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An Occasional Ser ies 2/2009TAX nSIGHTS

Malaysian DevelopmentsIncome Tax (Amendment) Act 2009The Income Tax (Amendment) Act 2009 (“the Act”) was gazetted on 23 April 2009 to enactthe proposals announced in the 2009 Mini Budget. As a result of the Act, two new sectionshave been introduced into the Income Tax Act, 1967 (ITA) alongside some amendmentsto Schedules 3 and 6 of the ITA as well. The changes are as follows:

• A new Section 44B has been introduced which allows for current year losses of upto RM100,000 to be carried back to the immediately preceding year. This benefit ofcarry-back of tax losses is available for the years of assessment (YA) 2009 and 2010to all businesses including partnerships and sole proprietors. There are certaincategories of taxpayers who are not entitled to benefit from the loss carry back,including companies enjoying pioneer status or the investment tax allowance underthe Promotion of Investments Act 1986, companies claiming reinvestment allowanceunder Schedule 7A of the ITA, etc. It should also be noted that Section 44(1) has beenamended to refer to the Section 44B loss carry back provision in determining themanner in which losses may be utilised;

• A new Section 46B has been introduced to give tax relief to individuals in relationto interest costs arising from housing loans in respect of sale and purchaseagreements executed between 10 March 2009 and 31 December 2010 (with effectfrom the YA 2009);

• Paragraphs 8A, 8B and 32A have been introduced into Schedule 3 to allow for theclaim of accelerated capital allowances of 50% per year to be claimed in respect ofprescribed qualifying capital expenditure (up to RM100,000) incurred on renovationor refurbishment between 10 March 2009 and 31 December 2010; and

The state of the global and domestic economy continues to dominate the news, with theMalaysian economy having seen negative growth for the first quarter of 2009, a first afterseveral years of positive growth. With the exception of the construction sector, all othersectors recorded a decline, with the manufacturing industry weakening the most.

Against this backdrop, the Government is preparing for the 2010 Budget, which willundoubtedly be a challenging task. The Government will need to enhance the revenuebase, whilst stimulating the economy – no easy feat by any measure. It is hoped that themeasures under consideration will not merely focus on increasing Government revenues,but will also focus on improving transparency and accountability in relation to Governmentspending.

There have been several tax developments, domestically and internationally over the lastquarter which are summarised below:

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MALAYSIANDEVELOPMENTS

Income Tax (Amendment)Act 2009

Labuan

Gazette Orders

Public Rulings

Administrative Matters

2010 Budget

Case Law

INTERNATIONALDEVELOPMENTS

Brunei

China

India

Indonesia

Hong Kong

South Africa

United Kingdom

United States

Vietnam

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• Paragraph 15(1) of Schedule 6 has been amended toincrease the tax exemption in respect of compensationfor loss of employment from RM6,000 to RM10,000 foreach completed year of service (with effect from the YA2009).

As reported in the last edition of TAX INSIGHTS, the otherproposals announced in the 2009 Mini Budget were enactedvia gazette orders soon after the proposals were announced.

LabuanLabuan’s commitment to the OECD’s exchangeof information standard

The Organisation for Economic Cooperation & Development(OECD) announced earlier this year that Labuan was on itstax haven blacklist for non-compliance with the internationalstandard of exchange of information on taxation. However,this announcement was subsequently withdrawn followingthe assurance from the Labuan Offshore Financial ServicesAuthority (LOFSA) that Labuan is working towards adheringto the new international standard on the exchange ofinformation on taxation.

Flexibility for Labuan holding companies tobe located onshore in Malaysia

Under the financial liberalisation package recentlyannounced by the Prime Minister, Labuan holdingcompanies are now given the flexibility to locate theiroperational and management offices onshore in Malaysiawith effect from 1 June 2009 upon satisfying several criteria,including the requirement for the Labuan holding companyto have made an irrevocable election under Section 3A of theLabuan Offshore Income Tax Act 1990 to be taxed under theITA. Such companies will be allowed to undertake thefollowing activities from their Kuala Lumpur offices:

- holding of investments in securities, stocks, shares,loans, deposits or immovable properties,

- provision of management services includingadministrative, human resource, accounting andbackroom support services to related companies withinMalaysia, or related or non-related companies outsideMalaysia,

- management of surplus funds and provision of creditfacilities to related companies within the group in andoutside of Malaysia,

- trading or re-invoicing activities outside Malaysia.

Gazette Orders• Income Tax (Exemption) Order 2009

The above gazette order enacts the proposals announcedin the 2009 Budget to exempt the following benefits-in-kindand perquisites arising from employment:

- Travelling allowance, petrol cards and petrol allowancefrom home to the work place and vice-versa up to anamount of RM2,400 per year;

- Travelling allowance, petrol cards and petrol allowancewhich are incurred for the purpose of performing officialduties up to an amount of RM6,000 per year;

- Child care allowances up to an amount of RM2,400per year;

- Discounted prices in respect of consumable businessproducts of the employer up to an amount of RM1,000per year; and

- Subsidies on interest in respect of housing, educationor car loans up to an amount of RM300,000.

It should be noted that the above exemptions do notapply to directors of controlled companies, sole proprietorsand partners.

• Income Tax (Deduction for Benefit and Giftfrom Employer to Employee) Rules 2009

The above Rules prescribe tax deductions for employersin relation to the following benefits and gifts provided toemployees:

- payment of monthly bills for subscription of broadband,fixed line telephones, mobile phones or pagersregistered in either the employees’ or employer’s name(from the YA 2008 onwards);

- travelling allowances, petrol cards or petrol allowancesprovided for employees for travel to and from home tothe place of work (from the YAs 2008 – 2010); and

- personal digital assistants, telephones, mobile phonesor pagers (from the YA 2008 onwards).

• Income Tax (Exemption) (No. 2) Order 2009

Following the 2007 Budget proposals granting incentives toBionexus status companies, the above Order has beengazetted to enact the concessionary tax rate of 20% forBioNexus companies upon the expiry of the 10 year taxexempt period granted to such companies. It should be

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noted that the concessionary tax rate applies in respect ofincome from qualifying activities for a further 10 yearsfollowing the expiry of the tax exempt period.

• Income Tax (Exemption) (No.7)(Amendment) Order 2009

The above order amends the Income Tax (Exemption)(No.7)Order 2008 to give effect to the following:

- A non-resident is exempt from tax on interest paid orcredited in the basis year for a year of assessment byBank Kerjasama Rakyat Malaysia Berhad,

- Resident individuals are exempt from tax on interestreceived from negotiable certificates of deposit orrediscounting of banker’s acceptance on repurchaseagreements or other similar instruments of tradefinancing which are traded in the money market,

- Resident individuals are exempt from tax on gains orprofit, interest or bonus received from money depositedin savings, current, fixed deposit or investment depositaccounts or the equivalent accounts under Islamicbanking principles, where the accounts are maintainedwith the following institutions:

i) a bank or finance company licensed under theBanking and Financial Institutions Act, 1989

ii) a bank licensed under the Islamic Banking Act,1983

iii) a development financial institution prescribedunder the Development Financial InstitutionsAct, 2002

iv) the Lembaga Tabung Haji established under theTabung Haji Act, 1995

v) the Malaysian Building Society Berhadincorporated under the Companies Act, 1965

vi) the Borneo Housing Mortgage Finance Berhadincorporated under the Companies Act, 1965

vii) a co-operative society registered under the Co-Operative Societies Act, 1993

• Windfall Profit Levy (Oil Palm Fruit)(Amendment) (No. 2) Order 2009

The Windfall Profit Levy (Oil Palm Fruit) Order 2008 has onceagain been amended to impose the windfall profit levy on oilpalm holding owners or oil palm fruit producers who haveworked oil palm holdings of not less than 40.46 hectares or

100 acres. (Previously, the windfall profit levy was imposedon oil palm fruit producers who owned oil palm holdings ofnot less than 40.6 hectares or 100 acres).

• Loans Guarantee (Bodies Corporate)(Remission of Tax and Stamp Duty) Order2009

The above Order provides for the remission of tax and stampduty in respect of any money payable under any agreement,note, instrument and document in relation to the issue of theIslamic Medium Term Note of two billion two hundred million(RM2,200,000,000) by Penerbangan Malaysia Berhad (awholly owned subsidiary of Ministry of Finance Inc.) Theremission also extends to certain prescribed guaranteesprovided by the Government.

Public RulingsThe following Public Rulings (PR) and addendums havebeen issued:

PR 1/2009 on Property Developers and PR2/2009 onConstruction Contracts. These PRs supercede theearlier PR3/2006 which was outdated following theissuance of the Property (Development) Regulations 2007and the Property (Construction Contracts) Regulations2007. All property developers and those involved inconstruction activities should familiarise themselveswith these new PRs.

Second Addendum to PR 1/2006 on Perquisites FromEmployment

Following the issuance of the Second Addendum to thePR1/2006, the Inland Revenue Board (IRB) has issued aletter (dated 23 June 2009) clarifying that the Ministry of

Finance has extended the income tax exemption givenin respect of meal allowances to allowances for overtimeand outstation/overseas assignments retrospectivelyfrom the YA 2008. Such allowances are for the purposes ofdefraying meal expenses and the exemption is subject tothe condition that the allowances be given at ratesprescribed by the employer.

Third Addendum to PR 2/2004 onBenefits-in-Kind – thePR 2/2004 has been updated to take account of theproposals announced in the 2009 Budget to exempt variousallowances/benefits from tax e.g. discounted prices forconsumable business products or services provided by theemployer, the benefit of free petrol, the provision of maternitybenefits, the payment of monthly telephone, mobile phone,broadband subscription bills, etc by employers.

Addendum to PR 3/2001 on Appeal Against AnAssessment – the addendum incorporates the changesarising from the 2009 Budget proposals wherein appealscan now be made against notifications of non-chargeabilityissued pursuant to Section 97A. The PR also specifies thecircumstances under which a notification of non-chargeability will be issued.

It is understood that the IRB will be issuing Public Rulingsand/or addendums to existing Public Rulings in relation tothe following in the near future:

- Forest Allowances/Charges

- Interest Expense and Interest Restriction

- Professional Indemnity Insurance

- Trade Associations

- Special Classes of Income

- Investment Holding Companies

- Allowable Pre-Operational & Pre-Commencement ofBusiness Expenses

Administrative MattersForm CP 55 [1/2009]

The IRB has issued the revised Form CP 55 for tax agentswho wish to use the e-filing system. The revised form(which can be downloaded at the IRB’s website athttp://www.hasil.gov.my) supersedes the earlier Form CP 55[1/2008].

Forms C & R for year of assessment 2009

Forms C & R for the year of assessment 2009 have beenreleased in PDF format for reference purposes. The forms

are available for download at the IRB’s website athttp://www.hasil.gov.my.

New form CP 15C [1/2009]

A new form CP 15C [1/2009] has been issued for taxpayerswho wish to apply for tax relief under Section 131(1) of theIncome Tax Act 1967. The form can be downloaded at theIRB’s website at http://www.hasil.gov.my.

Industrial Productivity Rate forManufacturing Sector

The IRB has issued the 2008 industrial productivity rate(IPR) for the purpose of claiming reinvestment allowance.The IPR can be obtained from the IRB’s website athttp://www.hasil.gov.my.

Double Tax AgreementsMalaysia and Turkmenistan have entered into a double taxagreement (DTA) which has been gazetted but has not beenratified yet. The DTA provides a reduced withholding tax rateon interest of 10%, and the definition of a permanentestablishment includes the following:

- a building site, a construction, assembly or installationproject or supervisory activities in connection therewith,but only when such site, project, or activities last formore than nine months

- the furnishing of services, including consultancyservices, by an enterprise through employees or otherpersonnel engaged by the enterprise for suchpurposes, but only if the activities of that nature continue(for the same or a connected project) within aContracting State for a period of periods aggregatingmore than 90 days within any 12 month period

2010 BudgetThe 2010 Budget is expected to be tabled on 23 October2009. A Budget Consultation was held on 11 June 2009

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which was chaired by the Prime Minister. TAXANDMalaysia’s Managing Director, Dr. Veerinderjeet Singh wasinvited by the Ministry of Finance as one of the discussantson the topic of “Enhancing the Revenue Base”.

Case Law

This section only reports cases which are considered tobe of importance to a larger cross-section of readers

SP(M) Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri[(2009) MSTC 3881]The deductibility of franchise fees (pursuant to Section 33(1)of the ITA) was addressed in this case.

The taxpayer, a Malaysian trading company, used multi-levelmarketing business systems based on methods developedand supported by a company in the United States i.e. SCorporation. The taxpayer claimed a deduction forfranchise fees paid to S Corporation. The franchise feeswere paid for the exclusive right to use the multi-levelmarketing system of S Corporation within Malaysia and toreceive supporting services from S Corporation. The InlandRevenue Board (IRB) disallowed the deduction claim inrespect of the franchise fees on the basis that the fees werenot paid for acquiring trading stock of the taxpayer but werepaid in order to obtain the exclusive right to market SCorporation’s products in Malaysia, and hence the franchisefees were considered to be capital expenditure. As a result,the IRB issued Notices of Assessment for the years ofassessment 2001 and 2002, and also imposed penalties atthe rate of 60%.

The taxpayer appealed to the Special Commissioners ofIncome Tax (SCIT). The SCIT held that the franchise fees paidfor the services were a necessary part of the income generatingprocess of the taxpayer and that the continuous servicesderived therefrom were necessary for the taxpayer to meetits continuing business needs. The franchise fees had adirect and immediate benefit for the business. In addition,the fees were recurring payments which were not paid “onceand for all” and did not give rise to an enduring benefit or thepurchase of any identifiable assets. Accordingly, thefranchise fees were held deductible under Section 33(1)of the ITA. The IRB has appealed to the High Court.

Kerajaan Malaysia v Neraca Untung Sdn Bhd [(2009)MSTC 4381]This case involved the question of whether the taxpayer hadbeen duly served with notices of assessment by the IRB.

The IRB issued a notice of assessment (Form J) as well as anotice of additional assessment (Form JA) for the YA1997.The IRB claimed that the notices of assessment were sentto the address as stated in the taxpayer’s tax return. Thenotices were not returned to the IRB and the tax assessedwas not paid by the taxpayer. Accordingly, the IRB imposedpenalties of 10% plus an additional 5% on the taxpayerunder Section 103(5A) of the ITA. The taxpayer deniedhaving received the Forms J and JA and appealed againstthe decision in favour of the IRB granting summaryjudgement in respect of the outstanding taxes and penalties.

The IRB contended that Section 145(2) of the ITA deems anotice to have been served through ordinary post orregistered post. In the present case, this was evidenced bythe acknowledgement of receipt of the Form J by thetaxpayer’s tax agent. However, the acknowledgement didnot make reference to the Form JA. The IRB was not ableto prove that the Form JA had been received by thetaxpayer’s tax agent.

The High Court ruled in favour of the taxpayer (in relation tothe Form JA) where it held that notwithstanding the fact thatthe taxpayer had received the Form J through its tax agent,there was some doubt as to whether the Form JA wasactually sent to the taxpayer. The Court held that thetaxpayer had succeeded in raising “a triable issue in relationto the validity or the due service” of the Form JA.

NVA Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri[(2009) MSTC 3897)The above case involved the issue of whether cashincentives paid to agents were deductible under Section33(1) of Income Tax Act 1967 (ITA).

The taxpayer was in the business of marketing of burial plots,urn compartments and funeral packages. The taxpayerappointed agents to perform the marketing functions forwhich it paid commissions pursuant to agency agreements.Apart from commissions, the taxpayer also rewarded theagents with cash incentives from time to time where certaintargets were achieved. The incentive scheme included bothtangible items and cash. The case centred on the issue ofthe deductibility of the cash incentives. The IRB took theview that the cash incentives amounted to ‘entertainment’within the meaning of Section 18 of the ITA and the costswere therefore disallowed under Section 39 of ITA. (It shouldbe noted that the case involved claims for deduction in theyears of assessment 2000 (current year of assessment),2001 and 2002, i.e. prior to the changes to Section 39). Inaddition, a 60% penalty was imposed by the IRB pursuantto Section 113(2) of the ITA on the basis that the taxpayerhad wrongly claimed the deductions. The IRB argued thatwhile the expenses prima facie met the Section 33(1)deductibility test, the cash incentives neverthelesscomprised ‘entertainment’, and accordingly were expresslydisallowed pursuant to Section 39.

The SCIT upheld the taxpayer’s appeal. They did not acceptthat the expenses constituted ‘entertainment’ under Section18 of the ITA. Accordingly, on the basis that the expenseswere incurred to motivate agents to increase the taxpayer’ssales, and hence related to the “profit earning operations”,the expenses were held to be deductible under Section33(1). Further, the SCIT held that the 60% penalty waswrongly imposed as the deduction was based on thetaxpayer’s interpretation of the law and was claimed in goodfaith. The IRB has appealed to the High Court.

ELM Sdn Bhd v. Ketua Pengarah Hasil Dalam Negeri[(2009) MSTC 3887]This case also addressed the question of “entertainment”.The taxpayer was a company involved in the pharmaceuticalindustry and in the course of its business, the taxpayerorganised congresses to disseminate information andmarket new products. The taxpayer sponsored doctors andpharmacists, some to attend such congresses whilst othersspoke at the same. The sponsorship costs included the costof travel, meals, accommodation and the registration fees forthe congress, for which the taxpayer claimed a deductionpursuant to Section 33(1). The IRB disallowed the claim forthe years of assessment 2001 and 2002 on the basis thatthe expenses amounted to ‘entertainment’ costs.Accordingly, the IRB raised additional assessments andimposed a penalty of 60% on the taxpayer. (It should benoted that the IRB had allowed a deduction for similarexpenses in prior years).

Citing the case of KPHDN v. Aspac Lubricants (Malaysia)Sdn Bhd [(2007) MSTC 4271], the SCIT held that where thedominant purpose of the expenditure is for the promotion ofthe business, then the expenditure would not amount toentertainment. It was also noted that the doctors gave uptheir time and the potential of earning income, in exchangefor knowledge of latest products and developments in theirfields. The time given and the opportunity costs arising fromunearned fees (by the doctors) amounted to considerationfor their attendance at the congress and the increasedknowledge obtained. The doctors also obtained new andupdated knowledge of the products which might translateinto increased sales. This ‘practical advantage’ could also beviewed as consideration (based on the case of FongHoldings Pte. Ltd. v. Computer Library (S) Pte Ltd (1992)1 SLR 332). In view of the fact that there was‘consideration’, it was held that the expenses did notamount to ‘entertainment’ and hence were deductible for taxpurposes. The SCIT further held that the penalty of 60% waswrongly imposed. It was noted that the IRB had previouslyallowed a deduction for such costs. Further the returnssubmitted were based on the taxpayer’s interpretation of thetax laws and the claims were substantiated by theappropriate information. The SCIT held that the returns werenot incorrect and penalties should not have been imposed.The IRB has appealed to the High Court.

SS Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri[(2009) MSTC 3862]This case addressed the question of when profits arisingfrom the sale of land should be taxed, i.e. in the year in whichthe Sale and Purchase Agreement (SPA) was signed, or inthe year in which the conditions precedent to the SPAwere met.

The taxpayer, a property developer, purchased a piece ofland in 1993 and subsequently entered into a SPA with MCSdn Bhd to sell the land in 1997. A deposit and partpayment was paid by MC Sdn Bhd upon execution of theSPA. The remaining consideration was to be paid uponfulfilling the conditions precedent stipulated in the SPA. Theterms of the SPA provided that the SPA would be deemed

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to have been terminated if the conditions precedent were notmet and the deposit would have to be refunded to MC SdnBhd. MC Sdn Bhd fulfilled all the conditions precedentbetween October 1998 and May 1999, and paid the balanceof the purchase price in June 1999 before the taxpayer’sfinancial year end of 30 June 1999 (i.e. in the year ofassessment 2000 (preceding year basis)). Both the taxpayerand the IRB agreed to treat the land sold as stock-in-tradeand thus the gains from the sale of the land should besubject to income tax.

The taxpayer argued that the recognition of the sale shouldbe based on the conditions of the SPA and hence the profitarising from the sale was derived in the year of assessment2000 (preceding year basis). As this was a tax waiver year,the income should not be subject to tax. The IRB, on theother hand, contended that the profit arising from the sale ofthe land was derived on the date on which the land (stock-in-trade) was sold, i.e. the date of the SPA (November 1997)and thus the profit should be taxed in respect of the financialyear ended 30 June 1998 (i.e. the year of assessment 1999).

The SCIT held in favour of the taxpayer expressing the viewthat income is accrued (pursuant to Section 24(1), ITA) whenan unconditional right to receipt comes into existence. TheSPA was a contingent agreement with a number ofconditions precedent. Accordingly the sale could only besaid to have taken place when the conditions were fulfilled,at which point the debt would have arisen. The IRB hasappealed to the High Court.

AT Sdn Bhd v. Ketua Pengarah Hasil Dalam Negeri[(2009) MSTC 3875]This case involved the issue of the deductibility ofguarantee fees. The taxpayer was awarded certaincontracts for which it secured financing facilities from thirdparty banks. The latter required corporate guarantees fromthe taxpayer’s parent company. The taxpayer obtained therequisite corporate guarantees for which it had to payguarantee commission fees to the parent company. Thetaxpayer claimed a deduction in respect of these fees, whichwas disallowed by the IRB. The IRB argued that theguarantee commission fees were capital in nature, havingbeen incurred to secure funds which enhanced thetaxpayer’s capital.

The SCIT ruled in favour of the IRB on the basis that the feesrelated to the securing of funds, which was capital in nature.The fees therefore, did not meet the Section 33(1) test,notwithstanding the fact that the funds were used in thetaxpayer’s operations. The taxpayer has appealed to theHigh Court.

International DevelopmentsBruneiNew Corporate Tax Measures

Brunei has recently reduced its corporate tax rate from25.5% to 23.5% with effect from the year of assessment2010. Other measures taken to create an attractivecorporate tax environment include the increase in the rate ofinitial allowances (in the computation of capital allowances)from 20% to 40%, or an option to claim annual allowancesof 33.33% per annum over three years. Certain informationtechnology equipment is eligible for a 100% allowance,including computers and peripherals, office systemsoftware, etc.

ChinaNew Corporate Reorganisation Rules

There are new rules in China to allow a qualified taxpayer toelect for special tax treatment to defer the enterprise incometax payable in respect of the gain arising from the followingreorganisation transactions and subject to the conditions setout below:

IndiaThe following summarises some interesting Indian case lawdevelopments:

Eligible ReorganisationTransactions:

- Change of legalform

- Debt restructuring- Equity acquisition- Asset acquisition- Mergers- Splits

Conditions with respect totransactions:

- The transaction must befor a reasonable businesspurpose and should notbe tax driven

- The transaction mustmeet the prescribedratios of assets or equitytransferred

- The business operationsshould continueunchanged for 12 months

- There must be an elementof continuity of ownershipfor 12 months

- For cross-borderreorganisations, there areadditional conditions tobe considered and thereorganisations mustinvolve 100% ownedforeign subsidiaries

Do Rights for the Use of Software amount toRoyalties?

The case of Lucent Technologies International Inc v. DCIT(2009 TIOL 161 ITAT Delhi)was heard by the Indian IncomeTax Appellate Tribunal (ITAT) in relation to the issue ofwhether income from the right to use software amounted toroyalties.

The taxpayer (a foreign entity) in this case was involved in thebusiness of supplying hardware and software which waspurchased by network operators for use in hand-phones toaccess cellular radio telephone systems. The software wasuploaded by the network operators into the customers’hand-phones for which the customers were required toenter into contracts with the taxpayer’s Indian subsidiary forthe installation of the equipment purchased from thetaxpayer. The network operators were not permitted tomake copies of the software for any purpose, other than forback-up purposes. They did not acquire the rights to thesoftware, but merely acquired the right to use the software.

Overruling the decision of the lower court, the ITAT held thatthe payments did not amount to royalties, on the basis thatthe transaction was essentially a sale of the softwareproduct, but not for the copyright in the software. Thepayments were therefore business profits which would onlybe taxable if the taxpayer had a permanent establishment inIndia. Based on the facts of the case, the ITAT found thatthe taxpayer did have a permanent establishment (PE) inIndia and hence the profits were taxable in India.

Can Provisions for Warranty Claims beDeducted for Tax Purposes?

The case of Rotork Controls India (P) Ltd v. Commissionerof Income Tax (2009 TIOL 64 SC IT) involved the interestingquestion of whether the taxpayer was entitled to claim adeduction in respect of provisions for warranty claims in itsbusiness, which involved dealing in large orders of advancedvalve actuators. The taxpayer was required to provide awarranty under the terms of the sales which required thetaxpayer to correct or replace faulty products within a giventime-frame. The taxpayer sought a deduction for provisionsit made in respect of warranties, which was disallowed bythe tax authorities. The taxpayer challenged the taxauthorities in court and the case went all the way to theSupreme Court which found in favour of the taxpayer.

The Supreme Court held that a liability involves a presentobligation as well as a probability of the need to utiliseresources to settle the obligation. The Court considered the

volume of advanced goods sold in this instance, and theevidence adduced clearly showed that every year, thetaxpayer would have to replace or repair faulty valves. If thewarranty provision merely amounted to a contingent liability(which was effectively uncertain), then the provision wouldnot be deductible. However, in the present case, given thevolume of the transactions and the level of sophistication ofthe products in question, the pattern of defects inevitablyarising in the past results in a present obligation that thetaxpayer would be required to repair or replace the valves.Therefore, based on the particular facts of the case, thetaxpayer was entitled to a deduction in respect of the defectwarranty provisions.

Transfer Pricing Methodology

The case of UCB India Private Ltd v. ACIT (2009 TIOL 184MUM) centred on the question of appropriate transferpricing methodologies. The taxpayer in this case was a drugmanufacturer which imported active pharmaceuticalingredients (API) from its Belgian parent company (whichwholly owned the taxpayer). The taxpayer was the onlycompany in India to which the Belgian company sold API.The Belgian company actually invented the API sold to thetaxpayer. The only other supplier of similar API in India wasa Chinese entity, which did not invent the API that it suppliedto India.

The taxpayer used the transaction net margin method(TNMM) on an entity wide basis as the method to determineits transfer price rather than on computing the net marginsfor the two drug products on a stand alone basis. Due tostrict confidentiality reasons, the taxpayer was unable to

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support its pricing by showing prices charged by itsBelgian parent to other independent customers. The taxauthorities challenged the use of the TNMM method on anentity wide basis.

The ITAT did not agree that the use of the TNMM method onan entity wide basis was acceptable. It held that this methodwas only appropriate when transactions of the same type,class and variety are undertaken and where there are nodissimilar transactions. With respect to demonstratingfunctional comparability, it was held that it is necessary toselect comparable manufacturers who manufacturelicensed and patented drugs, to compare whether theyowned the intangibles, etc. With respect to the comparableuncontrolled price method (CUP) preferred by the taxauthorities, the ITAT held that this was not appropriate in thisinstance without a scientific basis to show that thecomparables were identical in terms of purity, potency,background research, etc. The ITAT referred the caseback to the Assessing Officer and directed that thetaxpayer should be allowed to submit additionalinformation/evidence.

How should Independent Projects (of less thansix months) be treated in Determining theExistence of a PE?

This question was addressed in the case of Krupp UHDEGmBH (2009 TIOL 78 Mumbai). The taxpayer, a Germancompany provided supervisory activities in relation to aconstruction project in India. Under Article 5 of the India –Germany DTA, supervisory activities carried on in excessof six months in connection with a building site orconstruction, assembly or installation project in India wouldconstitute a PE. The taxpayer argued that in assessingwhether a PE would arise under Article 5, the period of timespent in relation to independent projects which werewholly unconnected should not be aggregated. The taxauthorities sought to aggregate the time spent by thetaxpayer in India on each of the projects despite the factthat these were unconnected. The ITAT ruled in favourof the taxpayer taking the view that the time spent onindependent projects should not be aggregated indetermining the existence of a PE.

Liaison Office Creates a PE

The question as to the scope of activities of a liaisonoffice which would give rise to a PE was addressed in thecase of DCIT Bangalore v. M/s Jebon Corporation IndiaLiaison Office (2009 TIOL 323 ITAT Bang). The caseinvolved a Korean company (JCo) with a liaison office in

India. Under the DTA between India and Korea, thecircumstances under which a PE would arise include afixed place of business through which the business ofan enterprise is wholly or partly carried out. Typically,activities of a preliminary or auxiliary nature would nothowever give rise to a PE. In this instance, JCo was inthe business of trading in semi-conductors and hadcustomers in India. The liaison office was involved inidentifying potential customers as well as meetingcustomers, negotiating and finalising prices (within pricebands a l lowed by the head off ice, but wi thoutre f e re n c e t o head office) and securing purchaseorders. The liaison office was also given a sales targetfor each year.

It was held (based on the facts) that the liaison office was notmerely carrying out activities that were preparatory andauxiliary in nature. The fact that the liaison office was entitledto negotiate, conclude and secure purchase orders wasindicative that the activities comprised an integral part of thehead office’s overall trading activity. Accordingly, JCo wasfound to have a PE in India.

IndonesiaTax Treatment of Islamic FinancialTransactions

The Indonesian authorities have recently issued newregulations on the tax treatment of Islamic financialtransactions which are effective from 1 January 2009. Theregulat ions aim to ensure that the tax treatmentbetween Islamic and conventional financial transactionsis tax neutral.

Bintan and Karimun Islands Remain as Tax-Free Zones

The free-zone status of these islands which was to haveexpired at the end of 2008 has been extended with effectfrom 1 January 2009. Therefore, goods imported into andservices provided on these islands remain exempt fromduties and taxes.

Special Tax Office for High Net WorthIndividuals

Since May 2009, the Indonesian tax authorities haveembarked on an interesting initiative by establishing aseparate tax office to deal with high net worth individuals.At present, this initiative has been implemented inJakarta, but is expected to be extended to Central andEast Java as well.

Hong KongDouble Tax Relief Arising from TransferPricing Adjustments

The Hong Kong tax authorities have recently releasedpractice notes to provide guidance for taxpayers seeking toclaim double tax relief in respect of tax adjustments arisingfrom economic double taxation and juridical double taxation.

Economic double taxation typically arises where the sameincome is taxed in two jurisdictions on different persons. Thisoften arises in transfer pricing situations where, for example,Company A located in Malaysia acquires goods fromCompany B in Hong Kong. Company A pays RM100 for thegoods. Company B is taxed in Hong Kong on the RM100.The Malaysian tax authorities then disallow a deduction forthe RM100 on the basis that the price is too high, and makean adjustment to Company A’s profits. In this instance bothcountries will be taxing the same income on two separate

entities, unless the Hong Kong tax authorities accept theadjustment.

Juridical double taxation which is more common, ariseswhere the same income is taxed in two or more countries onthe same person. In such a situation, the relevant DoubleTax Agreement will determine which country has the right totax the income.

The Hong Kong practice notes referred to above stipulatethat in cases of economic double taxation arising fromtransfer pricing adjustments by a treaty country, a claim forrelief must be made within 6 years. For juridical doubletaxation, a claim must be made within 2 years. Where thereis no tax treaty, Hong Kong will not grant any relief. In thiscontext, it should be noted that there is no tax treatybetween Malaysia and Hong Kong.

South AfricaAbolishment of the Stamp Duty Act

Over the last few years, the scope of stamp duty in SouthAfrica has gradually been narrowed such that only propertyleases of over 5 years required stamping. As part of theSouth African Government’s continuing efforts to simplifyand modify the tax system, with effect from 1 April 2009,South Africa has abolished the stamp duty altogether.

(In Malaysia, following the 2009 Budget proposals, thescope of the Stamp Act 1949 has been widened with effectfrom 1 January 2009 to subject loan agreements, serviceagreements, and equipment leasing agreements to an advalorem rate of 0.5%).

United Kingdom2009 – 2010 Budget Highlights

The 2009 – 2010 Budget was announced in late April 2009and some of the highlights are listed below:

- There will be an increase in the tax rate for individualswith a 50% rate imposed on income in excess of£150,000, which is expected to affect approximately350,000 taxpayers. This rate will take effect for the fiscalyear 2010 – 2011.

- Capital expenditure on general pool plant andmachinery incurred between the fiscal year 2009-2010will be eligible for a 40% first-year allowance instead ofthe existing 20% writing down allowance.

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- The restrictions in respect of capital allowances andleasing expenses in respect of cars costing over£12,000 have been reformed. The tax relief in respectof such cars will now depend on the level of carbondioxide emissions.

- The stamp duty tax holiday on residential properties upto £175,000 has been extended to 31 December 2009.

- Senior accounting officers of “large” companies will bepersonally accountable to ensure accurate tax reportingfrom 2009. In so doing, they are expected to takereasonable steps to ensure that accounting systems areadequate, etc. Failure to show that reasonable stepshave been taken may result in the imposition ofpenalties.

Transfer Pricing

The case of DSG Retail Ltd v. HMRC [(2009) STC (SCD)397] is the first U.K tax case concerning transfer pricingmethodologies and provides a detailed review andelucidation of the U.K’s transfer pricing laws. The facts ofthe case are somewhat complex, but essentially, the caseinvolved the sale of electrical goods by the taxpayer (‘DSG’),together with the sale of extended warranties in respect ofthe goods. The extended warranties were arranged with athird party insurer which entered into an administration andrepair arrangement with another company in the DSGgroup. The third party insurer then fully reinsured its riskwith another DSG company, DISL which was resident in theIsle of Man. The reinsurance was a profitable business andallowed for these profits to be captured in the Isle of Man.The U.K’s controlled foreign company (CFC) rules could not

apply in this instance to tax DISL’s profits in the U.K, as DISLwas involved in ‘exempt activities’ within the meaning of theCFC rules.

The U.K tax authorities argued that had the partiesconcerned transacted on an arm’s length basis, DISL wouldnot have had the benefit it enjoyed. The tax authoritiescontended that the benefit from the extended warrantiesarose at the ‘point of sale’ and therefore belonged to DSG.While recognising that DSG entered into the warrantycontracts with third parties, the tax authorities took the viewthat these were merely conduit entities.

The Special Commissioners found in favour of the taxauthorities on the basis that they found the transactions didnot take place on an arm’s length basis. The taxpayer’s useof the CUP method was held to be inappropriate and insteadit was held that the formulaic profit split method based onthe capital asset pricing model should have been used.

United StatesTransfer Pricing – Advance PricingArrangements (APA)

The Internal Revenue Service (IRS) has issued a reportsetting out its APA programme which has been designed toresolve transfer pricing disputes that might otherwise arise.The reports clearly sets out the five stages of the APAprocess as well as the list of IRS personnel responsible forthe APA process, which includes industry teams which willfocus on the pharmaceutical and medical devices sector, theauto sector, cost sharing, the financial products sector andthe semi-conductor sector. The report also has a usefulreference tool in the form of a model APA agreement.

VietnamPersonal Income Tax

Changes have been proposed to alleviate the tax burden inrespect of employment income by exempting severalbenefits from tax including the following:

- the benefit of the payment of school fees for the childrenof expatriates,

- one leave passage per year,

- prescribed meal allowances,

- prescribed amounts of per diems,

- one-off relocation allowances for expatriates moving toVietnam.

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Based on the recent corporate tax cut from 28% to 25%,alongside the host of tax incentives in Vietnam, it is clear thatthe country is bent on attracting foreign investment intoVietnam by now exempting certain typical expatriatebenefits from tax as well.

Taxand Awards and RecognitionTAXAND MALAYSIA has recently been ranked byInternational Tax Review as a leading tax transactional

practice in Malaysia. TAXAND MALAYSIA has beenranked as a Tier 1 firm in the second annual pollconducted by the International Tax Review, wherein taxexecutives from multinational companies, tax officialsand advisors voted for their top 3 tax transactionalfirms in 47 jurisdictions. Aside from TAXAND MALAYSIA,other TAXAND member f i rms have also gainedsignif icant recognition, having been voted as eitherTier 1 or Tier 2 local advisors in 31 of the 47 countriessurveyed.

ITR Asia Tax Executives Forum2009The Asia-Pacific TAXAND network played an activerole in the recent ITR Asia Tax Executives Forum 2009 inSingapore. The event was attended by senior taxexecut ives and advisors to address tax issuesaffecting the region. The forum included presentationsand panel discussions on a broad range of current taxissues, including managing a tax department in aneconomic downturn, tax audits and dispute resolutions,transfer pricing, etc. TAXAND was well represented both interms of speakers and on panel discussions.

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DISCLAIMER:The information contained in this newsletter is intended only to be a guide. It must not be relied on in, or applied to, specific situationswithout previously seeking proper professional advice. Even if all reasonable care has been taken in its preparation, Taxand MalaysiaSdn Bhd and all the members of the Taxand Network do not accept any liability for any errors or omissions that it may contain beforebeing issued, whether caused by negligence or otherwise, or for any losses, however caused, or sustained by any person or entity.Descriptions of, or references or access to, other publications within this publication do not imply endorsement of them.

UPCOMING EVENTS

TAXAND MALAYSIA will hold its2010 Budget Seminar onTuesday, 3 November 2009 at theHotel Maya, Jalan Ampang,Kuala Lumpur. Details will beprovided in due course.