Taxation 1 [BAC 2097]

Taxation 1 / BAC 2674 / Tutorial 4

Business income Part 1

QUESTION 1

What is The Badges of Trade? Discuss some of the salient features taken into account in the Badges of Trade.

QUESTION 2

Under what circumstances is income deemed derived from Malaysia? Why is it important to determine that it is deemed derived from Malaysia?

ANSWER

Under section 12, gross income of a person derived from Malaysia from a business, so much of the gross income from the business as is not attributable to the operation of the business carried on outside Malaysia shall be deemed to be derived from Malaysia.

It is important to determine the derivation because only income derived from Malaysia is taxable in Malaysia income derived from sources outside Malaysia being not taxable.

QUESTION 3

How would you distinguish between a capital income and a revenue income?

Please go through the solution on your slide/text on distinguishing characteristics of the two i.e. recurring, fixed capital etc.

QUESTION 4

Mr. Rajoo is a qualified engineer and works with a company that assembles and sells cranes. In 2010 the company ran into financial difficulties and was closed. Mr Rajoo with the help of Mr Nair, a banker and Mr. Pandy, a marketing agent with a local distributor of toys bought several pieces of crane parts. Mr Pandy put together the various componetns and the five cranes so assembled were sold over a period of two years for a large profit. The financing was arranged by Mr. Nair while the sales was arranged by Mr. Pandy.

The trio never engaged in a similar transaction after this. Mr Rajoo got a job with a oil palm factory in Johore and moved out of Selangor. Mr Pandy set up his own used car agency in Kajang . Mr Nair migrated to Australia in 2011.

Required: Discuss whether the profit arising from the assembly and sale of the cranes are taxable as a business profits.

ANSWER

The transaction appears to be an isolated transaction by people with diverse background. However the activity of acquiring parts, assembling and selling of the cranes has the color of an adventure in the nature of trade for the following reasons:

There was a profit motive

There was an organized activity of acquiring parts, assembling and selling of the cranes resembling a business process.

The activity yielded no personal enjoyment other than to make profit from the sale of the cranes.

QUESTION 5

Mr Presley is a music teacher who graduated with a Masters degree from the London School of Music. He teaches aspiring music students to play the piano at his home in Dengkil. He has three classes every for the various grades of students. He charges the students a fee by the number of hours the lessons are taught.

On weekends, he plays the piano at an international hotel. He has a contract with the hotel under which Mr Presley is entitled to a free welcome drink (a glass of beer) and is to be paid RM200 per hour to play western classical music on the piano for three hours, from 7 pm to 10 pm. The piano is provided by the hotel. Under the contract, the hotel can ask him to play after midnight at their discretion.

Required:

Determine the status of Mr Presley for income tax purposes i.e. whether he is a professional musician or an employee exercising an employment under a contract of employment.

ANSWER

As a music teacher, Mr Presley is exercising a profession as he runs his own classes and imparts professional knowledge and skill to music students in an environment that he controls, as well as assuming business risk in the process. The fees received are therefore professional income and would be assessment under section 4(a).

The income earned by playing the piano at the international hotel is an employment income i.e. there is a master servant relationship where the hotel pays him for his services, he is provided the tools of the trade by the hotel and is required to play on specific days and time as determined by the hotel.

QUESTION 6

What is the general provision relating to gross income and what is the principle of taxability of receipts?

ANSWER

Under section 22 Gross income from a business would consist of the following:

Gross income of a person from a source of his for the basis period for the year of assessment

Sums receivable or deemed to be receivable from insurance, indemnity, recoupment, recovery, reimbursement or otherwise

Compensation for loss of income

A receipt is taxable only if it is income falling within the meaning of the taxing statutes of the Income Tax Act 1967 (as amended). Receipts of a capital nature are not taxable.

QUESTION 7

Area Trading Sdn. Bhd. deals with recycled paper. In 2007 it found the business was very competitive and therefore entered into an agreement with its competitor also operating in the area. Under the arrangement to run for 25 years, both companies will share the raw materials and will distribute the recycled products in their own segregated market at prices agreed by both parties. In this way both companies will be able to make a reasonable profit and stay in business since the machinery for the recycling process is very expensive and use-specific, in addition to the market being limited. The arrangement worked very well until a new management took over the competitor. They were not in favor of the arrangement and called off the arrangement. They agreed to pay Area Trading RM 25m in settlement.

Required

1.What is the tax implication of the amount received by Area Trading Sdn. Bhd. and of the payment made by the competitor?

2.Would it make any difference to the tax treatment had Area Trading Sdn. Bhd. made several such agreements in the course of its trading activities?

ANSWER

The sum received would not be taxable the arrangement relates to the profit making structure and the cancellation of the arrangement is actually destroying that structure which would be a loss of capital advantage. The payment made by the competitor may also not be allowed the payment is not part of the trading expenditure and therefore may be considered to be a capital payment.

If the company had made several such arrangements it could be considered to be part of the operating style and as such the receipts may not be considered to be capital but revenue.

QUESTION 8 - SELF REVISION

Mr. Long, an employee of fast food company and Mr. Razak, a bank manager made some profit on the purchase and sale of nine units of fruit cutting machines. This was the first time that Mr. Long and Mr. Razak undertook such a transaction. The units of fruit cutting machines were sold to different buyers. Expenses such as commission, advertising, repairs, insurance, traveling and entertainment were incurred to facilitate sale.

State whether the profits arising from the above transactions are liable to income tax.

ANSWER

The purchase & sale of 9 units of machines appear to be isolated transactions under Adventure or concern in the nature of trade (An isolated transaction that gives rise to business income

Use badges of trade to distinguish gains arising from the disposal of an investment and gains from trade or an adventure or concern in the nature of trade the profits

Others: Existence of short-term ownership, profit motive, alteration of assets, efforts of disposals etc (Explain the points with situation).

QUESTION 9 - SELF REVISION

Mr Kollai Segaran is a well know lawyer in Dengkil. He has many clients for whom he arranges to purchase or acquire landed properties. In the course of his business he was able to acquire for himself a property in a good location with potential for development in about 15 years. He acquired it with the intention of holding it as a long term investment and sell it when the price is right.

However, two years after its acquisition, he came to know from the staff of the land office that the land has been earmarked for the building of a large hospital. He found an unsuspecting buyer for the property and sold it at handsome profit.

Required:

Determine whether Mr Kollai Segaran has engaged in the trade of dealing in landed properties.

ANSWER

Mr Kollai Segaran could be treated as dealing in properties as he is already engaged in the business of arranging land deals for his clients. The purchase and sale of the land, even though it was one off transaction, was no different from what he was doing for his clients acquiring and or disposing landed properties. Only this time, he was doing it for himself.

On the other hand the gains made could be treated as a capital gain as it was not the intention of Mr Kollai Segaran to buy and sell landed properties he was a lawyer and only arranged a sale or an acquisition for his clients as part of his legal business. The land was bought as a long term investment and the fact he sold it within 2 years was on account of changed circumstances i.e. the land was to be acquired soon by the government.

QUESTION 10 - SELF REVISION

MyVi Spares Sdn. Bhd. is a local company incorporated to produce leather seats for the MyVi car sold in Malaysia. The following are the activities after incorporation in January 2005:

DateActivity

November 2005Land acquired in Sepang

December 2006Foundation for factory laid by a minister who now lost his seat in the recent election.

June 2007Factory completed

September 2007Plant and machinery installed in the factory

October 2007Staff were trained in the plant operation by the supplier of the machine

December 2007The company received its first batch of leather from Australia

January 2008The first batch of manufactured leather seats were delivered to the MyVi car factory for installation in the cars.

Required

1.State the date of commencement MyVi Spares Sdn. Bhd.

2.What is the significance of the determination of the commencement date

ANSWER

The date of commencement is the day the raw materials arrived.

Case law: The Birmingham & District Cattle By-Products. Co. Ltd. V CIR

Expenses incurred prior to the date of commencement are treated as pre-commencement expenses and are not tax deductible.