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Malaysian Income Tax Law

LECTURE 2
BUSINESS
INCOME
BY

DR JEYAPALAN KASIPILLAI

Lecture 2: Outline
Why is it important to distinguish between business
income and capital receipt/receipts from hobby /other
types of income?
Badges of Trade 6 factors can be considered to determine
if the receipt/gain is from a trade/business activity or is a
capital item.
Note:
Business v Hobby
Business v Isolated Transactions
Compensation Payment in Hands of a Business
When did the business commence/start?

Introduction
Business income is taxed under Sec. 4 (a)
Business income of individuals has calendar year as basis period [Sec.21
Income Tax Act 1967] & business income of companies has accounting
year as basis period [Sec. 21A(2)]
Business income arises on the day it becomes due and payable to
recipient .
Sec. 3 Territorial jurisdiction of ITA 1967 covers income accruing in /
derived from Malaysia / received in Msia from outside Msia. However,
para 28 Schedule 6 ITA exempts income remitted from abroad.
Sec. 12 Business income deemed derived in Msia (widens tax
net).

Source of Income
The source of income should be from Malaysia before the income is
taxed in Malaysia.
CIR v Lever Brothers & Unilever Ltd explains source of income

General principle: Income deemed to be derived from a particular


country when (Any one of the following):
(i)

contract is made in the country;

(ii)

taxpayer carries on a trade or business in that particular country;

(iii)

business employs capital (to earn profits) in that country;

(iv)

services are performed in the country

What is Business Income ?


Definition of Business Sec. 2(1) Includes profession, vocation, trade
and every manufacture, adventure or concern in the nature of trade
(but excludes employment)
Profession Indicates an occupation requiring exercise of intellectual
skill, i.e. surgeon, sculptor. [CIR v Maxse]
Vocation The way in which a man passes his life, i.e. dramatist
[Billam v Griffith [1941]], racing bookie, etc.
Adventure in the Nature of a Trade Wider than trade and can cover
one-off transactions. Purchased and sold one million rolls of toilet
paper. [Rutledge v IRC]

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Badges of Trade
(MT: pp. 196-203 GMT)
The Royal Commission Report of 1954 referred to 6 guidelines (badges
of trade) for ascertaining whether a taxpayers profits / gains were from
a trade/business or capital receipt. The Badges of Trade are as follows :-

1) Nature of the Subject Matter of the Realization


Though most types of property can be acquired to be dealt in, property
like commodities / manufactured articles which are normally the subject
of trading, are only very rarely the subject of investment.
Cooke v Haddock Solicitor sold land in piecemeal to various
individuals. Profits are taxable.
Rutledge v IRC Adventure in nature of trade. Hence taxable.

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Badges of Trade (Contd)


2) Period of Ownership
The longer the property was held onto, the less likely it
was purchased with a trade motive.
TT Sdn Bhd v KPHDN
KLE S/B v KPHDN [1995]
Wisdom v Chamberlain ingots sold within a year adventure
in nature of trade.
Mount Elizabeth Ltd v CIT [1987] taxpayer developed a block
of apartments and sold after 7 years taxable

Badges of Trade (Contd)


3) Frequency of Similar Transactions by Taxpayer

AS Sdn Bhd v DGIR [1991]


TCS v DGIR
Mount Pleasure Corp S/B v KPHDN [2006]
Pickford v Quirke

4) Supplementary Work done to Subject Matter to


enhance value / marketability.
Cape Brandy Syndicate v IRC formed a syndicate and purchased a
quantity of brandy, blended and re-casked and sold to various
buyers.

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Badges of Trade (Contd)


5) Circumstances Responsible for the Realization/Sale
HCM v DGIR [1993] Taxpayer sold 3 pieces of land to educate
children capital
Penang Realty S/B v KPHDN [2006] Bought land, built house to
rent to RAAF, then sold them company sold a large tract of land in
pieces over time not taxable. Held to be taxable. Compulsory
acquisition by Government was held to be taxable.
Lower Perak Co-operative Housing Society Bhd v KPHDN [1994]
Forced to sell back to developer due to financial difficulties. Held to
be capital and not taxable.,

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Badges of Trade (Contd)


6) Motive
Kirkham v Williams [1989] Bought a site, build a house and sold
the land. Adventure in the nature of trade.
Simmons v IRC [1980]
Note : The courts will see through schemes designed to disguise the
taxpayers intentions. Also, if taxpayers motive is challenged, the onus is
on him to prove that the asset was an investment and not for resale
and profit. If there are mixed purposes, the dominant purpose will be
the relevant one.
Rutledge v IRC (Toilet rolls, Profits taxable)

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Business v Hobby
For distinction between business & hobby (MT: p 208). where money
can be made from both means, refer to case law Haws v Gardiner.
Profits from selling greyhounds bred as a hobby was held to be
taxable.
Characteristics of a Business :(1) Repetition: London Australia Investment [1977]
(2) System and Organization (i.e. commerciality)
Ferguson [1979] (Raise cattle after retiring). Systematic
organization.
Walker [1985] (Goat breeding and selling offspring)
(3) Magnitude ( Size & Scale )
McInnes [1977] Bought 4-5 cattle. Sold 2-3 of the natural
increase. Not business of grazing but a hobby.

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Business v Hobby
(Contd)
(4) Profit Making Intention
Barwick CJ in White [1943] A business necessarily involves the
earning of or intention to earn profits.
Note: Gambling tax cases, where the betting activities are on a
fairly large scale and organized
Graham v Green [1925] Definition habitual bets on horse
racing not taxable.
Partridge v Mallandaine (2 TC 179) systematic and habitual
betting on horse racing vocation taxable.
Profit / gains from Illegal / Unlawful Activities
Mann v Nash [16 TC 523] Gaming machines illegal but
profits taxable
Southern v A.B. [(1933) 18 TC 59] Illegal but still taxable

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Business v Isolated
Transactions
(MT: p. 195)
Generally Gains / profits from isolated transactions not
regarded as being from trade, profession / vocation.
BUT May well come under adventure in the nature of
trade and thus held to be business.
IRC v Korean Syndicate - Confirmed in DEF v CIT
Company formation/ transaction meant to be a business
Punjab Co-operative Bank v CIT
Profits from isolated transaction that is not t/ps ordinary business is
taxable
Teruntum Theatre S/B v KPHDN [2006]
Adventure in the nature of trade hence taxable

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Business v Isolated
Transactions
Leeming v Jones [(1930) 15 TC 333] - For an adventure in the
nature of a trade to exist, at least one of the 4 criteria must exist
(i) the existence of an organisation
(ii) activities which lead to the maturing of the asset sold
(iii) existence of special skill, opportunities in connection with the article dealt with
(iv) the nature of the article itself should indicate that it is for commercial
transactions.

Note : Whether an isolated transaction amounts to carrying on of a


business is a question of fact. Though it is a presumption that when a
company puts its assets to gainful use, it appears to be carrying on a
business [American Leaf Blending Co. Sdn Bhd v DGIR], it can be
rebutted by facts to the contrary.

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Compensation Payments in Hands of


a Business [Capital or Income?]
p.233-238: MT
(1) Contracts relating to Structure of the Business
Van den Berghs v Clark
Compensation payment to remove competitor. Held to be capital
M Properties Sdn Bhd v KPHDN Compensation received would not have
been part of profit chargeable to tax

(2) Compensation for Loss of Profits


Sec. 22(2)(b)
Burmah Steam Ship Co. Ltd v IRC
Compensation for late delivery of repaired delivery of vessel was taxable.

(3) Compensation for Sterilization of a Capital Asset


Glenboig Union Fireclay Co. Ltd. V IRC Compensation held to be capital
Suasana Indah S/B v KPHDN [2006] Compensation not related to
structure of taxpayer, therefore profits held to be taxable.
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When Did the Business


Start ?
For a business, this issue is important to ascertain which part (if any) of
the initial set up costs are deductible against later earned income.
Businesses normally make losses in the early years due to high start up
costs and so, taxpayers would rather push back the start of the business
as far as possible, for tax purposes, as losses are an allowable
deduction.
Expenses incurred in setting up a business or pre-operating expenses
are however, not deductible. Exception:
Schedule 4 B
Income Tax (Deduction of Incorporation Expenses) (Amendment)
Rules 2005.
Income Tax (Deduction of Pre-Commencement of Business Expenses
relating to Employee Recruitment) Rules 2008

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When Did The Business


Start ?
Thus is it important to determine when was the
commencement date of the business.
The ITA 1967 does not provide for this, so reference must
be made to case law. Much however, depends on the facts
of each case.
Public Ruling No. 2/2010 Determination of the date of
commencement of a business requires all the
circumstances & facts of the case to be considered.
Generally, commencement of a business means
commencement of activities that are part of the income
producing process as distinguished from activities
preparatory to the carrying on of a business.

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When Did The Business Start


?
The change from pre-commencement to commencement
of business is signified by a change from passive to active
participation, i.e. opening of shop/hotel for trade business.
Income generation is of no concern to commencement
date
Whereas for manufacturing businesses, it is on receipt of
first consignment of raw materials for processing, etc
Birmingham & District Cattle By-Products Co. Ltd v IRC

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Has Business
Commenced?
Southern Estates [1967]
Cost of clearing shrub & fencing land disallowed as business has not
commenced.
Softwood Pulp & Paper [1976]
Cost of feasibility studies into pulp & saw mills operations & paper
manufacturing plant were held to be pre-operating costs.
Ferguson [1979]
Small business. Sale of bull calves was evidence that a business has
commenced, hence expenses deductible.

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