TAXATION principles do not discriminate between legal and illegal activities. The fact that the income may be illegal or immoral is of no concern when it comes to taxation. As long as the income is of a business nature that arises from a profession, vocation or trade, the income is taxable.

The existence of corruption in the course of carrying on business transactions with the public sector or the private sector cannot be denied. Although it is not the norm, it is not uncommon for bribes to be given to obtain contracts or permissions. Such payments can be in the form of either cash payments, gifts or benefits in kind, special discounts given to the recipients, holiday trips disguised as business travel, etc.

The most common expense is usually a percentage of the contract given to certain parties who may be instrumental in obtaining contracts.

Where can you find these illegal payments?

Usually these payments are booked into the accounts as expenditure incurred in the course of carrying on the business. This is usually found in project costs, cost of sales, or it will be seen as payments made through the director’s accounts. There are many other ways of including such costs into the accounts.

Can you claim a deduction?

If the expenditure is incurred to obtain the business or to run the business, the expenditure, whether it is an illegal bribe or otherwise, will be deductible on the grounds that without incurring that expenditure, the taxpayer would not have been able to generate the income that is taxable.

Since this expenditure is directly connected for the purpose of generating that income, the law allows the taxpayer to claim the expense as a deduction. Similar to the taxation of income, there is no discrimination of the deductibility of the expenditure between legal and illegal activities.

In practice, as long as the taxpayer can show that the expenditure has been incurred, he can claim the expenditure. However, there is a “catch” here. The taxpayer claiming the expenditure must be prepared to reveal the name of the recipient and the service provided by the recipient.

For example, in a project where the taxpayer wins the award, he has to show that the “bribe” paid was instrumental in helping him obtain the contract.

In most cases, the payer is reluctant to reveal the name of the recipient. In such a situation, the tax authority will not allow the deduction since the taxpayer is unable to substantiate the authenticity of the payment.

Another important point to note is all information provided to the tax authority, whether illegal or not, is meant to be confidential. Therefore the tax authority cannot share such information automatically with other agencies. However, there are exceptional circumstances where such information can be shared.

The bottom line is the tax legislation equally applies to both legal and illegal activities. The taxpayer will not escape taxation but, in most cases, they will be denied the deduction of bribes since the majority of the taxpayers are unwilling to reveal the recipients.

This article was contributed by Thannees Tax Consulting Services Sdn Bhd managing director SM Thanneermalai (