Professional Level Options Module, Paper P6 (MYS)

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2 Professional Level Options Module, Paper P6 (MYS) Advanced Taxation (Malaysia) December 2009 Answers 1 (a) Moonwalk Sdn Bhd Star Street Spacetown 7 December 2009 The Secretary Asteroid Bhd Crater Road Bandar Bintang Dear Sir, Income tax for the year of assessment 2009 We have pleasure in presenting our report on the income tax situation of the company as specifi ed in your instructions. (i) Explanation of the treatment of the fi nance leases. Lease no.1 This is deemed to be a sale agreement because it gives the lessee an option to purchase the asset during or at the end of the lease term. As such it must be treated as attributable to a deemed separate business. However, no further adjustment is required because, on a sale by instalments, only the interest element would be recognised as income. Lease no.2 This is deemed to be a sale agreement because the lessee has previously claimed capital allowances on the asset. It is treated as attributable to the deemed separate business with no further adjustment in the same way as Lease no.1. Lease no.3 Although this transaction is a sale and leaseback, the lessee has not previously claimed capital allowances and there is no indication that he has been given benefi cial ownership of the asset so there is no reason to treat this as a sale agreement. The lease rentals are deemed to accrue evenly over the lease term, based on the total sums receivable under the lease. The amount of income to be recognised is 45,000 x 60 x 9/60 = 405,000. As income of 90,000 has been recognised in the accounts, there is an additional amount of 315,000 to be included. (The lessor is eligible to claim capital allowances on the assets.) Lease no.4 This is deemed to be a sale agreement because it is obvious that the lessee acquired the asset during or on expiry of the lease term at a price other than market value. As such it must be treated as attributable to a separate business. In practice, market value is taken to be equal to 80% of the tax written-down value of the asset. No further adjustment is required because, on a sale by instalments, only the interest element would be recognised as income. Any adjustments for prior years attributable to the retrospective application of the deemed sale treatment have been ignored as only information regarding the year of assessment 2009 is required. (ii) Gross income for tax purposes year of assessment The gross income from the leasing business is 2,016,000 and the gross income from the non-leasing business is 224,000. The total is 2,240,000. These fi gures form the basis for apportionment of common expenses and capital allowances between the two businesses in the proportions 9:1 respectively. Details of the calculation of gross income are contained in the appendix to this letter at Schedule 1. (iii) Chargeable income year of assessment The chargeable income is 214,500. Details of the calculation of this amount are contained in the appendix to this letter at Schedule 2. 13

3 Schedule 1 Determination of gross income year of assessment 2009 Leasing business Non-leasing business + + Gross revenue 1,992,000 Adjustments: Operating leases Arrears at 30 September ,000 Arrears at 30 September ,000 Finance leases Lease no.1 50,000 50,000 Lease no.2 62,000 62,000 Lease no.3 315,000 Lease no.4 112, ,000 2,380, , ,000 Gross income 2,016, ,000 Schedule 2 Computation of chargeable income year of assessment 2009 Leasing business Profi t before tax 892,000 Add: Zakat perniagaan 10,000 Depreciation 290,000 Arrears of operating lease rentals at 30 September ,000 Adjustment of rentals on lease no.3 315,000 Proportion of common expenses 800,000 (600, ,000) divided between leasing and non-leasing in proportion to gross income as above the part attributable to non-leasing 1/10th 80,000 1,660,000 Less: Arrears of operating lease rentals at 30 September 2008 (140,000) Gross revenue attributable to non-leasing business (224,000) (364,000) Adjusted income 1,296,000 Capital allowances Leased assets 1,200,000 Common assets 20,000 the part attributable to leasing business 9/10ths 18,000 1,218,000 Statutory income 78,000 Non-leasing business Gross revenue attributable to non-leasing business 224,000 Proportion of common expenses 800,000 attributable to non-leasing business 1/10th (80,000) Adjusted income 144,000 Proportion of common capital allowances 20,000 attributable to non-leasing business 1/10th (2,000) Statutory income 142,000 Statutory income from leasing business 78,000 Statutory income from non-leasing business 142,000 Aggregate income 220,000 Zakat perniagaan 10,000 limited to 1/40th of aggregate income (5,500) Total income and chargeable income 214,500 14

4 (b) The Court of Appeal in Ketua Pengarah HDN v Daya Leasing Sdn Bhd (2005) MSTC 4,124 upheld the decision of the lower courts requiring that common expenses (including capital allowances) be apportioned between the leasing and non-leasing sources in proportion to the gross income of each source. The court referred to s.33(1) of the Income Tax Act 1967, pointing out that the section lays down the manner of arriving at adjusted income and must authorise the apportionment of common expenses based on gross income. The inherent anomaly is that gross income from leasing as determined under the law comprises the full lease payment including both capital and interest portions whereas for the non-leasing source only the interest part constitutes gross income. This leads to a disparity in the fi gures so that an unduly large proportion will always be attributed to leasing income. 2 SM Tech Sdn Bhd (a) Report to the Board of directors of SM Tech Sdn Bhd From: Canny, in-house accountant Date: 7 December 2009 Income tax for the year of assessment 2009 (i) Based on the provisional results for the year to 31 December 2009, there will be no liability for the year of assessment After taking into account the exemption for income derived from the export of qualifying services there is no chargeable income. The balance of unrelieved exemption available to be carried forward to future years is 10,000. There is also a balance of unabsorbed losses amounting to 55,000 available to be carried forward. The exempt account balance is 70,000. Details of the calculation of these amounts are contained in the appendix to this report at Schedule 1. (ii) The effect of bringing forward the capital expenditure into 2009 is to increase the amount of capital allowances by 75,000 (100% of 75,000). This would reduce the statutory income after exemption from 30,000 to 7,500 because only 17,500 of the exempted amount could be offset (70% x 25,000). The result is an increase of 52,500 in the unrelieved exemption to 62,500 and in the unabsorbed losses by 22,500 to 77,500. The effect of bringing forward the contract into 2009 increases the statutory income before exemption by 120,000 and the available exemption by half that amount, 60,000. The result is that the whole of the exemption is offset in 2009, as 70% of the statutory income of 220,000 (154,000) is greater than the available exemption of 140,000 (80, ,000); and all but 5,000 of the 85,000 unabsorbed losses are utilised. The effect of bringing forward both the capital expenditure and the contract still results in an overall increase in statutory income, but only by 45,000 (120,000 75,000), thereby resulting in an exempt amount of 101,500 (70% of 145,000). The result is an unrelieved exemption of 38,500 (140, ,500) and unabsorbed losses of 41,500 (85,000 43,500). The revised fi gures are summarised in the appendix to this report at Schedule 2. (iii) In each case the chargeable income is nil and there seems to be no real advantage in bringing forward either the capital expenditure or the income as each will be of use in the year Indeed to bring forward the capital expenditure could be counterproductive because the use of the capital allowances reduces the amount of the increased exports exemption that can be used in The same restriction to 70% of statutory income will apply in future whereas the use of capital allowances is only constrained by the availability of adjusted income. 15

5 Schedule 1: Provisional income tax computation for the year of assessment 2009 Profi t before tax 150,000 Add: depreciation 15,000 Adjusted income 165,000 Capital allowances (65,000) Statutory income 100,000 Exemption for increased exports Qualifying services provided in the year to 31 December ,000 Qualifying services provided in the year to 31 December ,000 Increase 40,000 50% of increase 20,000 Qualifying amount brought forward 60,000 80,000 Exemption 70% of statutory income (70,000) (70,000) Qualifying amount carried forward 10,000 Aggregate statutory business income 30,000 Unabsorbed loss brought forward 85,000 (30,000) Chargeable income Nil Unrelieved exemption carried forward 10,000 Unabsorbed loss carried forward 55,000 Unabsorbed capital allowances carried forward Nil Exempt account balance 70,000 Schedule 2: Summary of the revised figures The tax consequences of bringing additional items into 2009 Capital Indonesian Both expenditure income Capital allowances 100% x 75,000 75,000 Exemption for increased exports 50% x 120,000 60,000 Total 135,000 Statutory income before exemption 25, , ,000 Statutory income after exemption 7,500 80,000 43,500 Unrelieved exemption 62,500 Nil 38,500 Chargeable income Nil Nil Nil Unabsorbed capital allowances Nil Nil Nil Unabsorbed losses 77,500 5,000 41,500 Exempt account balance 17, , ,500 (b) The fi rst thing to be determined is whether the tuition fees represent the provision of information and communication technology services so as to qualify for the exemption. In view of the nature of the tuition, there is little room for doubt that they do. Next, it must be asked whether the clients are foreign clients as defi ned. For individuals, only those who are non-malaysian citizens not holding work permits or non-resident Malaysian citizens living abroad qualify. A company client must be incorporated or registered outside Malaysia but this would only be relevant where the contract to provide the tuition is made directly between SM Tech Sdn Bhd and the client company. Therefore it is possible that some of the tuition fees earned could be taken into account for the purposes of the exemption for qualifying services provided to foreign clients. 3 (a) (i) The following are some examples of fi xed capital: Money invested in land and buildings held for use in carrying on a business activity; Money invested in plant and machinery held for use in carrying on a business activity; Money invested in patents, trademarks and other intangible property held for use in carrying on a business activity; Money invested in assets held to produce income such as shares held to produce dividends; or property held to produce rents. ONLY TWO examples required 16

6 (ii) The following are examples of circulating capital: Raw material stocks held for use in a manufacturing business; Trade debtors resulting from business transactions; Cash and bank balances held for use to buy trade goods or to defray business expenses; Work-in-progress of a professional business activity. ONLY TWO examples required (iii) The nature of an asset for the purposes of considering fi xed and circulating capital depends not so much upon the asset itself but upon the use to which the owner intends to put it. A piece of land bought by a manufacturing company to build a factory on is obviously fi xed capital, whereas to a land dealer it will represent circulating capital because he intends to sell it and make a profi t on it. Similarly, while to most people a motor car is fi xed capital because it will be kept and used for many years, to a motor trader it is circulating capital because he will immediately offer it for sale, not expecting to use it or to own it for very long. (b) (i) Individual A s activities have the characteristics of income-earning because he has the intention to make money and does so on a regular basis. The fact that his activities are illegal does not prevent him from being liable to income tax. Minister of Finance v Smith [1972 AC 193]. (ii) A sum received by an individual from his employer by way of a scholarship may have the nature of income if it is attributable to having or exercising his employment. Nevertheless, such a sum is exempt from income tax [paragraph 24, Schedule 6, Income Tax Act 1967]. (iii) Although the subsidy appears to have the nature of income because it is intended to replace a loss of earnings (Ostime v Pontypridd and Rhonda Joint Water Board [28 TC 261] [HL]), it is exempt from income tax [Income Tax (Exemption) (No.22) Order 2006 PU(A)2007/2006]. (iv) Individual D s present gambling activities have more of the nature of windfall gains than a business activity. This can be seen from the fact that he treats gambling as a hobby and his livelihood comes from a more traditional form of employment. However, his plans for the future may lead to his gains being treated as business income if he develops the intention to be a professional gambler. (Graham v Green (9 TC 309).) 4 Tasik Sdn Bhd (a) Because the milling machine was disposed of by Tasik Sdn Bhd within fi ve years of its own acquisition date, any reinvestment allowance given is deemed not to have been given. Consequently there will now be a clawback of the allowance claimed by Tasik Sdn Bhd in the year of assessment In view of the fact that there is still a balance of reinvestment allowance unused, the clawback can be effected by reducing that balance. Tasik is not entitled to the annual allowance for the old milling machine for the year of assessment 2009 as it was not owned and in use at 31 March As it is disposed of in a controlled transfer, the disposal value is equal to the residual value and there is no balancing adjustment. (b) Tasik Sdn Bhd tax payable year of assessment 2009 Adjusted business income 130,000 Capital allowances working 1 (79,600) Statutory income 50,400 Reinvestment allowance restricted working 2 (35,280) 15,120 Unabsorbed losses brought forward (10,000) Chargeable income 5,120 17

7 Working 1 capital allowances New milling machine Deposit 20,000 First instalment (164,000 20,000) 36 4,000 Installation charges not eligible as withholding tax unpaid 24,000 Initial allowance 20% 4,800 Annual allowance 20% 4,800 Old milling machine not eligible Other assets 70,000 79,600 Working 2 reinvestment allowance Brought forward 138,216 Clawback in respect of the old milling machine 150,000 at 60% withdrawn with effect from the year of assessment 2007 (90,000) 48,216 New milling machine Deposit as above 20,000 First instalment as above 4,000 Installation charges 10,000 34,000 60% x 34,000 20,400 68,616 Utilised for the year of assessment 2009 restricted to 70% of statutory income of 50,400 (35,280) Unused 33,336 5 (a) Circumstances in which a Labuan Offshore Company will not pay tax at 3% on the whole of its income include: Where the company s income is derived from offshore business activity none of which is offshore trading activity, in which case the income is exempt from tax. Where the company carries on offshore business activity and is therefore liable to tax at 3% but elects to pay a fi xed sum of 20,000 for any particular year of assessment. Where the company carries on an offshore business activity but has made an irrevocable election to be taxed under the Income Tax Act Where any activity carried on by the company is not within the scope of charge under LOBATA because it is not an offshore business activity. The Income Tax Act 1967 would apply to income from that activity. ONLY TWO required (b) (i) Firestar Limited year of assessment 2010 Audited net profi t before tax 900,000 Tax at 3% 27,000 Rebate for zakat (25,000) Tax payable 2,000 (ii) Firestar Limited carries on a mixed offshore business activity consisting of offshore trading (stamps and coins) and offshore non-trading (investment in US treasury bonds). For this reason the interest on US treasury bonds fails to qualify for an exemption and must be included together with the offshore trading income. (iii) Firestar Limited is entitled to make an election to pay a fi xed sum of 20,000 instead of the tax at 3% for the year of assessment The rebate for zakat can be offset against this fi xed sum to give a net amount payable of nil. There is no carry forward for the excess zakat of 5,000. The election must be made within three months of the commencement of the year of assessment, that is by 31 March

8 (c) Resident in the context of the definition of an offshore business activity means: In relation to a natural person, a citizen or permanent resident of Malaysia. In relation to any other person, a person who has established a place of business in Malaysia and is operating in Malaysia. A person who is resident for exchange control purpose. ONLY TWO required 19

9 Professional Level Options Module, Paper P6 (MYS) Advanced Taxation (Malaysia) December 2009 Marking Scheme Marks 1 (a) (i) Lease 1: deemed sale transaction, with reason 1 0 attributable to separate business 1 0 no further adjustment, with reason 1 0 Lease 2: deemed sale transaction, with reason 1 0 attributable to separate business/no further adjustment 1 0 Lease 3: not as a sale, with reasons 1 0 deemed to accrue evenly over the lease term 1 0 amount recognised 405, additional adjustment 315, Lease 4: deemed sale transaction, with reason 1 0 market value at 80% TWDV 1 0 no further adjustment, with reason 1 0 effects of retrospective application not considered Marks available 11 0 (ii) Computation of gross income (Schedule 1): Operating leases: arrears arrears Finance leases: Lease Lease Lease Lease Gross income fi gures 0 5 Summarising outcomes ex-schedule in letter 1 0 Identifying basis of apportionment 1 0 (iii) Computation of chargeable income (Schedule 2): Leasing business: Adjustments: Zakat perniagaan 1.0 Depreciation 0.5 Arrears of operating lease rentals at 30 September Adjustment re lease no Non-leasing common expenses (1/10th) 1.0 Arrears of operating lease rentals at 30 September Non-leasing gross revenue 1.0 Capital allowances: leased assets 0.5 common assets (attributable 9/10ths) 0.5 Non-leasing business: Gross revenue 0 5 Common expenses (1/10th) 0 5 Common capital allowances (1/10th) 0 5 Aggregate income 0 5 Zakat perniagaan restricted to 1/40th 1 0 Chargeable income amount ex-schedule referred to in letter Marks available 9 0 Format and presentation of letter 1 0 Effectiveness of communication (b) Basis of judgement by reference to s.33(1) principle 1 0 Nature of inherent anomaly 1 0 Effect to attribute unduly large proportion to leasing income

10 Marks 2 (a) (i) Provisional income tax computation (Schedule 1): Depreciation adjustment 0 5 Capital allowances 0 5 Correctly identify statutory income fi gure 0 5 Increase in exports 1 0 Exempt amount 50% 1 0 Qualifying amount brought forward 0 5 Exemption 70% 1 0 Unabsorbed loss brought forward 1 0 Unrelieved exemption carried forward 0 5 Unabsorbed loss carried forward 0 5 Unabsorbed capital allowances carried forward 0 5 Exempt account balance 0 5 No YA 2009 liability, as chargeable income is nil 1 0 Summary of carry forward position in report (ii) Summary of revised fi gures (Schedule 2): Capital allowances (option A) 1 0 Increased exemption (option B) 1 0 Statutory income before exemption (3 x 0 5) 1 5 Statutory income after exemption (3 x 0 5) 1 5 Unrelieved exemption (3 x 0 5) 1 5 Chargeable income 0 5 Unabsorbed capital allowances 0 5 Unabsorbed losses (3 x 0 5) 1 5 Exempt account balance (3 x 0 5) 1 5 Summary of effects of option A only: on statutory income 0 5 on exemption and losses 1 0 Summary of effects of option B only: on statutory income 0 5 on exemption and losses 1 0 Summary of effects of both combined: on statutory income 0 5 on exemption and losses 1 0 (iii) No real advantage nil chargeable income in all cases 1 0 Disadvantages of bringing forward capital expenditure 2 0 Format and presentation of report 1 0 Effectiveness of communication (b) Tuition fees represent provision of ICT services 1 0 Foreign clients defi nitions: individual 1 0 company 1 0 Contract must be directly with company 1 0 Conclusion

11 Marks 3 (a) (i) Any TWO examples of fi xed capital (1 mark each) 2 0 (ii) Any TWO examples of circulating capital (1 mark each) 2 0 (iii) Depends on intended use rather than asset itself 1 0 Example of different applications (1 mark each) (b) (i) Characteristics of income earning intention/regularity 1 0 Illegal nature not relevant 1 0 (ii) Income if attributable to having/exercising employment 1 0 But specifi cally exempt 1 0 (iii) Characteristics of income intended to replace lost earnings 1 0 But specifi cally exempt 1 0 (iv) Present activities windfall gains rather than business activity 1 0 Hobby/livelihood comes from elsewhere 1 0 Different if becomes professional gambler (a) Disposal within fi ve years clawback 1 0 Balance of investment allowance reduced 1 0 No 2009 annual allowance, with reason 1 0 Disposal at residual value controlled transfer 1 0 (b) Capital allowances working 1: Deposit 0 5 First instalment 1 0 Installation charges not eligible 1 0 Initial allowance 0 5 Annual allowance 0 5 Old machine not eligible 0 5 Other assets 0 5 Reinvestment allowance working 2: Clawback at 60% 1 0 Deposit and fi rst instalment (ex working 1) 0 5 Installation charges 1 0 Allowance 1 0 Utilised 2009 restricted to 70% of statutory income 1 0 Correctly identify statutory income fi gure 0 5 Capital allowances applied 0 5 Reinvestment allowance applied 0 5 Deduct unabsorbed losses brought forward 1 0 Correctly identify chargeable income fi gure

12 Marks 5 (a) Any TWO circumstances (2 marks each) 4 0 (b) (i) Year of assessment Audited net profi t 1 0 Tax at 3% 1 0 Rebate for zakat 1 0 (ii) Mixed offshore business activity 1 0 No exemption/taxed as offshore trading income 1 0 (iii) Can elect to pay fi xed 20, Rebate for zakat offsettable 1 0 But no carry forward of excess 1 0 Time limit for election (c) Any TWO meanings (1 mark each)