By Dickson Loo
Often quoted once too many times by celebrities and influencers, it is said that wealth is not the key to happiness. In this article we seek to persuade you that wealth alone is not the key to happiness. Rather, the key to true happiness is the ability to retain one’s wealth through proper tax planning.
Although the notion of tax planning is not new, it is often confused with tax evasion (illegal) or tax avoidance caught within the ambit of section 140 of the Income Tax Act 1967 (“ITA”). This article aims to shed light on when exactly can one truly (and legally) mitigate tax through an examination of the application of section 140.
Whilst this article explores the application of section 140, we should point out that there are other specific anti-tax avoidance provisions in the ITA such as section 24, 29, and 65. Likewise, similar provisions are provided under the Labuan Business Activity Tax Act 1990 for Labuan entities.
Tax evasion is when someone utilises illegal methods to avoid tax. This is a criminal offence. Generally, tax evasion can result from something as simple as understating your taxable income or situations where there is evidence of artificial transaction(s) designed to evade tax. An example would include having a transaction officially conducted on paper, but in actuality conducted otherwise or refunded to the respective parties via ‘backdoor methods’.
On the contrary, tax avoidance is when someone takes an unfair advantage by finding ways within legal means to minimize tax liability. This is where section 140 comes into play – to determine whether tax shall be charged in such schemes. If section 140 is successfully applied, the scheme will be considered as tax avoidance (legal but not allowed and liable to pay taxes as assessed by the tax authorities). On the other hand, if the tax scheme is found to be outside the scope of application of section 140, it will be considered to be tax planning (legal and allowed).
Scope of powers granted to the Tax Authorities
The legislation gives considerable powers to the authorities to ensure that the tax regime is complied with. Section 140 gives tax authorities discretion to disregard or vary the transaction for any scheme if they have reasons to believe that it is a form of tax avoidance.
Although extensive powers are given to the tax authorities and they have unfettered discretion in certain matters of tax avoidance, as seen in the case of UHG v DGIR [1950-1985] MSTC 145, it is stated that the powers given to the tax authorities are not plenary. Likewise, a similar viewpoint is reflected in the case of Sungei Batu Perlombongan Sdn Bhd v DGIR (1988) 1 MSTC 243, 2053 (SBP) whereby the tribunal commented that the sweeping powers granted to officials must be interpreted and applied with a sense of balance.
Application of section 140
In an attempt to uncover the judicial attitude on the differences between an acceptable tax planning scheme and an unacceptable tax avoidance scheme, this article will examine a handful of cases where the tax authorities have invoked section 140. Our findings will be divided into the following sections:
- Principle of Commercial Justification; and
- Emphasis on The Purpose of The Transaction.
On the application of section 140(1)(a), Justice Yusoff in the case of Lahad Datu Timber Sdn Bhd v DGIR 6 MTJ 52 stated that for a transaction to be considered a form of tax avoidance, it must be shown that the transaction lacks any commercial justification. To further expand on the principle of commercial justification, the following cases are examined:
Yeoh Eng Hock Holdings Sdn Bhd v Ketua Pengarah HDN  MLJU 867
- The company had provided to its directors a sum of money by way of interest free loans with no terms of repayment.
- The monies are then placed into fixed deposits by the directors in their individual capacity and thereafter only returned to the company as and when required by the company.
- This scheme allowed the company to avoid corporate tax in the interest income gained from the fixed deposit.
Findings of the case
- The Court ruled in favour of the tax authorities as it lacks any commercial rationale and justification as ordinary business dealing.
Syarikat Ibraco-Peremba Sdn Bhd V. Ketua Pengarah Hasil Dalam Negeri  10 CLJ 114
- The developer company set up a wholly owned subsidiary to own a constructed property and to derive rental income from it for 9 years before disposing the said property.
- Thereafter, the subsidiary claimed to be assessed under real property gains tax (‘RPGT’) (under the exemption qualification) resulting in zero RPGT payable.
- This scheme allowed the developer company to avoid paying any taxes.
Findings of the case
- The Court ruled in favour of the tax authorities due to lack of justification of a commercial reason and held that although a taxpayer is entitled to plan its affairs to attract the minimum tax, the plan is subject to the scrutiny of section 140.
- The Court further noted that not only does a transaction need to be in compliance with the requirements of the law, any tax savings obtained or gained should be purely incidental.
- The Court allowed the imposition of a penalty payment by the tax authorities.
Sungei Batu Perlombongan Sdn Bhd v DGIR (1988) 1 MSTC 243, 2053 (SBP)
- Company A ceased its mining activity (main business) and disposed of its mining assets as well as accumulated an unabsorbed loss of RM411,197.
- Subsequently, the owners of a profitable mining company B acquired all of the shares of company A.
- The owners of mining company B are then elected as directors whilst the existing directors resigned.
- Acting in the capacity of a director for company A, the owners of company B used company A to acquire company B as a going concern.
- This scheme allowed company B to benefit from the tax relief derived from the unabsorbed loss of RM411,197 from company A.
Findings of the case
- In considering the application of section 140, the tribunal is of the opinion that there was a finding of fact that the aim of the taxpayer was to avoid tax and the said scheme is incapable of being seen as ‘genuine’. This is mainly owing to the following factual reasons:
- No reasons were provided as to why the existing shareholders and directors resigned in light of a possible revival of the company due to the acquisition of a profitable mining business; and
- The fact that the loss-making company had no assets other than the unabsorbed loss as “tax benefits”.
- Due to the lack of any commercial substance and the strong evidence hinting towards the possibility of a scheme crafted specifically to avoid tax, the tribunal found in favour of the tax authorities.
In the above cases, it is clear that the courts/tribunals will be looking for some form of commercial substance to justify a tax scheme. However, the emphasis of the commercial substance appears to lie in the purpose of the transaction as opposed to the methods selected to facilitate the tax scheme. In this regard, we refer to the following case:
Sabah Berjaya Sdn Bhd v Ketua Pengarah HDN  3 CLJ 587
- A charitable trust foundation decided to obtain the necessary funding from its subsidiary company via donations as opposed to its initial usage of dividend payments.
- The underlying reason behind the change of payment methods is due to the lack of tax payment for payments made via donations, and the ability to maximise the amount of funding that can be spent on charitable/community projects.
Findings of the case
- The crux of the issue in this case revolved around the method of payment of the funds to the foundation and little was mentioned on the commercial justification for the said transaction.
- The Court ruled in favour of the taxpayer based on a technical point and commented that section 140’s anti-avoidance provisions do not apply to tax mitigation where the taxpayer obtains a tax advantage by reducing his chargeable income or by incurring expenditure in circumstance in which taxing statute affords a reduction in tax liability.
- Although little is mentioned concerning the matter of commercial substance, this may likely be attributed to the peculiar nature of the case where it involved a donation to a charitable trust, thereby warranting no doubts as to the purpose of the transaction. That said, this case does serve to indicate that if a taxpayer is able to justify the commercial purpose of the transaction, the taxpayer is entitled to select any methods that are legally available to him to mitigate his tax liability.
- It should be noted, however, that the Court made no mention on the application of section 140(6) which relates to transactions between associated companies and this factor may change the Court’s decision. Unfortunately, no further appeal was made on this matter and given that section 140(6) was not addressed, it may be prudent to treat this case as a standalone case for transaction between associated entities and not overly rely on it.
It goes without saying that tax evasion will certainly be pursued by the tax authorities as it involves an element of deception and illegality. That said, tax schemes which consists of legal methods in avoiding taxes does not entitle a taxpayer to go scot-free either.
The real test for taxpayers is to ensure the tax scheme operates outside the scope of application of section 140 of the Income Tax Act 1967. From the illustrated cases above, it can be said with reasonable certainty that a proper tax planning scheme should at the very least consist of some element of commercial substance and not simply for the sake of tax avoidance. Satisfying that, the taxpayer will be able to mitigate his or her tax based on the legal avenues afforded to him or her.
However, the final determination by the court or the tribunal will ultimately depend on the unique circumstances of each case.