Gazette Orders MALAYSIAN DEVELOPMENTS INTERNATIONAL DEVELOPMENTS. Gazette Orders enacting 2010 Budget Proposals. A x C B

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1 TAX nsights An Occasional Series 4/ 2009 MALAYSIAN DEVELOPMENTS 2010 Budget Proposals Gazette Orders Clarifications from the Tax Authorities Administrative Matters Double Tax Agreements Free Trade Agreement (FTA) Case Law INTERNATIONAL DEVELOPMENTS China India Indonesia Singapore United Kingdom OECD Following the 2010 Budget proposals which were announced in October this year, the Government s challenge will clearly be to manage the budget deficit. Although there have been some signs of recovery both globally and domestically, with domestic GDP being forecast to be around 2%-3% in 2010, the need to raise revenue and to manage spending is paramount. To this end, the recent announcement of the tabling of the Goods and Services Tax (GST) Bill in Parliament this month is important. A 4% GST rate is expected to be implemented within 18 months of the passing of the GST Bill. Businesses as well as the Customs Department will have their work cut out to ensure that both parties are ready for the implementation of GST. In this edition of Tax Insights, various other Malaysian tax developments as well as some interesting international tax developments are reported. MALAYSIAN DEVELOPMENTS 2010 Budget Proposals The 2010 Budget Proposals were reported in the 2010 Budget edition of Tax Insights. Several of these proposals have since been gazetted as law. The promptness with which this was done is commendable and it is hoped that the Finance Act, 2009 will be enacted before the end of the year. The proposals which have been gazetted are outlined below. Gazette Orders Gazette Orders enacting 2010 Budget Proposals Real Property Gains Tax (Exemption) Order 2009 This order revokes the earlier Real Property Gains Tax (Exemption) (No.2) Order 2007 which means that real property transactions (including those involving shares in real property companies) will now be subject to real property gains tax (RPGT). This order (which is effective from 1 January 2010) essentially provides for an effective rate of 5% to be applied on chargeable gains, albeit via a convoluted formula as set out below. This formula is used to arrive at the portion of the chargeable gain which is exempt from tax: A x C B A = (Chargeable gain x applicable tax rate* (Chargeable gain x 5%)) B = Chargeable gain x applicable tax rate* C = Chargeable gain (*based on the period of ownership of the asset as per Schedule 5, RPGT Act, 1976) 1

2 Example: Company A disposes of a piece of land on 1 February 2010 which was acquired on 1 July The land was acquired for RM1 million and is disposed of for RM1.4 million. The computation would be as follows: RM Disposal proceeds 1,400,000 Acquisition cost 1,000,000 Chargeable gain 400,000 Exempt portion: (400,000 x 30%*) (400,000 x 5%) x 400,000 (333,333) (400,000 x 30%*) Chargeable gain subject to RPGT 66,667 RPGT Payable: 66,667 x 30% 20,000 The RPGT payable of RM20,000 would also be arrived at by multiplying the RM400,000 gain by 5%. [*30% being the applicable tax rate for a disposal within 2 years] Income Tax (Exemption) (No.5) Order 2009 & Income Tax (Exemption) (No.7) Order 2009 These orders provide for the following respectively (effective from 24 October 2009): - a resident company licensed under the Insurance Act 1996 and a takaful operator registered under the Takaful Act 1984; and - a resident bank registered under the Banking and Financial Institutions Act 1989 or the Islamic Banking Act 1983, will be exempt from income tax for five (5) years of assessment in respect of income derived from its overseas branch or investee company (i.e a foreign company in which the resident company/takaful operator/bank holds 20% of the share capital). The branch or investee company must be involved in the respective businesses of insurance or takaful, or of banking or Islamic banking. To qualify for this exemption, the resident entity must submit its application to the Central Bank or Bank Negara (BN) before 31 December 2015 and the branch/investee company must commence business within two years from the date of BN s approval. The five year exempt period shall commence on a date which may be determined by the resident entity provided that the date is within 3 years of assessment (YA) from the commencement of the insurance/takaful or banking/islamic banking business of the branch/investee company respectively. Income Tax (Exemption) (No.6) Order 2009 This Order provides that effective from YA 2010 until YA 2014, healthcare service providers offering services to foreign clients (including companies, partnerships, or any organisation or co-operative society which is registered outside Malaysia, as well as to non-malaysian citizens) in Malaysia are eligible for an enhanced allowance for increased exports at the rate of 100% of the value of increased exports, subject to 70% of the statutory income. For the purpose of this incentive, foreign clients exclude the following:- - A non-malaysian citizen that participates in the Malaysia My Second Home Programme and his dependants - A non-malaysian citizen holding a Malaysian student pass and his dependants - A non-malaysian citizen holding a Malaysian work permit and his dependants - A Malaysian citizen who is non-resident and his dependants Capital allowances must be claimed in arriving at statutory income and should be apportioned if the plant and machinery in question is used for more than just the healthcare business. Further, this order will not apply to a person in any year of assessment in which the person has been granted the following incentives: - any incentive under the Promotion of Investments Act investment allowance for an approved service project under Schedule 7B of the Income Tax Act 1967 (ITA) - an exemption under paragraph 127(3)(b) or 127(3A) of the ITA - an exemption under the Income Tax (Exemption) (No.9) 2002 Income Tax (Exemption) (No.8) Order 2009 This Order provides a tax exemption equivalent to 100% of the qualifying expenditure incurred in relation to the construction of a building, and the alteration, renovation, extension or improvement of an existing building to meet the Green Building Index (GBI) certificate requirements as per the Board of Architects Malaysia (BAM) criteria. The allowance can be set off against 100% of the statutory income. It is important to note that cost of purchasing a building would not be considered as qualifying expenditure for this incentive. It should be noted however, that this order is not applicable to persons who have been granted the investment tax 2

3 allowance or pioneer status incentive in respect of qualifying expenditure incurred in relation to the generation of renewable energy or for the conservation of energy. Additionally, this incentive is for GBI certificates obtained before 31 December 2014, and is only available for the first GBI certificate obtained in relation to a building Income Tax (Exemption) (No.9) Order 2009 This Order, which takes effect retrospectively from the year of assessment 2003, states that a resident person with a business source of income in Malaysia is exempted from income tax for five years of assessment in respect of income derived from the consolidated management of smallholding and idle land projects. The application for this incentive must be submitted to the Minister responsible for approving such projects before 31 December Income Tax (Deduction for Investment in an Approved Consolidation of Management of Smallholding and Idle Land Project) Rules 2009 These rules also operate retrospectively from the year of assessment 2002 to grant a deduction to a resident person (with a business source of income) for an investment made in an approved project involving the consolidation of management of smallholding and idle land projects. Investment in this context means investment in the form of cash or the holding of shares exclusively for the purpose of the project. The application for this incentive must be made before 31 December Income Tax (Deduction for Cost of Preparation of Corporate Knowledge Based Master Plan) Rules 2009 These are a further set of rules which operate retrospectively from the year of assessment These rules apply to a resident company that is incorporated under the Companies Act 1965 and is approved by the Minister to participate in a strategic knowledge-intensive activity. The rules allow the company a deduction for expenses incurred on the preparation of the corporate knowledge based master plan which is used for the business of the company and which has been verified by the Malaysian Industrial Development Authority (MIDA). The corporate master plan must be implemented within 2 years from the date of verification by MIDA. Income Tax (Deduction of Expenses for Establishment of an Islamic Stock Broking Business) (Amendment) Rules 2009 These rules amend the Income Tax (Deduction of Expenses for Establishment of an Islamic Stock Broking Business) Rules 2007 to extend the time-frame during which a deduction will be given for the costs incurred in setting up an Islamic stock broking firm from 2009 to The rules are effective from 1 January 2010 and apply to applications received by Bursa Malaysia before 31 December Income Tax (Deduction for Promotion of Malaysia International Islamic Financial Centre) Rules 2009 These rules extend the double deduction incentive given on expenses incurred to promote Malaysia as the MIFC (as per the Income Tax (Deduction for Promotion of Malaysia International Islamic Financial Centre) Rules 2008) until the year of assessment Income Tax (Deduction for Expenditure on Registration of Patents and Trade Marks) Rules 2009 These rules allow a small and medium enterprise (SME) to claim a tax deduction for fees or payments made to patent and/or to register trademarks under the Patent Act 1983 and Trade Marks Act These rules are effective from YA 2010 to YA

4 For the purposes of these rules, an SME is defined as follows: A company ( the relevant company ) with a paid up capital (PUC) of less than RM2.5 million and which meets the following requirements: i) 50% of the PUC of the relevant company must not be owned by a related company, ii) the relevant company itself must not own 50% of the PUC of a related company, and iii) a third company does not own 50% of the PUC of the relevant company and a related company. In addition to the above, the following conditions must also be fulfilled by the SME, depending on the industry the company is involved in: Manufacturing, Manufacturing-Related and Agro Based Industries: - the SME must be resident in Malaysia at the end of the basis period for the year of assessment - it should not have more than 150 full-time employees, and - its annual sales should not have exceeded RM25 million Services, Primary Agriculture and Information & Communications Technology (ICT) Industries: - the SME must be resident in Malaysia at the end of the basis period of the year of assessment - it should not have more than 50 employees, and - its annual sales should not have exceeded RM5 million. Income Tax (Deduction for Expenditure on Issuance of Islamic Securities) Rules 2009 This order extends the deduction given on expenses incurred on the issuance of Islamic securities approved by the Securities Commission until the YA Further, Islamic securities approved by the Labuan Offshore Financial Services Authority (LOFSA) will also enjoy the above incentive effective from YA 2010 until YA Stamp Duty (Remission)(No.2) Order 2009 This order, which is effective 1 January 2010, extends the 20% stamp duty remission on instruments of Islamic Financing stipulated in the Stamp Duty (Remission)(No.2) Order 2007 until 31 December Stamp Duty (Exemption) Order 2009 This order provides for a stamp duty exemption on additional costs incurred to obtain a Green Building Index (GBI) certificate from the Board of Architects Malaysia (BAM). The exemption is available to purchasers of buildings including residential properties, who purchase their properties directly from developers. The costs in respect of which the stamp duty exemption will be given are those costs incurred on the design and construction elements of the property which are required for the GBI certification purposes. It should be noted that these costs must be verified by the BAM. This exemption is available for sale and purchase agreements executed from 24 October 2009 until 31 December Other Gazette Orders Income Tax (Exemption)(No.4) Order 2009 This order stipulates that a non-resident person is exempted from tax in respect of any gains or profits falling under Section 4(f) of the Income Tax Act (ITA) received from a Labuan offshore company. It should be noted that this order takes effect retrospectively from 1 January Therefore a Labuan offshore company would not be required to withhold tax on such payments (which would otherwise be required pursuant to Section 109F, ITA). Stamp Duty (Remission) Order 2009 Following the concession granted by the Ministry of Finance (MOF) earlier this year, this order provides that any service agreement executed from 15 September 2009 until 31 December 2010 will only be subject to stamp duty of RM50 and the excess stamp duty which would otherwise be payable (under Item 22 of the First Schedule of the Stamp Act, 1949) will be remitted. From 1 January 2011, all such instruments will be subject to 5% stamp duty pursuant to Item 22 mentioned above. In connection with the above Order, the MOF recently issued a circular stipulating that the service agreement may be stamped at any Stamp Duty office without the requirement to seek approval for the remission of stamp duty from the MOF. Clarifications from the Tax Authorities Companies, Trust Bodies and Co-operative Societies Change of Accounting Period The Inland Revenue Board (IRB) has recently clarified that where a company, trust body or co-operative society commences operations or where there has been a change 4

5 of accounting period resulting in a basis period involving more than one accounting period, these entities are allowed to submit their tax returns together with the tax returns for the second accounting period, i.e. on or before the last submission deadline for the second accounting period. The balance of tax and debt due to the Government must also be settled when submitting the tax returns. The above is applicable in the year of commencement of operations or in the event there has been a change in the accounting period. Example: Company A commences business on 1 July 2009 and the accounts are prepared to 31 March As set out below, the basis period of the year of assessment 2010 covers two accounting periods (i.e. the 9 month accounting period from 1 July 2009 to 31 March 2010 and the year ended 31 March 2011) and hence the tax return for this period can be filed together with the tax return for the second accounting period. Therefore the basis periods and respective filing deadlines would be: Year of Basis Period Filing Assessment Deadline Service Tax and Exported Taxable Services The service tax treatment in respect of exported taxable services has recently been clarified by the MOF. Basically, with effect from 1 January 2010, the legislation will be strictly followed, such that service tax must be imposed on the provision of all taxable services, where the services are in respect of goods or land situated within Malaysia. This will apply regardless of whether the services are billed to a nonresident party. All taxable persons providing taxable services should take note and ensure that the nature of services are reviewed and that service tax is properly imposed. Administrative Matters Tax Return Forms for Trust Bodies for YA 2009 The IRB has recently issued the Form TA (tax return for a trust body), together with other related documents such as the guidebook, explanatory notes, etc. Forms to Amend Tax Returns for YA 2009 The IRB recently issued the following forms and guidance notes in relation to the amendment of income tax returns for YA Form CP6B[2009] for Trust Bodies - Form CP6C[2009] for Unit Trusts/Property Trusts - Form CP6D[2009] for Real Estate Investment Trusts/Property Trust Funds Certificate of Tax Residence In an application for a certificate of tax residence, a Form STM1 must be used. Apart from the Form STM1, the following supporting documents need to be attached together with the form when applying for the certificate of tax residence. Taxpayer category Company Documents required Where the company has yet to submit their tax returns, then the following documents need to be furnished. - a copy of the Minutes of Board of Directors' Meeting; or - confirmation by a company director that the management and control of the company is in Malaysia Individual - passport : original and photocopy - record of the individual's movement in/out of Malaysia Partnership - passport: original and photocopy (individual partners) - record of movement in/out of Malaysia (individual partners) Trust If the trust has not been registered with the IRB - a copy of the trust deed Unilateral Advance Pricing Arrangement (APA) Application Form The IRB has issued a new form, Form APA 1[2009] for APA applications. This form must be used by any person who wishes to enter into a unilateral APA with the Director General of Inland Revenue ("DGIR") to determine the transfer pricing methodology to be used to determine an arm s length price. (Note: The relevant forms and guidelines, etc reported under Administrative Matters can all be obtained from the IRB s website at 5

6 A 70% income tax exemption for 10 years is given to companies that provide healthcare services to foreign clients, effective YA Import duty and sales tax exemptions on machinery and equipment directly used in rendering healthcare services. There is a list of activities stipulated in the guidelines for the purpose of this incentive. Further, the applications for the incentives need to be submitted to MIDA before 31 December Please refer to MIDA s website for further details ( Review of the National Automotive Policy (NAP) The Ministry of International Trade and Industry (MITI), in its recent review of the NAP, indicated that the following tax incentives will be available: Venture Capital Tax Incentives The Securities Commission (SC) has the authority to certify applications for tax incentives for the venture capital industry 1 and pursuant to this authority, the SC has issued guidelines on Venture Capital tax incentives (on 29 September 2009). These guidelines supersede the previous guidelines for annual certification for tax incentives for the Venture Capital Industry (VCI). The guidelines indicate that two forms are available for applying for the tax incentives for the VCI. Both the forms are available on the SC s website It is important to note that the first application must be accompanied with the following documents: (a) A copy of the Memorandum and Articles of Association or other constituent documents (b) The latest audited financial statements of the applicant (c) A copy of the approval letter/certificate for Pioneer status or Investment Tax Allowance or other supporting documents relating to any incentives currently enjoyed by the applicant. Once the application is certified by the SC, the certification must be submitted to the IRB together with the tax return form. Tax Incentives for the Wellness Zone in Port Dickson, Negeri Sembilan MIDA has issued guidelines regarding tax incentives for the Wellness Zone in Port Dickson. The guidelines provide that the following incentives will be given:- Companies that export vehicles and components/ parts will be given an enhanced allowance for increased exports at the following rates: 30% (as opposed to the previous 10%) of the value of increased exports if the value added is at least 30% 50% (as opposed to the previous 15%) of the value of increased exports if the value added is at least 50% Companies that manufacture transmission systems, brake systems, airbag systems and steering systems are eligible for the following tax incentives: Pioneer Status (PS) - 100% exemption on statutory income for 10 years; or 100% Investment tax allowance (ITA) on qualifying capital expenditure for 5 years Companies that assemble or manufacture hybrid cars are eligible for the following tax incentives: PS - 100% exemption on the statutory income for 10 years; or 100% ITA on qualifying capital expenditure for 10 years 50% excise duty exemption Companies that assemble or manufacture critical components relating to hybrid cars (e.g. electric motors, electric batteries, battery management system, inverters, electric air conditioning and air compressors) are given the following tax incentives: PS - 100% exemption on statutory income for 10 years; or 100% ITA on qualifying capital expenditure for 5 years 1 (as provided for in the Income Tax (Exemption) (No.11) Order 2005, as amended by the subsequent Income Tax (Exemption)(Amendment)(No.2) Order 2006 and the Income Tax(Deduction for Investment in a Venture Company) Rules

7 Double Tax Agreements Malaysia and Venezuela The double tax agreement (DTA) between Malaysia and Venezuela, signed on 28 August 2008 has been gazetted. This does not provide for reduced withholding tax rates and hence the following rates apply: Royalties 10% Technical fees 10% Interest 15% Malaysia and the Republic of San Marino The DTA between Malaysia and the Republic of San Marino was signed on 19 November San Marino is a very small European country (approximately 60km²) with a population of about 31,000. Details of the tax treaty are not available as yet. Protocols to DTAs Malaysia has recently signed protocols in respect of the DTAs with the United Kingdom (U.K), France and the Netherlands. It is understood that the protocols fundamentally provide exchange of information provisions to accord with the OECD Model Convention. Free Trade Agreement (FTA) Malaysia and New Zealand signed a FTA on 26 October The bilateral FTA provides a framework for closer economic cooperation and partnership between both countries and their respective business communities. Case Law This section only reports cases which are considered to be of importance to a large cross-section of readers LFC Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri (Rayuan PKCP(R) No. 54/2007) The issue in this case involved the question of whether the vessels rented by the taxpayer from the Sabah State Government constituted Malaysian ships within the meaning of Section 54A of the ITA to enable the taxpayer to enjoy the tax exemption provided in that section. Section 54A of the ITA provides as follows: (1) Subject to the following subsections, where a person who is resident for the basis year for a year of assessment carries on the business of - (a) transporting passengers or cargo by sea on a Malaysian ship; or (b), the statutory income for that year of assessment from that business shall be exempt from tax. Section 54A (6) defines a Malaysian Ship as follows Malaysian Ship means a sea-going ship registered as such under the Merchant Shipping Ordinance 1952 [Ord. 70 of 1952], other than a ferry, barge, tug-boat, supply vessel, crew boat, lighter, dredger, fishing boat or other similar vessel The IRB contended firstly that as the vessels were not registered under the Merchant Shipping Ordinance (MSO), the exemption would not apply. Secondly, the IRB contended that the vessels were ferries and not ships and hence did not fall within Section 54A. On the question of the requirement for registration of the vessels under the MSO, the taxpayer argued and the Special Commissioners of Income Tax (SCIT) agreed that as the vessels were owned by the Sabah State Government, these were exempted from the registration requirements under the MSO (as per the provisions of the MSO). On the second question as to whether the vessels fell within the term ship, based on the facts concerning the size of the vessels, the distance travelled and the purpose for which these were used, the SCIT concluded that the vessels were ships. As the ships were exempted from the requirement for registration under the MSO, the SCIT held that the Section 54A exemption applied in this case. 7

8 Binastra Holdings Sdn Bhd v. Ketua Pengarah Hasil Dalam Negeri (Court of Appeal Decision Unreported) The taxpayer company acquired shares in a property developer company ( SPSB ) in Being a property developer, SPSB held real property, which was classified in the accounts as stock-in-trade. SPSB entered into development activities in respect of the land, but in view of a dispute concerning an access road with a third party developer, SHL, which was involved in a neighbouring property development, the development was halted. The taxpayer subsequently sold its shares in SPSB to SHL in The tax authorities assessed the gain on the disposal of the shares to real property gains tax (RPGT) on the basis that the shares in SPSB were held to be real property company (RPC) shares. The taxpayer argued that the acquisition and disposal of the shares was not a speculative scheme to acquire and dispose of property, but was a genuine investment in a property development company. Furthermore, SPSB was a genuine property developer which held and treated the land as stock-in-trade. Therefore, the disposal in this instance fell out of the spirit/intention behind the introduction of RPGT in respect of RPC shares, which was to curb speculation in real property via the use of companies. The Special Commissioners ruled in favour of the IRB, but the High Court reversed the decision and ruled in favour of the taxpayer. Their decision was based on the intention behind the legislation which as mentioned above, was to curb property dealing by individuals via the use of companies. The High Court found that notwithstanding the wording of Paragraph 34A of the RPGT Act, 1976, the character of the assets of the company were important. In this case, they found that the real property was stock-intrade and therefore SPSB should not be viewed as a RPC. Unfortunately, on further appeal by the IRB, the Court of Appeal overruled the High Court, by adopting a literal interpretation of Paragraph 34A. This decision, which is unreported has significant implications for shareholders of property development companies. Pemungut Duti Setem v BASF Services (Malaysia) Sdn Bhd (Appeal Reference: C ) This case involves the question of the value of a transaction for the purposes of stamp duty. The transaction involved a Purchase, Sale, Development and Infrastructure Agreement between the taxpayer and the Pahang State Development Board. The total purchase price, development fee and infrastructure fees under the agreement amounted to RM170.6 million on which stamp duty was assessed under Item 32(a) of the First Schedule of the Stamp Act, 1949 ( SA ). The taxpayer however argued that the infrastructure costs should not be subject to stamp duty. The Court of Appeal focused on Section 12A(b) of the SA which provides for the assessment of the value of property under transfer and which states that the market value of the property transferred under an instrument of transfer is relevant. The market value, in the case of a transfer implementing a sale under a duly stamped agreement of sale and purchase, should be determined based on the value at the date of execution of the agreement. The instrument of transfer rather than the actual transactions was held to be relevant in determining the stamp duty payable, as stamp duty is payable on the instrument. In the present case, the relevant instrument was the agreement for the sale, purchase, development and infrastructure and this instrument fell within Item 32(a). Based on Section 12A(b) therefore, the entire consideration for this being reflective of the market value was subject to stamp duty. BD Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri [(2009) MSTC 3869] This case involved the question of whether shares in a company which held a contractual right to develop land constituted shares in a real property company (RPC). The taxpayer in this case held 100% of the shares in BI Sdn Bhd ( BISB ). BISB in turn entered into a joint venture agreement with a third company to develop the land held by the third company in exchange for a share of the sales proceeds 8

9 Ang Lay Ang Imm v Pengarah Lembaga Hasil Dalam Negeri Malaysia Johor Bahru [(2009) MSTC 4436] This case involved the disposal of property by a trustee (who was also a co-owner of the property), who at the time of disposal was a no longer a Malaysian citizen. In this case, the plaintiff and his sisters inherited a portion of a property from their late mother. The plaintiff held the portion of land belonging to his sisters as trustee. Several years later, the plaintiff sold the property and distributed the gains derived evenly between himself and his sisters. The IRB subjected the gain to RPGT at the rate of 30% on the basis that the plaintiff, as trustee, was not a Malaysian citizen. The plaintiff contended that inherited property should not be subject to RPGT on its disposal, and that the rate of RPGT used was not appropriate. It was held by the High Court that the disposal was subject to RPGT. The fact that the property was inherited still fell within an acquisition for RPGT purposes. Further, as a trustee, the plaintiff was a chargeable person, and on the basis that he was a noncitizen at the time of disposal, the appropriate rate of RPGT was 30%. from the development. BISB paid the third company RM2 million for the rights to develop the land. BISB did not however have legal title to the land. The taxpayer subsequently sold its shares in BISB and the IRB assessed the gain to RPGT on the basis that the BISB shares constituted RPC shares within the meaning of paragraph 34A of Schedule 2 of the Real Property Gains Tax (RPGT) Act, The taxpayer contended that BISB did not own the land and therefore, the company was not a RPC. The IRB however argued that real property as defined in the RPGT Act, includes any interest, option and other rights over real property which BISB clearly had in this case. Further it was argued that on the facts, the land was actually a capital asset (notwithstanding the accounting treatment) as the land had been left undeveloped since the date of alienation (to the third company) until the sale of the shares. Paragraph 34A defines a RPC as a controlled company which has/acquires real property or shares or both whereby the defined value of real property or shares or both owned at that date is not less than seventy-five per cent of the value of its total tangible assets. Based on the facts of the case the SCIT found in favour of the IRB. INTERNATIONAL DEVELOPMENTS China Treaty Benefits New Rules The Chinese State Administration of Taxation (SAT) has recently issued rules concerning the claiming of tax treaty benefits by non-residents in respect of dividends, interest, royalties and capital gains. Additionally, notification requirements are imposed in respect of non-residents providing independent and dependent personal services in China as well as for those having permanent establishments in China. Non-Chinese resident parties deriving income from China or doing business in China should ensure that they familiarise themselves with the new SAT rules if treaty benefits are relied on. Determination of Beneficial Ownership for Treaty Purposes To benefit from tax treaty reduced tax rates in respect of dividend, royalty and interest income, one typically needs to show beneficial ownership of the relevant income. The SAT has recently issued a ruling to clarify what is required to 9

10 satisfy the beneficial ownership test. Essentially, a substance over form test is applied and the recipient of the income must have the power to dispose of the income without any restrictions. Therefore, if the recipient is required to distribute a substantial portion of the income (more than 60%) to a third country within a 12 month period, this would fail the beneficial ownership test. There are several guidelines which the SAT has issued in this regard. Therefore, those deriving dividend, royalty and interest income from China should ensure that they are familiar with these guidelines. India Case Law Do Payments for Bandwidth Charges constitute Royalties? The case of New Skies Satellites NV v. ADIT (Delhi Special Branch) sets an interesting and important precedent for telecommunications and satellite companies deriving income from India. This case involved a Dutch based company involved in the business of operating telecommunication satellites. The Dutch company entered into an agreement with an Indian telecasting company (Indian customer) to provide transponder capacity for transmission signals, which essentially enabled the Indian customer to uplink and downlink programmes to be telecast. The Indian tax authorities treated the payments by the Indian customer to the Dutch entity as royalties on the basis that they viewed this as a payment for a process within the meaning of the term royalty in both the Indian domestic legislation as well as under the tax treaty between India and the Netherlands. It was argued that the term process referred to a process which had Intellectual Property Rights (IPR) protection and could not include all processes. The process in this instance was not used by the Indian customer, but was used by the taxpayer company in providing the service to enable the Indian customer to uplink and downlink the programmes. Hence the payment was a payment for services. The Court held that the payment was for the process which was embedded in the transponder, which the Court viewed as being used by the Indian customer rather than the taxpayer, given that the taxpayer did not have any control over the data which was uplinked/downlinked by the Indian customer. The Court took the view that consideration for any process could be treated as a royalty and that the process need not be protected by IPR. This decision clearly has a far-reaching impact on non Indian residents deriving bandwidth charges from India. Would an outright purchase of Technical Knowhow constitute a Royalty? The above question was addressed in the case of CIT vs Maggronic Devices Pvt Ltd (Unreported) where the taxpayer entered into an agreement with a foreign company to acquire plant and product know-how for a lump sum consideration, payable in three installments. The taxpayer received the design documents in respect of the knowhow outside of India. Following the agreement, the taxpayer became the absolute owner of the relevant plant and the related know-how. The Revenue authorities took the view that the payment was made towards the purchase of rights relating to a patent or invention and was therefore a royalty subject to withholding tax. The High Court however held that outright purchase of the know-how together with the plant fell within the meaning of plant and did not amount to royalty. Deductibility of Costs Incurred in carrying out Feasibility Studies for Diversification of the Business In the case of Hindustan Times Ltd vs ACIT (2009 TIOL 628) (Delhi), the question arose as to whether costs incurred in carrying out feasibility studies towards the setting up of an insurance business were tax deductible. The taxpayer was 10

11 Indonesia Value Added Tax and Luxury Goods Sales Tax Indonesia will introduce a new Value Added Tax (VAT) and Luxury Goods Sales Tax from 1 April 2010 which is intended to contribute to expanding the tax base and increasing tax collections. Basic food necessities, medical services, social services, education services, water and air transportation services and several other key services will be exempted from VAT. The rate of VAT will remain at 10% with the discretion to reduce this to 5% or increase it to 15% depending on the country s economic circumstances. involved in several businesses and incurred costs in carrying out studies on the viability of entering into the life insurance business and subsequently formed a joint venture to undertake the insurance business. The tax authorities denied the taxpayer a deduction for the costs incurred on the basis that these did not relate to the taxpayer s business and were capital in nature. The Income Tax Appeal Tribunal (ITAT) however found in favour of the taxpayer, noting that one of the objects clause in the Memorandum of Association permitted the company to undertake an insurance business activity. The ITAT also noted that there was an inter-connection between the various activities of the company as there was an inter-flow of funds and common unity of control. The ITAT took the view that the term business should not be given a restrictive meaning and that it should include activities undertaken by the management to generate efficiency, cost control and gaining recognition in the business world. Therefore, the expenses were held to be tax deductible. Withdrawal of Circulars on the Taxation of Non-residents in India It should be noted that the Indian tax authorities have withdrawn Circular 23 and two related circulars which relate to when non-residents would be deemed to derive certain types of income in India and when they would not be deemed to have Indian derived income. The Circular also clarified that withholding tax is not applicable in respect of commissions paid by Indian residents to non-resident agents, etc. The withdrawal of the circulars does not necessarily prejudice taxpayers who would continue to be entitled to rely on case law precedent in support of taxpayers, as well as the double tax treaties, etc. The Luxury Goods Sales tax will range from 10% to 200% and will be imposed on the import of luxury goods. Anti-Avoidance Provisions and Administrative Provisions in relation to Tax Treaties The Indonesian tax authorities require all persons seeking treaty benefits to produce a certificate of domicile from the respective country of residence. Additionally, the authorities have introduced anti-avoidance provisions to be applied in the context of tax treaties. Basically, treaty benefits will not be granted in respect of transactions which lack economic substance and which are arranged purely for treaty benefits. Further, the issue of true beneficial ownership will also need to be satisfied before treaty benefits are given. In relation to the question of beneficial ownership, some of the following factors will be considered: - the Indonesian company must have a substantive presence in the form of an actual business, employees and the ability to manage its own business affairs; - the company must be free to use at least 50% of its income freely, without any obligation to flow this out to another country in the form of royalties, interest, etc. Singapore Exchange of Information Standards Singapore passed the Income Tax (Amendment) (Exchange of Information) Bill and signed various agreements to incorporate the OECD s exchange of information standards. With this, Singapore has joined the white list of countries which have implemented the OECD s required standards, having signed protocols with several tax treaty partners to enhance the exchange of information provisions in their tax treaties. 11

12 United Kingdom Value Added Tax (VAT) The temporarily reduced rate of VAT of 15% (since 1 December 2008) will no longer apply after 31 December The rate of VAT will revert to the previous 17.5% with effect from 1 January OECD Telecommunication transactions The OECD has released an interesting discussion draft on treaty issues concerning telecommunication transactions, which are intended to be incorporated into the OECD Model Convention. The discussion draft addresses interesting questions including the question of whether a satellite, roaming arrangements, sub-sea cables and platforms can constitute a permanent establishment (PE). Additionally, the draft considers the question of whether payments under transponder leasing arrangements amount to royalties, and interestingly, concludes that such payments should not amount to royalties (contrary to the Indian case of New Sk i es Satel l i tes NV referred to above). provides that where a PE is deemed to exist in a contracting state and the latter makes an adjustment in respect of profits attributable to that PE, the other contracting state is obliged to allow for a corresponding adjustment. In view of this proposed change, proposed revisions have also been made to the commentary on Article 7. State Owned Entities and Sovereign Wealth Funds In addition to the above, the OECD has also issued a discussion draft on the application of tax treaties to state owned entities and sovereign wealth funds. Business Profits Article The OECD has also released a revised draft of the new Business Profits Article (Article 7) of the Model Convention. This includes a new paragraph to the Article which effectively TAXAND AWARDS: TAXAND MALAYSIA AWARD: International Tax Review (ITR) Asia 2009 award for Malaysian Transfer Pricing Firm of the Year. Taxand Malaysia together with several Taxand firms in Asia won 6 ITR Asia awards which were announced in Singapore on 24 November 2009 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