Upfront Fees, Stamp Duty Charges & Legal Fees Incurred For A Working Loan Are Tax Deductible
Recently, in a landmark ruling, the Court of Appeal in POM, PMR and PFI v Ketua Pengarah Hasil Dalam Negeri ruled in favour of the taxpayer and held the upfront fees, stamp duty charges and legal fees (Financing Expenses) incurred by the taxpayers for their working capital facility agreements were deductible under Section 33(1) of the Income Tax Act 1967 (ITA).
The firm’s Tax, SST & Customs Partner, S. Saravana Kumar and Senior Associate, Nur Amira Ahmad Azhar, successfully represented the taxpayers in this matter.
Background Facts
POM’s principal activity is the marketing of petroleum products in East Malaysia, PMR’s principal activities are the manufacturing and marketing of petroleum and petroleum-related products in Peninsular Malaysia and PFI is in the business of marketing petroleum products in Malaysia.
On 7.8.2013, the taxpayers submitted their tax returns for the year of assessment 2012 without taking a deduction for the Financing Expenses. Pursuant to Sections 90(1) and 90(2) of the ITA, the tax returns were deemed to be notices of assessment served on the taxpayers on the date of filing. Accordingly, pursuant to Section 99(1) of the ITA, the taxpayers filed notices of appeal (Forms Q) against the deemed notices of assessment to the Special Commissioners of Income Tax (SCIT). The main basis for the appeal was that the Financing Expenses were deductible under Section 33(1) as it was incurred in the course of business. The taxpayers argued that the purpose of the Financing Expenses must be examined as the working capital facilities were used by the taxpayers to purchase petroleum products which formed their stock in trade.
Both the SCIT and High Court dismissed the taxpayers’ appeals. Aggrieved by the dismissals, the taxpayers further appealed to the Court of Appeal. The Court of Appeal in an unanimous decision reversed the decisions of the SCIT and High Court. Under the two-tier appeal system for tax appeals originating from the SCIT, the Court of Appeal’s ruling is the final and conclusive.
This alert discusses the arguments set out by both parties and the broad grounds of the Court of Appeal.
The Taxpayer’s Submission
On appeal, the taxpayer submitted that:
(a)SCIT erred in law and fact
The taxpayers’ appeals was in relation to the deductibility of Financing Expenses. However, the SCIT in the case stated prepared by them, considered a completely different issue which was irrelevant to the taxpayers’ appeals i.e. bad debts. On appeal, the High Court failed to address the error committed by the SCIT. Instead, the High Court relied on the SCIT’s erroneous grounds contained in the case stated and dismissed the taxpayers’ appeals.
Moreover, the High Court held that the SCIT had taken into consideration that the expenses claimed by the taxpayers were capital in nature. However, the taxpayers’ submission was that the SCIT did not address the above in their grounds of judgment.
(b)Financing Expenses were revenue in nature
The taxpayers’ submission was that an expenditure incurred in the course of business is deductible if it falls under Section 33(1) of the ITA. The basic rule of deductibility is that the expense incurred must be revenue in nature, which is wholly and exclusively incurred in the production of income (see Margaret Luping & Ors v Ketua Pengarah Hasil Dalam Negeri [2000] 3 CLJ 409).
The taxpayers also highlighted that in the present matter, it was not disputed that:
(i)The Financing Expenses that arose from the Facilities Agreements which were used as part of the taxpayer’s working capital.
(ii)The Financing Expenses were incurred by the taxpayers in the YA 2012 and were wholly and exclusively used for the production of income of the taxpayers.
(c)Nature of Facilities Agreement
The taxpayers submitted that in order to determine the nature of the Financing Expenses, the character or nature of the loan provided by the Facilities Agreement must be ascertained. This argument was supported by the Singapore Court of Appeal in Comptroller of Income Tax v IA [2006] 4 SLR(R) 161.
In submitting that the Financing Expenses were revenue expenditure, the taxpayers highlighted that:
(i)There was no creation of assets nor enduring benefit to the taxpayers’ business from the Facilities Agreement.
(ii)The Facilities Agreement were entered to raise working capital to facilitate any imports and local purchases for purchases of raw materials such as crude oil and refined petroleum products, which were purchased by the taxpayers in the ordinary course of business.
(iii)There was a nexus between the Financing Expenses incurred and the taxpayers’ production of income.
(d)Expenses in relation to borrowings are deductible
The taxpayers further submitted that our Courts and the Commonwealth countries have adopted the same position and agreed that financing expenses are revenue in nature (see Fernrite Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri (2004) MSTC 4,065).
In the IA case, the Singapore Court of Appeal held that other borrowing costs incurred to raise funds to construct a property for sale were deductible under Section 14 of the Singapore Income Tax Act, which is pari materia to Section 33(1) of the ITA. The Singapore Court of Appeal held that one must ascertain the purpose of the taxpayer entering into the loan - i.e. whether the loan was for the purpose of revenue or capital?
In arriving at its decision, the Singapore Court of Appeal considered the Federal Court of Australia’s ruling in Federal Commissioner of Taxation v Hunter Douglas Limited 83 ATC 4562 where it was held that the purpose of loan to be important in determining the nature of the borrowings. It was held that borrowings to purchase trading stock were for a revenue purpose.
The Revenue’s Submission
The Revenue submitted that there was no error committed by the SCIT and High Court and maintained its stance for the following reasons:
(a)The expenses were not eligible for deduction as it was expended for the initiation of income making mechanism, i,e the credit facilities.The facility expenses were expenses which the taxpayers had to incur before the credit facilities could be made available to the taxpayers and the expenses incurred were not for the purpose of obtaining the stock or working capital but it was for the purpose of enabling the taxpayers to obtain the working capital itself i.e. the credit facilities.
(b)The expenses were merely expended to ensure and to enable the taxpayers to obtain the working capital. The expenses in issue were not used as working capital but only to make the working capital available to the taxpayers.
(c)Applying the “enduring benefit of the trade” test, the object and effect of the expenses taken by the taxpayers was to enable the taxpayers to secure the facility and not for the facility itself. It is a case of once and for all expenditure on a capital asset designed to make it more advantageous.
(d)The expenses incurred was made with a view to bringing into existence an advantage for the enduring benefit of a trade. Therefore, the expenditure was incurred for acquiring a source of income and it would be of capital in nature.
(e)The purpose or usage of the loan itself was irrelevant. The court must look at the real purpose of the expenditure i.e. to enable the taxpayers to enjoy the facilities.
The Court of Appeal’s Ruling
The Court of Appeal held that the Financing Expenses incurred for the YA 2012 by the taxpayers in respect of the financing obtained via two working capital facility agreements were deductible under Section 33(1) of the ITA. The Court of Appeal briefly explained that applying the purpose test, the sole purpose of the Facility Agreements was for the taxpayers to purchase the taxpayers’ stock in trade to be used only for the taxpayers’ business. The purpose of the Facility Agreements was not to acquire any fixed asset for the taxpayers or for any other party. There was a “sufficient linkage or relationship” between the Facility Agreements and the taxpayers’ purchase of stock in trade. The taxpayers’ purchase of stock in trade was clearly revenue in nature because such stock in trade was solely used for the production of the taxpayers’ gross income. As the taxpayers’ purchase of stock in trade was revenue in nature, the Facilities Agreements were revenue in nature. Hence, the taxpayers could claim a deduction for the Financing Expenses under Section 33(1) of the ITA and were not precluded from making such a deduction pursuant to Section 39(1)(c) of the ITA.
29 November 2023