A HIGH profile case that was reported in the media in September which involved the Inland Revenue Board (IRB) and the disposal of a long-term investment by DRB-Hicom Bhd in subsidiary Alam Flora Sdn Bhd, which was held for 24 years, is a very good example of the current climate where such sales are being challenged and brought to tax under income tax.
A long holding period is becoming less significant in the eyes of the IRB.
The difference here is if the gain from such a sale was brought to tax under income tax, then the taxpayer has to pay 24% compared to capital gains tax (2% of sale proceeds or 10% on gains) or real property gains tax (RPGT, 0% to 30% on gains for individuals, 10% to 30% on gains for companies).
Lately, there has been a noticeable increase in challenges by the IRB on transactions involving real property where taxpayers have declared and paid their RPGT. Now they are facing additional income tax and penalties ranging up to 45%.
Where is the challenge coming from?
The IRB is relying on the badges of trade to challenge taxpayers to bring such income as business income. The original six badges of trade are: the motive or the intention at the time of the purchase of the property, existence of similar trading transactions or interests, frequency of transactions, period of ownership, circumstances responsible for the realisation of the property, and the nature of the asset. Other badges of trade include the way the sale was carried out, improvements to the asset, and method of financing.
Taxpayers must be very clear they can defend their position so that none of the above badges of trade will negatively impact them. The facts must be supportable with evidence. For example, circumstances responsible for the disposal of the asset can go either way. If the taxpayer if able to show that the sale occurred within a short period of time, but it was an unanticipated offer which was too good to refuse or unsolicited, or a sale was made because there was an urgent need for cash within the group, the case for supporting the capital gains argument is strengthened.
What is worrying now is that the IRB is frequently connecting peripheral facts to support its challenge. Examples of such issues are where an individual has any history of dealing in or developing properties. The IRB is of the view that disposals by such individuals will always be subject to income tax. There are sufficient case laws such as the Lim Foo Yong case which clearly stated that it is possible for individuals or companies to have both investments and trading assets.
Another argument put forward by the IRB is that a company’s constitution allows both trading and investment holding. This condition is found in most companies’ constitutions, and that should not be the basis for challenging such transactions.
Another common challenge is the location of the property. If a property is located in a prime area, the IRB seems to think the property is highly valuable and saleable and therefore becomes stock-in-trade. If such a notion exists, then all properties in this country located in prime areas will be all stock-in-trade. That should not be the basis for determining whether it is stock or investment.
The other common challenge is that if companies acquire properties through loan financing, then the chances of the asset being classified as stock-in-trade increase. The classification in the accounts is extremely important as it reflects the intention of the owners, thus it is important to look at the board minutes. Any changes or modifications made to the asset to make it more marketable, and the method of the sale (e.g. using agents to solicit offers) will affect the case.
This article is contributed by Thannees Tax Consulting Services Sdn Bhd managing director SM Thanneermalai (www.thannees.com).
