In a recent ruling, AJ v Ketua Pengarah Hasil Dalam Negeri, the Special Commissioners of Income Tax (SCIT) held that expenses in the form of Base Facility Charges (BFC) were deductible under Section 33(1) of the Income Tax Act 1967 (ITA).
The taxpayer was successfully represented by the firm’s Tax, SST & Customs Partner, S. Saravana Kumar together with Associate, Tan Jia Hua.
Background Facts
AJ (the Taxpayer), a steel manufacturing company, entered into a Supply Agreement with APNSB (the Supplier), a third-party air supplier. The Supplier was to provide an uninterrupted supply of gaseous oxygen, nitrogen and liquid argon — which were required for the Taxpayer’s manufacturing activity. The Supplier installed a facility in the Taxpayer’s factory complex to enable the supply of gases to the Taxpayer’s manufacturing plant through a network of interconnected pipelines.
According to the terms of the Supply Agreement, the Taxpayer was required to fulfil a monthly payment obligation referred to as the BFC for RM 950,000. This charge was invoiced on the first day of each supply month, with a payment deadline of 30 days. The BFC encompasses the allocation of up to 7,292 Nm3/hr (250 MTD) of Gaseous Oxygen (GOX) and 8,333 Nm3/hr (250 MTD) of Gaseous Nitrogen (GAN) (collectively known as the Gases).
The BFC was then supplemented by a Minimum Take or Pay (MTOP) or a monthly variable charge. MTOP was the minimum volume or quantity of the Gases that the Taxpayer was obligated to pay for, regardless of whether the Gases were used for the manufacturing activity. This operated on a take-or-pay basis. On the other hand, the monthly variable charge applies when the monthly usage exceeds the minimum consumption units. Both charges (BFC and MTOP) were the combined purchase price for the supply of the Gases each month.
The Taxpayer sought to claim tax deduction for both the BFC and MTOP under Section 33(1). However, consequent to a tax audit, the Revenue took the position that whilst the MTOP qualified as a deductible expense, the Revenue disallowed the tax deduction for the BFC.
The Legal Position
As a general rule, expenditure incurred in the course of business is deductible if it falls under Section 33(1) of the ITA. In Aspac Lubricants (Malaysia) Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri [2007] 5 CLJ 353, the Court of Appeal referred to Section 33(1) as “the basket provision”, which applies to all sources of income.
The Taxpayer argued that the Gases were the fundamental components of its manufacturing activity and this point was unchallenged by the Revenue. The Taxpayer further submitted that the on-site plant provided by the Supplier had the capacity to significantly enhance the Taxpayer’s manufacturing capability by offering a threefold increase in gas supply. Hence, the supply of the Gases was closely connected to the Taxpayer’s business activity whereby the purpose was to enable the Taxpayer to carry on and earn profits on the trade (Director General of Inland Revenue v Kulim Rubber Plantations Ltd (1981) 1 MLJ 214).
Further, the Taxpayer highlighted that the BFC was a recurring monthly expenditure, which had to be incurred by the Taxpayer to ensure the supply of the Gases. Hence, the BFC payment was determinable with exact accuracy. As such, the BFC was not a contingent liability despite the Revenue argued that the BFC was provisional and contingent in nature. In fact, the Taxpayer led evidence to establish that the BFC payments had been duly paid and settled by the Taxpayer each month.
Although the payments were made under two invoices, this does not vitiate the intention of the contracting parties to treat them as considerations for the supply of the same product. There is no prohibition under the law for the Supplier to issue two invoices for the same product. Therefore, it was argued that the Revenue had failed to consider that the Supply Agreement in totality (CIMB Bank Bhd v Anthony Lawrence Bourke & Anor [2019] 2 MLJ 1).
Considering that the BFC payments formed an integral part of the total purchase price of the Gases, it was therefore unreasonable for the Revenue to disallow the BFC from the total costs and only allow the MTOP as a deductible expense.
The SCIT’s Decision
Upon hearing the submissions by both parties, the SCIT held that the BFC payments were deductible under Section 33(1) and set aside the additional taxes and penalties imposed by the Revenue.
In conclusion, the ruling delivered by the SCIT underscores the paramount importance of satisfying essential criteria for deductions under Section 33(1), namely the expenditure being wholly and exclusively incurred in the production of income.
4 August 2023