MICPA EXAMINATION

NOVEMBER 2005

Questions,
Unofficial Suggested
Answers and
Examiners’ Reports

ADVANCED STAGE
EXAMINATION
Module C

Advanced Taxation

Published by MACPA STUDENTS SOCIETY

1
This booklet contains the questions, unofficial suggested answers and examiners’ reports for
MODULE C of ADVANCED STAGE EXAMINATION for the November 2005
examination session.

The unofficial suggested answers were prepared by the MACPA Students Society and are not
purported to be the official positions of The Malaysian Institute of Certified Public Accountants
(MICPA).

While every care has been taken to anticipate and satisfy the examiners’ requirements in the
preparation of the suggested answers, these should not be regarded as the only solutions.

Some of the answers set out are considerably more substantial than even the best candidate
could achieve in the time available in and examination. It is felt, however, that longer, more
detailed answers can be great help for study purposes and that shorter answers would not always
be as helpful.

ALL RIGHTS RESERVED : NO PART OF THIS PUBLICATION MAY BE

TRANSMITTED IN ANY FORM OR BY ANY MEANS, ELECTRONIC,
MECHANICAL PHOTOCOPYING, RECORDING OR OTHERWISE, WITHOUT
THE PRIOR PERMISSION OF THE MACPA STUDENTS SOCIETY.

2
 THE MALAYSIAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS
(INSTITUT AKAUNTAN AWAM BERTAULIAH MALAYSIA)

NOVEMBER 2005

Advanced Stage Examination - Module C

ADVANCED TAXATION

1. Time allowed: 3 hours

2. This paper consists of SIX questions totalling 100 marks.

3. Answer ALL questions.

4. Any reference to "the Act" means the Income Tax Act, 1967 (as amended).

5. Workings that support the answer should be submitted with your answer.

6. After the instruction to stop writing at the end of the paper, you will be given five
minutes to assemble your answers. Fasten your answer sheets to the respective
folders provided using the tags.

7. The answer folders and examination stationery, used or unused, must not be
removed from the Examination Hall.

DO NOT TURN OVER UNTIL YOU ARE TOLD TO DO SO

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 ADVANCED TAXATION
(Answer ALL questions)

Question 1

Gloria Confectionery (M) Sdn Bhd is principally involved in the manufacture of biscuits, snacks
and other packaged food products.

The company prepares its accounts to December 31 annually. The company’s profit and loss
account for the year ended December 31, 2004 is as follows:

Note RM’000 RM’000

Sales 90,000
Less: Cost of sales
Opening stock 4,500
Cost of goods manufactured 1 76,000
----------
80,500
Closing stock 5,500
---------- 75,000
-----------
Gross profit 15,000
Add: Other operating income
Dividends 2 5,045
Rental income 3 250
Profit on disposal of fixed assets 4 20
Foreign exchange gain 5 35
---------
5,350
Less: Selling expenses
Promotional expenses 6 3,000
Travelling expenses 7 500
Fees & allowances 3,500
----------
7,000
Less: Administrative expenses
Staff remuneration 8 3,500
Depreciation 700
Utilities 800
Repairs and maintenance 9 840
Legal & professional fees 10 800
Printing & stationery 600
Miscellaneous expenses 11 230
Provision for doubtful debts 13 200
----------
7,670
Less: Finance cost 12 500
----------
Profit before taxation 5,180
======

4
Notes

1. Cost of goods manufactured includes:

(i) Depreciation RM’000
Factory building 320
Plant and machinery 2,090
Furniture & fittings 150
--------
2,560
--------
(ii) Provision for wages 35

2. Dividends comprise the following:

Tax exempt dividends 2,500
Taxable dividends from Malaysian investments 1,000
Dividend from Singapore subsidiary 1,545
--------
5,045
--------

3. Assume that rental income, which is derived from the shophouses owned by the
company, qualifies for treatment as income from a separate business source for tax
purposes.

4. Profit on disposal of fixed assets comprises the following:

RM’000 RM’000
(i) Motorcar 1 (purchased on January 1, 2002)
Cost 400
Accumulated depreciation (160)
--------
Net book value 240
Sales proceeds (300)
--------
Profit on disposal 60

(ii) Motorcar 2 (purchased on January 1, 2002)

Cost 148
Accumulated depreciation (58)
--------
Net book value 90
Sales proceeds (90)
--------
Profit on disposal Nil

(iii) Office equipment transferred to holding company

Cost 150
Accumulated depreciation (60)
-------
Net book value 90
Sale proceeds (50)
--------
Loss on disposal (40)
-------
Net profit on disposal of fixed assets 20
-------
5
5. Foreign exchange gain comprises:
RM’000
Gain realised on settlement of trade debts 50
Loss realised on settlement of purchase price for
factory equipment (15)
--------
35
--------

6. Promotional expenses include the following:

RM’000

Samples of biscuits given to supermarkets 300

Gifts to suppliers during Chinese New Year 100
Reimbursement of entertainment expenses incurred by staff 200

7. Travelling expenses include lease rental of a motorcar for the managing director at a
monthly rental of RM2,500 commencing from January 1, 2003. The cost of the motorcar
is RM250,000.

8. Staff remuneration includes:

RM’000
(i) Leave passage provided to staff 150
(ii) Employer’s contribution to EPF is at the statutory rate of 12% with the exception
of contributions for the managing director and chief accountant, which are at the
rate of 20%. The total annual salary of the managing director and chief accountant
for the year ended December 31, 2004 is RM600,000

9. Repairs & maintenance comprise revenue expenditure and include repairs amounting to
RM150,000 on shophouses rented out.

10. Legal & professional fees comprise:

RM’000
Technical fees paid to a foreign consultant in India for services
rendered in Malaysia.
(No withholding tax has been deducted from the fees) 430
Legal fees for purchase of shophouse 10
Legal fees for recovery of trade debts 60
Audit & tax filing fees 100
Provision for renovation works to office 90
Professional fees for tax appeal to the High Court 60
Staff recruitment fees 50
-------
800
-------

6
11. Miscellaneous expenses comprise the following:-
RM’000
Cash donations to approved institutions 90
Cash donations to non-approved institutions 40
Expenses incurred for obtaining ISO and halal certification
from Jabatan Kemajuan Islam Malaysia (JAKIM) 30
Quit rent and assessment on shophouses 10
Insurance premium on factory 50
Insurance premium on shophouses 10
---------
230
---------

12. Finance cost is incurred on loans obtained for working capital of the manufacturing
business but includes interest on loans to finance the acquisition of shophouses
amounting to RM95,000.

13. Other information

(i) Movement and balance in provision accounts

Balance Provision Provision Balance

as at for the written as at
January 1, year off December 31,
2004 2004
RM’000 RM’000 RM’000 RM’000

Provision for doubtful debts

Non-trade debtors 40 50 - 90
Trade debtors (specific) 100 120 (50) 170
Trade debtors (general) 30 80 - 110
Provision for general expenses - 50 - 50

RM’000
(ii) Loss brought forward from prior year (manufacturing business) 3,200
(iii) Capital allowance claim on qualifying capital expenditure for
manufacturing business 800

Required:

Compute the chargeable income of Gloria Confectionery (M) Sdn Bhd for the year of
assessment 2004, showing all relevant tax adjustments.

(20 marks)

7
Question 2

A&N Motel Sdn Bhd (ANM) was incorporated by Alan Yap and his brother Nicky Yap on July
1, 1999 with an initial paid-up capital of RM1,000,000 comprising 1,000,000 ordinary shares of
RM1.00 each. The shares are held equally by Alan and Nicky, both Malaysian citizens.

On August 1, 1999, ANM signed an agreement to acquire a piece of commercial land for
RM1,900,000. ANM incurred stamp duty of RM50,000 for the acquisition. The acquisition was
financed partly by a term loan of RM1,000,000 and partly by ANM’s share capital. ANM
completed the construction of a motel on the land on June 1, 2000 at a total cost of
RM1,500,000. The construction cost of the motel was financed by way of a rights issue of
1,500,000 ordinary shares of RM1.00 each. Both Alan and Nicky subscribed equally for the
rights issue on June 1, 2000.

On May 1, 2002, Alan transferred his entire shareholding in ANM to his son, Bobby Yap as a
gift. Bobby faced financial difficulties in 2003 and was thus forced to sell his entire
shareholding in ANM to his friend, Daniel for a consideration of RM2,000,000. The sale and
purchase agreement for the shares was signed on June 1, 2003.

Both Daniel and Nicky sold their shareholdings in ANM to Perdana Merdu Sdn Bhd on June 1,
2004 for a total consideration of RM4,500,000.

ANM then sold the motel to another hotel chain on December 1, 2004 for a consideration of
RM5,500,000.

Required:

Compute the real property gains tax payable, if any, by Alan, Bobby, Daniel, Nicky and ANM
for the relevant years.
(15 marks)

Question 3

(a) 4D Gaming Bhd awarded a pension to its founder director on his retirement in 1998 after
30 years of service. In 2004, the company incurred a premium of RM1 million for the
purchase of an annuity for the retired director. The annuity was purchased to replace the
annual pension payment and the amount of annuity payable to the retired director is
actuarially equivalent in value to the amount of pension payable to him.

In the same year, the company also made a one-off cash contribution of RM5 million to a
pension fund newly established by the company for the benefit of its existing staff. The
amount contributed was calculated actuarially as being the sum required to enable the
existing employees to qualify for pension based on their past services.

Required:

State, with reasons, whether the amounts of RM1 million and RM5 million are
deductible for tax purposes.
(8 marks)

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(b) Mast Shipping Sdn Bhd (MSS) carries on a shipping business. In 2004, it bought a
second-hand ship and sent it to a shipyard for repair. The time stipulated for completion
of the repairs was exceeded and the shipyard paid a compensation of RM300,000 to
MSS. The compensation was calculated by reference to the estimated profit which would
have been earned had the ship been used for MSS’s business during the additional time
taken for the repairs.

MSS entered into contracts with a petroleum company for the supply of diesel for its
ships at a predetermined price for 2 years. It was later found that the diesel due under
these contracts was in excess of its requirements. MSS thus allowed another company to
take delivery of the surplus diesel in return for a sum of RM1 million.

Required:

State, with reasons, whether the amounts of RM300,000 and RM1 million are taxable.
(7 marks)
(Total: 15 marks)

Question 4

(a) Mr Arumugam has been carrying on a sole proprietorship business in Klang for the past
12 years. As his tax agent, you have been submitting his annual tax returns for him to the
Inland Revenue Board (IRB) together with his accounts.

The IRB suspects Mr Arumugam of under-declaring his income and has thus issued him
a notice to furnish a capital statement for the years 2001 to 2003. Mr Arumugam has
requested you as his tax adviser to prepare the capital statement based on the following
information in respect of his assets and liabilities:

(1) A double storey bungalow located in Klang was bought in 1995 at a cost of
RM800,000. It had a market value of RM1,200,000, RM1,300,000 and
RM1,500,000 in 2001, 2002 and 2003 respectively.

(2) In 1990, Mr Arumugam inherited a shophouse located in Banting from his

grandfather who had acquired it in 1980 for RM100,000. He sold it in 2002 for
RM200,000.

(3) Mr Arumugam acquired a Mercedes Benz car in the middle of 2001 on hire
purchase. He paid a downpayment of RM100,000 and took a 3-year hire purchase
loan of RM350,000. The outstanding loan balance as at end of 2001, 2002 and
2003 amounted to RM300,000, RM200,000 and RM100,000 respectively.

(4) Mr Arumugam also bought a Toyota Camry for RM120,000 for his wife in 1998.

(5) The following savings accounts were opened in January 2003 and the balances as
at December 31, 2003 were as follows:
RM
Public Bank Bhd – self 150,000
Malayan Banking – wife 45,000

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 (6) Cash in hand as at end of 2001, 2002 and 2003 was estimated at RM15,000,
RM20,000 and RM30,000 respectively.

(7) Cost of jewellery belonging to Mrs Arumugam as at end of 2001, 2002 and 2003
was estimated at RM50,000, RM60,000 and RM90,000 respectively.
(8) His remisier confirmed that the cost of quoted shares held by Mr Arumugam
were as follows:
RM
December 31, 2001 900,000
December 31, 2002 1,600,000
December 31, 2003 2,000,000
(9) Mr Arumugam recalled writing off an interest-free loan of RM100,000 in 2003.
The loan was given to his mother-in-law in October 2002.
(10) Mr Arumugam has two children, both of whom are studying in the United
Kingdom. Public Bank Bhd was instructed by him to remit RM12,500 monthly
since January 2001 to each child’s bank account in the United Kingdom.
(11) Mr Aurmugam has declared income of RM300,000, RM400,000 and RM500,000
for the years of assessment 2001, 2002 and 2003 respectively, and paid income
taxes of RM100,000 (in 2002) and RM120,000 (in 2003). His wife had no
income for the respective years of assessment.
(12) According to Mrs Arumugam, she estimated their household expenses to be
RM10,000 per month in 2001, RM15,000 per month in 2002 and RM18,000 per
month in 2003.
(13) The sole proprietorship business started with a capital of RM50,000 and the
balance of the profit and loss account submitted to the IRB was RM70,000,
RM90,000 and RM120,000 as at December 31, 2001, December 31, 2002 and
December 31, 2003 respectively. The drawings account balance was RM65,000,
RM85,000 and RM95,000 as at December 31, 2001, December 31, 2002 and
December 31, 2003 respectively.

Required:

Prepare Mr Arumugam’s capital statements (statements of assets and liabilities) as at end

of the years 2001 to 2003 and determine his additional income, if any, for the years 2002
and 2003.
(10 marks)
(b) (i) Explain the meaning of “arm’s length approach” in the determination of transfer
price between related parties.
(2 marks)

(ii) State THREE arm’s length pricing methodologies accepted by the Inland Revenue
Board (IRB) as outlined in the Transfer Pricing Guidelines.
(3 marks)
(Total: 15 marks)

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Question 5

(a) The National Estates Cooperative Society, which was registered in 1992, prepares its
accounts to July 31 annually. The audited accounts of the Co-operative Society for the
year ended July 31, 2004 show the following:
RM’000 RM’000
Members’ subscriptions 3,000
Gross Malaysian dividends 500
Fixed deposit interest 1,500
---------- 5,000

Less: Salaries and bonus 400

EPF and allowances 50
Travelling & accommodation 20
Rental 30
Depreciation 100
---------- 600
----------
Excess of income over expenditure 4,400
----------

The details of the members’ funds as at July 31, 2003 and July 31, 2004 are as follows:
July 31, 2003 July 31, 2004
RM’000 RM’000
Paid-up capital 3,000 3,500
Bonus shares (issued out of
revaluation surplus of building) 500 500
Share premium reserve 2,000 3,500
Statutory reserve 6,000 8,000
Unappropriated profits 5,500 6,000
---------- ----------
17,000 21,500
====== ======

Required:

Compute the chargeable income of National Estates Co-operative Society for the year of
assessment 2004.
(5 marks)

(b) (i) State any SIX circumstances which would give rise to a permanent establishment
or a fixed place of business under a double tax agreement.

(3 marks)

(ii) M Co Sdn Bhd (MCSB) engaged the services of Stansfield Services Ltd, a
company resident in Hong Kong, to advise on the restructuring of its loans as
MCSB has not been able to meet its obligations. The services were rendered
partly in Malaysia and partly in Hong Kong over a period of one year from May
1, 2003 to April 30, 2004.

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 Required:

State the withholding tax implications, if any, in respect of the advisory fees
payable to Stansfield Services Ltd on the assumption that the services provided
by the company do not give rise to a place of business in Malaysia.

(2 marks)

(iii) Hi-Tech Equip Ltd, a German company engaged in the distribution of technology
products, is proposing to market and sell its products in Malaysia and is exploring
avenues to operate in Malaysia.

Required:

State the circumstances under which the appointment of a Malaysian agent would
result in Hi-Tech Equip Ltd having a permanent establishment in Malaysia.

(5 marks)

(c) First-REIT, a real estate investment trust approved by the Securities Commission,
commenced operations on November 1, 2004 and prepares its accounts to October 31
annually. The income and expenditure statement for the year ended October 31, 2005 is
as follows:
RM’000 RM’000
Rental income from letting of property 5,000
Malaysian gross dividends 3,000
Interest income 2,000
--------- 10,000
Expenses (assume all deductible) (4,500)
---------
Excess of income over expenditure 5,500
---------

On November 2, 2005, First-REIT distributed an amount of RM5,000,000 to the unit

holders, of whom 20% are non-residents of Malaysia and the rest are Malaysian
corporate and individual residents.

Required:

(i) Compute the tax payable/repayable of First-REIT for the year of assessment
2005.
(3 marks)

(ii) State the tax treatment applicable to the unit holders on the distributions made on
November 2, 2005.

(2 marks)
(Total: 20 marks)

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Question 6

Kuat Setia Bhd (KSB), a company principally engaged in investment holding, is controlled by
Tan Sdn Bhd, which in turn is controlled by the Tan family. Its group structure is
diagrammatically shown below:

Tan Sdn Bhd

KSB

100% 100% 100%

KS Healthcare KS Gloves KS Plantations
Sdn Bhd (KSH) Sdn Bhd (KSG) Sdn Bhd (KSP)

100% 100% 60%

KS Vietnam KS Shanghai P.T. KS Indonesia

Ltd (KSV) Ltd (KSS) (KSI)

Tan Sdn Bhd, KSB, KSH, KSG and KSP are resident in Malaysia.

KSV, KSS and KSI are resident in Vietnam, China and Indonesia respectively.

KSB only derives dividend income from its subsidiaries. Its expenses are financed solely from
these dividends.

KSB manages the operations of its subsidiaries but does not charge any management fees. The
level of management services provided to the subsidiaries has increased significantly over the
years due to expansion of their operations.

KSH is engaged in the manufacturing of surgical rubber gloves. Due to stiff competition in the
export market, it has been incurring significant losses over the years. KSH also has significant
unutilised reinvestment allowances and capital allowances due to an aggressive expansion
programme in the last 2 years.

KSH intends to manufacture a special range of surgical rubber gloves which have a huge
potential in the European market. The additional capital expenditure required to acquire plant
and machinery is estimated at RM20 million. KSH is contemplating incorporating a wholly
owned subsidiary to undertake this project. Discussions with the Malaysian Industrial
Development Authority indicate that the project is unlikely to qualify for pioneer status or
investment tax allowance.

KSG is engaged in the manufacturing of household rubber gloves. It is a highly profitable

company. Although it enjoys the reinvestment allowance incentive in respect of qualifying
capital expenditure on plant and machinery for the expansion projects, it has been paying
significant taxes.

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KSP operates five oil palm plantations in Terengganu. The plantations were acquired more than
20 years ago. One of the plantations, measuring approximately 500 acres, is located strategically
within 10 kilometers of the town of Kuala Terengganu. Due to the booming property market in
Kuala Terengganu, KSP intends to undertake mixed property development on this parcel of land
in the next 6 months. KSP is considering submitting an application to the State authority to
convert the land for commercial use.

KSV is engaged in the manufacturing of household rubber gloves in Vietnam. It has yet to
generate profits since it commenced operations two years ago.

KSS is engaged in the manufacturing of household rubber gloves in China. It is a highly

profitable company and has been paying dividends.

KSI operates two oil palm plantations in Indonesia which were acquired a year ago. It has been
generating profits but has not paid any dividends since the plantations were acquired.

Required:

Advise what steps the KSB Group of companies should undertake so as to achieve maximum tax
efficiency. State the reasons for your answer.
(15 marks)

14
 NOVEMBER 2005 EXAMINATION
SUGGESTED ANSWERS
ADVANCED TAXATION

Question 1
Gloria Confectionery (M) Sdn Bhd
Chargeable Income for Y/A 2004
RM’000 RM’000
Manufacturing business
Profit before taxation 5,180
Add/(Less)
Depreciation (2,560,000 + 700,000) 3,260
Provision for wages 35
Dividends (5,045)
Rental income (250)
Profit on disposal of fixed assets (20)
Loss on foreign exchange 15
Gifts to suppliers (100K x 50%) 50
Entertainment allowance/reimbursement (200K x 50%) 100
Lease rental for vehicles > RM50,000 [See note (b)] 10
Leave passage 150
Contribution to EPF > 19% (600,000 x 1%) 6
Repairs of shop houses rented out 150
Technical fees to consultant in India 430
Legal fees for purchase of shop house 10
Provision for renovation works 90
Fees for tax appeal to High Court 60
Donations (90,000 + 40,000) 130
Expenses incurred for obtaining ISO
and halal certification (30)
Quit rent & assessment for shop houses 10
Insurance premium – shophouses 10
Interest cost 95
Provision for doubtful debts (50,000 + 80,000) 130
Provision for general expenses 50
-------- (554)
----------
Adjusted income 4,626
Add/(Less): Balancing charges (18,000 + 21,000) [See note (a)] 39
Capital allowance (800) (761)
-------- ----------
Statutory income 3,865
Less: Business loss brought forward (3,200)
----------
Statutory business income c/f 665

15
 RM’000 RM’000

Statutory business income (manufacturing) c/f 665

Rental business
Gross rental income 250
Less: Repairs (150)
Quit rent and assessment (10)
Insurance (10)
Interest expense (95)
--------
Adjusted loss (15)
--------

Dividend income
Gross dividend income 1,000
----------
Aggregate income 1,665
Less: Current year loss (Rental business) (15)
----------
Total income 1,650
Less: Donations to approved institutions
(restricted to 5% of 1,665,000) (83)
----------
Chargeable income (1,567)
======

Notes

(a) Profit on disposal of motor vehicle

Motorcar 1 Motorcar 2

Qualifying cost 50,000 100,000

CA – YA 2002 (40% x 50,000) (20,000) (40% x 100,000) (40,000)
CA – YA 2003 (20% x 50,000) (10,000) (20% x 100,000) (20,000)
------------ ------------
Tax written down value 20,000 40,000
Sale proceeds 50,000 x 300,000 100,000 x 90,000
400,000 (37,500) 148,000 (60,811)
------------ ------------
Balancing charges 17,500 20,811
------------ ------------

(b) Lease rental in excess of RM50,000

Lease rental paid:- RM
YA 2004 (RM2,500 x 12) 30,000
YA 2005 (RM2,500 x 12) 30,000
----------
Total 60,000
----------
Amount in excess of RM50,000 10,000
======

16
Question 2

(i) RPGT computation for transfer of shares in ANM by Alan to Bobby.

- By virtue of Sch 2 paragraph 12, Alan would be deemed to have received no gain and incurred no loss on the transfer of his 1,250,000
shares in ANM.

(ii) RPGT computation for transfer of shares in ANM by Bobby to Daniel

Deemed
No. of acquisition Disposal Disposal Deemed acquisition Chargeable Tax
shares date date Tax rate price *price_____ gain/(loss) less relief payable
% RM RM RM RM

500,000 1.5.2002 1.6.2003 30 800,000 500,000 (150,000) Nil

(i.e. 500,000 ------------ x 1,900,000
x 2,000,000)
----------------
1,000,000
750,000

= 950,000

750,000 1.5.2002 1.6.2003 30 1,200,000 750,000 1,200,000 – 750,000 – 45,000

= 405,000 121,500
------------- ------------- ======
1,250,000 2,000,000
======== ========

* Bobby is deemed to acquire the shares at a price equal to the deemed acquisition price for Alan Pursuant to Sch 2 para 12.

17
(iii) RPGT computation for disposal of shares in ANM by Nicky and Daniel.

Deemed
No. of acquisition Disposal RPGT Disposal Deemed acquisition Chargeable RPGT
Taxpayer shares date date rate price *price_____ gain/(loss) less relief liability
% RM RM RM RM

Nicky 500,000 1.8.1999 1.6.2004 5 900,000 500,000 (50,000) Nil

------------ x 1,900,000
1,000,000

= 950,000

750,000 1.6.2000 1.6.2004 5 1,350,000 750,000 1,350,000 – 750,000 – 60,000

(4 yrs and 1 day) = 540,000 27,000

Daniel 1,250,000 1.6.2003 1.6.2004 30 2,250,000 2,000,000 2,250,000 – 2,000,000 – 25,000

= 225,000 67,500
------------- -------------
2,550,000 4,500,000
======== ========

18
(iv) RPGT computation for disposal of land and motel by ANM

RM

Sale consideration 5,500,000

Less: Enhancement cost (1,500,000)
---------------
Disposal price 4,000,000

Less: Acquisition price (1,900,000)

Stamp duty for acquisition of land (50,000)
---------------
Gain on disposal 2,050,000
=========

Acquisition date : 1.08.1999

Disposal date : 1.12.2004
Tax rate : 5%

RPGT = RM2,050,000 @ 5%
= RM102,500

Question 3

(a) (i) Deductibility of RM1 million premium for annuity

Pension payments made to a retired employee is a deductible expense as it constitutes

part of staff cost.

The lump sum incurred on the annuity did not bring into existence any new capital
asset and it was in no way related to the capital of the company.

It is the pension in another form, it is actuarially equivalent in value and it is identical

in character.

It was made to avoid a recurring expense and it takes the place of a recurring pension
payment which was itself a deductible expenditure. On this basis, the premium of RM1
million is a deductible expenditure.

(ii) Deductibility of RM5 million contribution to pension fund

The contribution was incurred with a view to bring into existence an asset or an
advantage for the enduring benefit of a trade in the form of contented staff (Atherton
v British Insulated & Helsby Cables Ltd 10 TC 155.) On this basis, it is capital
expenditure and therefore not deductible.

The company will be eligible for a deduction on the contribution made if it obtains
approval from the Director General of Inland Revenue for the newly established
pension scheme and a special deduction for the one-off contribution (under Section
34(5) of the Income Tax Act.)

19
(b) Taxability of RM300,000 compensation

It is evident from the way the compensation was computed that it was paid to
reimburse MSS for the trading profits which they would have earned had the vessel
been delivered on time. It is a payment for loss of profits and not a payment for any
loss in the capital value of the vessel. As such, it is a taxable receipt.

The amount is also specifically taxable under Section 22(2)(b) of the Income Tax Act,
1967.

Taxability of RM 1 million

The diesel under the contract was purchased on revenue account i.e. it represented
consumable items for use in MSS’s shipping business.

MSS did not sell the contract for the supply of diesel since it could still take delivery if
it found that it needed diesel.

The company received the amount for allowing someone else to take delivery of diesel
instead of doing so itself. It is akin to the sale of the surplus diesel for a profit which is
clearly taxable as the diesel was purchased on revenue account.

Question 4

(a) Mr. Arumugam – Capital Statements

As at December 31 each year 2001 2002 2003

RM’000 RM,000 RM,000
1. Sole proprietorship business
Capital 50 50 50
Balance of Profit & Loss account 70 90 120
Less: Drawings (65) (85) (95)

2. Land & property

(a) Double storey bungalow, at cost 800 800 800
(b) Single storey terrace house, at cost (inherit) - - -

3. Private bank accounts – savings accounts

(a) Public Bank Bhd – self - - 150
(b) Malayan Banking – wife - - 45

4. Investment in quoted shares, at cost 900 1,600 2,000

5. Loan to mother-in-law - 100 -

6. Cash in hand 15 20 30

20
 2001 2002 2003
RM’000 RM,000 RM,000
7. Motor car, at cost
(a) Mercedes Benz 450 450 450
(b) Toyota Camry 120 120 120

8. Jewellery 50 60 90

9. Loans taken
Hire purchase loan – Mercedes Benz (300) (200) (100)
---------------------------------------
2,090 3,005 3,660
Net assets b/f - (2,090) (3,005)
---------------------------------------
Increase in net assets 915 655

Add: Living expenses 180 216

Overseas education expenses (2 children) 300 300
Income tax paid 100 120
Loan to mother-in-law written off (capital loss) - 100

Less: Capital gains

Gain on sale of single terrace house (200) -
---------------------------------------
1,295 1,391
Less: Declared income (400) (500)
---------------------------------------
Additional income 895 891
---------------------------------------

(b) (i) The arm’s length approach is where the price of a transaction between related parties is
determined as if:

 Such transactions were made between independent entities; and

 Under the same or similar circumstances.

(ii) The various methodologies are:

 Comparable uncontrolled price method
 Resale price method
 Cost plus method
 Profit split method
 Transactional net margin method

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Question 5

(a) RM,000 RM,000

Excess of income over expenditure 4,400
Less: Dividend income 500
Interest income 1,500 (2,000)
-------- -----------
2,400
Add: Depreciation 100
-----------
Adjusted/statutory business income 2,500
Dividends 500
Interest 1,500
-----------
Total income 4,500

Less: Deduction under Section 65(A)(a)

i.e. 25% x 4,400,000 1,100
or
amount transferred (8,000,000 – 6,000,000) 2,000 (1,100)
--------- -----------
3,400
Deduction under Section 65(A)(b)
8% x (3,000,000 + 2,000,000 + 6,000,000 + 5,500,000) (1,320)
-----------
Chargeable income 2,080
=======

(b) (i) The circumstances giving rise to a PE/fixed place of business are:
- a place of management
- a branch
- an office
- a factory
- a workshop
- a warehouse
- a farm or plantation
- a building site or construction or assembly project which exists for a period of
more
than 6 months
- supervisory activities for a period of more than 6 months in connection with the
construction, installation or assembly project which is being undertaken in the
other country

(ii) Fees for services rendered outside Malaysia are not subject to withholding tax under
Section 109B. Only services rendered in Malaysia are subject to withholding tax under
Section 109B.

(iii) A PE would exist:

- Where the agent has and habitually exercises in Malaysia the authority to conclude
contracts in the name of Hi-Tech Equip (unless his activities are limited to the
purchase of goods.)
- Where the agent maintains in Malaysia a stock of goods belonging to Hi-Tech
Equip from which he regularly fills orders on behalf of Hi-Tech Equip.
- Where the agent does not carry on business as an independent agent.
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(c) (i) First-REIT – YA 2005
RM’000
Rental income 5,000
Malaysian gross dividends 3,000
Interest income 2,000
-----------
10,000
Less: Expenses (all deductible) (4,500)
-----------
5,500
Less: Distribution (5,000)
-----------
Chargeable income 500
=======
Tax payable at 28% 140
Less: Section 110 set-off (28% x RM3,000,000) (840)
-----------
Tax repayable (700)
-----------

(ii) The income distributed by First-REIT is subject to tax on the unit holders at the
following rates:
Resident unit holders:
- Companies 28%
- Individuals Graduated rates

Non-resident unit holders 28%

(collected via withholding tax by First-REIT)

Question 6

1. As a pure investment holding company, KSB is only eligible for a deduction of a portion
of its permitted expenses. KSB should charge management fees to the subsidiaries for
services rendered so that the fees derived constitute a business source of income that can
set off the operating expenses in full without any restriction. KSB must demonstrate that it
actively provides services to the subsidiaries to justify the management fees being a
business source of income.

Management fees charged should commensurate with the level of services provided. With
regard to service tax, intra-group management services provided should qualify for
exemption from service tax.

2. As MIDA has indicated that the new project is unlikely to qualify for incentives, the
project should be undertaken directly by KSH. KSH is currently incurring losses and the
profits of the new project can set off the losses of the existing business. KSH would also
enjoy reinvestment allowances (RA) on the additional investment in plant and machinery.
KSH also has substantial unutilised RA and capital allowances for set off against profits
from the new project.

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3. KSG’s business operations could be restructured by way of a transfer to KSH. Since both
businesses relate to the manufacturing of similar products (i.e. rubber gloves), KSH would
be considered to have only one business source. KSG’s profit can off set the existing
losses of KSH. Also, KSH’s unutilised RAs and capital allowances can be used to be set
off against KSG’s business profit.

KSG’s assets transferred to KSH within 1 year of their acquisition are subject to the
clawback of RA in the books of KSG.

KSH can claim RA on the qualifying plant and machinery transferred subject to the tax
written value of the assets transferred.

4. KSP should not undertake property development on its own. If it undertakes property
development and sells completed properties, any land that it subsequently sells may be
subject to income tax since it would have a history of dealing in land and properties.
Property development should be undertaken by its subsidiary. Sale of land to the
subsidiary would be subject to RPGT at 5% since it has been held for more than 5 years
(over 20 years) and has been deriving income from the plantations.

KSP should not submit an application to the State authority to convert the land for
commercial use as doing so would make the land more marketable and this is one of the
badges of trade that may cause the gain on the eventual transfer of land to the subsidiary to
be subject to income tax. The actual application should be undertaken by the subsidiary
concerned.

Consider RPGT exemption if it can be demonstrated that the transfer of land to the
subsidiary is to achieve greater efficiency and the consideration for the transfer is satisfied
by at least 75% shares in the subsidiary.

5. Tax exempt dividends for KSS stops at 2 tiers at Tan Sdn Bhd. Shareholders of Tan Sdn
Bhd will not be able to receive exempt dividends. Suggest to transfer KSS to KSB to
enjoy the 2 tier exemption of dividends. Relief from stamp duty under Section 15A of the
Stamp Act, 1949 would be applicable.

6. If management fees are charged to the off shore companies, the fees are not considered
foreign source income to KSB if the provision of management services does not crystallise
a PE in those countries, and is hence taxable. Consider setting up an OHQ in Malaysia
providing at least three qualifying services to KSV, KSS and KSI so that the management
fees received are exempt from Malaysian tax. Management fees are a better source of
income for KSB since dividends from KSV and KSI are not forthcoming.

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 THE MALAYSIAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS
(INSTITUT AKAUNTAN AWAM BERTAULIAH MALAYSIA)

EXAMINERS’ REPORT
NOVEMBER 2005 EXAMINATION

ADVANCED TAXATION

Question 1

Subject matters examined: Computation of the chargeable income of a company.

Most of the candidates had done well in this question. However, the following common
weaknesses were observed:

(i) failure to make correct adjustments to movements in the provision for doubtful debts
accounts;

(ii) incorrect computation of the balancing charge on the disposal of motor vehicles;

(iii) failure to restrict approved donation to 5% of aggregate income;

(iv) incorrect setting off of business loss brought forward.

Question 2

Subject matters examined: Computation of real property gains tax (RPGT).

Most of the candidates were unable to compute the RPGT payable by Bobby and Nicky, which
required the splitting of shares in a real property company into two tranches for computation
purposes.

Question 3
Subject matters examined: Taxability of income and deductibility of expenses based on case law.

Generally, candidates were unable to articulate their arguments for/against the taxability of an
item of income or deductibility of an expense.

Part (a): Candidates were unable to provide arguments for the deductibility of the RM5
million cash contribution to a pension fund. They argued that the contribution was
not deductible as it was a provision / contingent liability.

Part (b): Candidates were unable to provide arguments for the taxability of the RM1 million
received by MSS for the supply of diesel to another company. Candidates
emphasised on the profit making motive.

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Question 4

Subject matters examined: (a) Preparation of capital statement; (b) transfer pricing.

Part (a): Almost all the candidates were able to prepare the capital statement. However,
most of them made mistakes with regard to the treatment of the private loan and
inherited property.

Part (b): Some of the candidates were unable to state the arm’s length pricing
methodologies accepted by the Inland Revenue Board for transfer pricing.

Question 5

Subject matters examined: (a) chargeable income of co-operative society; (b) permanent
establishment under double tax agreement and withholding tax; (c) taxation of a real estate
investment trust.

The following common weaknesses were observed:

(i) In part (a), some candidates excluded members’ subscriptions as income of the co-
operative society.

(ii) In part (b), candidates failed to distinguish between the requirements which would give
rise to a permanent establishment or a fixed place of business under a double tax
agreement and the requirements under which the appointment of a Malaysian agent would
result in a foreign company having a permanent establishment in Malaysia.

Question 6

Subject matters examined: Tax planning to achieve maximum tax efficiency.

The following common weaknesses were observed from candidates’ answers:

(i) Failure to understand the tax implications of the transfer of a profitable business operation
to a loss making company and the merging of two companies.

(ii) Tendency to emphasise the “dividend trap” and therefore, failure to consider other tax
implications being tested.

26