Tutorial 12: Business Income - Deductibility of Business Expenses

Question 1

What are the tests (or principles) that may be applied in determining whether an expense is
deductible or not in arriving at the adjusted income from a business?

The general principles that may be applied in granting deduction of an expense in arriving at the
adjusted income from business are:

Answer Question 1

FOR THE EXPENSE TO BE ALLOWED OR TO BE DEDUCTIBLE

(a) the expense must be revenue in nature and not capital in nature

(b) It must be incurred for purpose of that business, and not for other purposes.

(c) The expense must be authorised by provision (S33 and S34) of the Income Tax Act, 1967
It must not be prohibited by the S39 Income Tax Act, 1967

(d) The expense mist be incurred in the basis period for the relevant year of assessment
If it is incurred prior to the commencement or after the relevant basis period, it is not deductible

(e) The expense must be incurred / ascertained and is not an an anticipated or contingent expense
or a (general) provision. .An anticipated or contingent expense or a (general) provision cannot be
given deduction.

(f) The expense must be wholly and exclusively incurred in the production of gross income to qualify
for deduction under S33(1) of ITA 1967. Wholly means the entire amount of expense; exclusively
means only for the sole purpose of

Question 2

With reference to Section 33(1) of Income Tax Act (ITA) 1967, explain the meaning and the
application for each of the following -

(a) incurred;

(b) wholly and exclusively incurred; and

(c) in the production of income.

Answer to Q 2

Answer to Question 2a

(a) The outgoings and expenses must be incurred.

Incurred means not only be paid, but also payable or becoming payable;.
Where there is a liability it must be one that is ascertained, and not one that is anticipated or

contingent. (Owen v Southern Railway of Peru Ltd.)

Under the Act, specific provision for bad debt can be given deduction.

Answer to Question 2b

(b) The outgoings and expenses must be wholly and exclusively incurred for the relevant

business purpose (of producing income). If an expense is partly incurred for purpose of

producing income and partly for a private reason, the portion relevant to the production of

income can be given deduction. (CIT v Alcock).

An expense must be exclusively for the purpose of producing income of the business. If an

expense is for a private or domestic purpose, it is not allowable [S39(1)(a)]. If an expenses is

for dual purpose, it is not allowable. (Robertson v Newsom).

Answer to Question 2c

(c) The outgoings and expenses must be incurred in the production of income. The expense is

allowable if it does not produce income immediately, but is expected to produce income in

the future. (Vallambrosa Rubber Co. Ltd. v Farmer)

Pre-commencement expenses incurred in order to commence business are not allowable,

except for those that are specifically authorised by the Act.

Expenses that relate to the cessation of business are not allowable too (such as compensation

for retrenchment of employees in order to cease business).

Question 3

‘(a) Give any six examples of expenses that are revenue in nature.

(b) Give any six examples of expenses that are capital in nature.

Answer to Q3(a)

Revenue expenses

Purchase of stock, travelling expenses, staff training, subscription to trade association, repainting of

office building, renewal of trademark.

Answer to Q3(b)

Capital expenses

Advice of shareholding structure, compensation to prevent competition, expenses to purchase

shares, plant installation, goodwill, renovation.

Question 4

Explain the following and give any two examples for each of them -

(a) initial expense;

(b) dual-purpose expense; and

(c) pre-commencement expense.

Answer to Q 4

Answer to Q 4a

 An initial expense is incurred for the first time, like the case of a fee for a new license

for business or entrance fee to a club.

 It is capital in nature and is not allowable.

 Subsequent expense on the renewal of the license or renewal of club membership

would be allowed deduction.

 In a case of newly acquired plant / machinery that is in a state of disrepair, an

expense incurred in order to put it into a functional / usable state is regarded as an

initial expense (Law Shipping Co.Ltd v CIR). It is capital in nature and is not

allowable.

Answer to Q 4b

 An dual-purpose expense is mainly for a private purpose or non-business

purpose. If there is any business purpose involved, it is a secondary in nature.

 Like in the case of Robertson v Newson, a solicitor brought back some work from

his office to do at his home. The travelling expense from his office to his home was

held to be non-allowable as the main reason of incurring the expense was to go home.

 It is of a dual purpose and is not exclusively incurred in the production of income,

hence, it was not allowable.

Answer to Q 4c

 A pre-commencement expense is incurred before the commencement of a business.

 It is preparatory in nature and puts one / a company in a position in order to start

carrying on a business.

 Such an expense is not allowable in arriving at the adjusted income from business,

except for certain expenses that are specifically authorised under the Act.

Question 5

Ashton, a Malaysian tax resident individual, is a sole trader of a small local grocery shop. He has no
staff in the business. His business’ profit and loss account for the year ended 31 December 2019 is as
follows:

Notes RM RM
Turnover 68,000
Less: Cost of goods sold 1 38,000
30,000
Add other income 2 16,200
46,200
Less: Expenses
Remuneration 24,000
Allowance for doubtful debts 3 300
Travelling and transport 4 2,300
Donation 5 500
Repair and maintenance 6 4,000
Miscellaneous 200
Water and electricity 2,900 34,200
Net Profit 12,000

Notes

1. Cost of goods sold RM

It includes:
Depreciation 3,500
Provision for stock obsolescence 180

2. Other income RM
Interest income received in Malaysia (from Public bank) 510
Bad debt recovered (non trade)* 190
Gain on disposal of a non current asset 4,700
Rental income from an apartment (net) 10,800
16,200
*It was not given a tax deduction when the bad debt was written off previously.

3. Allowance for doubtful debts RM

General allowance on non trade debtors 200
Specific allowance on trade debtors 100
300

4. Travelling and transport RM

Transportation charges for goods sold 1,250

Leave passage with his family - Penang 1,050

5. Donation to approved institution RM

Cash 300
Foods 200
500

6. Repair and maintenance RM

These include:
Replace a storage rack with better material (high quality metal rack) 1,200
Repaint the shop 2,800

7. Miscellaneous
Included an amount of RM200 being a contribution to a political party.

8. Additional information RM
Current year capital allowances 4,000
Current year balancing charge 1,650

Required:

(a) Starting with net profit before tax, compute the total income of Ashton. for the year of
assessment

2019. Indicate ‘Nil’ under the appropriate column, where no tax adjustment is required.

Ashton
Computation of Total income for Year of Assessment 2019
RM RM
Net profit 12,000
+ --
Interest income received in Malaysia (from Public bank) 510
Bad debt recovered (non trade)* 190
Gain on disposal of a non current asset 4,700
Rental income from an apartment (net) 10,800
Remuneration 24,000
Political party donation 200
Water and electricity Nil
 Depreciation 3,500
Provision for stock obsolescence 180
General allowance on non trade debtors 200
Specific allowance on trade debtors Nil
Transportation charges for goods sold Nil
Leave passage with his family - Penang 1,050
Cash 300
Foods 200
Replace a storage rack with better material (high quality metal rack) 1,200
Repaint the shop Nil
30,830
Adjusted income 16,200 14,630
Add Balancing charge 26,630
1,650
Less Current year capital allowances 28,280
Statutory income from business 4,000
24,280
Interest income received in Malaysia (from Public bank)
Rental income from an apartment (net) Nil
Aggregate income 10,800
35,080
Donation Cash (Restricted to 7% of 11,590= RM811 300
Kind Nil
Political donation Nil
300
Total income
34,780

Question 5b

(b) Give brief explanation on the tax treatment for each of the expenses under Notes 5.

Answer to question 5(b)

Donation in cash and in kind - Not expenses for business purpose/not in the production of business

income. Only donation in cash to approved institution is allowed to be deducted against aggregate

income subject to maximum of 7% of the aggregate