tax Business Commencement and From the tax perspective, the determination of the date of business commencement is an important exercise. It is crucial for a business to determine its date of business commencement as any expenses incurred prior to commencement (other than qualifying expenditure for capital allowance claim and those allowed under the prevailing tax law) will be disallowed for tax deduction as such expenses are considered not to be wholly and exclusively incurred in the production of income. MIA Professional Standards and Practices The term business commencement is not sufficiently dealt with in the Income Tax Act 1967 (the Act) and there is lack of clarity on the actual date on which a person commences operations 1 or business. For this purpose, one has to distinguish the activities undertaken which are merely pre-operating preparation and do not constitute commencement of business. A limited company is not deemed to have commenced business until it is incorporated. It has been commonly questioned if the expansion of existing business is being considered as a form of new business or merely an extension of the business currently in operation. It all boils down to the question of facts. In practice, the business of trading and distribution of goods would deem to have commenced when the business first opens its doors to the public, regardless whether the first sale has been made. The same principles apply to business whether as service provider or in marketing, business is deemed to have commenced when the key personnel have been employed and the company is ready to render services to its clients. Again, it would not matter whether revenue has been generated or earned. Public Rulings in Malaysia The Inland Revenue Board of Malaysia (IRB) has issued a series of Public Rulings that provide guidance on the determination of business commencement. FOOTNOTE 1. Operations in accordance to Section 21A (8) of the Income Tax Act, 1967 refers to: a. an activity which consists of the carrying on of a business; b. an activity which consists wholly in the making of investments; c. an activity which consists of both the carrying on of a business and the making of investments; or d. an activity which consists of the making of investment prior to the commencement of a business or after the cessation of a business. 16 accountants today JUNE 2011
Public Ruling 1/2009 Property Development (PR No. 1/2009) PR No. 1/2009 was issued on 22 May 2009. This PR provides that a property development business is deemed to have commenced business on a date when some significant activities or essential preliminaries to the normal operations of property development are undertaken. The purchase of land might be an indication that the property development business has commenced but again, the act or series of activities that follows suit will need to be taken into consideration. Examples of significant activities or essential preliminaries provided in PR No. 1/2009 are: i) the physical possession of the development site; ii) the active development of the land such as levelling of land or piling; or iii) booking of houses by house buyers. Public Ruling 2/2009 Construction Contracts (PR No. 2/2009) PR No. 2/2009 highlights circumstances that may be indicative that the construction contract business has commenced its business operations as follows: a) on the date on which the contract is secured, a letter of award is offered, or possession of a construction site is obtained, whether in writing or otherwise; b) on the commencement of an activity which constitutes part of a series of activities that are actively carried out in the course of a construction contract business; or c) on any other date as the Director General of Inland Revenue considers appropriate and reasonable. In all circumstances, one has to be mindful that proper documentation should be put in place to substantiate the claim of expenses and to facilitate tax audit in later years by the IRB. Public Ruling 2/2010 Allowable Pre-Operational and Precommencement of Business Expenses (PR No. 2/2010) PR No. 2/2010 was issued on 3 June 2010 and supersedes PR No. 2/2002 which was issued on 8 July 2002. PR No. 2/2010 provides that the date of commencement of a business requires consideration of all circumstances and facts. Commencement of business, as stated therein, generally refers to the commencement of activities undertaken in the course of business or activities that are part of the income producing process as distinguished from activities that are preparatory to the carrying on of a business. Subject to specific circumstances and facts of the case, the following examples may be indicative of the commencement of a business, if the act or activity constitutes part of a series of acts or activities that are actively carried out or undertaken in the course of the business: i) the purchase of raw materials in the case of manufacturing; ii) the purchase of goods for resale in the case of retailing; or iii) the first planting of seedlings or buying of animal stocks in the case of agriculture. Public Ruling 4/2011 Income from Letting of Real Property (PR No. 4/2011) The PR was issued on 10 March 2011 and supersedes PR No. 1/2004 which was issued on 30 June 2004. This PR will be effective from year of assessment (YA) 2011 and subsequent years of assessment. PR No. 4/2011 provides the circumstances that determine the date of commencement for the letting of real property as follows: i) For rental income to be treated as Section 4(d) of the Act i.e. non-business source, the date of commencement will be the date the real property is first being let out; ii) Where rental income is being treated as a business source i.e. Section 4(a) of the Act, the date of commencement will be the date the real property is made available for letting. The Ruling further explains that a real property is considered to be made available for letting when the real property is ready to be occupied by tenants and steps for letting out the said real property have been taken such as advertisement or appointment of agent to facilitate the letting. Furnishing of Estimated Tax Payable for Newly Commenced Companies Under the Self-Assessment System (SAS), it is a statutory requirement for companies, trust bodies and co-operative societies to furnish their estimates of tax payable for a year of assessment (YA) to the IRB, thirty (30) days before the commencement of the new basis period. For companies that first commence business operations, the companies are required to submit the estimated tax payable within three (3) months from the date of commencement. With effect from YA2011, following the 2010 Budget announcement, with regard to companies other than small-and-medium enterprises (SMEs) that commence FOOTNOTE 2 SME as defined in Schedule 1, 2A and 2B of the Act refers to a resident company with paid-up ordinary share capital of not more than RM2,500,000 at the beginning of the basis period for a YA and i) not more than 50% of its paid-up ordinary share capital is directly or indirectly owned by a related company or vice-versa; or ii) both the company and its related company are directly or indirectly owned by another company. Related company means a company which has paid-up ordinary share capital of more than RM2,500,000 at the beginning of the basis period for a YA. JUNE 2011 accountants today 17
business operations in a YA where the basis period for that YA is less than six (6) months, the companies are exempted from the requirement of furnishing an estimate of tax payable for that particular YA. Effective YA2008 as provided for under Section 107C(4A) of the Act, SMEs 2 will no longer be required to furnish estimates of tax payable from the first two (2) YA from its date of commencement. Determination of Basis Period Basis period refers to the period of income received relative to a year of assessment. It is important to note that a Company s basis period upon commencement of business operations may not coincide with the accounting period of a Company. Basis period determines the filing period for tax returns submission which is due within seven (7) months from the close of its financial year/period end as prescribed under Section 77A of the Act. The ensuing paragraphs will further discuss how to determine the basis period for tax purposes. The IRB has issued PR No. 7/2001 dated 30 April 2001 that complements Section 21A of the Act. Except where provided for under Section 21A of the Act, the basis year for a YA generally shall constitute the basis period for that YA in relation to all sources of income of a company. The examples below are provided for purposes of illustration: (a) A company has sources of income comprising business, rental and dividend and prepares its accounts from 1 January 2011 to 31 December 2011. The basis year ending 31 December 2011 is the basis period for the YA2011 for all of the company s income sources in accordance to Section 21A(1) of the Act. (b) A company has sources of income comprising business, rental and dividend but makes up its accounts for a period of 12 months ending on a date other than 31 December in a basis year i.e. from 1 July 2010 to 30 June 2011. The basis year ending 30 June 2011 is the basis period for the YA2011 for all of the company s income sources pursuant to Section 21A(2) of the Act. Section 21A sets down various circumstances that determine the basis period of a newly commenced company. Let s look at some of the illustrations below: (i) A company prepares its accounts for 12 months (a) A company incorporates and commences operations on 1 July 2010 and makes up its accounts from 1 July 2010 to 30 June 2011. The accounting period is the basis period for the YA in which the accounts are closed. 2011 01.07.2010 (date of Incorporation) 30.06.2011 01.07.2010 (date of commencement) 30.06.2011 2012 01.07.2011 30.06.2012 01.07.2011 30.06.2012 (b) A company commences operations on 1 March 2010 and makes up its accounts from 25 February 2010 (date of incorporation) to 28 February 2011. The accounting period is the basis period for the YA in which the accounts are closed. 2011 25.02.2010 (date of Incorporation) 28.02.2011 01.03.2010 (date of commencement) 28.02.2011 2012 01.03.2011 28.02.2012 01.03.2011 28.02.2012 (ii) A company prepares its accounts for less than or more than 12 months with financial year ending 31 December. The basis period for the YA is the period ending 31 December. 18 accountants today JUNE 2011
(a) A company commences operations on 1 September 2010 and makes up its accounts from 1 August 2010 (date of incorporation) to 31 December 2011 i.e. the accounts are prepared for a period of more than 12 months. 2010 01.08.2010 (date of Incorporation) 31.12.2011 01.09.2010 (date of commencement) 2011 do 01.01.2011 31.12.2011 (b) A company commences operations on 25 April 2010 and makes up its accounts from 1 March 2010 (date of incorporation) to 31 December 2010 i.e. the accounts are prepared for a period of less than 12 months. 2010 01.03.2010 (date of Incorporation) 25.04.2010 (date of commencement) 2011 01.01.2011 31.12.2011 01.01.2011 31.12.2011 (iii) A company prepares its accounts for less than or more than 12 months and its financial year does not end on 31 December. The basis period for the YA is the year/ period ending 31 December each year until accounts are prepared up to a 12 month accounting period. (a) A company commences operations on 1 July 2010 and makes up its accounts from 28 June 2010 (date of incorporation) to 30 September 2011 i.e. the accounts are prepared for a period of more than 12 months. With effect from YA2011, following the 2010 Budget announcement, with regard to companies other than small-andmedium enterprises (SMEs) that commence business operations in a YA where the basis period for that YA is less than six (6) months, the companies are exempted from the requirement of furnishing an estimate of tax payable for that particular YA. JUNE 2011 accountants today 19
2010 28.06.2010 (date of Incorporation) 30.09.2011 01.07.2010 (date of commencement) 2011 do 01.01.2011 31.12.2011 * 2012 01.10.2011 30.09.2012 01.10.2011 30.09.2012 * overlapping periods : 01.10.2011 to 31.12.2011(Note) (b) A company commences operations on 25 April 2010 and makes up its accounts from 1 March 2010 (date of incorporation) to 30 November 2010 i.e. the accounts are prepared for a period of less than 12 months. 2010 01.03.2010 (date of Incorporation) 30.11.2010 25.04.2010 (date of commencement) 2011 01.12.2010 30.11.2011 01.12.2010 30.11.2011 * * overlapping periods : 1.12.2011 to 31.12.2011(Note) Note: The adjusted income of the overlapping period would be taxed in the first YA pursuant to Section 42(2) of the Act. The adjusted income of the following YA would be reduced accordingly by the adjusted income of the overlapping period. (iv) Section 21A(5) states that the basis period for a YA is the date of commencement of business operations to the end of the accounting period under the following circumstances: a) where a company is required under any law of the place of incorporation to make up its accounts ending on a particular date; or b) where a company, trust body or co-operative society within a group of companies makes up its accounts ending on the same day as that of all other companies in that group. For example: A company commences operations on 01 April 2010 and the law of the place where it is incorporated requires it to make up its accounts to 31 October 2010. The basis period for the company for the YA2010 will be: 01.04.2010 31.10.2010 A company commences operations on 01 April 2010 and its holding company closes its year end to 31 December 2010. The basis period for the company for the YA2010 is: 01.04.2010 (v) Section 21A(6) provides that, where a company, trust body or co-operative society with existing business operations commences a new business which is an extension of the existing operations, the basis period of the existing business(es) will be the basis period of the new business operations. Example: A company has been in business for several years and closes its financial year to 30 September. The company commences a new business/ operations on 01 May 2010 The basis period for the company for the new operations for the YA2010 will be:. 01.05.2010 30.09.2010 20 accountants today JUNE 2011