MHL Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri Appeal No. PKCP(R) 45/2008 (Special Commissioners of Income Tax)

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1 Issue 3, August/Sept 2010 CASE DIGESTS MHL Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri Appeal No. PKCP(R) 45/2008 (Special Commissioners of Income Tax) Income tax Deductibility of sales incentives Whether sales incentives are entertainment Imposition of penalty under Section 113(2) Facts The taxpayer was in the business of manufacturing and distributing eyecare products and prescriptive lenses. The taxpayer did not sell its lenses to consumers directly. The law only authorised registered opticians and optometrists to issue prescription for lenses. As the taxpayer did not employ opticians or optometrists or have its own chain of retail shops, the taxpayer sold its lenses to independent retailers. The retailers did not exclusively sell the taxpayer s lenses. Hence, the taxpayer had to constantly promote its lenses to the retailers. The taxpayer was fully dependent on the retailers to sell its lenses. Consequently, to promote its sales, the taxpayer offered sales based incentives to retailers who bought its products in bulk, maintained a specified stock of the taxpayer s products and met their sales target. The sales incentives offered were usually in the form of cash rebates, tours and items of value like computers. The sales incentives were effectively the taxpayer s strategy to promote its business. The sales incentives worked on points-basis, whereby if the retailers collect more points, the rewards were more lucrative. Further, the taxpayer was under a contractual obligation to provide the sales incentives once the retailers satisfy all the conditions set under the sales incentives scheme. Retailers who did not achieve the minimum target points during the stipulated time period were not eligible for the sales incentives. The taxpayer deducted the expenses incurred in promoting and providing the sales incentives to the retailers as part of its promotion strategy under Section 33(1) of the Income Tax Act 1967 ( ITA ). However, the Inland Revenue Board ( IRB ) categorised the sales incentives as entertainment and disallowed the deduction claimed by the taxpayer pursuant to Section 39(1)(l) of ITA. The IRB also imposed penalty on the taxpayer. 1

2 Issues (a) (b) Whether the sales incentives provided by the taxpayer to its retailers were entertainment as defined under Section 18 of ITA? Whether the IRB was correct in imposing penalty under Section 113(2) of ITA? Decision The Special Commissioners of Income Tax ( Special Commissioners ) found in favour of the taxpayer. It was held that the sales incentives were not entertainment as defined under Section 18 of ITA and were deductible under Section 33(1) of ITA. The sales incentives were held to have solely been incurred to promote the taxpayer s lenses to the retailers and there was no element of hospitality involved. The Special Commissioners also added that the taxpayer was also under a contractual obligation to provide the rewards under the sales incentives scheme when the retailers met their sales target. On the second issue, the Special Commissioners held that the IRB should not have imposed any penalty under Section 113(2) of ITA as the taxpayer had acted in good faith at all material times, made full disclosure and obtained professional advice. [Note: Datuk D.P. Naban, Mr S. Saravana Kumar and Ms Siti Fatimah Mohd Shahrom from our firm s Taxation & Private Clients Practice Group represented the taxpayer in this matter.] 2

3 LKC & Anor v Ketua Pengarah Hasil Dalam Negeri Civil Appeal No. (MT-5) (High Court) Income tax Under-declaration of income Gross profit ratio Best judgment assessments Facts The taxpayers were partners in the business of trading scrap ferrous metals. Prior to a field audit by the Inland Revenue Board ( IRB ), the taxpayers declared that their gross profit ratio for the years of assessment ( YA ) 1998, 1999, 2000 (CYB) and 2001 as 28.33%, 26.84%, 16.79% and 15.82% respectively ( the First Return Forms ). Following a field audit in 2003, the IRB found that the taxpayers: (a) (b) (c) (d) (e) did not completely record all their business transactions; failed to keep record of their trading; did not declare income from their crane rental business; deposited more money into their business account compared to the amount declared in tax computation; and understated their income. The taxpayers agreed with the audit findings. This resulted in additional taxes based on a gross profit ratio of 4%. The IRB issued notices of additional assessment in January 2004, which amounted to RM271, inclusive of penalty. Subsequent to the tax audit, the taxpayers submitted revised audited accounts for the year ended 2001 to the IRB. However, the IRB did not accept the audited accounts as it was found to be inaccurate and unreliable. Notwithstanding the notices raised in January 2004, the IRB proceeded to raise further taxes based on an average gross profit margin of 22%. The average rate of 22% was obtained from the total amount of gross profit declared in the First Return Forms, divided by the four years of assessment. This resulted in additional assessments amounting to RM4,807, inclusive of penalty of 60%. 3

4 The taxpayers disagreed with the gross profit margin computation and appealed to the Special Commissioners of Income Tax ( Special Commissioners ). The IRB contended that the notices of additional assessment were correct and were issued according to the best judgement of the Director-General of Inland Revenue pursuant to Section 91(1) of the Income Tax Act 1967 ( ITA ). The Special Commissioners held in favour of the IRB. The taxpayers appealed to the High Court. Issue Whether the average gross profit ratio of 22% used by the IRB was incorrect and excessive? Decision The High Court allowed the taxpayers appeal. The High Court commented that when issuing best judgment assessments, the IRB is required to make a reasonable judgment based on the material available and should not make an arbitrary decision. In this regard, the IRB had acted in a capricious manner by failing to exercise best judgment when it revised the taxpayers tax computations using an average gross profit ratio of 22% based on the First Return Forms, which the IRB had earlier acknowledged to be wrong. The High Court set aside the decision of the Special Commissioners and ordered for fresh notices of additional assessment to be issued on a gross profit ratio of 8%, which the High Court found to be a just and appropriate ratio. 4

5 Revenue and Customs Commissioners v Procter & Gamble UK [2009] EWCA Civ 407 (Court of Appeal, United Kingdom) Value added tax Zero rating Excepted items Whether savoury snack zero-rated or standard-rated similar to made from Facts The taxpayer was producer of a savoury snack known as Regular Pringles. Regular Pringles was made from potato flour, corn flour, wheat starch and rice flour, together with fat and emulsifier, salt and seasoning. The potato flour content was about 42 percent. Food products are generally zero-rated, save for some excepted items which were packaged for human consumption without further preparation such as potato crisps and similar products made from potato, potato flour or potato starch. The Revenue and Customs Commissioners ( HMRC ) determined the snack to be standard-rated for value added tax ( VAT ) purposes since it was similar to a potato crisp and was made from potato. The taxpayer argued that Regular Pringles were not similar to potato crisps for reasons such as regularity of shape, uniform colouring, texture, taste and packaging. Further, the manufacturing process was different from crisps, and was more like biscuit or cake. The taxpayer contended that a product should be 100% made of potato or nearly so in order to be categorised as potato crisps. The HMRC submitted that the similarity of Regular Pringles to potato crisps was supported by a number of factors such as potato being the main ingredient. At the VAT Tribunal, Regular Pringles was held to be standard-rated. On appeal to the High Court, it was found to be zero-rated. The HMRC subsequently appealed to the Court of Appeal. Issue Whether Regular Pringles, a savoury snack, was a zero-rated or standard-rated item for VAT purposes? 5

6 Decision The Court of Appeal held that the words similar to and made from were loose textured concepts for classification of goods. In this regard, the VAT Tribunal had to determine whether the Regular Pringles were similar to potato crisps or made from potato. The Court of Appeal accepted the reasonable man test applied by the Tribunal to determine this. The VAT Tribunal had considered whether a reasonable man would be aware of the fact that the normal potato crisp had a maximum potato percentage of 70 percent and the Regular Pringles had a potato content of about 42 percent. While the Regular Pringles was different from potato crisps from appearance, taste, ingredients, process of manufacture, marketing and packaging, the VAT Tribunal ruled that Regular Pringles was near the borderline and sufficiently similar to potato crisps. The Court of Appeal upheld the findings of the VAT Tribunal. The Court of Appeal also held that it was improbable that Parliament had only intended products made from 100% potato to be standard rated products. The Court of Appeal upheld the VAT Tribunal s decision and dismissed the taxpayer s appeal. 6

7 GAZETTE ORDERS Double Taxation Relief (The Federal Republic of Germany) Order /2010 This Order was issued by the Minister of Finance pursuant to Section 132(1) of the Income Tax Act 1967 and Section 65A(1) of the Petroleum (Income Tax) Act This Order was gazetted on 8 June The Order gazettes the Double Taxation Agreement ( DTA ) dated 23 February 2010 between Malaysia and the Federal Republic of Germany ( Germany ). The salient features of the DTA are: (a) (b) (c) (d) (e) The withholding tax rate for interest paid to a resident in Germany is 10% if the recipient is the beneficial owner of the interest; Interest means income from debt-claims of every kind, whether or not secured by mortgage and whether or not carrying a right to participate in the debtor s profits, and in particular, income from government securities and income from bonds or debentures, including premiums and prizes attaching to such securities, bonds or debentures. Penalty charges for late payment are not regarded as interest. The withholding tax rate for royalties and fees for technical services paid to a resident in Germany is 7% if the recipient is the beneficial owner of the payment; Royalties means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work (including cinematograph films and films or tapes for radio or television broadcasting), any patent, trade mark, design or model, plan, secret formula or process, or for the use of, or the right to use, industrial, commercial or scientific equipment, or for information (know-how) concerning industrial, commercial or scientific experience; and Fees for technical services mean payments of any kind to any person, other than to an employee of the person making the payments, in consideration for any services of a technical, managerial or consultancy nature. The DTA enters into force on the date on which both countries have notified each other that the national requirements for such entry into force 7

8 have been fulfilled. The relevant date shall be the day on which the last notification is received. Income Tax (Exemption) (No. 10) Order /2010 This Order is a corrigendum to the Income Tax (Exemption)(No.10) Order 2009 ( 473/2009), which was gazetted on 30 December This Order was gazetted on 29 July Customs (Prohibition of Import) (Amendment) (No.2) Order /2010 This Order was issued by the Minister of Finance pursuant to Section 31(1) of the Customs Act This Order was gazetted on 29 July The Second Schedule of the Customs (Prohibition of Imports) Order 2008 [ 86/2008] is amended by deleting subheading in column (3) in relation to item 12. This Order took effect on 1 August Customs Duties (Goods under the Free Trade Agreement between Malaysia and New Zealand) Order /2010 This Order was issued by the Minister of Finance pursuant to Section 11(1) of the Customs Act This Order was gazetted on 29 July The First Schedule to this Order contains the Rules of Origins under the Free Trade Agreement between Malaysia and New Zealand. The Second Schedule to this Order prescribes the rate of import duty of products imported into Malaysia from New Zealand. This Order took effect on 1 August

9 Customs Duties (Goods Of ASEAN Countries Origin) (ASEAN Harmonised Tariff Nomenclature And Common Effective Preferential Tariff) (Amendment) (No. 3) Order /2010 This Order was issued by the Minister of Finance pursuant to Section 11(1) of the Customs Act This Order was gazetted on 30 July This Order substitutes: (a) (b) the title Customs Duties (Goods of ASEAN Countries Origin) (ASEAN Harmonised Tariff Nomenclature and Common Effective Preferential Tariff) Order 2007 (440/2007) with Customs Duties (Goods of ASEAN Countries Origin) (ASEAN Harmonised Tariff Nomenclature and ASEAN Trade In Goods Agreement) Order 2007 ; and the word CEPT wherever appearing in Customs Duties (Goods of ASEAN Countries Origin) (ASEAN Harmonised Tariff Nomenclature and Common Effective Preferential Tariff) Order 2007 (440/2007) with ATIGA. This Order also amends the First Schedule to Customs Duties (Goods of ASEAN Countries Origin) (ASEAN Harmonised Tariff Nomenclature and Common Effective Preferential Tariff) Order 2007 (440/2007). This Order is deemed to take effect on 17 May Exemptions From Entertainments Duty The following events were exempted from entertainments duty by the Minister of Finance in June 2010: Gazette Orders 188/2010 Event Venue Dates The Konsert Amal Diraja Sempena Sambutan Hari Keputeraan Yang Ke-64 DYMM Sultan Sharafuddin Idris Shah Alhaj show Plenary Hall, Convention Centre 14 and 15 November

10 189/2010 The Placebo Live In show KL Live, 16 March /2010 The Ben 10 Alien Force Live On Stage In Power Of The Omnitrix show Plenary Hall, Convention Centre 27 until 29 November /2010 The West Side Story, The Musical show Istana Budaya, 12 until 27 May /2010 The Disney On Ice Princess Wishes show Stadium Putra, Kompleks Sukan Bukit Jalil, 12 until 14 March /2010 The Super Junior 2 nd Asia Tour Live in 2010 show Stadium Putra, Kompleks Sukan Bukit Jalil, 20 March /2010 The Lionel Richie show Convention Centre 2 April /2010 The Amit Live First World Tour In Malaysia 2010 show Stadium Putra, Kompleks Sukan Bukit Jalil, 24 until 26 April /2010 The Stereophonics Live In Malaysia 2010 show KL Live, Life Centre, 28 April /2010 The A Starry Night With Julio Iglesias-World Tour 2010 show Convention Centre 1 April

11 Value Of Crude Palm Oil For Customs Duty The value of crude palm oil in June and July 2010 for customs duty purposes is as follows: Gazette Orders Value (per tonne) Effective Dates 192/2010 RM 2, June 2010 to 13 June /2010 RM 2, June 2010 to 20 June /2010 RM 2, June 2010 to 27 June /2010 RM 2, June 2010 to 4 July /2010 RM 2, July 2010 to 11 July /2010 RM 2, July 2010 to 18 July /2010 RM 2, July 2010 to 25 July /2010 RM 2, July 2010 to 1 August

12 Value Of Crude Petroleum Oil For Customs Duty The value of the various types of crude petroleum oil for customs duty purposes for June and July 2010 was prescribed in the following orders: Gazette Orders 191/ / / / /2010 Effective Dates 3 June 2010 to 16 June June 2010 to 30 June July 2010 to 14 July July 2010 to 28 July July 2010 to 11 August 2010 Value Of Palm Kernel Oil For Customs Duty The value of palm kernel for customs duty purposes for June and July 2010 is as follows: Gazette Orders Value (per tonne) Effective Dates 185/2010 RM 1, June 2010 to 30 June /2010 RM 2, July 2010 to 31 July

13 SEMINARS In-House Congress 2010 On 24 June 2010, our Mr S. Saravana Kumar presented a paper entitled the Basic Obligations Of Employers Under The Income Tax Act His paper discussed the obligations of employers under Section 83 of the Income Tax Act It is notable that nearly 150 in-house legal counsel attended this session which also featured Mr Lim Heng Seng, the firm s Head of Employment & Industrial Relations Practice Group. If you are interested to obtain Saravana s handout, please contact us at tax@lh-ag.com The 15 th Malaysian Law Conference 2010 Datuk D.P. Naban, the firm s Head of Taxation & Private Clients Practice Group, was among the speakers at the 15 th Malaysian Law Conference. The tax session, which was held on 31 July 2010, was moderated by Yang Berbahagia Tan Sri Hasmah Abdullah, the Director-General of Inland Revenue ( DGIR ). Datuk Naban s paper was entitled The Exercise Of Discretion: The Powers Of The DGIR. He spoke on the powers of the DGIR in imposing penalty under Section 113(2) of the Income Tax Act If you are interested to obtain Datuk Naban s handout, please contact us at tax@lh-ag.com 13

14 The Tax Practice is brought to you by the firm s Taxation & Private Clients Practice Group. The practice group consists of experienced lawyers who represent their clients in virtually all direct and indirect tax areas. Our tax lawyers frequently represent taxpayers before the Special Commissioners of Income Tax, High Court and Court of Appeal. They also represent taxpayers in discussions and negotiations with the Inland Revenue Board, Royal Malaysian Customs and Ministry of Finance. Particular areas of expertise include tax litigation, tax planning & advisory, transfer pricing, thin capitalisation, tax audit & investigation, cross-border transactions, stamp duty, anti-dumping duty, sales & service tax, customs duty and excise duty. If you have any queries, please do not hesitate to contact: Datuk D.P. Naban Head of Taxation & Private Clients Practice Group DID : Fax : / tax@lh-ag.com S. Saravana Kumar Senior Tax Associate & Editor of Tax Practice DID : /5814 Fax : / tax@lh-ag.com Editorial team: Siti Fatimah Mohd Shahrom (Sub-Editor) Elaine Lim Chiew May Cheryl Denise Thean Leong Tsu Quin Lim Phaik San Published by the Taxation & Private Clients Practice Group.. All rights reserved. The views and opinions attributable to the authors or editor of this publication are not to be imputed to the firm, Lee Hishammuddin Allen & Gledhill. The contents of this publication are intended for purposes of general information and academic discussion only. It should not be construed as legal advice or legal opinion on any fact or circumstance. 14