Recently, the Court of Appeal affirmed the decision of the High Court which allowed the taxpayer’s appeal to deduct the Bumiputera discount payments under Section 33(1) of the Income Tax Act 1967 (ITA).
The taxpayer was successfully represented by our Tax, SST & Customs Partner, S. Saravana Partnership along with Nur Amira binti Ahmad Azhar.
Background Facts
The taxpayer’s principal activity was the business of property development in Selangor. The taxpayer entered into an agreement with the State Government of Selangor and amongst others, agreed to allocate a percentage of Bumiputera quota on the shop lot units they wish to build. Despite numerous attempts made to sell the shop lots, the taxpayer was unable to sell the Bumiputera lots. According to the State Government’s circular, if the taxpayer fulfils all the conditions stipulated, the taxpayer can make a contribution to the State Government for the release of the Bumiputera quota (Bumiputera Discount Payments). The taxpayer made the contribution and sought for the expense to be deducted under Section 33(1) of the ITA.
The contribution made to the state government consists of two different payments i.e.: 10% consists of the contributions to the state government where approval has been sought and obtained. Meanwhile, where approval was not sought before the units were sold, there was an additional penalty of 5%. In the present appeal, the taxpayer only sought to deduct the 10% portion of the contribution made to the State Government.
The Revenue disallowed the deduction on the grounds that the payments made to the state government were capital and penal in nature. During the hearing, the IRB focused on the point that the Bumiputera Discount Payments were penal in nature hence, not incurred wholly and exclusively in the production of income.
The Revenue disagreed with the High Court's perspective that the expenses incurred for the release of Bumiputera lots were entirely and exclusively in the income production, qualifying as deductible expenses. The High Court further held that to obtain the release of Bumiputera lots, the state government has stipulated that the taxpayer must repay 10% of the discounted price given to Bumiputera lots for sale. If the taxpayer fails to obtain this release, there will be no sales to non-Bumiputera and consequently, no income generation.
The main issue for determination by the Court of Appeal was whether the Bumiputera Discount Payments incurred by the taxpayer is deductible under Section 33(1) of the ITA.
IRB’s Arguments
The Revenue argued as follows:
The Bumiputera Discount Payments were penal in nature as the State Government has intended for the shop units to be sold to Bumiputera purchasers. The Revenue cited the case of CIR v Alexander von Glehn & Co Ltd 12 TC 232 to support their averment as the English Court of Appeal held that expense that is penal in nature is not deductible for income tax purposes.
An expense that is penal in nature is not incurred wholly and exclusively in the production of income.
Based on the 2007 circular, it was clear that the State Government imposed a penalty of 15% on the Taxpayer for the failure to comply with the State Government’s condition that is to release the Bumiputera lots only after receiving approval from the State Government. However, the Taxpayer sought to sell the Bumiputera lots before receiving the approval from the State Government.
Further, the intention of the State Government in allowing the release was simply because the Taxpayer had sold the lots before the approval. This was not a case where the Taxpayer complied with the terms set by the State Government.
The Court must look at the spirit of the circular by the Lembaga Perumahan Selangor i.e. the State Government intended to penalise property developers in order to curb the practice of releasing Bumiputera lots to non-Bumiputera status.
The Court of Appeal in the cases of Primanova and Taman Equine held that Bumiputera Release Fee was not deductible.
Taxpayer’s Rebuttals
The taxpayer’s key arguments were as follows:
For the purposes of deductibility, so long as a taxpayer fulfils the requirements stipulated in Sections 33(1) and 39(1) of the ITA, the Bumiputera Discount Payments incurred by the Appellant should be allowed as a deduction.
The effect of the payments was to achieve sales. Without making these payments to the State Government, the transfer or release of Bumiputera units to non-Bumiputera buyers would not be possible. It is indisputable that without these payments, the Taxpayer would not be able to sell Bumiputera units to non-Bumiputera buyers and generate income. The direct result of selling Bumiputera lots to non-Bumiputera purchasers is the generation of income for the Taxpayer as a property developer;
The nature of the payments made are not penalty. The taxpayer did not infringe or breach any statutory laws. Pursuant to the Agreement entered with the State Government, the taxpayer was given the option to contribute to the State Government in return for the release of the Bumiputera Lots provided all the conditions were satisfied.
The case of CIR v Alexander von Glehn & Co Ltd 12 TC 232 can be distinguished from the current case at hand as:
The penalty raised against the taxpayer in Alexander was because the company undertook an unlawful business practice. The Court of Appeal looked at the intention of the legislature in enacting the Customs (War Powers) Act 1915 i.e. to make it very difficult for goods to be exported to neutral countries.
In distinguishing, the taxpayer had no other choice but to incur the Bumiputera Discount Payments as the taxpayer had to release the Bumiputera lots in order to sell them to the non-Bumiputera.
However, in this present appeal, the circulars allow for the release of the Bumiputera lots so long as the Bumiputera Discount Payments were paid to the state. The taxpayer did not violate any law.
Be that as it may, the taxpayer had apportioned the amount of contribution and penalty separately to be paid to the State Government.
Further, there is no additional gain to the taxpayer in making the payments for the Bumiputera Discount and the Taxpayer has not profited by selling any Bumiputera unit to a non-Bumiputera purchaser.
There were no grounds released by the Court of Appeal in Primanova and Taman Equine. In fact, the Court of Appeal in Mitraland recently allowed the deduction for the release of Bumiputera Discount Payments and the Court of Appeal issued its grounds for decision.
Conclusion
This recent ruling provides a positive development by acknowledging that Bumiputera Discount Payments, when incurred by property developers, fall within the ordinary course of business. The payments made were considered revenue expenses as they are directly related to the taxpayer’s stock-in-trade and recur every time a Bumiputera unit is sold to a non-Bumiputera purchaser. Further, the payments made do not bring about enrichment or improvement to items of fixed capital. The court relied on the fact that the payment is necessary to sell units that would otherwise not be sold to the general public and it is incurred to remove an obstacle to profitable trading.
The significance of this decision extends to highlighting the principle that the Revenue cannot arbitrarily disallow an expense as a deduction unless it is expressly prohibited by the prevailing legal framework. This underscores the importance of adherence to established legal provisions when determining the deductibility of business expenses, preventing arbitrary disallowance by tax authorities.
27 February 2024