Recently, the Special Commissioners of Income Tax (SCIT) allowed a taxpayer’s appeal to claim capital allowance on the capital expenditure incurred for customised computer software. The Director General of Inland Revenue (DGIR) disallowed the taxpayer’s capital allowance claim by relying on the DGIR’s Public Ruling.
The taxpayer was successfully represented by the firm’s Tax, SST and Customs Partner, S. Saravana Kumar and pupil, Lim Chinn Wei.
Background
The taxpayer incurred capital expenditure for the acquisition costs, initial software licence fees, software development costs as well as upgrading and enhancement costs for the software used by the taxpayer in its business. The taxpayer is in the financial services business. In relation to this expenditure, the taxpayer claimed capital allowance and accelerated capital allowance amounting to RM 221,968,699 in the years of assessment (YAs) 2014 to 2017.
The taxpayer made the capital allowance claim on the premise that they were entitled to claim the allowance at an accelerated rate as the banking systems and software systems or software packages used by them were information and communication technology equipment as provided under the Income Tax (Accelerated Capital Allowance) (Information and Communication Technology Equipment) Rules 2014 and the Income Tax (Accelerated Capital Allowance) (Information and Communication Technology Equipment) Rules 2018 (collectively referred to as “the Rules”).
The crux of dispute before the SCIT was whether the DGIR has any basis in law to disallow the capital allowance claim made by the taxpayer for the customised software development and for the upgrading of the customised software.
Case Analysis
The taxpayer relied on an earlier decision of the High Court in CIMB-Principal Asset Management Bhd v Ketua Pengarah Hasil Dalam Negeri [2022] 1 LNS 2047, where it was ruled that the capital expenditure incurred for consultancy fees paid in connection with the implementation, customisation, development, integration, installation, licensing, testing of, and other additional improvement to the taxpayer’s computer software, as well as other incidental charges incurred on the provision of computer software were claimable as capital allowance under Schedule 3 of the Income Tax Act 1967 (ITA).
However, the DGIR attempted to distinguish the present appeal from the CIMB-Principal Asset case on the premise that the latter case involved the issue of ownership of the software. The taxpayer argued that the DGIR’s attempt to distinguish the case should not be given weight as the DGIR’s position failed to take into account the following:
(i)In both cases, the software purchased was customised to suit the taxpayer’s business needs and purposes in the financial services industry.
(ii)The disputed capital expenditure in both cases involve expenditure for customisation, development and other additional improvement to the computer equipment and software for the purposes of carrying on business activity.
(iii)The disputed capital expenditure in both cases were related to the incidental costs to the purchase and customization of the software.
The Capital Allowance Claims
The DGIR did not dispute that the taxpayer fulfilled the requirements for claiming capital allowance for the software systems or software packages under Schedule 3 of the ITA. However, the DGIR alleged that the Rules only permitted the costs incurred in the purchase of any information and communication technology equipment. On this basis, the DGIR disallowed the capital allowance claim for the customised software development and the accelerated capital allowance claim for the upgrading of the customised software.
However, the DGIR failed to realise that the Rules do not specify the eligibility for capital allowance. Instead, the Rules merely prescribe the rate of specific qualifying plant expenditure without addressing whether software packages qualify for capital allowance. This was the position taken by the High Court in the CIMB-Principal Asset case.
In addition, there was no requirement for an item to be specifically listed under Schedule 3 of the ITA or in any subsidiary legislation as a plant in order to qualify for capital allowance. As held by the Court of Appeal in Ketua Pengarah Hasil Dalam Negeri v Tropiland Sdn Bhd (2013) MSTC 30-054, there is a need to take a holistic approach in every case and look at the taxpayer’s business in its entirety instead of taking particular facts in isolation. In Tropiland,the Court of Appeal allowed the taxpayer’s claim for capital allowance for a multi-storey carpark notwithstanding that Schedule 3 did not expressly state that a multi-storey carpark was a plant.
Further, the costs to upgrade and develop the software were necessary expenditure incidental to the installation of the software as otherwise the software systems or software packages will not be usable in the taxpayer’s business. The High Court in CIMB-Principal Asset also held that all incidental costs were claimable as capital allowance under Schedule 3 of the ITA.
The Requirement To Segregate Costs
In the present appeal, the DGIR alleged that the taxpayer ought to have segregated the costs for the purchase, upgrading and development of the software as the Rules limited accelerated claim to software items only. However, based on the trite principle that taxing statutes must be read strictly, it was argued that there was no requirement to segregate the costs incurred on the taxpayer’s computer software or software packages. If Parliament had intended for the requirement to segregate the costs, then Parliament would have used express words to that effect.
As there was no requirement to segregate the costs incurred on the software system or software packages, the DGIR was not permitted to impose such additional condition on the taxpayer in disallowing the Capital Allowances Claims.
The Public Ruling No. 12/2014
The DGIR also relied on paragraph 8.2(ii) of the Public Ruling No. 12/2014 and alleged that payment for developing software such as consulting fees, right to use the software such as licence fee and other incidental charges were not part of the cost for the provision of computer software.
However, the DGIR failed to realise that Public Ruling has no force of law as it was merely a guide for the public setting out the DGIR’s interpretation in respect of tax law and the policy as well as the procedure applicable to it. As such, the Public Ruling cannot be used by the DGIR to impose additional conditions on the taxpayer.
Conclusion
Based on the above, the SCIT has correctly followed the High Court’s ruling in CIMB-Principal Asset and set aside the assessments raised by the DGIR. The taxpayer was permitted to claim capital allowance at an accelerated rate based on the Rules on the capital expenditure incurred on the customised software program and the related incidental expenses.
30 June 2023