association, it was not authorised to carry out a steel mill business, although the Special Commissioners did note that objects per the memorandum are not necessarily conclusive - the size of the land in question was more appropriate for a housing development, rather than a steel mill - the taxpayer s conduct with respect to the purchase and sale of the property indicated an adventure in the nature of trade, i.e. the seeking of approval for development and subdivision and immediate sale of the land thereafter. The taxpayer has appealed against this decision. SESB v Ketua Pengarah Hasil Dalam Negeri (Rayuan PKCP 33/2004) This case involved the question of whether the disposal of a right to build amounted to a disposal of stock in trade for income tax purposes. The taxpayer, a company involved in both property development and property investment, was granted the absolute right to construct a mixed development project. The project involved the construction of a shopping complex, two apartment blocks and a hotel which was to be built above the shopping complex. The shopping complex and hotel would comprise investment property while the apartment units were to be sold to individual buyers. The taxpayer subsequently sold the right to build the hotel to a wholly owned subsidiary. The reason for the sale was to facilitate better management of the hotel and to capitalise on the opportunity for the hotel project to benefit from tax incentives. The consideration for the sale of the right to build amounted to RM7,000,000 which was satisfied by the issuance of shares in the subsidiary company. 7

8 The IRB sought to subject the transaction to income tax on the basis that the right to build constituted trading stock of the taxpayer. The taxpayer however argued that the hotel project would have been a fixed asset and hence the transfer of the right to build was a transfer of a capital asset and should be subject to RPGT rather than income tax. The Special Commissioners held that based on the facts, the taxpayer had clearly discharged the onus on proof required under Schedule 5, paragraph 13 of the ITA that the assessment to income tax was erroneous, and hence ordered the notice of assessment to be discharged. The gains derived from the sale of the right to build the hotel should be subject to RPGT. The IRB has appealed against the decision. SH Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri (Rayuan PKCP 34/2007) This case involved the question as to whether the balance of the industrial building allowance (IBA) in respect of a hotel can continue to be claimed after the expiration of the taxpayer s tax exempt period arising from the investment tax allowance incentive (in relation to the hotel business). The taxpayer was in the hotel business and was eligible for the investment tax allowance for a five year period commencing in Upon expiration of the tax exempt period, the taxpayer continued to claim IBA in respect of the hotel building. The IRB did not allow the IBA claim on the basis that this was only available during the tax exempt period. The IRB argued that prior to the year of assessment 2002, hotel buildings did not qualify for IBA under Schedule 3, ITA. In the taxpayer s case, the taxpayer could only claim the IBA in view of Section 30 of the Promotion of Investments Act, 1986 (PIA) which allowed a claim for IBA where a company was entitled to the investment tax allowance incentive in respect of the hotel. The IRB argued that upon expiry of the tax exempt period, the right to the IBA claim also lapsed. The Special Commissioners dismissed the taxpayer s appeal. They held that the taxpayer was not eligible to continue to claim IBA on the residual expenditure after the expiry of the tax exempt period. The taxpayer has appealed against this decision. FFH (M) BHD v Ketua Pengarah Hasil Dalam Negeri (Rayuan PKCP 42/2007) This case involved the question of whether interest-free loans can be grouped together with interest-bearing loans as a source of interest income. The taxpayer was an investment holding company which incurred interest costs on borrowings which were used to finance its business activities as well as to make advances to its subsidiaries. Some of the advances made were interest bearing and others were interest free. The taxpayer took the position that the advances to its subsidiaries constituted a single source of interest income relying on the decision in MP Holdings Sdn Bhd v. KPHDN [(2001) MSTC 3880].The IRB did not accept this. The Special Commissioners decided against the taxpayer and distinguished the facts of this case from the MP Holdings decision which held that in the attribution of interest expense, there was no need to distinguish between income producing and non-income producing sources of income. For instance, an investment in shares was a potential source of income even if the shares did not generate any dividend income for the year in question. In the present case, it was held that an interest-free advance was not a source of income and would not be a source as long as the advance was interest free. Accordingly, related interest expenses would not be allowable as a deduction as the interest cost cannot be said to have been incurred in the production of income. The taxpayer has appealed against the decision. SE & TM Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri (Rayuan PKCP 14/2008) This case involves the issue of qualifying expenditure for the purposes of claiming the reinvestment allowance (RA). The taxpayer in this case was a manufacturer who incurred costs on expanding its business by building a new factory adjacent to its existing factory. The new factory started production in July 2002 and the taxpayer claimed RA in respect of this 8

9 expansion. The taxpayer claimed RA in respect of the entire premises, including the warehouse, the office space, meeting rooms, toilets, the lift lobby, and the surau. The IRB disallowed the RA claim in respect of these costs (with the exception of the actual production area) on the basis that these costs did not relate to the production facility. The Special Commissioners held that the costs were eligible for RA on the basis that these costs comprised capital expenditure incurred by the taxpayer in relation to a qualifying project. Qualifying capital expenditure in respect of a factory is not confined to the production area alone, as the term factory includes both production and nonproduction areas in order for the factory to function as a whole. Furthermore, the other items of expenditure such as the installation of air-conditioning, partition walls, etc. were also held to be qualifying expenditure for RA purposes. Lastly, interest costs which were capitalised as part of the construction costs were also held to be eligible for RA. The IRB has appealed against this decision [The decision in this case is important for taxpayers, as the IRB has tended to adopt a narrow approach towards qualifying capital expenditure for RA purposes.] International Developments Bangladesh Tax Incentives for Private Power Generation Companies To attract investment in the power sector, private power generation companies which commence commercial production of power/energy by 30 June 2012 will be entitled to an exemption from corporate tax on business income for a period of 15 years. Further, capital gains arising from the disposal of shares in such companies will be exempt from tax, as are payments in respect of interest (on foreign loans), royalties, technical know how and technical service fees. Interestingly, aside from offering incentives to the power generation companies, tax exemptions will also be granted for expatriate employees of such companies for a three year period. China Restrictions on Interest Deductions There are new rules in China which restrict deductions in respect of interest on loans where the shareholders in the relevant company have not fully paid for their shares. Where the capital contribution is not fully paid and the company is required to borrow funds, a portion of the interest in respect of such borrowed funds will not be deductible to the company based on a formula which takes into account the total interest payable, the unpaid registered capital and the total loan for the period. Greece New Transfer Pricing Rules and the Introduction of Thin Capitalisation Rules In keeping with the global trend, new transfer pricing rules have been enacted in Greece which include the requirement for transfer pricing documentation. Furthermore, Greece has introduced thin capitalisation provisions wherein interest costs will not be deductible where the debt:equity ratio of the relevant company exceeds 3:1, subject to certain exceptions. Hong Kong International Standards of Exchange of Information Hong Kong has announced that it will take steps to facilitate the amendment of its tax treaties to allow for the adoption of international standards of exchange of information, while adopting certain steps to safeguard individuals privacy. This is in line with the standards for the exchange of information set by the Organisation for Economic Development and Corporation (OECD). 9

10 Are Circulars issued by the Tax Authorities Binding on the Courts? In the case of Commissioner of Central Excise v. Hindoostan Spinning and Weaving Mills Ltd (2009 TIOL 54 SC CX), the question arose as to whether circulars issued by the tax authorities were binding on the courts. It was held that while such circulars are binding on the tax authorities, the courts are not bound by these. Such circulars cannot therefore override decisions of the courts. [From a Malaysian perspective, the same should apply - public rulings and internal IRB circulars cannot override legal precedent]. Is Tax Planning Legitimate from an Anti- Avoidance Perspective? CIR v. Punjab State Electricity Board (I.T.A No 227/2009) involved a taxpayer which had claimed capital allowances on certain assets subsequently entering into a sale and leaseback arrangement in respect of the same assets. Upon leasing the assets, the taxpayer then claimed a deduction for the lease rentals. The tax authorities denied the deduction taking the view that the sale and leaseback was a sham transaction aimed at avoiding tax. India New Direct Tax Code The Indian Government has recently released the Direct Taxes Code Bill 2009 which seeks to align Indian tax laws with internationally accepted taxation principles. It is interesting that rather than simply modifying the existing tax laws, the new tax code has been drafted afresh. The new tax code attempts to simplify the tax laws and regulations and will involve many changes including the following: - an exhaustive list of taxable income and deductible expenditure will be provided - the computation of business profits will need to be done separately for separate business units - the incentives system will be revamped moving away from profit linked incentives to a recovery of capital and revenue expenditure for a specified period of time - the loss utilisation provisions will be amended - advance pricing agreements will be introduced for transfer pricing purposes The above merely highlights a few of the changes. There are many more changes proposed and the new code is expected to be implemented from 1 April Case Law Developments The following summarises some interesting Indian case law developments: The High Court held that the sale and leaseback was a valid legal arrangement giving rise to valid legal transactions and hence were not sham transactions. The Court also held that tax planning within the existing legal framework was acceptable. [From a Malaysian perspective, the above facts would be caught by the Income Tax Leasing Regulations 1986 which would deem the lease agreement to be a sale.] Substance over Form Where does a Gain Accrue on the Disposal of Shares? Vodaphone International (Holdings) B.V v. Union of India and Another (311 ITR 46), involved the issue of where a gain is considered to arise for capital gains tax purposes in respect of the disposal of shares. The facts of the case involved the sale of shares of a Cayman Island company (CIC) by Hutcheson International Hong Kong (HIHK) to Vodaphone Netherlands (VN). The CIC owned shares in a Mauritius company, which in turn owned 67% of the share capital of Hutch Essar India (HEI). The Indian tax authorities sought to enforce VN to withhold tax on the payment to HIHK in respect of the sale of the CIC shares, on the basis that this disposal gave rise to the transfer of a valuable interest in HEI, an Indian company, and hence was subject to capital gains tax. Typically, a gain on the transfer of shares will accrue in the country in which the shares are situated. The shares in 10

11 question were shares in CIC which was located in the Cayman Islands. Accordingly, VN argued that India had no jurisdiction over the sale of the shares and Indian capital gains tax was not applicable. Under Indian laws, capital gains tax will arise where a gain is deemed to accrue or arise in India whether directly or indirectly, through or from any business connection in India or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situated in India. VN argued that the transaction did not fall within this provision. The Supreme Court, upholding the decision of the High Court in favour of the tax authorities held that the gain was subject to capital gains tax in India for the following reasons: - the income arose to HIHK because of the transfer of the economic interest which HIHK indirectly held in HEI - the transfer of shares in CIC gave rise to a controlling interest for VN in HEI - various post acquisition events which focussed on growing the business of HEI indicated a transfer of economic interest of HEI to VN - the key motive behind the transfer of the CIC shares was to entitle VN to have a controlling interest in HEI - the economic substance and dominant purpose of the transaction was to give effect to the transfer of a capital asset in India, rather than merely the shares in CIC [The case illustrates clearly that the Court s decision was based on the substance and economic form of the transaction rather than the legal form. The substance over form issue has long been debated in the courts in the United Kingdom, Australia and elsewhere and will obviously continue to be. However, this decision is important in the context of structuring investments into India via intermediary companies. It is important to note that there is no tax treaty between India and the Cayman Islands but the question of whether the Indian tax authorities would enforce this decision where a tax treaty exists is clearly of interest] Capital v Revenue Expenditure The taxpayer in this case, CIT v. Sri Mangayarkarasi Mills (P) Ltd (Civil Appeal No of 2009) was a manufacturer of cotton yarn. The taxpayer incurred costs for replacing parts of the machinery used in its manufacturing activity and claimed a tax deduction in respect of these costs, on the basis that this was revenue expenditure for replacement of part of the machine. The taxpayer argued that the whole spinning mill system was one integrated machine system The tax authorities however took the view that the spinning mill system comprised different machines and that the replacement of one of these amounted to capital expenditure which was not deductible. On appeal, both the Income Tax Appeal Tribunal and the High Court ruled in favour of the taxpayer. However, the Supreme Court ruled against the taxpayer, taking the view that the spinning mill system comprised several different machines which performed different functions. The fact that the different machines were interconnected did not take away the independent identity of each machine. Therefore, the cost of replacement of one of the machines brought a new asset into existence and hence the expenditure was capital in nature. New Zealand Transfer Pricing Compliance The tax authorities in New Zealand, much like their counterparts in several other jurisdictions, will focus on transfer pricing compliance in the coming months. Their plans to implement this include the possibility of issuing transfer pricing questionnaires to taxpayers as well as coordinated efforts with other jurisdictions, where necessary. Singapore Exchange of Information Compliance with International Standards In an effort to comply with the standards for the exchange of information set by the Organisation for Economic Development and Corporation (OECD), the Government released a bill concerning the exchange of information which would enable Singapore to enter into tax treaties which comply with the OECD s standards. Indeed, Singapore has since signed protocols to several of its tax treaties including those with Belgium, Denmark, Netherlands, New Zealand and the United Kingdom to implement this change. Tax Treatment of Limited Partnerships The Singapore tax authorities have issued a guide clarifying the tax treatment of limited partnerships. Essentially limited partnerships are taxed in the same manner as general partnerships and limited liability partnerships, i.e. these are see through entities for tax purposes wherein the partners, rather than the partnership are taxed. The guide set outs various rules concerning the conversion of general partners to limited partners, the appointment of managers, the dissolution of the limited partnership, etc. Taiwan Characterisation of Income The Ministry of Finance has released a ruling clarifying what is meant by income sourced in Taiwan. In particular, it should 11

12 be noted that the ruling provides that where profits are derived from activities carried on outside of Taiwan, such profits would not be viewed as being sourced in Taiwan. United States of America (U.S.A) Transfer Pricing Transfer pricing and related issues continue to be of great significance in the U.S.A, and the Internal Revenue Service (IRS) has recently released the following rules/regulations: - Cost sharing and contract manufacturing rules which relate to the arm s length standard for transfer pricing purposes - Regulations on controlled services transactions Association of South East Asian Nations (ASEAN) The free trade agreement (FTA) between ASEAN and Australia and New Zealand, which was signed in February 2009, covering various matters including investments, trading in goods, the provision of services, e-commerce issues, etc., is expected to take effect in Additionally, the Indian government and ASEAN have signed an agreement on 13 August 2009 which covers trade in goods as well as the sharing of customs procedures followed by ASEAN signatory nations. OECD Transfer Pricing The OECD has released a proposed revision of the Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations. The proposed revision attempts to include all possible transfer pricing methodologies in one chapter and recognises that in choosing a transfer pricing methodology, one should be able to choose the "most appropriate method to the circumstances of the case". The revision also incorporates more guidance and illustrations on the use of the transactional profits method. The proposed revision is open for comment from interested parties. In addition to the proposed revision referred to above, the OECD has also issued the 2009 edition of the same guidelines UPCOMING EVENTS TAXAND MALAYSIA in collaboration with the Malaysian International Chamber of Commerce and Industry will hold its 2010 Budget Seminar on Tuesday, 3 November 2009 at the Maya Hotel, Jalan Ampang, Kuala Lumpur. TAXAND MALAYSIA and Zaid Ibrahim & Co will hold a Workshop entitled Islamic Financing Transactions The Legal and Tax Intricacies on 24 November 2009 at The Gardens Hotel, Mid Valley, Kuala Lumpur. Please refer to the TAXAND website at for additional details and registration forms. DISCLAIMER: The information contained in this newsletter is intended only to be a guide. It must not be relied on in, or applied to, specific situations without previously seeking proper professional advice. Even if all reasonable care has been taken in its preparation, Taxand Malaysia Sdn Bhd and all the members of the Taxand Network do not accept any liability for any errors or omissions that it may contain before being issued, whether caused by negligence or otherwise, or for any losses, however caused, or sustained by any person or entity. Descriptions of, or references or access to, other publications within this publication do not imply endorsement of them. TAXAND MALAYSIA SDN BHD ( X) Suite 13A.05, Level 13A, Wisma Goldhill, 67 Jalan Raja Chulan, Kuala Lumpur, Malaysia T F E info@taxand.com.my 12