A recent taxation issue that has arisen in the context of developers, is the deductibility of expenditures incurred by the developers to procure the approval to sell units of development reserved for Bumiputera, to non-Bumiputera.
Housing developers are required by the state government to reserve and sell a percentage of units in a development project to Bumiputera purchasers. However, the developer can make an application to the state government to release the Bumiputera quota units, subject to the payment of a certain sum to the state government. The issue then arises as to whether the developer’s expenditures incurred to procure the release of the Bumiputera quota units are deductible business expenditures under s. 33(1) of the Income Tax Act 1967 (“the Act”).
This issue was canvassed by the High Courts in the cases of Prima Nova Harta Development Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri [Appeal No.WA-14-7-12/2019] and Sovereign Teamwork (M) Sdn Bhd v Director-General of Inland Revenue [Case No. WA-14-1-01/2020], which dealt with appeals arising from decisions of the SCIT.
The same approach was taken by the High Court in Taman Equine (M) Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri [(2021) MSTC 30-465], where the High Court allowed the taxpayer’s appeal against the decision of the SCIT, finding that the payments made for selling Bumiputera units to non-Bumiputera purchasers were deductible under s. 33(1) of the Act. The High Court found that the payments were directly related, incidental and relevant to the taxpayer’s principal activity in its entirety as a property developer. The High Court in Taman Equine, in reliance on the decisions in Prima Nova Harta Development Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri [Appeal No. WA-14-7-12/2019] and Sovereign Teamwork (M) Sdn Bhd v Director-General of Inland Revenue [Case No. WA-14-1-01/2020], held that the contributions made to the State Government for the release of the Bumiputera units were deductible under s. 33(1) of the Act, since they were made to generate the taxpayer’s income. The payments made by the taxpayer to obtain the release of the unsold Bumiputera units were necessary and integral for the taxpayer. The taxpayer’s purpose or object behind the payments was to procure a purely business benefit. Nowhere in s. 39(1) of the Act was it stipulated that such payments were non-deductible. Further, even if the payments were seen and found by the SCIT to not have been wholly and exclusively incurred in the production of gross income, they were deductible under s. 44(6) of the Act, which explicitly provided that any gift of money made in the basis year to a State Government or local authority was deductible for that year in arriving at the total income.
Subsequently, the High Court in Mitraland Kota Damansara Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri [Appeal No. WA-14-39-07/2020] took the same approach as in the aforementioned three (3) High Court decisions.
However, this consistent line of High Court decisions was overruled by the Court of Appeal in Ketua Pengarah Hasil Dalam Negeri v. Taman Equine (M) Sdn Bhd, where the Court of Appeal allowed the appeal by the KPHDN against the decision of the High Court, thereby setting aside the order of the High Court and restoring the SCIT’s order. The Court of Appeal accepted the following submissions by the KPHDN. First, that the SCIT had made findings of fact that the payment for the release of Bumiputera units was in fact a penalty for the breach of a condition imposed by the state government. A breach of law, rules or condition laid down by the government do not form part of a taxpayer’s income producing activity. In the premises, any expenditure arising from such a breach is not incurred in the production of gross income as envisaged by s. 33(1) of the Act. Secondly, that the payment was for the purpose of bringing into existence an advantage in terms of procuring the permission/consent from the state government for the enduring benefit of the taxpayer’s business i.e. to release the units to enable them to be sold to non-Bumiputera. The payment was therefore capital in nature and prohibited as a deduction under s. 39(1) of the Act. We would highlight that, to date, the Grounds of Judgment of the Court of Appeal have yet to be released.