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MAY 2017

UBAT2023 OUTLINE
TAXATION I 1. Definition of business
2. Badges of trade
3. Revenue receipt: gross income from business
4. Distinction between capital and revenue receipts
5. Derivation of business income
TOPIC 6 6. Commencement of business
BUSINESS INCOME 7. Basis period of business income
8. Adjusted income from business
9. Mutual and illegal transactions

MAY 2017 MAY 2017

LEARNING OUTCOMES LEARNING OUTCOMES


After studying this topic, you should be able to: After studying this topic, you should be able to:
Define what is meant by business Determine the date of commencement of business
Apply the badges of trade to establish the existence of trade or
State the importance of commencement date of business
an adventure or concern in the nature of trade
Determine the basis period of business income
Determine the gross income from business (revenue receipt)
Compute the adjusted income from business
Distinguish between capital and revenue receipts
Determine the taxability of income from illegal transactions
Explain how business income is derived or deemed to be derived
from Malaysia
MAY 2017 MAY 2017

S4(A): BUSINESS INCOME

S4(A) Section 4(a) income:


Gains or profits from a business
BUSINESS INCOME
Business" includes profession, vocation and trade and
every manufacture, adventure or concern in the nature of
trade, but excludes employment
[S 2, ITA 1967]

MAY 2017 MAY 2017

S4(A): BUSINESS INCOME S4(A): BUSINESS INCOME

Profession Trade
Using intellectual skill to earn income Buying & selling
Example: Engineering, legal & medical practice Intention to make profit

Vocation
Manufacture
Way of passing life
Original material undergo a transformation so that a new
Example: Placing bets systematically , attend races
and different article or product emerges
S4(A): BUSINESS INCOME
MAY 2017
S4(A): BUSINESS INCOME MAY 2017

BADGES OF TRADE BADGES OF TRADE


1. Intention/motive of taxpayer
An isolated transaction would be taxed as business
income if it carries the nature of trade. 2. Subject matter of transaction
Guide to establish the existence of 'trade' or 'an 3. Length/period of ownership
adventure or concern in the nature of trade' in a 4. Frequency of transactions
particular case
5. Formation of organization
6. Financing arrangement
Trading receipt Income tax?
7. Alterations/supplementary work on the asset
8. Circumstances leading to the sale
9. Method of disposal
Capital gain from
Income tax? 10. Accounting evidence/treatment
disposing investment

S4(A): BUSINESS INCOME MAY 2017


S4(A): BUSINESS INCOME MAY 2017

BADGES OF TRADE BADGES OF TRADE


1. Intention/motive of taxpayer 2. Subject matter of transaction (nature of asset)
Asset which can only bring benefit to its owner by
Where the subject matter was held for resale at profit
realization is more likely to be subject of trading
(profit-making motive), the profits earned should be
than asset which produce income or can be used or
treated as business income
enjoyed during possession

Investment/ Self
Since Subsequent Enjoyment LONG TERM
or
acquisition Change to that

Profit Making SHORT TERM


S4(A): BUSINESS INCOME MAY 2017
S4(A): BUSINESS INCOME MAY 2017

BADGES OF TRADE BADGES OF TRADE


3. Length/period of ownership 4. Frequency of transactions
The longer the holding period of the subject Where the same type of asset is repeatedly bought
matter, the greater the possibility that it was held and sold, there is a strong indication that trading
for investment, instead of for resale at profit activities are being carried out

REPEAT TRANSACTION TRADING


A quick resale may point towards the transaction
being in the nature of trade
However, an isolated transaction with some
characteristics of trade could also be considered as an
adventure in the nature of trade

S4(A): BUSINESS INCOME MAY 2017


S4(A): BUSINESS INCOME MAY 2017

BADGES OF TRADE BADGES OF TRADE


5. Formation of organization 6. Financing arrangement
Where a person borrows more than he could
It is presumed that the main purpose for forming
normally afford to buy an asset, there is
companies or partnerships is to carry on a
indication that he hopes to resell the asset at a
business
profit within a short period of time
Disposal of an asset by company or partnership is
more likely to be a business venture, compared to The shorter the period of financing, the
situation where the asset was disposed of by higher the probability that the transaction
individual constitutes business transaction
S4(A): BUSINESS INCOME MAY 2017
S4(A): BUSINESS INCOME MAY 2017

BADGES OF TRADE BADGES OF TRADE


7. Alterations/supplementary work on the asset 8. Circumstances leading to the sale
Supplementary work to enhance the marketability A forced sale prompted by emergency need for fund,
of the asset would indicate the presence of a trade or compulsory acquisition by government or some
an adventure in the nature of trade private factors would not constitute a trade

Processing Nevertheless, proceeds from the sale of stock in trade


Packaging under hard pressed situation would still be treated as
normal business income
Modification
Renovation

S4(A): BUSINESS INCOME MAY 2017


S4(A): BUSINESS INCOME MAY 2017

BADGES OF TRADE BADGES OF TRADE


9. Method of disposal 10. Accounting evidence/treatment
Organized activities undertaken in promoting the
subject matter will indicate the existence of a profit-
Current asset Non current asset
making undertaking
- stock in trade

Extensive
advertisement Held for resale Held for long term
investment/own use

Setting up Employment
sales office of sales staff
Business income Capital gain
S4(A): BUSINESS INCOME MAY 2017 S4(A): BUSINESS INCOME MAY 2017

SUMMARY OF BADGES OF SUMMARY OF BADGES OF


TRADE TRADE
Business income Capital gain Business income Capital gain
1 Intention of Profit-making Investment 5 Formation of Company or Individual
taxpayer organization partnership
2 Subject matter Subject of trading Income producing or 6 Financing Borrowed fund Own fund or long
for personal arrangement (short term) term loan
enjoyment/use 7 Alterations on the With alterations Without alterations
3 Length of Short period Long period asset
ownership 8 Circumstances Free will Forced sale
4 Frequency of Repetitive One-off responsible for
transactions realization

S4(A): BUSINESS INCOME MAY 2017


Example:
MAY 2017

SUMMARY OF BADGES OF SMART Sdn Bhd has been engaged in general manufacturing industry since year 1980. In
2000, the company diversified into agricultural activities through the acquisition of a
TRADE rubber estate in Perak Malaysia. The estate was then, classified as a fixed asset in
companys balance sheet.
Business income Capital gain
In year 2014, smart Sdn Bhd applied to the relevant authorities for conversion of the estate
9 Method of Active (organized Passive (ad hoc)
for commercial use. After obtaining approval for the conversion in December 2014, the
disposal activities)
company applied for a housing developers license.
10 Accounting Current asset (stock Non current asset
treatment in trade) Before smart Sdn Bhd could commence development works on the land, it encountered
financial difficulties and sold the land in November 2015 for a profit of rm18 million. The
The badges/factors needs to be considered collectively to ascertain the company had no previous dealing in land.
nature of a transaction
No single badge is conclusive in itself Required:
Certain badges should be given more weight to ascertain the nature of a State your arguments for and against the taxability of the profit on sale of the land.
transaction
MAY 2017 Answer: MAY 2017
Answer: Not assessable to income tax
Argument against taxability
Argument for taxability Length/ period of ownership
Intention/ motive of taxpayer Long holding period from year 2000 till 2015.
The application for housing developers license indicates that the nature
of the estate land changed into stock-in-trade due to the change in Frequency of transactions
intention. There is no previous dealing in land. It is an isolated transaction.

Accounting evidence/ treatment


Alterations/ supplementary work on the asset
Land disclosed as fixed asset in balance sheet, indicating the intention to hold
The company has taken the action to make the estate land more
as a long-term investment
marketable by applying conversion into commercial use.
Subject matter of transaction
Formation of organization
Operated as a rubber estate for many years before sale, generate income
The land is disposed of through company, SMART sdn bhd. during the holding period.

Circumstances leading to the sale


Assessable to income tax The company encountered financial difficulties and sold the estate. It is a
forced sale.

S4(A): BUSINESS INCOME MAY 2017


S4(A): BUSINESS INCOME MAY 2017

DERIVATION OF BUSINESS DERIVATION OF BUSINESS


INCOME INCOME
The existence of business source; Such business income is deemed derived from Malaysia
Contract concluded in Malaysia
The business transaction is income in nature
Stocks are maintained in Malaysia
Such business income is deemed derived from Malaysia
Passing of ownership & risk of trading stock in Malaysia
Section 12(1)(a): gross business income is not attributable
to operation of business carried on outside Malaysia Sales proceed received in Malaysia

[Section 12, ITA 1967] Services rendered in Malaysia


S4(A): BUSINESS INCOME MAY 2017
S4(A): BUSINESS INCOME MAY 2017

DERIVATION OF BUSINESS DERIVATION OF BUSINESS


INCOME INCOME
Example Example
Sale of goods costing RM200 from Malaysia to customer in Sale of goods costing RM200 from Malaysia to customer in
Thailand: Thailand:
1. Through branch in Thailand 2. Directly to customer in Thailand
Malaysia > Branch > Customer Malaysia > Customer
Revenue RM230 RM280 Revenue RM280
(-) Cost (RM200) (RM230) (-) Cost (RM200)
Profit RM30 RM30 Profit RM80

Non-Malaysian
Malaysian source Malaysian source
source

S4(A): BUSINESS INCOME MAY 2017 MAY 2017

S4(A): BUSINESS INCOME


DERIVATION OF BUSINESS
REVENUE RECEIPT
INCOME
Example Debts arising in the course of carrying on a business
Leisure bhd manufactures refrigerator in Malaysia. In 2015, the Sale of stock in trade (inventory)
company sold 20% of its products in China. Provision of services rendered
Use or enjoyment of any property
Is the sales deemed derived from Malaysia? [S 24(1), ITA 1967]

Market value of goods exported in the course of carrying on a


business
[S 24(6), ITA 1967]
MAY 2017 MAY 2017

S4(A): BUSINESS INCOME S4(A): BUSINESS INCOME


REVENUE RECEIPT REVENUE RECEIPT
Market value of stock in trade withdrawn for own use Realized foreign exchange gain arising from revenue
[S 24(2) & (3), ITA 1967] transaction which forms part of normal business activities

Dividend income of share dealing business Release/waiver of debt by creditor pertaining to expense
[S 24(4), ITA 1967] previously been allowed as business deduction (eg rent
payable)
Interest income of investment dealing business/money [S 30(4), ITA 1967]
lending business (eg bank & finance company)
[S 24(5), ITA 1967] Recovery of bad debt which has previously been allowed as
business deduction
[S 30(1), ITA 1967]

MAY 2017 MAY 2017

S4(A): BUSINESS INCOME S4(A): BUSINESS INCOME


REVENUE RECEIPT REVENUE RECEIPT
Insurance recovery where insurance expense has been claimed as business Example
deduction (eg for loss of trading stock) Berjaya sdn bhd acted as agent for several manufacturers. One of the
[S 22(2)(a), ITA 1967] companys agencies which had been entered into twenty years ago accounted
for 40% to 50% of the companys profits.
Compensation for loss of income (eg upon cancellation of ordinary trade
agreement which is normal incident in business) When that agency has only two more years to run, it was terminated by the
[s 22(2)(b), ita 1967] manufacturer and the company was paid a sum as compensation for the loss of
To filled up the hole of profit lost the agency. Although the company managed to secure two other small agencies
Arise in normal trading transaction in the same year, there was a reduction in profits.
The agreement was only one of many similar agreement signed
The business structure of company was not affected. Required:
Explain on the taxability of the compensation received.
S4(A): BUSINESS INCOME MAY 2017
S4(A): BUSINESS INCOME MAY 2017

REVENUE RECEIPT CAPITAL RECEIPT


Answer:
The agency had two more years to run. The compensation is therefore to fill
a hole in the profits that the company would otherwise have made. Proceeds from disposal of fixed assets

The facts would indicate that the winning and losing of agencies is normal Receipt for substantial restriction on business activities
in the course of the companys business. In the year which the agency was (restrictive covenant)
lost, two new agencies were gained.

In the circumstances, it cannot be said that the entire structure of the Compensation for destruction of whole structure of profit-
companys business was affected. It is clear that the agency in question was making apparatus (eg termination of major business contract
just one of several agencies that the company held. joint venture)

The compensation received is therefore a receipt in the ordinary course of


Not assessable to income tax
business and liable to tax.

S4(A): BUSINESS INCOME MAY 2017


S4(A): BUSINESS INCOME MAY 2017

COMMENCEMENT OF BUSINESS COMMENCEMENT OF BUSINESS


The commencement date of business is important as:
Embarks on activities that are part of the income producing
process
It may affect the first basis period of the company
Retailing the day shop is opened for business
Submission of estimated tax payable to the IRB is within 3
Hotel the day hotel is opened to public
months from the date of commencement of business
Manufacturing the day factory is in a position to start
Pre-commencement revenue expense is not deductible
manufacture
(permanent loss)
Plantation the day seeds are sown or seedlings are
Qualifying expenditure incurred prior to the
planted
commencement of business is deemed to be incurred on the
Acquisition of existing business the acquisition date of
date of commencement of business (eg Capital allowance
business operation
can only be claimed after commencement of business)
S4(A): BUSINESS INCOME MAY 2017
S4(A): BUSINESS INCOME MAY 2017

BASIS PERIOD ADJUSTED INCOME FROM


BUSINESS
Companies

Trust bodies Financial year Gross income xx


Less: Deductible expenses (xx)
Co-operative societies
Adjusted income* xx

Others: Calendar year


Net profit xx
Add: Non-Deductible expenses xx
Adjusted income* xx

MAY 2017
S4(A): BUSINESS INCOME MAY 2017

S4(A): BUSINESS INCOME ADJUSTED INCOME FROM


ADJUSTED INCOME FROM BUSINESS
BUSINESS
Gross income RM33,000 Gross income
Deductible expenses RM20,000 Less: Deductible expenses
Non-deductible expenses RM3,000
Adjusted income*
Net profit RM10,000

Required: Net profit


Compute the adjusted income of the business Add: Non-Deductible expenses
Adjusted income*
MAY 2017 MAY 2017

S4(A): BUSINESS INCOME S4(A): BUSINESS INCOME


MUTUAL TRANSACTION ILLEGAL TRANSACTION
Gains derived from mutual transactions are not taxable as
such gains are not income based on the principle of Gains or profits generated from illegal activities are
mutuality where a man cannot trade with himself and to taxable as long as the activities bear the characteristics of
make a profit out of such transactions a trade

Receipts of subscription by members to a club do not form Tax on income, not only on legal income
part of the assessable income

Gains derived from transactions with non-members is


assessable to tax

SELF-CHECK ON LEARNING MAY 2017

OUTCOMES
After studying this topic, are you able to:

Define what is meant by business


Apply the badges of trade to establish the existence of trade or an
adventure or concern in the nature of trade
Determine the gross income from business (revenue receipt)
Distinguish between capital and revenue receipts
Explain how business income is derived or deemed to be derived from
Malaysia
Determine the date of commencement of business
State the importance of commencement date of business
Determine the basis period of business income
Compute the adjusted income from business
Determine the taxability of income from illegal transactions