Reinvestment allowance (RA) is a special tax incentive under Schedule 7A of the Income Tax Act 1967 (ITA) which is designed to encourage Malaysian resident companies to reinvest in their manufacturing business by way of expansion, modernization, automation, or diversification. RA aims to promote growth and innovation in the Malaysian manufacturing sector and is often favored by taxpayers because it can be claimed as a matter of right without prior approval.
This alert examines the High Court’s recent ruling in Impressive Edge Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri, which centers on the Revenue's decision to limit the taxpayer’s RA claim for the new factory floor area by imposing additional conditions that were not specified by the law.
Brief Facts
The taxpayer manufactures engineering spare parts, mould parts, die parts, and precision tools. The business operated from its old factory in Batu Berendam, Melaka (Old Factory) in 1994. In 2006, the business moved to a new factory in (New Factory) though the Old Factory continued to be used for warehousing and some production activities.
From the years of assessment (YAs) 2006 to 2008, the taxpayer incurred expenses related to the expansion of its manufacturing business where the taxpayer claimed RA for the capital expenditure incurred for the New Factory and equipment such as computer, iron frame cabinet, and tooling equipment (Disputed Items).
Consequent to a tax audit, the Revenue disallowed the RA claims for the Disputed Items, arguing that they were not directly related to production activity. Additionally, the Revenue contended that the RA claim for the New Factory should be limited to the difference in floor area between the New Factory and the Old Factory.
As a result, the Revenue issued additional tax assessments.
Dissatisfied with the Revenue’s decision, the taxpayer appealed to the Special Commissioners of Income Tax (SCIT), which dismissed the taxpayer’s appeal. The taxpayer then appealed to the High Court which reversed the SCIT‘s ruling.
The Revenue’s Position
Under Schedule 7A of the ITA, RA can be claimed by taxpayers who meet the following criteria:
(a) A company which is resident in Malaysia;
(b) Has been in operation for not less than 36 months; and
(c) Has incurred capital expenditure on a factory, plant, or machinery for a qualifying project under subparagraph 8(a).
It was not contested that the taxpayer fulfills the first two requirements: being a Malaysian resident and having been in business for over 36 months, with capital expenditure incurred on the factory in YA 2006. The taxpayer had previously been granted RA for the Old Factory from YAs 1998 to 2005.
The core issue revolved around whether the taxpayer’s New Factory qualified as a “qualifying project” under subparagraph 8(a) of Schedule 7A:
“8. In this Schedule, “qualifying project” means –
(a) a project undertaken by a company, in expanding, modernizing or automating its existing business in respect of manufacturing of a product or any related product within the same industry or in diversifying its existing business into any related project within the same industry.”
The Revenue’s stance was that the taxpayer’s RA claim should be restricted to the portion of the new factory floor area attributable to the expansion project in YA 2006 as:
(a) The taxpayer had enjoyed a reinvestment allowance for the Old Factory which was first claimed in YA 1998 for consecutive years until YA 2005.
(b) The New Factory’s primary function was to consolidate the production processes into a single facility.
(c) Rather than acquiring an entirely new factory, the taxpayer merely replaced assets within their existing production line.
(d) As such, the expansion project at the New Factory was only an addition to the area of the Old Factory.
Further, the Revenue contested the RA claim for the Disputed Items, arguing that the capital expenditure was not integral to the manufacturing process. These items were situated outside the production area and thus, were ancillary. The Revenue argued that the Disputed Items were primarily used for administrative purposes, such as by the Planning Office's director, CAD Department for design work and Customer Service Department for stock storage, rather than in the direct manufacturing of products.
The Taxpayer’s Position
The taxpayer argued that although the term “expanding” was not explicitly defined in the ITA at the relevant time, the taxpayer’s interpretation aligns with the legislative intent.
Paragraph 9, Schedule 7A of the ITA defines “expanding” as:
“ “expanding” refers to an increase of a product capacity or expansion of factory areas”
The taxpayer asserted that relocating to the New Factory constituted expansion, as it not only increased the factory area but also enhanced product capacity. This assertion was supported by judicial precedents such as the cases of Ketua Pengarah Hasil Dalam Negeri v OKA Concrete Industries Sdn Bhd (2015) MSTC 30-091 and RR v Ketua Pengarah Hasil Dalam Negeri (2013) MSTC 10-042, where an increase in annual turnover was considered as one of the most important indications of expansion.
Evidence presented during the trial showed significant growth in the taxpayer’s annual revenue production and sales increased.
The taxpayer also highlighted that neither the ITA nor Schedule 7A prescribes that the RA claim should be restricted to the difference in area between the old and new factories. Such a restriction would imply that the Revenue is relying on its interpretations or internal guidelines, which are not legally binding.
The taxpayer also referenced the case of Ketua Pengarah Hasil Dalam Negeri v Success Electronics & Transformer Manufacturer Sdn Bhd (2012) MSTC 30-039, where the High Court rejected the Revenue’s attempt to limit RA based on the area difference between old and new factories. This decision, which was later affirmed by the Court of Appeal, affirmed that the Revenue’s internal rulings on RA lack legal authority.
Regarding the Disputed Items, the taxpayer contended that the Revenue’s requirement for these items to be in the production area was not legally mandated and reflects internal guidelines rather than statutory law. The taxpayer maintained that the Disputed Items fell within the scope of “modernizing” and “automating,” and were essential to the manufacturing process. Without these items, productivity would be severely compromised, if not halted altogether.
High Court’s Decision
The High Court found that the SCIT had erred on a question of law, resulting in a flawed judgment that necessitated judicial intervention. The High Court agreed with the taxpayer’s argument that the Revenue had not met its burden of proof. Specifically, the court held that the Revenue had failed to demonstrate that the taxpayer was negligent or had knowingly misrepresented its RA claims. According to the court, the Revenue needed to provide more substantial evidence. This carries significant implications for taxpayers and the application of RA under Malaysian tax law.
This ruling not only clarifies the legal standard for qualifying projects but also highlights the importance of adhering to statutory definitions rather than relying on internal interpretations or guidelines.
5 August 2024