Challenges for companies during tax filing season

THE tax filing season for companies will reach its peak soon – in August 2021 when companies with a Dec 31 year end have to submit their tax returns for the tax year of 2020. That is five months away, a not-too-distant deadline. Every year’s filing has its unique compliance requirements. This year is no different. In fact, this year’s compliance burden has increased due to recent changes to the law and market conditions.

Some of the more significant developments and compliance requirements are discussed below.

This article was first published in The Sun Daily (29 March 2021 2021).

1. The law governing Transfer Pricing (TP) documentation has been introduced in the Income Tax Act 1967 (ITA) with effect from Jan 1 2021. TP documentation is required for every company that has controlled transactions regardless of the amount. Controlled transactions are transactions between related parties including the supply or acquisition of goods or services, provision of financial assistance and transactions involving intangibles.

In this context, related parties are more than just holding companies and subsidiaries. They encompass parties such as shareholders that have at least 20% shareholding in the company or vice versa. TP documentation has to be prepared prior to the due date for furnishing a tax return for that year of assessment and may be required to be submitted to the Inland Revenue Board (IRB) within 14 days of their request. Failure to submit the TP documentation on time will render the company open to penalties.

As part of the TP documentation, the company has to ensure that all its transfer prices are at “arm’s length” to avoid any “surcharge” being imposed by the IRB. Arm’s length price is the price that an independent person will charge to another independent person whilst a surcharge is another word for penalty. The surcharge could be applied whether or not a TP adjustment results in additional tax payable. Hence, it is important that the possibility of a potential transfer pricing adjustment be minimised.

2. Did the company lend any money to directors out of internally-generated funds in 2020? Under Section 140B of the ITA, the company is required to calculate the deemed interest income on the loan to directors and bring the said interest income to tax in 2020. If this is not done, the IRB will impose a back tax and penalty for the omission if it is discovered in an IRB tax audit.

The deemed interest income under Section 140B of the ITA is calculated on a monthly basis and the interest rate is based on the average lending rate prescribed by Bank Negara Malaysia. It is notable that a NIL balance at year end does not mean that a company is not required to perform the deemed interest adjustment for that tax year.

3. The law relating to the definition of “plant” has changed in 2021. Although it does not affect the tax computations in the year 2020, this change has to be kept in mind for proper tax management moving forward. Previously, the word “plant” was not defined in the ITA. It was generally classified according to principles established in court cases.

From 2021 onwards, “plant” has now been defined separately in the ITA and excludes fixed assets used as premises for a taxpayer’s business or as intangible assets. If any equipment does not come within the definition of “plant”, the taxpayer is not allowed to claim tax depreciation or capital allowances on the expenditure incurred. With this definition, only assets which are expressly defined as “plant” are eligible for capital allowances e.g. software, expenditure on customised computer software and fixed assets used as an apparatus in the business, e.g. computers. Expenditure on buildings which are classified as industrial buildings are allowed industrial building allowances.

With the change in the tax law, will gaps appear such that certain fixed assets will not be eligible for capital allowances e.g. telco towers? It is therefore necessary to review assets which are borderline in nature to see whether such assets fall within the meaning of “plant” for capital allowances purposes.

4. Has the company paid all the withholding tax on payments made to overseas parties? If no withholding tax has been paid and the non-compliance is not rectified by the tax filing date, the company is not eligible to claim the expense incurred.

Withholding tax can be payable on a variety of payments made to overseas parties e.g. commissions, guarantee fees, interest on loans, royalties for use of intellectual property, contract payments to overseas contractors (on the services portion of the contract payment only for services rendered in Malaysia), rentals for use of moveable equipment, technical fees, installation fees, service fees, etc.

5. Did the company receive advance payments for services to be rendered? Under Section 24(1A) of the ITA, these advance payments are taxable upon receipt and not after the services have been rendered. Many companies in certain industries have been caught by this law especially those in the IT, education, professional services, F&B and hotel industries. Omission to include these advance payments as income in the tax computation will expose the company to back taxes and penalties if discovered by the IRB in a tax audit or tax investigation.

6. Did the company sell any property and bring the gains to tax under real property gains tax instead of income tax? This is the classic “revenue versus capital” contention in Malaysian tax law where one has to distinguish gains from the sale of capital assets as either trading gains or capital gains.

Trading gains are subject to income tax while capital gains are subject to real property gains tax if the property disposed is real property or shares in real property companies.

Failure to distinguish the nature of these investments and to accord the proper tax treatment will expose the company to potential income tax and penalties if the tax treatment adopted is disputed by the IRB.

7. Bad and doubtful debts – 2020 was an unprecedented year for business stoppages and interruptions as we all know. For companies that have to deal with customers which may be delinquent, the temptation is to claim bad debt deduction in the tax computation if the customer has not paid within a reasonable time. However, will the IRB agree to the treatment?

Bad or doubtful debts are only allowed tax deduction if the debt is “reasonably estimated to be partially or wholly irrecoverable” according to tax laws. In practice, the IRB would insist on recovery action such as legal action being taken against the debtor except in certain circumstances e.g. the debtor is not contactable or in liquidation. If the company claims the deduction but the claim is later disputed by the IRB, the company will be liable to back taxes and penalties.

The company therefore needs to assess the bad and doubtful debts carefully before claiming tax deduction. Temporary failure to pay by customers will not be sufficient justification for claiming of bad debt relief for tax purposes.

8. SMEs are allowed a preferential tax rate of 17% on the first RM600,000 of chargeable income. However, from the tax year of 2020, this rate comes with a caveat. The caveat is that the company claiming the preferential rate must have a gross income from business sources not exceeding RM50 million in that year. With the changes, many SMEs will fall outside the eligibility criteria. In addition, investment holding companies and companies which solely earn interest income or rental income (i.e. not business income) will no longer enjoy the preferential tax rate.

The tax filing for the tax year of 2020 will become more challenging due to more onerous provisions of the tax law. It is therefore advisable for companies to get prepared.