Issue 109 November 2013 PP 9741/10/2012 (031262)
PwC Alert
Local versus
foreign sourced
income
– A continuous
debate
Determining the locality of the source of
income is a “practical hard matter of fact”,
as succinctly expressed by the Court of
Appeal judges in the case of
Commissioner
of Inland Revenue (NZ) v NV Philips
Gloeilampenfabrieken (1954) 10 ATD 435
(“the
Philips case”). Taxpayers and tax authorities
have to deal with the above question in order
to determine whether an item of income falls
within the country’s tax net and Malaysia is
not spared from this monumental task.
The current law is provided in Paragraph 28, Schedule 6 of the Act which exempts from tax,
The word “source” is not defined in the Act and guidance is often sought from case laws. However, the derivation of business income is further dealt with under Section 12(1)(a) of the Act. This section deems an item of income to be derived from Malaysia and hence taxable in Malaysia, unless it can be proven that the income is attributable to the operations of the business carried on in a foreign Malaysia adopts a territorial
scope of taxation. Section 3 of the Income Tax Act 1967 (“the Act”) provides that only income that is accruing in or derived from Malaysia, and income remitted to Malaysia from outside Malaysia is subject to tax. In ongoing efforts to encourage Malaysian businesses to venture overseas and thereafter repatriate their profits to Malaysia, the government had since 1995, introduced various legislations which exempts from tax, foreign sourced income remitted to Malaysia except for taxpayers carrying on banking, insurance, sea or air transport businesses.
Scope of taxation
“… income of any person, other than a resident company carrying on the business of banking, insurance or sea or air transport, for the basis year for a year of assessment derived from sources outside Malaysia and received in Malaysia.”
The concept of “source” is a difficult area of tax law which has been much debated in the regional courts over the years - from the courts in New Zealand (the Philips case, 1954) to Hong Kong (Privy Council cases of Hang Seng Bank and Hong Kong-TVB in the 90s followed by numerous other cases), to Singapore (Chandos Pte Ltd v Comptroller of Tax (1987) 2 MLJ 670) and Malaysia.
It has been well recognised in the tax circles that the broad guiding principle for determining where income is sourced from is as enunciated by Lord Bridge in the landmark Privy Council case*,
Commissioner of Inland Revenue v Hang Seng Bank Ltd (1990) STC 733:
This article will focus on the developments of Malaysian tax cases and seek to examine if the Hang Seng Bank principle has been adopted by the Malaysian courts.
Broad guiding principle
“The broad guiding principle, attested by many authorities, is that
one looks to see what the taxpayer has done to earn the profit in question. If he has rendered a service or engaged in an activity such as the manufacture of goods, the profit will have arisen or derived, from the place where the service was rendered or the profit-making activity carried on. But if the profit was earned by the exploitation of property assets as by letting property, lending money or dealing in commodities or securities by buying and reselling at a profit, the profit will have arisen in or derived from the place where the property was let, the money was lent or the contracts of purchase and sale were effected …”
* Refer to page 13 for a summary of the Commissioner of Inland Revenue v Hang Seng Bank Ltd (1990) STC 733 case
Malaysian case laws
The issue of “source” had been deliberated by the Malaysian courts from as early as the 1980s with cases such as
ROD Co Ltd v Director General of Inland Revenue (1990) 1 MSTC 422, and OA Pte Ltd v Pengarah Hasil Dalam Negeri (1996) MSTC 2752 in the 1990s.
The issue in the first case was whether payments for the rental and hire of a rig made by a Malaysian company to ROD Co Ltd (incorporated in Hong Kong), was taxable in Malaysia. The Special Commissioners of Income Tax (“SCIT”) decided that the income was derived from outside Malaysia under Section 12 of the Act as central management and control of ROD Co Ltd was exercised in Hong Kong. The decision was upheld by the High Court.
In 1996, the SCIT dismissed OA Pte Ltd’s appeal against the assessment of fees received from a bareboat charter to a Malaysian company. OA Pte Ltd (incorporated in Singapore), in its argument that the fees were foreign sourced, drew support for its position by relying on the ROD decision. The SCIT however, rejected this argument and
instead applied the broad guiding principle of the Hang Seng Bank case in deciding that the income was derived from the place where the ship was let, i.e. Malaysia. The 2000s saw a series of appeals to the courts against the Inland Revenue Board’s challenge of the treatment of income received by taxpayers as foreign sourced income: Aneka Jasaramai Ekspress Sdn Bhd, Cardinal Health Malaysia 211 Sdn Bhd and Kyros International Sdn Bhd. All three cases advanced to the Court of Appeal, the highest court for tax appeals under the Act.
Aneka Jasaramai Ekspress Sdn Bhd
In AJE Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri (2001) MSTC 3357, the taxpayer is in the business of operating express bus services. The issue in contention with the Inland Revenue Board (“IRB”) was whether income from the sale of bus tickets in Singapore for single journeys from Singapore to Malaysia for the years of assessment 1990 to 1998 was income accruing in or derived from Malaysia or Singapore.
The taxpayer’s appeal was allowed by the SCIT. Matters taken into consideration by the SCIT were the fact that the contract, sale and payment of the tickets took place in Singapore. They also took into account the interpretation and application of Sections 3 and 12 of the Act; and the
ambiguity of the legal position prior to the introduction of Section 3C (which provided the specific exemption of foreign sourced income for the years of assessment 1995 to 1997), leading to the SCIT adopting a position which was favourable to the taxpayer.
Both the High Court and the Court of Appeal upheld the decision of the SCIT. However, the Court of Appeal’s written judgement is not available.
Cardinal Health Malaysia 211 Sdn Bhd
Cardinal Health Malaysia 211 Sdn Bhd (CHM), part of the Cardinal-Allegiance group, is a manufacturer and exporter of latex and synthetic gloves. It invested its surplus business profits by way of loans to a related company, AH BV, a Dutch investment holding company which acts
as a treasury company for the group. CHM treated the interest income received from the loans as foreign sourced income on the basis that the income arose from the provision of loans in the Netherlands. The IRB however, contended that the interest income was sourced in Malaysia as the funds lent were generated from CHM’s Malaysian business activities.
The case was decided in the favour of the taxpayer at all three levels of judiciary appeal but there was no written judgement of the Court of Appeal’s decision. The SCIT found that this
case clearly fell within the circumstances envisaged by Lord Bridge in the Hang Seng Bank case, i.e. “where profit was earned from the lending of money, the profit will have arisen from where the money was lent.”
The High Court in concurring with the SCIT, concluded that it was the supply or provision of credit to AH BV (and not the source of the credit), that was the originating cause or source of the interest received by CHM. This was further supported by Watermeyer CJ’s quote in the South African case of
Commissioner of Inland Revenue v Lever Brothers & Unilever Ltd (1946) 14 SATC 1:
“….this supply of credit
is the service which the
lender performs for the
borrower, in return for
which the borrower pays
him interest. Consequently
this provision of credit is the
originating cause or source
of the interest received by the
lender”
Kyros International Sdn Bhd
The case of Kyros International Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri (2013) MSTC 30-056 is the most recently decided Malaysian case on foreign sourced income. Kyros International Sdn Bhd (“Kyros”), the registered owner of trademark, KYROS, granted sole and exclusive rights to franchisees in foreign countries to establish and operate kebab fast food outlets in those countries. The IRB challenged Kyros’ treatment of the franchise fees as foreign sourced income as it was of the view that the franchise fees were derived from Malaysia under Section 12(1)(a) of the Act.
The SCIT concluded that the franchise fees were foreign sourced income as the business operations of the foreign franchisees took place outside Malaysia. The SCIT applied the principles established in the Hang Seng Bank case in concluding that the fees received from its foreign franchisees were akin to “profit earned ….by letting of property” where “ …. the profit will have arisen in or derived from where the property was let ….”.
The High Court overturned the SCIT’s decision as it did not think it was correct to look at the operations of the franchisees (as the SCIT did), instead of the operations of the Malaysian franchisor, Kyros. However the Court of Appeal reversed the High Court’s decision as it found that the High Court did not have sufficient reason to interfere with the SCIT’s finding of facts.
Application of broad
guiding principle
Did the Malaysian courts adopt the broad guiding principle
in Hang Seng Bank?
The RO Drilling appeal was heard by the courts prior to the “birth” of the broad guiding principle. The courts focused on the place where business acumen, judgement, intuition, knowledge and experience were exercised and employed, i.e. where the central and management control of the business was. Although the facts of the OA Pte Ltd case are somewhat similar to the ROD Co Ltd case, the court’s decision in the OA case that the income was sourced from outside Malaysia was made based on the Hang Seng Bank case. The courts in the Aneka Jasaramai case did not discuss the Hang Seng Bank case. They appear to have placed more reliance on the finding of fact that the activities of the taxpayer were outside Malaysia, i.e the sale and payment for the bus tickets were in Singapore, in applying Section 12(1)(a).
Subsequent cases had generally applied the “broad guiding principle.” In the CHM case, the court found that the originating cause that produced the interest income was the provision of loans in the Netherlands. In the Kyros case, the Hang Seng Bank principles were also considered and applied by the Courts. The SCIT found in favour of the taxpayer based on the finding of fact that the operations of the foreign franchisees took place overseas. In making the decision, the operations of the franchisor were not examined.
A variation of the broad
guiding principle?
In considering the source of income especially income from intellectual property, the case of Commissioner of Inland Revenue v HK-TVB International Ltd (1992) STC 723 should be reviewed. It is another Hong Kong case which was decided by the Privy Council after the Hang Seng Bank case.
The issue deliberated in this case was whether sub-licence fees received by HK-TVB International Ltd (HK-TVB), from its customers abroad were taxable in Hong Kong. HK-TVB (incorporated in Hong Kong) was granted by its parent company the rights to grant sub-licences for Chinese dialect video films to others to exploit the derivative rights in the films. HK-TVB granted the sub-licences to customers abroad in consideration of fixed sums (which may be
agreed abroad) paid in Hong Kong. In carrying out the sub-licensing business, HK-TVB may send representatives abroad to solicit customers. The sub-licence agreements were prepared in Hong Kong and sent abroad for the customer’s signature or signed by both parties abroad.
The approach adopted by the Privy Council in this case was not exactly the same as the approach taken in the Hang Seng Bank case. Instead, the Hang Seng Bank broad guiding principle was expanded as follows:
“The proper approach is
to ascertain what were the
operations which produced
the relevant profits and
where those operations took
place.”
Applying the above test, the Privy Council held that the sub-licence fees were taxable in Hong Kong as “the relevant business of the company was the exploitation of film rights of exercisable overseas and it was a business carried on in Hong Kong.” It is interesting to note that the Privy Council dismissed HK-TVB’s analogy between the licensing of intellectual property rights abroad and the letting of property (per Lord Bridge in the Hang Seng Bank case). The reason for this was that intellectual property does not have a situs similar to immovable property. More food for thought - The Privy Council was also of the view that while the profit-making activity of the sub-licensees was carried on outside Hong Kong, the grant of the sub-licenses took place in Hong Kong where the company operated.
An analysis of both the Hang Seng Bank and HK-TVB cases seems to differentiate the tests adopted – a focus on the specific transaction (in the Hang Seng Bank case) versus operations (in the HK-TVB case), that gave rise to the income in question. It is noted that the HK-TVB decision was not discussed and distinguished in the Kyros case.
Conclusion
The determination of the source of income is a complex and contentious area of law. It is observed that the Malaysian courts have generally applied the broad guiding principle of the Hang Seng Bank case. However, in applying case precedents, our specific legislation should be considered e.g. the deeming provision under Section 12 of the Act.
Finally, due to the complexity of the law and the diverse range of income and circumstances, the facts of each case must be considered separately in determining the tax treatment to be adopted. The continuous development of cases taken to the courts both overseas and in Malaysia, indicates that the concept of source of income is indeed difficult and often open to interpretation. With this, the debate on this issue will continue.
Appendix
Commissioner of Inland Revenue v Hang Seng Bank
Ltd (1990) STC 733
Hang Seng Bank Ltd carried on its banking business in Hong Kong. It invested its excess holdings of foreign currencies in certificates of deposit (CDs) in Singapore and London. These CDs were normally sold before maturity. The Singapore and London banks would give instructions for the purchase and sale of the CDs. The required funds for these transactions were debited and credited to the bank’s accounts with other overseas banks.
The issue was whether the bank was liable to profits tax on the profits arising from the purchase and sale of the CDs.
The Privy Council held that the income was not taxable in Hong Kong. In
arriving at this conclusion, Lord Bridge had outlined a broad guiding principle in determining the source of an
income:-“But the question whether the gross profit resulting from a particular transaction arose in or derived from one place or another is always in the last analysis a question of fact depending on the nature of the transaction. It is impossible to lay down precise rules of law by which the answer to that question is to be determined. The broad guiding principle, attested by many authorities, is that one looks to see what the taxpayer has done to earn the profit in question.”
The activity of the bank from which the income arose was the trading of the CDs in the Singapore and London markets and hence the income was not derived from Hong Kong.
Let
’
s talk
Kuala Lumpur Jagdev Singh +60(3) 2173 1469 [email protected] Jennifer Chang +60(3) 2173 1828 [email protected] Steve Chia +60(3) 2173 1572 [email protected]Fung Mei Lin
+60(3) 2173 1505 [email protected]
Khoo Chuan Keat
+60(3) 2173 1368 [email protected] Heather Khoo +60(3) 2173 1636 [email protected] Margaret Lee +60(3) 2173 1501 [email protected] Theresa Lim +60(3) 2173 1583 [email protected]
Lim Phaik Hoon
+60(3) 2173 1535 [email protected] Pauline Lum +60(3) 2173 1059 [email protected] Dorothy Ooi +60(3) 2173 1444 [email protected]
Phan Wai Kuan
+60(3) 2173 1589 [email protected] Frances Po +60(3) 2173 1618 [email protected] Lavindran Sandragasu +60(3) 2173 1494 [email protected] SM Thanneermalai +60(3) 2173 1582 thanneermalai somasundaram@ my.pwc.com
Teh Wee Hong
+60(3) 2173 1595
If you would like further information in relation to the issues outlined earlier, please call the Corporate Tax senior executive directors and
executive directors of PricewaterhouseCoopers Taxation Services Sdn Bhd:
Wan Heng Choon
+60(3) 2173 1488 heng [email protected] Clifford Yap +60(3) 2173 1446 [email protected] Lorraine Yeoh +60(3) 2173 1499 [email protected] Penang / Ipoh Tony Chua +60(4) 238 9118 [email protected] Johor Bahru Benedict Francis +60(7) 222 4448 [email protected] Melaka
Teh Wee Hong
+60(3) 2173 1595 [email protected] Labuan Jennifer Chang +60(3) 2173 1828 [email protected]
pwc.com/my
PwC Alert is a digest of topical financial and business information for clients and business associates of PwC Malaysia. Whilst every care has been taken in compiling this newsletter, we make no representations or warranty (expressed or implied) about the accuracy, suitability, reliability or completeness of the information for any purpose. PwC Consulting Services (M) Sdn Bhd, its employees and agents accept no liability, and disclaim all responsibility, for the consequences of anyone acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it. Recipients should not act upon it without seeking specific professional advice tailored to your circumstances, requirements or needs.
