Recently, the Court of Appeal in the case of PNK v Ketua Pengarah Hasil Dalam Negeri held that the commission paid by the taxpayer to obtain a bank guarantee for the purchase of diesel was eligible for tax deduction under Section 33(1) of the Income Tax Act 1967 (ITA). This decision holds significance as the court recognised that borrowing costs such as guarantee fees are business expenses.
Background Facts
PNK is a fishermen's association under the Ministry of Agriculture and Food Security, where it is primarily involved in the distribution of subsidised diesel fuel to fishermen. Additionally, the taxpayer was also engaged in various ancillary operations such as fishery product processing and marketing of fresh seafood.
As part of its business operations, the taxpayer purchased diesel fuel supplies from established suppliers. Based on the supply agreements between the taxpayer and the suppliers, the diesel fuel was supplied at a fixed price and for each purchase, the taxpayer was granted a 30-day credit term, during which the taxpayer was required to settle the payment due. In order to manage its financial obligations, the taxpayer successfully secured a bank guarantee facility from a local bank. This facility stood as a guarantee for the payment obligations related to the diesel supply obtained by the taxpayer from its suppliers. The bank imposed a commission expense of 1% per annum, with a minimum RM 100.00 charge for each letter of guarantee, which was payable in advance, to this bank guarantee facility.
The taxpayer incurred the commission expense and treated it as a revenue expenditure incurred wholly and exclusively in the production of its gross income. In other words, the taxpayer took a tax deduction under Section 33(1) of the ITA for the bank commission expenses incurred in years of assessment (YAs) 2008 to 2010. However, during a tax audit, the Revenue disallowed the amount claimed as a deduction on the ground that the bank guarantee commission incurred by the taxpayer was not tax deductible. The Revenue took the position that the bank commission expense was a capital expense. Consequently, the Revenue raised additional tax assessments against the taxpayer in addition to imposing a penalty.
Aggrieved by the Revenue’s decision, the taxpayer appealed to the Special Commissioner of Income Tax (SCIT), who ruled in favour of the taxpayer. However, the SCIT’s decision was reversed by the High Court. This led to the taxpayer appealing to the Court of Appeal, which recently ruled in favour of the taxpayer and restored the decision of the SCIT.
The Taxpayer’s Argument
The taxpayer submitted that the bank guarantee commission was an expense incurred in the course of the taxpayer’s business of buying and supplying diesel to fishermen. The High Court had overlooked the fact that the taxpayer's primary business activity involved managing the entire diesel supply chain, from procurement to distribution, and ensuring that the diesel ultimately reaches the fishermen. Considering the substantial quantity of diesel purchases, credit payments were necessary to manage cash flow and ensure the continuity of the taxpayer’s business operations, whether through a bank guarantee or a loan. Given that interest expenses for a loan were deductible under Section 33(1) of the ITA, then, the bank guarantee commission being an expense closely connected to the generation of the taxpayer’s income, should likewise be eligible for tax deduction.
Further, the bank guarantee commission was a recurring revenue expenditure that served to facilitate the bank guarantee, which was in place to secure the supply of diesel i.e. the taxpayer’s stock in trade. The bank guarantee did not bring into existence an asset or an advantage for the enduring benefit of trade and therefore, it was not a capital expenditure.
The Revenue’s Argument
In disallowing the deduction, the Revenue argued that the bank guarantee commission was capital in nature as the bank guarantee itself was not obtained directly for the purpose of buying the diesel. Instead, the bank guarantee was merely a pre-condition imposed to enable the taxpayer to buy the diesel. Hence, the Revenue contended that the bank guarantee served a business facilitation purpose rather than being an integral business activity and the expenditure for such facilitation was capital in nature as they aim to establish profit-earning mechanism rather than profitability. The Revenue further submitted that the bank guarantee commission was an expense made with a view of bringing into existence an asset or an advantage for the enduring benefit of trade (i.e. the right to purchase the diesel).
The Court of Appeal’s Ruling
The Court of Appeal reversed the decision made by the High Court and held that the bank guarantee commission was revenue in nature. Hence, the court allowed the expenses to be deducted under Section 33(1) of the ITA.
First, the court commented that the absence of the bank guarantee would compel the taxpayer to explore alternative methods of procuring diesel from its suppliers such as cash payment or obtaining a loan, in which case the taxpayer would have incurred interest expense, which would have been tax deductible. Thus, the court did not see any significant difference between a mode of doing business where the bank guarantee was in place instead of a situation where a bank loan was obtained.
Further, the court held that the bank guarantee commission was essentially incurred when the bank guarantee facility was utilised, which was in the course of the taxpayer’s business. Hence, the court found it difficult to classify the commission paid as a capital expenditure as it was not directed at procuring any business asset. Instead, the commission formed a part of the payment method to obtain diesel from suppliers.
Conclusion
The Court of Appeal’s ruling is welcome as this ruling recognises that bank guarantee commission is a form of borrowing costs. It forms a part of the payment mechanism that taxpayers use in the course of their business such as in this appeal where the taxpayer used the bank guarantee as a payment mechanism to obtain its diesel supply in the course of its business. By comparing the situation of the taxpayer obtaining the bank guarantee to that of obtaining a loan, the court highlighted the parallel nature of these approaches in terms of their impact on the taxpayer's business. This decision, therefore, not only grants relief to the taxpayer in this appeal but also recognises the use of financing facilities such as bank guarantees in the ordinary course of business to manage cash flow in achieving operational efficiency.
8 September 2023