TAX LAW

KETUA PENGARAH HASIL DALAM NEGERI MALAYSIA v. EHSAN ARMADA SDN BHD [2024] 3 CLJ 428 [Court of Appeal]

Brief facts

This case addresses a tax dispute involving the deductibility of an exemption sum of RM6,226,981 paid by the respondent, Ehsan Armada Sdn Bhd (‘the developer’) a property developer, to Lembaga Perumahan dan Hartanah Selangor (‘LPHS’). This was in relation to Majlis Mesyuarat Kerajaan Negeri’s (‘the State’) decision to alienate 84 acres of land (‘the project land’) to the developer with the requirement of building low-cost housing as part of a mixed development project (‘the project’). In order to mitigate the unaffordability of housing due to the soaring property prices, it is a common property development practice and policy that the State Authority would impose mandatory conditions for the development of low-cost housing on developers who are desirous to undertake any property development (‘low-cost policy’). The appellant, Director General of Inland Revenue (‘DGIR’), when conducting a field audit on the income tax returns assessments for the years 2007, 2008, 2009 and 2010, took the position that the exemption sum claimed by the developer was wrongful and not deductible under Section 33(1) of the Income Tax Act 1967 (‘ITA’). DGIR issued a notice of additional assessment, notices of assessment, and notification of non-chargeability to the developer for those respective years.

The developer appealed to the Special Commissioners of Income Tax (‘SCIT’) against DGIR’s notices, who found that the exemption sum ought not to be considered deductible because (i) the project’s own non-feasibility to develop low-cost housing was self-induced, and the exemption sought (ii) was not a necessity to remove a business impediment, (iii) was beyond the ordinary expense of the project which was already attached and expected to have a low-cost housing element and (iv) would cause the project to veer away from the originally intended business and purpose of the alienation of the project land to the developer. Dissatisfied with the SCIT’s decision, the developer appealed to the High Court.

High Court’s Decision

The High Court allowed the developer’s appeal, on the primary ground that the exemption was a bare necessity to remove a business impediment. The Court took the simplistic approach that any sum paid (notwithstanding context, purpose and object of the payment) was a deductible expense if that payment had the effect of aiding the business to earn more profit.

The developer was ‘unable’ to abide by the low-cost policy because the allocated class 3 slope area, which the developer apportioned, was unsuitable and economically unfeasible for low-cost housing. As such, the developer was relieved of compliance with the low-cost policy and was free to construct free-market housing in place of low-cost units. Dissatisfied with the High Court’s decision, the DGIR appealed to the Court of Appeal.

Issues Considered by the Court of Appeal:

(i) Whether the payment of the exemption sum made by the developer to LPHS to exempt itself from building low-cost housing in the project was deductible under S.33(1) of ITA?

(ii) Whether the DGIR was time-barred under S.91(3) of the ITA to issue the notice of additional assessment; and 

(iii) Whether the DGIR had correctly and reasonably imposed a penalty under S.113(2) of the ITA at the rate of 45% on the assessments and additional assessments?

Court of Appeal’s Decision

The Court of Appeal, through the judgment delivered by Azimah Omar JCA, allowed DGIR's appeal, setting aside the High Court's decision with costs of RM25,000 on the grounds that:

1.This Court adopted a wholly subjective test which was to determine the nature and purpose of the disbursement rather than its effect. It was not that the developer was ‘unable’ to abide by the low-cost policy; but instead, the developer had deliberately flouted to seek to be exempted from the low-cost policy. The developer could have (but intentionally did not) apportioned a different land area within the 84 acres of the project land which was more suitable for low-cost housing, fully aware that the class 3 slope area would incur higher costs if apportioned for low-cost housing. Thus, the developer could not then seek for an exemption.

2. To be exempted from the low-cost policy is an extraordinary feature in the project’s development. An ordinary development and developer subject to the low-cost policy would have to ordinarily abide by it, and ordinarily expect a lower profit margin as a result (as the very nature of low-cost housing is for affordability and not maximum profit). The exemption sought by the developer was a one-off capital payment to maximize profits, well beyond the nature and expectation of a mixed development with low-cost housing policy in place. Hence, this pre-empted and self-induced predicament could not be considered a commonly recurring business expense, but a capital outlay to set the business and therefore, the exemption sum was not deductible under ITA.

3. Pertaining to the second issue, the developer had argued that DGIR's notices were issued beyond the statutory time limit. The court ruled that the DGIR was not time-barred, as the developer's negligent deduction of the exemption sum from its taxable income constituted an exception to the time limitation.

4. Pertaining to the third issue, the Court of Appeal answered in the positive and upheld the DGIR's imposition of a 45% penalty under S.113(2) of ITA (where DGIR has the discretion to impose a penalty up to the amount of the undercharged or undeclared income). The developer had attempted to defend its actions by claiming good faith, but the court found this defense to be inapplicable in the context of S.113(2) of ITA because it is only applicable where there is a criminal prosecution. Besides that, ‘good faith’ must involve elements of honesty and earnest pursuit of the truth notwithstanding the risk that the ‘truth’ of the matter might be unsavory or unfavorable to one’s case. The Court also noted that the developer's conduct did not reflect good faith, as the developer neither wrote in to DGIR nor communicated with DGIR to clarify the taxability of the exemption sum. Instead, the developer had proceeded to ‘gamble’ the matter and outright claimed the exemption sum as a deductible (in hopes that the gamble would play out in its favour).

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