Lecture 3

- Part 1Business Income

(Sole Proprietor)

Topics Addressed
Definition of business
Badges of trade
Business income

Definition of Business
Section 4 Income Tax Act 1967 (as amended) [ITA]:
Subject to this Act the income upon which tax is chargeable under this
Act is income in respect of:
(a) Gain or profits from a business, for whatever period carried on;

Section 2
Business includes profession, vocation, concern or adventure in the
nature of trade but excludes employment

Profit-seeking
Profession

Business

Vocation
Manufacturing
Trade
Adventure

or
Concern in the
Nature of Trade

motive
Method of financing
Period of ownership
Frequency of
transaction
Development or
processing of asset
Nature of the subject
matter
Organization and
special skill

Profession.
Not defined in the Act.
Intellectual skill or manual skill controlled by
intellectual skill.
Carried out by a company or an individual.

Kamarulzaman a chartered accountant has formed an

enterprise to provide accounting and tax services to
small medium enterprises in Meru, Klang. His enterprise
has staff strength of four persons and a client base of
fifteen companies and fifty sole proprietorships.
Kamarulzaman is exercising a profession and the profits
from the enterprise will be taxable as business income
accruing to Kamarulzaman.

Trade - Buy and Sell.

Sunder operates a business in Chow Kit selling beaded scarves and
punjabi suits, which he brings in from Pakistan. He makes a
monthly profit of RM10,000 from the purchase and subsequent sale
of the scarves and suits.
Sunder is in the business of trading scarves and punjabi suits.

Vocation
Analogous to the word calling. Means the way
in which a person passes his or her life.
Bud is a professional beggar. Every morning he wakes up at 7 a.m., has his
bath, changes into tattered clothes and ambles to the overhead bridge in
Pudu. He then lays down a worn out sarong, sits cross-legged on it, and
places a dish in front of him. There from, he requests every passer by to help
him and his family by making a monetary contribution into the dish. This he
does until above 7 in the night, after which he returns to his home for a good
rest. Bud is exercising a vocation.

Manufacture - Transforming original material so that a new and different article or product emerges;

Muthiah has opened a yogurt factory in Mak Mandin. The factory

operates under the name Milk Products Enterprise. It converts
cows milk into yogurt through a process of pasteurization and
fermentation. Muthiah is in the business of manufacturing yogurt

Adventure or concern in the nature of trade

An isolated transaction that gives rise to business income
Use badges of trade to distinguish gains arising from the
disposal of an investment and gains from trade or an
adventure or concern in the nature of trade
The issue of whether a trade or business exists has been a
contentious issue

A single transaction may not be a trading transaction.

If however if it is carried out in a manner consonant with
an ordinary trading transaction then it may fall to be
treated as a trading transaction.

In the United Kingdom, the Radcliff Commission was

appointed in 1954 to study this matter and they listed out
several factors that would lend itself to treating a
transaction as a trading or business transaction.

That factors were later came to be called the Badges of

trade

Case law: Marson v Morton

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Subject Matter of The Transaction

Treated as trading stock = sale=income tax
Treated as investment = sale = capital gain = no tax
A taxpayer bought 1 million toilet rolls and sold them for a profit. It was the
only transaction he had undertaken. The court held that it was a trading
transaction
Case law: Rutledge v CIR

Period of Ownership
Longer the period of ownership less likely a trade at least 5
years ;capital gain
A taxpayer, an actor by profession, bought and sold silver ingots,
within a year. The court held that the transaction amounted to an
adventure in the nature of trade.
Case law: Wisdom v Chamberlain

Frequency of Transactions

If a transaction is repeated several times then it reflects a

systematic and methodical activity (resale). This is however a
question of fact.

For example, a taxpayer bought shares in a mill company and

then liquidate the company and selling the companys assets to
another company formed to buy the assets at a large profit.
He repeated this with four other companies.

Case law: Pickford v Quirke

Organization
An agriculture machinery merchant acquired 45 million yards
of war surplus linen (cloth used to make parachute) and
systematically organized its sale by cutting, packing,
advertising and delivering in small batches to various textile
merchants.
Case law: Martin v Lowry

Alterations to property/ Supplementary work

before sale

Material alterations or improvements that alter character or

quality indicate that property was derived from a profit making
scheme.

Three individuals formed a syndicate (a loose partnership) and

purchase brandy from South Africa, shipped to England where it
was blended with French brandy and re-casked and the entire
lots were sold to various customers over 18 months. The activity
was held to be a trading activity.
Case law: Cape Brandy Syndicate v IRC

Circumstances
Motive??

Surrounding

Realization

Sale due to sudden emergency or unanticipated need for

funds indicate that property was not acquired for purpose
of resale at a profit.

Motive or Intention Of Taxpayer

This is a difficult area.

One needs to look at the circumstances surrounding the transaction, the

manner the transaction was conducted, the stated intentions as well as the
motive itself behind the transaction and the intention to trade.
A company acquired a large tract of land in return for surrendering its
Charter. The land was later sold over several years. The sale was held to
be capital
Case law: Steven v Hudson Bay Company;
A lady disposed three pieces of land held for between 10-20 years, to
meet her domestic expenses and her children's education. The IRB held
the sum to be income from employments (as a director of the company)
but the courts held the sale to be capital
Case law: HCM v DGIR

Manjit bought a piece of land in Kulim. The land was

financed via bank borrowings. A few months after
completing the transaction, he advertised it for sale.
He managed to sell the land and make a profit of
RM200,000.
State, with reference to the badges of trade, whether
the disposal is subjected to income tax.
The isolated transaction is an adventure in the nature
of trade as several badges of trade exists such as
short period of ownership, external financing, and
significant efforts to dispose the property.

Capital & Revenue

Income

Tax is imposed on receipts that are revenue in nature.

Income is defined in the tax law.

Therefore one needs to look at judicial guidance and case laws to

distinguish between capital receipts and revenue receipts.

Capital receipts are not taxable

Revenue receipts would be taxable subject to exemption provisions
in the tax legislation.

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In determining whether the business income is derived from

Malaysia, one needs to consider the following:
Existence of a business source
The nature of the business transaction (whether capital or
revenue)
Its derivation from Malaysia
Law : Sec 12

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Example
6

Income derived by Mplant from the Indonesian contract for the year of
assessment 1999 is not deemed to be derived from Malaysia as it is clearly
attributable to a project carried on outside Malaysia. In addition, any income for
the project that is remitted back to Malaysia is exempted from tax under Income
Tax (exemption) (No. 48) Order 1997. It can therefore if remitted be credited to a
tax-exempt income account from which two-tier tax exempt dividends can be paid
out.

To ascertain any gross income of a person derived from

Malaysia from a business, so much of the gross income
from the business as is not attributable to the operation
of the business carried on outside Malaysia shall be
deemed to be derived from Malaysia.

Law: Sec 12(1)(a)

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Some of the factors that need to be considered are

whether:
Contract concluded in Malaysia;
Stocks are maintained in Malaysia;
Passing of ownership and risk of trading stocks in
Malaysia;
Sale proceeds received in Malaysia;
Services rendered in Malaysia.

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In the case of business like manufacturing, plantation

operations and mining, the gross income, any sale
taking place outside Malaysia will be taken to be:
The sale value of the article; or
The market value of the article

The value of the transactions have therefore to be at

arms-length (even between related companies)

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Date of
Commencement &
Cessation

For income tax purposes, it is critical to determine the

date of commencement for the following reasons:
Pre-commencement expenses are not deductible
Allowances on qualifying capital expenditure are given
only when the business has commenced
The date of commencement in relation to the year end
has implication for the first basis period and year of
assessment

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The commencement refers to the carrying on of an essential

business activity and does not require the completion of a product
manufactured (in the case of manufacturing), the sale of a product
(trading) or even the provision of a service (hotel)
Some business lends itself to a clear cut indication of
commencement, others, particularly with long gestation period
(i.e. long start up time) can pose serious difficulties
Example
Sundry shop (easy); housing developer (difficult)

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Some factors to consider in the determination

of commencement or cessation:

Commencement

Received Raw Material

For Processing
(manufacturing
company)
Open Door To Public
(trading company)

Cessation

Refer BOD Minutes

Disposal Of All P&M

Implications:
Commence
Pre-Commence

Post-Commence

Revenue exp.

Not Deductible

Deductible

CA on QE

QE incurred of

Claimable

commencement
date.
Unabsorbed CA

None

Carried Forward

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Cessation
Temporary

Permanent

Revenue exp.

Deductible

Not deductible

CA on QE

Claimable

Unabsorbed CA Carried Forward

Lost

Asset Distrib.

Capital Receipts

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Gross Income from

Business

Gross income from a business would consist of the

following:
Gross income of a person from a source of his business for
the basis period for the year of assessment - Sec 12(1)(b)
and 24(1)

Sums receivable or deemed to be receivable from

insurance, indemnity, recoupment, recovery,
reimbursement or otherwise - Sec 22(2)(a)
Compensation for loss of income - Sec 22(2)(b)
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Principles of Assessability
Tests

Positive

Income

earning assets
versus income earning
process.
Course
Fixed

of conduct

assets versus
trading stock

Negative

Source

of fund.

Accounting
Recurring

treatment.

versus once and for

all.
Magnitude
Payment

of receipt.

determined by
reference to profits.

Sales must accrue from the principal activity or activities

of enterprise.

Taxed on accrual basis and not on received or cash basis.

In the case of export sales, taxable value can be either of

the following:
Sale value of article, product or produce sold overseas;
Market value of article, product or produce sold overseas
in the event that the sales value does not apply (in the
case of sale to related companies).

Example
Aziz has a business which sells handphones. During the year 2006, the business
concern has sales of RM400,000 of which the breakdown is as follows:
RM
Cash sales
200,000
Credit sales
200,000
---------400,000
======
Other information;
(a)
RM100,000 credit sales remained uncollected as at 31st December, 2006.
(b)
50% of the credit sales were to overseas customers (export sales)
Issue: Determine the gross income from trading for the year 2006.
Discussion: RM400,000 as gross business income includes both cash and credit
sales. Overseas sales also form part of gross business income being deemed
derived from Malaysia.

Insurance Recoveries

Receipts
Capital

Replacement of assets.

Revenue

Trading stock.
Defalcation by employees.
Repairs to assets.
Life or accident insurance.

Example
MRZ Car Seat is an enterprise selling leather car seats. It obtained its
leather from various suppliers in Europe. In 2008, several customers
complained that their leather seats which had been supplied by MRZ Car
Seat had started to peel after only four months of use. The company traced
the leather shipment which had been used for the defective car seats and
replaced all the car seats made from the said shipment. It then made a
claim against the leather supplier. After a period of lengthy negotiations
and to maintain goodwill, the supplier paid MRZ Car Seat a sum of
RM12,000.
Issue: Discuss whether the RM12,000 is taxable.
Discussion: It is taxable. The RM12,000 is a revenue receipt as it is a recovery in
respect of the cost of leather used in the manufacturing process. As the cost of
leather used in the manufacturing process is deductible the consequent recovery is
also taxable

Example
Ghee Enterprise, which manufactured ghee under the brand name Goat & Kid
suffered losses due to a fire which burned down its factory and warehouse in the Shah
Alam Industrial Park. The losses were reported to be RM10 million. The company
made an insurance claim to Giant Insurance Bhd for loss of plant and machinery
(RM6 million) and stock in-trade (RM4 million).
Issue: Determine whether the compensation receivable is taxable.

Discussion:
Sums receivable in respect of losses of trading stock (circulating capital) are income
and hence taxable under section 4(a) of ITA 1967.
However, the sums receivable for damaged plant and machinery (fixed capital) are
capital in nature.
The recoveries akin to proceeds received upon the disposal of assets will be matched
with the tax written down values of the plant and machinery to compute the balancing
charge or allowance on disposal.

Example
Ahmad Trading is involved in the distribution of printer cartridges.
In year 2005, one of its cars was involved in an accident.
The company received compensation of RM50,000 from its insurer Safe
Cars Sdn Bhd. The money was used to repair the vehicle.
Determine whether the insurance recovery of RM50,000 is taxable.
Discussion: The compensation will be included as gross income from the
business for the basis period in which the insurance recovery is receivable.
The compensation is a reimbursement of repair expenses (which are
deductible for business purposes)

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Was the agreement cancelled a capital

asset?
One of many agreements was cancelled?
Business
structure
altered
upon
cancellation of agreement?

Cancellation of Contract
Receipts

Capital

Contract cancelled
constitutes the whole
business of the
company or
Contract related to the
whole structure of a tax
payers profit making
apparatus.

Revenue

Contract was in the ordinary

course of trading.
Normal incident that the
contract might be modified,
altered or discharged.
The capital framework of the
business was not affected.
No parting with enduring
asset.

Example
Ship Managers, had entered into a management contract to manage the ships
of Naza Shipping Line Sdn Bhd. In 2006, Naza Shipping was liquidated. The
management contract with Ship Managers was terminated and it was paid a
compensation of RM200,000.
After the loss of the contract with Naza Shipping, several of the Ship
Managers staff were retrenched and the remaining staff moved into a smaller
premises.
Issue: Determine whether the compensation of RM200,000 is taxable.
Discussion: The compensation is a capital receipt because the contract with Naza
Shipping Line Sdn Bhd related to the whole profit making apparatus of Shipping
Managers. This is clearly epitomized by the fact that Ship Managers had to rightsize and move to a smaller premises upon cancellation of the contract with Naza
Shipping Line Sdn Bhd.

Example
In 2004, Accounting Enterprise entered into an agreement for a term of 5
years with Audit Enterprise. The agreement provided for the sharing of
profits from their respective businesses, pricing and areas of operations.
Accounting Enterprise has similar agreements with several other business
entities. In 2006, there was a dispute with Audit Enterprise and both parties
decided that the agreement be terminated. Accounting Enterprise received a
sum of RM200,000 from Audit Enterprise as compensation.
Issue: Determine whether the RM200,000 is taxable.
The RM200,000 is a revenue receipt. The primary reasoning is that the
agreement with Audit Enterprise was not a capital asset. It was one of
many agreements entered by Accounting Enterprise. Consequently, the
business structure of Accounting Enterprise could not have been radically
altered upon the cancellation of the agreement with Audit Enterprise.

Others
Receipts

Capital

Remission

of capital debt.

Unclaimed

balances which
were liabilities when first
received.
Payments

covenants.

for restrictive

Revenue

Remission

of trade debt.

Deposits

received and not refundable

to customer in case of default.
Market

value of stock in trade taken for

private purpose or for gifts and
donations.
Recoveries

where such sums were

given deductions in prior years.

Example
Samad, is an owner of a provision shop.
As at 31-12-2004, he had an amount of RM2,500 owing to one of his
confectionary suppliers. In the middle of 2004, the supplier agreed to
waive the amount owed to him on the basis of the long-term relationship
between him and Samad.
Samad consequently debited the supplier account in his monthly
accounts and credited the income statement account.
Is the waiver taxable?
Discussion: The RM2,500 is gross business income because it is a
release of debt related to deductions (purchases account) which have
been made, in arriving at adjusted income.

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