Chapter 6; business income students (1)

04/12/2023 ATXB 213 MALAYSIA TAXATION I 1

CHAPTER 6

BUSINESS INCOME: INDIVIDUAL


LEARNING OBJECTIVE

Concept and definition of business

Application of badges of trade

Derivation of business income

Types of gross income

Business deduction

To calculate the gross income, adjusted income & statutory income

Introduction

Income tax is imposed under sec 4(a) of ITA 1967 on the gains or profits of a business.

The tax is imposed not on business itself but on the person carrying on the business or trade.

To tax a person under sec 4(a), it is important to establish that the taxpayer has derived gains or profits from the carrying on of a business.

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Definition of Business

Profession. Not defined in the Act. Intellectual skill or manual skill controlled by

intellectual skill. Carried out by a company or an individual.

Trade – repetitious buying goods and selling such goods with intention to make profit.

Vocation Analogous to the word “calling”. Means the way in which a person passes his or her life


CONTINUEManufacture

Transforming original material so that a new and different article or product emerges;

Adventure or concern in the nature of trade Deal with isolated buying and selling transactions. It is difficult to hold such transaction as trade

activities due to isolated nature. However it is possible to hold them as an adventure

or concern in the nature of trade and apply income tax upon them – referring to badges of trade.


Example

Melisa a chartered accountant has formed an enterprise to provide accounting and tax services to small medium enterprises in Muar, Johor. Her enterprise has staff strength of four persons and a client base of fifteen companies and fifty sole proprietorships.

Discussion:

Melisa is exercising a profession and the profits from the enterprise will be taxable as business income accruing to Melisa.


Badges of Trade

It is well-defined characteristics of trade which can be act as a guide in differentiate gains arising from the disposal of an investment and gains from trading or from an adventure or concern in the nature of trade.

The former is not subject to income tax but gains from trading or from an adventure or concern in the nature of trade are taxable.

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Badges of Trade

Radcliff Commission has laid down six key characteristics of trade called it as badges of trade.

Existence of one or more of the said badges of trade indicate trading or the existence of an adventure or concern in the nature of trade.


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Badge 1:Subject Matter

The intention of the acquirer at the point in time that the subject matter was acquired is the important consideration to determine whether a gain derived is capital or revenue in nature.

If intention mainly to resell the subject matter at a profit, then the gain received is revenue in nature and liable to be taxed.

Where the property does not itself yield income or personal enjoyment to its owner merely by virtue of its ownership, it more likely to have been acquired for the purpose of resale.


Continue

Rutledge vs I.R.C – where a taxpayer bought a large quantity of toilet paper, an act which not part of his normal business. It was said that “as the purchase was made for no other purpose, except that for resale at a profit, thus the deal was in the nature of trade.


Badge 2:Period of Ownership

If period of ownership of asset is a short one, it may interpreted that the asset was acquired for trading and not for investment.

It implies that longer the period of ownership of asset, the less likely to have a trade.Wisdom v Chamberlain (1968)Mount Elizabeth (Pte) Ltd v The Comptroller of

Income Tax


Badge 3: Frequency of Transaction

If a particular transaction is one of a series of such transactions and if there is evidence of a systematic and methodical activity, it will constitute an adventure in the nature of trade.

Distinction must be established between a number of transaction spread over a considerable period of time and that is closely related to each other to form a series.

A number of transactions in the same kind of property raises the presumption that the particular property was purchased for resale at a profit.Pickford vs Quirke


Badge 4: Supplementary work done prior to sale

When subsequent processing of an asset has taken place, such processing indicate an intention to trade.

This includes material improvement to an asset after acquisition so that it more marketable.

Cape Brandy Syndicate vs I.R.CThe company after purchasing a large quantity of

brandy, proceeded to blend and re-case the brandy before selling it in lots.

It was held that the transaction was a trading transaction.


Badge 5: Organization set-up to dispose of the goods

If special exertion is made to find or attract purchasers such as the opening up of an office or extensive advertising such facts will indicate the presence of a profit making undertaking.

Martin v LowryKLE Sdn Bhd v Ketua Pengarah Hasil Dalam

Negeri – the subject’s land commercial potential was a very good ready made advertisement in itself.


Badge 6: Motive of the Transaction

Circumstance surrounding the transaction:Sale due to sudden emergency or unanticipated need for

funds indicate that property was not acquired for purpose of resale at a profit.Steven v Hudson Bay CoHCM v DGIR (1993)

Profit motive as a factorKirkham v Williams (1989)SCL v Cit (1991)KLE Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri

Intention to tradeSimmons v IRC


Principle of Mutuality

A man cannot trade with himself and make a profit out of the transaction.

The surplus of contribution over expenditure cannot be income


Derivation of Business Income

Business receipt are subject to income tax provided they are revenue in nature and derived from Malaysia.

Conditions that must exist:The existence of businessThe business transaction is income in natureSuch business income is deemed derived

from Malaysia


Derivation of Business Income

Gross income from business which is not attributable to operations of a business carried on outside Malaysia shall be deemed to derived from Malaysia.

For business income is attributable to operations of the business carried on o/side Malaysia if one of following factors exist: Contracts are concluded o/side Malaysia. Stocks are maintained o/side Malaysia from which orders are filled. Sales proceeds are received overseas Service are rendered outside Malaysia.


Example

Meranti Sdn Bhd is a Malaysian resident company, involved in the provision of professional computer services. It has a branch in Jakarta, Indonesia. Meranti has signed a contract with a commercial bank in Indonesia, to provide computer services for the bank’s network of branches in Indonesia. The service was provided by Meranti’s employees stationed in Jakarta. The duration of the project is expected to be for a period of least 20 months. Work on the project commenced in January 2012. Meranti’s financial year ends on December 31.


Example

Issues: Advice the Financial Controller of Meranti Sdn Bhd on whether the income from the Indonesian project is taxable when remitted back to Malaysia.


Discussion


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Commencement of Business


The determination of the date of commencement of a business is important because:To determine the basis period in relation to year of

assessmentTo identify the expenditure incurred before the date of

commencementTo identify capital expenditure incurredTo allow capital allowance against the business income

in relation to the relevant year of assessment.

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New Business or a Continuation of Business


The distinction is very important because it has an impact on the deduction of capital allowance and allow ability of business losses in the computation of taxable income.

Conditions to be considered: CustomersManagementMethod of accounting

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Charge to Income Tax


Sec. 3 of the Income Tax Act 1967:“Income tax shall be charge for each year of assessment

upon the income of any person accruing in or derived from Malaysia or received in Malaysia from outside Malaysia..”

Accrue: natural growth or increment; to arise or spring as a natural growth or result

Derive: to draw; to fetch; to obtain; to come into something as its source

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Capital vs Income


Business activities (income) have to be distinguished from investment transactions (capital)

Capital natures business receipt are not taxable (i.e. gain from disposal of fixed assets)

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The Ascertainment of Gross Income


Section 22 (1) and (2):

Applies to revenue receiptIf the gross income resulted from past expenses

and outgoings of revenue nature, it would then be treated as income.

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Sales of Goods and Rendering of Services – S 24(1)


The principle activity of most business concerns is either trading or providing a service.

Therefore, gross income from the sale of goods (stock in trade) and rendering of services constitutes business income.

The gross business income is taxable on a accrual basis, for both local and export sales.

The gross business income for export sales can be based either sales value or market value of the goods.

When the export sales are made to related company, Market Value is advocated.

ExampleAh Chong has a business which sells hand phones. During the year 2012, the business concern has sales of RM500,000 of which the breakdown is as follows:

RMCash sales 250,000Credit sales 250,000

----------500,000=======

Other information;(a) RM100,000 credit sales remained uncollected as at 31st December, 2012.(b) 50% of the credit sales were to overseas customers (export sales)

Issue: Determine the gross income from trading for the year 2012. Answer: Gross Income is RM500,000.


Non-refundable Advance received – S 22(2)

Sum receivable by way of insurance, indemnity, recovery and reimbursement constitute gross business income.

For instance, such sum include insurance recoveries which are in respect of trading stock, defalcation by employees, repairs of assets as well as life and accidents insurance.

Insurance recoveries for replacement of assets are capital receipt, thus not taxable.


Example

MESRA Car Seat is an enterprise selling leather car seats. It obtained its leather from various suppliers in Europe. In 2012, several customers complained that their leather seats which had been supplied by MESRA Car Seat had started to peel after only four months of use. The company traced the leather shipment which had been used for the defective car seats and replaced all the car seats made from the said shipment. It then made a claim against the leather supplier. After a period of lengthy negotiations and to maintain goodwill, the supplier paid MESRA Car Seat a sum of RM55,000.


Discussion

Discuss whether the RM55,000 is taxable.

Answer:


Compensation for Loss of Income

Compensation for loss of income from a source is a revenue receipt and is taxable.

This receipt exhibit one or more of the following attributes:The receipts must be filling a hole in profits.The receipt must not be in respect of physical

damage or disposal of capital assets.The receipt must not relate to the restructuring

of company.ATXB 213 MALAYSIA TAXATION I 3204/12/2023

Recovery of Trade Debt

The recovery of trading debt is taxable subject to key condition being satisfied.The debt previously written off as being bad and

were allowed as deductions in arriving at the adjusted income from business.


Waiver of Amounts Owing to Creditors

The waiver of amounts owing to creditors (i.e. suppliers) is taxable.

Example:Kamal, is an owner of a provision shop. As at 31-12-2012,he had an amount of RM3,800 owing to one of his confectionary suppliers. In the middle of 2011, the supplier agreed to waiver the amount owed to him on the basis of the long-term relationship between him and Kamal. Kamal consequently debited the “supplier account” in his monthly accounts and credited “the income statement account”.


Waiver of Amounts Owing to Creditors

Issue: Advise Kamal whether the waiver of RM3,800 is taxable.

Discussion: The RM3,800 is gross business income because it is a release of debt related to deductions (“purchases” account) which have been made, in arriving at adjusted income.


Taxation of Gains from Foreign Exchange Exposure

A foreign exchange exposure arises when a business entity has transactions denominated in currencies other than home country.

Realized foreign exchange gains are taxable and losses on revenue account are deductible.

Unrealized forex gains or losses on revenue account are not admissible for tax purpose.

Gains or losses on capital account are neither taxable nor deductible whether realized or unrealized.


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BUSINESS DEDUCTIONS

- Chapter 10 -


CONTINUE

Principles of Deduction

Revenue versus capital expenditure

Expenditure incurred by the taxpayers carrying on a business

Qualifying deduction under the ITA

Timing of the expenditure

Expenditure wholly and exclusively incurred in production of gross income


General provisions for deductions

Deductibility under Section 33 of ITA:

– Outgoings and expenses– Wholly and exclusively– Incurred– During that period; and– In the production of gross income


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Deductions prohibited under the Act

Adjusted and Statutory Income from Business

The format to compute the adjusted income and statutory income from business as follows:


Add Less

Net profit/(net losses) xx

+) Any item/expenses not allowable for deduction xx

-) Items allowed for double deduction (xx)

-) Non business income / Non taxable income Sec 4(c) : dividend, interest and discount Sec 4(d): rent, royalty and premium

(xx)

Adjusted income/loss XX

+) Balancing charges xx

-) Capital allowance/ balancing allowance (xx)

Statutory Income XX

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THANK YOU

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Chapter 6; business income students (1)