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High Court Rules In Favour Of Taxpayer In MRTCSB v Ketua Pengarah Hasil Dalam Negeri

Recently, the High Court in MRTCSB v Ketua Pengarah Hasil Dalam Negeri ruled in favour of the taxpayer. The issue was on the tax deduction of operational expenditure incurred by the taxpayer in relation to a public transport construction project known as the MRT Project based on the Income Tax (Exemption) (No.22) Order 2006 (the Exemption Order).

The Exemption Order states that the Minister exempts any person from the payment of income tax in respect of income relating to allocation given by the Federal Government or State Government in the form of a grant or a subsidy. In other words, the allocation given by the Federal Government or State Government must first be income that would be subjected to income tax in order to qualify for the exemption.

Background Facts

MRTCSB (the taxpayer) was engaged in the construction of the MRT Project. The cost of the MRT Project was funded through capital injections made by the Federal Government to the taxpayer. The capital injections were made through funds raised by DNB, a company which was wholly owned by the Minister of Finance Incorporated (MoF Inc). The capital injections were recorded as equity in the taxpayer’s audited financial accounts and were never treated as part of the taxpayer’s income.

The taxpayer incurred operational expenses which were ordinarily deductible under Section 33(1) of the Income Tax Act 1967 (ITA). However, due to substantial business losses incurred in the years of assessment (YAs) 2013 to 2017, the expenses could not be utilised for tax deduction and became adjusted losses, which the taxpayer utilised to set off against its interest income.

In 2017, the Revenue conducted a tax audit and disallowed the expenses deducted by the taxpayer for the following reasons:

(a)The capital injections received by the taxpayer from the Federal Government was an income in the form of a grant, which was tax-exempt by virtue of the Exemption Order.

(b)Consequently, the taxpayer was not entitled to deduct the operational expenses against its interest income pursuant to paragraph 3(1) of the Exemption Order.

Consequently, the Revenue raised additional assessments for the YAs 2013 to 2017 against the taxpayer. Aggrieved by the Revenue’s decision, the taxpayer filed an appeal to the Special Commissioner of Income Tax (SCIT), which ruled in favour of the Revenue. Subsequently, the taxpayer pursued an appeal to the High Court of Kuala Lumpur.

The question on appeal was whether the capital injections were grant falling under the Exemption Order and in the answer is in the affirmative, the taxpayer was not entitled to deduct the expenses incurred.

The Taxpayer’s Submission

On appeal, the taxpayer submitted that:

(a)Capital injections are not revenue in nature

Based on Section 3 of the ITA, income tax does not apply to the capital receipt of a taxpayer. Funds injected into a company in exchange for the issuance of shares qualify as capital receipts. Capital injections cannot be considered as revenue and therefore, they are not subject to income tax.

In the present appeal, the capital injections funded through MoF Inc have been documented as paid-up capital in the taxpayer’s books. The taxpayer increased its authorised share capital corresponding to the capital injections in order to cater for its operational expenses. This fact was contemporaneously recorded in the taxpayer’s board meeting minutes.

Hence, the Revenue failed to establish the income requirement for the application of the Exemption Order in disallowing the taxpayer’s deduction for operational expenses as the capital injections were not the taxpayer’s income.

(b)Capital injections were not a ‘grant’

The Revenue also failed to appreciate that capital injections were not a grant from the Federal Government. As the ITA does not include a specific definition for the term ‘subsidy’ or ‘grant’, the ordinary interpretation of the word was to be applied. This approach was consistent with the legal principle laid out in the case of Chantika Kelang Beras Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri [2016] 1 LNS 1065, which considered the Exemption Order. The High Court ruled that the word subsidy was construed as an award or gift given by the Government to a third party as it did not require any consideration or form of return.

The present appeal, however, the capital injections resulted in shares being issued to the funder. As such, the capital injections were not a grant given by the Federal Government to the taxpayer as envisaged under the Exemption Order.

The Revenue’s Submission

The Revenue maintained its stance for the following reasons:

(a)Unjust enrichment

The Project Development and Management Agreement (PDMA) signed between the taxpayer and Federal Government stated that “The Government shall be solely responsible to procure and arrange to be raised the financing to meet the total project costs of the MRT Project.” Although the PDMA provided for an estimated project cost, the taxpayer was always allowed to re-negotiate the additional costs with the Federal Government if the total costs of the project exceed the estimated project cost.

(b)Failure to maintain a separate record

The taxpayer failed to adhere to maintaining separate accounts — one to record the contributions received from the Federal Government and another to track the MRT Project construction costs.

Moreover, as the taxpayer included the MRT Project costs in its profit and loss statement, this caused the taxpayer to suffer a loss in its business, as there was no income generated yet due to the ongoing construction of the MRT Project.

The High Court’s Ruling

The High Court reversed the decision of the SCIT and held that the Exemption Order did not apply in the present appeal. The capital injections from the Federal Government do not conform to the definition of income, which was subject to income tax. For the Exemption Order to be applicable, the Revenue must demonstrate two crucial requirements:

  (a)The capital injections are considered “income”

  (b)The capital injections qualified as a “grant”

Upon careful scrutiny of the evidence led by both parties, the High Court concluded that these requirements were not present. The additional assessments were set aside. The Revenue has lodged an appeal to the Court of Appeal against this ruling.

2 October 2023


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