1 February, 2016
On 29 December 2015, the Finance Act 2015 ("FA") received the royal assent and was passed into law. One of the amendments introduced in the FA affects the taxation of advance payments, and signifies a departure from the previous tax treatment for advance payments.
We have considered the impact of the amendments under the FA to the taxation of advance payments in further detail below.
Tax Treatment Prior to FA amendments
Prior to the year of assessment ("YA") 2016, it was generally accepted that business income is assessed to tax at the time of accrual or derivation of income, instead of at the time of receipt. Therefore, advance payments received by a taxpayer for, amongst other things, services which have yet to be rendered, would only be subject to income tax once the services have been rendered.
This principle has been accepted and endorsed by various decisions of the Commonwealth Courts, including Australia and Singapore.
In Malaysia, there was previously some ambiguity as to whether advance payments for services that have yet to be rendered would be brought to tax in the year in which it was received, by virtue of Section 24(1)(b) of the Malaysian Income Tax Act ("ITA")1. However, this ambiguity was largely addressed by the Malaysian High Court in the case of Clear Water Sanctuary Golf Management Berhad v Ketua Pengarah Hasil Dalam Negeri, which held that Section 24(1)(b) would not apply to advance payments, and as such advance payments for services which have not yet been rendered would only be recognized for tax purposes once the services have been rendered.
Amendments to Section 24 of the ITA
The provisions of the FA seeks to introduce two amendments to Section 24 of the ITA with respect to payments for services, and these amendments shall take effect from YA 2016 onwards.
First, Section 24(1)(b) of the ITA has been amended to apply to "services rendered or to be rendered". Therefore, any debt owing in respect of services that have been performed, or which will be performed, will be taxable in the period in which the debt is owing.
Secondly, a new Section 24(1A) has been introduced to stipulate that any sum received by a person in respect of any services to be rendered or the use or enjoyment of any property shall be treated as gross income for the relevant period in which the sum is received, notwithstanding that there is no debt owing in respect of such services or use or enjoyment.
In other words, this new provision seeks to subject advance payments for services to be taxed in the year of receipt, notwithstanding that the services have not yet been performed and there is no debt owing. This is the case even if the payment is refundable, and represents a departure from established taxation principles whereby business income would only be assessed to tax once it has accrued. It also raises some questions as to whether Section 24 as it is now sits well with current accounting principles on income and revenue recognition, as well as contractual law principles.
Conclusion
In view of the amendments above, it would be advisable for taxpayers to undertake a review of their customer contracts, and in particular the payment terms, to assess what may be the Inland Revenue Board's position as a result of the amended Section 24 of the ITA.
1 Section 24(1)(b) of the Income Tax Act provided that " Where in the relevant period a debt owing to the relevant person arises in respect of … any services rendered at any time in the course of carrying on a business; … the amount of the debt shall be treated as gross income of the relevant person from the business for the relevant period." [Emphasis added].
For further information, please contact:
Adeline Wong, Partner, Wong & Partners
adeline.wong@wongpartners.com
