When starting on or engaging in businesses, spending or investing some money in acquiring assets and other setting up costs is unavoidable. Therefore, when comes to taxation matter on the business income, businessmen tend to seek for tax reduction or lesser tax liability on their business income after all they have invested an amount of capital into it. The taxation authority does recognize this expenditure and they are being classified as capital expenditure in generating of business income. Therefore, capital expenditure spent by businesses would be given certain provisions of allowance and they include different types of area and scope. The emphasis here is that these allowances may help to reduce tax liability on capital expenditure spent by businesses.
Before proceeding to explanation of circumstances that eligible for capital allowance, it is wise for us to know that in business income taxation computation ,there are some deductions that may not be allowed. This means that these unapproved expenses are not being permitted to the deduction on gross income of the business source in deriving the adjusted income. Section 39, Malaysia Income Tax Act 1967 provides the lists of deductions that are not allowed for business source incomes (see appendix). Under the list, we can see that capital expenditure, assets depreciation, dosmetic or private expenses and provisions are among the non deductible expenses types. The general rule is that provision for deductions are for expenses representing outgoings and wholly or exclusively incurred in the production of business income (Malaysia Income Tax Act 1967).
Therefore , capital expenditure on asset acquisition is as well not allowed for deduction but there are capital allowance given in accordance with Income Tax Act. This form of allowance given is known as capital allowance and it is given to qualifying capital expenditure incurred by businesses. Capital allowance is also being regarded as similar form of provision for depreciation incurred on assets from year to year. Initial allowance is given once in the year of asset acquisition and annual allowance is given every year in way of a straight line method. Schedule 3 of Income Tax Act 1967 provides the qualifying lists of capital expenditure that allow businesses to claim tax relief which is regarded as capital allowance (see appendix) (Malaysia Income Tax Act 1967).
Capital allowance given would be set off against adjusted income after adding any balancing charge. In deriving statutory income, the adjusted income after adding any balancing charge would then less the capital allowance amount for the current year and any unabsorbed capital allowance from previous year together with balancing allowance. Any excessive or unabsorbed capital allowance will be carried forward to next year but only can be set off against the same business source (Choong, 2010).
Therefore taxpayer may be able to pay lesser tax liability on capital expenditure if he or she engages in business areas and incurred capital expenditure for the selected fields in the form of tax deduction or given capital allowance.The scopes of capital allowance given are to include : plant and machinery expenditure, industrial building expenditure,, agriculture, forest, mining approved agricultural projects. These are the circumstances of businesses that eligible for them to claim capital allowance when there are capital expenditure incurred. We will look at each of the areas of qualifying expenditure that eligible for capital allowance claims.
Qualifying Plant Expenditure
Qualifying plant expenditure (QPE) is the capital expenditure that incurred in the usage or provision of machinery or plant used in the business itself. Costs on assets like office equipments, furnitures, motor vehicles, machines are all considered in the ranges. Meanwhile, the costs of installation and construction or expanding of building and other related expenditure for the purpose of machinery and plants' installation are deemed to be inclusive. Apart from that, expenditure spent on fish ponds, chicken houses, cages, animal pens, structures used for poultry and animal farms or other agricultural or pastoral pursuits are included in the scope (Choong, 2010).
There are some qualifying criteria to be met in order to qualify for claiming the capital allowances. Firstly,for initial allowance which is an allowance given at the time of assets acquisition requires that the person claiming must be carrying on a business, then the person has incurred some qualifying plant expenditure or qualifying building expenditure, the important point here is that the assets acquired must be used in the business itself and still become the owner of the assets at the end of basis period (Choong, 2010). It is noted that initial allowance would be given for whole year basis irrespective of the acquisition period. Meanwhile, Annual allowance is given in form of every year at the end of every basis period until any disposal incurred. Annual allowance only given when taxpayer incurred qualifying expenditure where the assets are being used in the business in the basis period provided he still owns the assets at the end of basis period.
Qualifying Industrial Building Expenditure
Industrial building allowance will be given to businesses that involve in constructing or purchasing of buildings(purchase price) or structures that being used as industrial buildings (Malaysian Tax and Business Booklet, 2010). Qualifying building expenditure as provided in paragraph 3, section 3 of Income Tax Act is described as the capital expenditure that incurred on the construction or purchase of building and its usage after being completed or purchased as an industrial building. By para 63, Section 3, the Act provided the definition of an industrial building which include factory ; dock, wharf,jetty and similar building ; warehouse let to public, utilities usage building; building used in working of mine or farm; or workshop, mill in mine's working. Industrial building expenditure is defined as capital outlay incurred on buildings as well as related cost to the building in an exclusive basis. Therefore, architect's fee; preparation costs; clearing and demolition costs; construction cost; construction loan bearing's interest expense; incidental and installation costs; as well as legal and stamp duty expenses incurred in building purchase are all included in qualifying building expenditure. The cost of land is not included in the scope( Choong, 2010) .
Initial allowance and annual allowance (including acquisition year) would be given when there is qualifying building expenditure incurred on the construction and purchase of industrial building and the building's usage should be serve as an industrial building for the business with the condition of still owning the asset at the end of basis year. The disposal is deemed when there are sale or transfer , demolition or destruction, and when building is no longer in use as an industrial building (Choong, 2010).
Qualifying Agriculture Expenditure
If the taxpayer is engaged in an agriculture business and incurred qualifying agriculture expenditure, his or her adjusted business income would be able to be reduced by setting off agriculture allowance given. When there are costs incurred on land clearing and preparation for the agriculture purpose together with new planting activity on that land, it is considered in the range of qualifying expenditure. Meanwhile any construction of road or bridge on farm as well as buildings that being partly or wholly related to business purpose or either for employees welfare and living accommodation are deemed to be included. However, the plant and machinery involved would not be classified in agriculture expenditure but in the scope of common capital allowance (qualifying plant expenditure). Qualifying agriculture expenditure excludes the cost of land as its accepted scope. Taxpayer should take notice that agriculture as defined by Income Tax Act means any forms of crops planting and cultivation, animal farming, inland fishing, aquaculture, as well as reafforestation of timber and any other agricultural or pastoral pursuit. Taxpayer should aware of the difference between replanting and new planting concept where replanting would be able to claim revenue deduction that inclusive of land clearing cost and planting cost. New planting which means planting on virgin land, replacing of different crops, purchasing of land from other owner and continuing planting on same crops would be eligible for agriculture allowance. The conditions imposed are that the ownership must be in the hand of the taxpayer and the qualifying expenditure is till in used at the end of basis year ( Choong, 2010) .
Qualifying Farm Expenditure (Approved Agricultural Projects)
Meanwhile, in order to promote the development and expansion of agriculture business, the government provides tax deduction scheme under the Income Tax (Approved Agriculture Projects) order 2002 where taxpayers engaging in approved agriculture projects would enjoy tax deduction against their adjusted income on incurred qualifying farm expenditure. However, taxpayer who received the deduction would not be eligible for agriculture allowance. Besides the similar capital expenditure as incurred in qualifying agriculture expenditure, costs incurred in construction of pond and drainage or irrigation system for the approved purpose would also be qualified. Taxpayers can claim either in return of income or deduction to be made against the aggregate income. It is important to note that the eligibility for this deduction is asserted with certain conditions like minimum hectarage and time frame where exceeding of time frame may only eligible for agriculture allowance ( Choong, 2010).
Qualifying Forest Expenditure
Provided in schedule 3, Forest allowance is given to taxpayers who incurred qualifying forest expenditure in the business of timber extracting in a forest. Taypayers should be reminded that they are not eligible for other capital allowance in the same area once forest allowance is claimed. Qualifying forest expenditure include construction costs incurred in a forest where road or building being built for the purpose of the business either in partly or exclusively basis. Meanwhile, building provided in conjuction with the timber extraction which is used for the welfare and accommodation of persons or employees is considered qualified. The term of this allowance is defined in relation to person who possess license of timber extracting, carrying the business of which consist partly or wholly in extraction in a forest. However, there will no be any initial allowance given while allowance would be given on 10 percent on costs incurred involving roads or building construction used in timber extracting activity and 20 percent allowance given for expenditure of buildings used in providing welfare and accommodation as mentioned earlier ( Choong, 2010).
Qualifying Mining Expenditure
Qualifying mining expenditure is expenditure taxpayer incurred when engaging in the working of mine or when in preparation for mine operating business. The expenditures may include the following : mine or rights acquisition ; searching, discovering, testing, or access gaining costs; construction costs of building or other works (little or no value to any person except involvement in another mine) or development , general administration, and management's costs before any mining production done. The above mentioned incurred mining expenditures allow the taxpayer to claim for mining allowance in the form of revenue expense which is deducted under gross income portion ( Choong, 2010).
Qualifying Prospecting Expenditure
Provided in schedule 4 of Income Tax Act, expenditure incurred on prospecting activity and operation will be given tax deduction against the aggregate income. Taxpayer must first understand the definition of qualifying prospecting expenditure which relating to expenditure incurred in the process of searching, discovering, testing , as well as involving of access exploration in an eligible area. Taxpayer should know that when there is successfulness in locating of mineral deposit, mining license would be issued indicating mining allowance's entitlement. Claiming of return from income is allowed with election done and having incurred this qualifying prospecting expenditure, taxpayer may either claim it in the incurred year of assessment or have its expenditure accumulated up to a stage of abortive in a ten years frame with declaration made for permanent cease of mineral searching and no intention in mining business ( Choong, 2010).
Balancing allowances and balancing charges
Under the provision of the act, during the activity of disposal of assets incurred, balancing adjustment will have to be done based on the taxpayer's incurred qualifying expenditure in the purpose of business. The residual expenditure derived after calculation and provision of capital allowance would be determined and being compared to the sales proceeds amount. in the circumstance where sales proceeds exceed the residual expenditure, there will be balancing charges imposed and it will be added to the adjusted income in business income column. Balancing charge is actually a form of withdrawal of capital allowance claimed in the previous basis year and therefore its amount charged will only limited to the total amount of capital allowance claimed. Taxpayer should be reminded that balancing charge is not a tax on the gains from disposal but withdrawal of previously incurred capital allowance. On the other hand when the sales proceed amount or disposal price is lower than the residual value, balancing allowance will be given where it is later being deducted from business adjusted income.
Question 2 - Case Of RubberCock Sdn Bhd
Income Tax Act 1967, under its section 20,21,and 21A , govern about the rules and concept on basis period where it sets the time frame for the ascertainment of income for different sources. Starting from year 2000 the basis year would be the current year of assessment. For this assignment case, the focus of discussion will be on the concept of basis year for company (section 21A).
When determine the basis period of a company especially for newly established company, the first step is to determine the commencement date of the business. According to Income Tax Act, the commencement date of the business will determine the basic period of taxation for the company. In general rule, the basis year for assessment would be formed by the basis period of 12 months for a financial year. For instance, the financial year for 01.04.10 to 31.03.11 (12 months) would constitute the year assessment of 2011.Therefore, it is preferable for company to close its account for a 12 months period starting from its commencement date to avoid overlapping period and adjustments. Another allowable formation of basis period by the Act is between business commencement date until 31 December, the period will be regarded as basis period for the company's first year of taxation.
The importance of business commencement date determination could be related to its deduction of revenue expenses. Taxpayer should be put in mind that any revenue expenses that incurred before the commencement of the business are not recognized and hence are not deductible, it would be permanent losses except for certain pre-commencement business expenses . It is the revenue expenses that incurred after the business has begun can have its deductions and in the case of no income generated, the expenses can be deducted from other income source in current year assessment or set off against all business income in the future assessment year.
There are tests to determine the commencement date of businesses, usually in common opinions, the business is deemed to start commencement when it opens to the public where services are being rendered to customers. However, from the point of view from taxation perspective, the commencement of business is according to the commencement of business's essential activities but not based on the starting of income (sales revenue) generating. This means that even in the situation where sales or turnover are not being recorded can be treated as commencement of business, for instance a manufacturing company may deemed to commence its business starting from its first stage of manufacturing process.
For RubberCock Sdn Bhd's case, its commencement date would be on 15 March 2001, where seedling activities were done. This is based on the business commencement guidelines that stated for plantation company, its business commencement date is based on period which seeds are sown or planted.
For the basis period for the first year of assessment for RubberCock Sdn bhd, it would start from its commencement date which was 15 March 2001and ended at its financial year closing of 31 December 2001.
Basis period of RubberCock Sdn Bhd:
RubberCock sold its rubber plantation to TT Development Sdn Bhd, a property developer company and made a profit of RM 300,000. RubberCock bought the land for RM 200,000 on 31 February 2001 and sold on market value of RM 500,000. The important issue here is whether the disposal of rubber estate investment would be treated and assessable as business income. Transaction that increase or contributing to the income would be taxable in Malaysian taxation context, where income derived from ‘trade' or engaging in ‘ adventure or concern in the nature of trade' would be classified and taxed in the category of business income. On the other income, realization of investment which contribute to capital gain is not taxable.
RubberCock may argue that the transaction is not a part of trade but long term investment judging from its long period of the state's ownership before it was being disposed. RubberCock Sdn Bhd is incorporated as an operator of rubber plantation and the plantation is its income generating source. The company also use the land for plantation purpose and there was no intention to sell the land for profit. Therefore, the company has made clear on its subject matter of transaction and its formation as well as intention.
The real property gains tax (RPGT) incurred on the disposal would be as below:
Disposal price RM 500,000
Less: acquisition price (RM 200,000)
Chargeable gain RM 300,000
RPGT payable (4 yrs = 5%)
RM300,000 x 5% RM 15,000
Then, in 1 January 2006, RubberCock Sdn Bhd bought that piece of land back from TT Development Sdn Bhd with RM 800,000. RubberCock Sdn Bhd has its company's objective changed to become a property developer. By 15 May 2009, RubberCock Sdn Bhd has completed its construction of 100 units of shoplot with cost of RM10 million, and sold off the among 95 units with the amount of RM 23.75 million. This means that there are 5 units of the shoplots left and the company planned to keep 3 units for the purpose of investment and rent it out while the balance of 2 units to be used as administrative offices.
The factor that RubberCock Sdn Bhd needs to put into consideration is the tax implication of doing so. According to section 24 (2) of Income Tax Act, any withdrawal of stock in trade (in this case is the shoplots) for own use purpose would be classified as fixed assets in the company's balance sheet (Income Tax Act 1967). However, the section would not applicable for shoplots that the company keeps for future rent out purpose. The 3 shoplots that RubberCock plans to keep would still be considered as stock in trade. There is no intention for the company to change or withdraw the 3 units of shoplots to its own use purpose. The remaining 2 shoplots would be reclassified from stock in trade status to company's fixed assets and capital allowance would be eligible to claim. The intention to keep the 2 units for own use which will be provided for occupancy of administrative offices is shown by the company at the first place.
Meanwhile, the profits gained from RubberCock Sdn Bhd now after its amendment in its company objective from the construction of shoplots would be deemed as business income and taxable under the trade category. The company now is a property developer after the conversion of company objective and its intention to re-acquire the land from TT Development for the purpose of developing and constructing of shoplots. The nature of the plantation land has been changed into commercial use with intention judging from the company's objective change right after land acquisition.
For tax planning purpose, the company can have a few options or alternatives to refer in their tax liability and implications.
From the above calculation, the lowest tax payable amount is RM 3,237,500 where RubberCock Sdn Bhd could proceed with its plan where 5 units of shoplots will be keep for company's investment and administration offices.
