PwC - Local vs foreign sourced income

7/26/2019 PwC - Local vs foreign sourced income

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Issue 109November 2013

PP 9741/10/2012 (031262)

www.pwc.com/my

PwC AlertLocal versusforeign sourcedincome

A continuousdebate


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Determining the locality of the source of

income is a practical hard matter of fact,as succinctly expressed by the Court of

Appeal judges in the case of Commissioner

of Inland Revenue (NZ) v NV Philips

Gloeilampenfabrieken (1954) 10 ATD 435(the

Philips case). Taxpayers and tax authorities

have to deal with the above question in order

to determine whether an item of income falls

within the countrys tax net and Malaysia is

not spared from this monumental task.

2 Local versus foreign sourced income - A continuous debate PwC Alert Issue 109, November 2013


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The current law is provided in Paragraph 28, Schedule 6 of the Actwhich exempts from tax,

The word source is not defined in the Act and guidance is oftensought from case laws. However, the derivation of business incomeis further dealt with under Section 12(1)(a) of the Act. This sectiondeems an item of income to be derived from Malaysia and hencetaxable in Malaysia, unless it can be proven that the income isattributable to the operations of the business carried on in a foreign

country.

Malaysia adopts a territorialscope of taxation. Section 3of the Income Tax Act 1967(the Act) provides that onlyincome that is accruing in orderived from Malaysia, andincome remitted to Malaysiafrom outside Malaysia issubject to tax. In ongoingefforts to encourage Malaysianbusinesses to venture overseasand thereafter repatriatetheir profits to Malaysia, thegovernment had since 1995,introduced various legislationswhich exempts from tax, foreignsourced income remitted toMalaysia except for taxpayerscarrying on banking, insurance,sea or air transport businesses.

Scope of taxation

income of any person, other than a resident company carrying on

the business of banking, insurance or sea or air transport, for the basis

year for a year of assessment derived from sources outside Malaysia

and received in Malaysia.

PwC Alert Issue 109, November 2013 Local versus foreign sourced income - A continuous debate 3


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The concept of source is a difficult area of tax law which has beenmuch debated in the regional courts over the years - from the courtsin New Zealand (the Philips case, 1954) to Hong Kong (Privy Councilcases of Hang Seng Bank and Hong Kong-TVB in the 90s followed bynumerous other cases), to Singapore (Chandos Pte Ltd v Comptroller ofTax (1987) 2 MLJ 670) and Malaysia.

It has been well recognised in the tax circles that the broad guidingprinciple for determining where income is sourced from is asenunciated by Lord Bridge in the landmark Privy Council case*,Commissioner of Inland Revenue v Hang Seng Bank Ltd (1990) STC 733 :

This article will focus on the developments of Malaysian tax cases andseek to examine if the Hang Seng Bank principle has been adopted bythe Malaysian courts.

Broad guiding principle

The broad guiding principle, attested by many authorities, is that

one looks to see what the taxpayer has done to earn the profit in

question. If he has rendered a service or engaged in an activity such as

the manufacture of goods, the profit will have arisen or derived, from

the place where the service was rendered or the profit-making activitycarried on. But if the profit was earned by the exploitation of property

assets as by letting property, lending money or dealing in commodities

or securities by buying and reselling at a profit, the profit will have

arisen in or derived from the place where the property was let, the

money was lent or the contracts of purchase and sale were effected

* Refer to page 13 for a summary of the Commissioner of Inland Revenue v Hang Seng

Bank Ltd (1990) STC 733 case



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Malaysian case laws

The issue of source had beendeliberated by the Malaysiancourts from as early as the1980s with cases such asROD Co Ltd v Director General

of Inland Revenue (1990) 1

MSTC 422, andOA Pte Ltd vPengarah Hasil Dalam Negeri

(1996) MSTC 2752in the1990s.

The issue in the first case waswhether payments for therental and hire of a rig madeby a Malaysian company toROD Co Ltd (incorporatedin Hong Kong), was taxablein Malaysia. The SpecialCommissioners of IncomeTax (SCIT) decided thatthe income was derivedfrom outside Malaysia underSection 12 of the Act ascentral management andcontrol of ROD Co Ltd wasexercised in Hong Kong. Thedecision was upheld by theHigh Court.

In 1996, the SCIT dismissedOA Pte Ltds appeal against theassessment of fees receivedfrom a bareboat charter to aMalaysian company. OA Pte Ltd(incorporated in Singapore), inits argument that the fees wereforeign sourced, drew supportfor its position by relying on theROD decision. The SCIT however,rejected this argument andinstead applied the broad guidingprinciple of the Hang Seng Bankcase in deciding that the incomewas derived from the place wherethe ship was let, i.e. Malaysia.

The 2000s saw a series of appealsto the courts against the InlandRevenue Boards challenge of thetreatment of income receivedby taxpayers as foreign sourcedincome: Aneka JasaramaiEkspress Sdn Bhd, CardinalHealth Malaysia 211 Sdn Bhd andKyros International Sdn Bhd. Allthree cases advanced to the Courtof Appeal, the highest court fortax appeals under the Act.



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Aneka Jasaramai Ekspress

Sdn Bhd

InAJE Sdn Bhd v KetuaPengarah Hasil Dalam Negeri

(2001) MSTC 3357, thetaxpayer is in the business ofoperating express bus services.The issue in contention with

the Inland Revenue Board(IRB) was whether incomefrom the sale of bus tickets inSingapore for single journeysfrom Singapore to Malaysia forthe years of assessment 1990to 1998 was income accruing

in or derived from Malaysia orSingapore.

The taxpayers appeal wasallowed by the SCIT. Matterstaken into consideration bythe SCIT were the fact that the

contract, sale and paymentof the tickets took place inSingapore. They also took intoaccount the interpretationand application of Sections3 and 12 of the Act; and the

ambiguity of the legal positionprior to the introduction ofSection 3C (which provided thespecific exemption of foreignsourced income for the yearsof assessment 1995 to 1997),leading to the SCIT adopting aposition which was favourableto the taxpayer.

Both the High Court and theCourt of Appeal upheld thedecision of the SCIT. However,the Court of Appeals writtenjudgement is not available.

Cardinal Health Malaysia 211

Sdn Bhd

Cardinal Health Malaysia211 Sdn Bhd (CHM), partof the Cardinal-Allegiancegroup, is a manufacturer and

exporter of latex and syntheticgloves. It invested its surplusbusiness profits by way ofloans to a related company,AH BV, a Dutch investmentholding company which acts



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as a treasury company for thegroup. CHM treated the interestincome received from the loansas foreign sourced income onthe basis that the income arosefrom the provision of loans in theNetherlands. The IRB however,contended that the interestincome was sourced in Malaysiaas the funds lent were generatedfrom CHMs Malaysian businessactivities.

The case was decided in thefavour of the taxpayer at all threelevels of judiciary appeal butthere was no written judgementof the Court of Appeals decision.

The SCIT found that thiscase clearly fell within thecircumstances envisaged byLord Bridge in the Hang Seng

Bank case, i.e. where profitwas earned from the lending ofmoney, the profit will have arisenfrom where the money was lent.

The High Court in concurringwith the SCIT, concluded thatit was the supply or provisionof credit to AH BV (and not thesource of the credit), that wasthe originating cause or sourceof the interest received by CHM.This was further supportedby Watermeyer CJs quotein the South African case of

Commissioner of Inland Revenue

v Lever Brothers & Unilever Ltd

(1946) 14 SATC 1:

.this supply of credit

is the service which thelender performs for the

borrower, in return for

which the borrower pays

him interest. Consequently

this provision of credit is the

originating cause or source

of the interest received by the

lender



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Kyros International Sdn Bhd

The case ofKyros International Sdn Bhd v Ketua Pengarah HasilDalam Negeri (2013) MSTC 30-056is the most recently decidedMalaysian case on foreign sourced income. Kyros InternationalSdn Bhd (Kyros), the registered owner of trademark, KYROS,granted sole and exclusive rights to franchisees in foreign countriesto establish and operate kebab fast food outlets in those countries.

The IRB challenged Kyros treatment of the franchise fees as foreignsourced income as it was of the view that the franchise fees werederived from Malaysia under Section 12(1)(a) of the Act.

The SCIT concluded that the franchise fees were foreign sourcedincome as the business operations of the foreign franchisees tookplace outside Malaysia. The SCIT applied the principles established

in the Hang Seng Bank case in concluding that the fees receivedfrom its foreign franchisees were akin to profit earned .by lettingof property where . the profit will have arisen in or derived from

where the property was let ..

The High Court overturned the SCITs decision as it did not think itwas correct to look at the operations of the franchisees (as the SCIT

did), instead of the operations of the Malaysian franchisor, Kyros.

However the Court of Appeal reversed the High Courts decisionas it found that the High Court did not have sufficient reason tointerfere with the SCITs finding of facts.



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Application of broad

guiding principle

Did the Malaysian courts adopt the broad guiding principle

in Hang Seng Bank?The RO Drilling appeal was heard by the courts prior to the birthof the broad guiding principle. The courts focused on the placewhere business acumen, judgement, intuition, knowledge andexperience were exercised and employed, i.e. where the central andmanagement control of the business was. Although the facts of the

OA Pte Ltd case are somewhat similar to the ROD Co Ltd case, thecourts decision in the OA case that the income was sourced fromoutside Malaysia was made based on the Hang Seng Bank case.

The courts in the Aneka Jasaramai case did not discuss the HangSeng Bank case. They appear to have placed more reliance onthe finding of fact that the activities of the taxpayer were outsideMalaysia, i.e the sale and payment for the bus tickets were inSingapore, in applying Section 12(1)(a).

Subsequent cases had generally applied the broad guidingprinciple. In the CHM case, the court found that the originatingcause that produced the interest income was the provision of loansin the Netherlands. In the Kyros case, the Hang Seng Bank principleswere also considered and applied by the Courts. The SCIT found infavour of the taxpayer based on the finding of fact that the operationsof the foreign franchisees took place overseas. In making the decision,the operations of the franchisor were not examined.



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A variation of the broad

guiding principle?

In considering the source of income especially income fromintellectual property, the case of Commissioner of Inland Revenue vHK-TVB International Ltd(1992) STC 723 should be reviewed. It isanother Hong Kong case which was decided by the Privy Councilafter the Hang Seng Bank case.

The issue deliberated in this case was whether sub-licence feesreceived by HK-TVB International Ltd (HK-TVB), from its customersabroad were taxable in Hong Kong. HK-TVB (incorporated inHong Kong) was granted by its parent company the rights to grantsub-licences for Chinese dialect video films to others to exploit thederivative rights in the films. HK-TVB granted the sub-licences tocustomers abroad in consideration of fixed sums (which may be



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agreed abroad) paid in HongKong. In carrying out thesub-licensing business, HK-TVB may send representativesabroad to solicit customers. Thesub-licence agreements wereprepared in Hong Kong andsent abroad for the customerssignature or signed by bothparties abroad.

The approach adopted by thePrivy Council in this case wasnot exactly the same as theapproach taken in the HangSeng Bank case. Instead, the

Hang Seng Bank broad guidingprinciple was expanded asfollows:

The proper approach is

to ascertain what were the

operations which producedthe relevant profits and

where those operations took

place.

Applying the above test, the PrivyCouncil held that the sub-licencefees were taxable in Hong Kongas the relevant business of thecompany was the exploitationof film rights of exercisableoverseas and it was a businesscarried on in Hong Kong.

It is interesting to note thatthe Privy Council dismissedHK-TVBs analogy between thelicensing of intellectual propertyrights abroad and the lettingof property (per Lord Bridgein the Hang Seng Bank case).

The reason for this was thatintellectual property does nothave a situs similar to immovableproperty. More food for thought- The Privy Council was also ofthe view that while the profit-making activity of the sub-

licensees was carried on outsideHong Kong, the grant of the sub-licenses took place in Hong Kongwhere the company operated.

An analysis of both the HangSeng Bank and HK-TVB casesseems to differentiate thetests adopted a focus on thespecific transaction (in theHang Seng Bank case) versusoperations (in the HK-TVBcase), that gave rise to theincome in question. It is notedthat the HK-TVB decision wasnot discussed and distinguishedin the Kyros case.



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Conclusion

The determination of the source of income is a complex and

contentious area of law. It is observed that the Malaysian courtshave generally applied the broad guiding principle of the HangSeng Bank case. However, in applying case precedents, our specificlegislation should be considered e.g. the deeming provision underSection 12 of the Act.

Finally, due to the complexity of the law and the diverse range

of income and circumstances, the facts of each case must beconsidered separately in determining the tax treatment to beadopted. The continuous development of cases taken to the courtsboth overseas and in Malaysia, indicates that the concept of sourceof income is indeed difficult and often open to interpretation. Withthis, the debate on this issue will continue.



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Appendix

Commissioner of Inland Revenue v Hang Seng BankLtd (1990) STC 733

Hang Seng Bank Ltd carried on its banking business in Hong Kong. It invested itsexcess holdings of foreign currencies in certificates of deposit (CDs) in Singaporeand London. These CDs were normally sold before maturity. The Singapore andLondon banks would give instructions for the purchase and sale of the CDs. Therequired funds for these transactions were debited and credited to the banksaccounts with other overseas banks.

The issue was whether the bank was liable to profits tax on the profits arisingfrom the purchase and sale of the CDs.

The Privy Council held that the income was not taxable in Hong Kong. Inarriving at this conclusion, Lord Bridge had outlined a broad guiding principle indetermining the source of an income:-

But the question whether the gross profit resulting from a particulartransaction arose in or derived from one place or another is always in the

last analysis a question of fact depending on the nature of the transaction.

It is impossible to lay down precise rules of law by which the answer to that

question is to be determined. The broad guiding principle, attested by many

authorities, is that one looks to see what the taxpayer has done to earn the

profit in question.

The activity of the bank from which the income arose was the trading of the CDsin the Singapore and London markets and hence the income was not derivedfrom Hong Kong.



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Lets talk

Kuala LumpurJagdev Singh+60(3) 2173 1469

[email protected]

Jennifer Chang+60(3) 2173 1828

[email protected]

Steve Chia+60(3) 2173 [email protected]

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+60(3) 2173 [email protected]

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+60(3) 2173 1582thanneermalai [email protected]

Teh Wee Hong+60(3) 2173 1595

[email protected]

If you would like further information in relation to the issues outlinedearlier, please call the Corporate Tax senior executive directors andexecutive directors of PricewaterhouseCoopers Taxation Services Sdn Bhd:

Wan Heng Choon+60(3) 2173 1488heng [email protected]

Clifford Yap+60(3) 2173 [email protected]

Lorraine Yeoh+60(3) 2173 [email protected]

Penang / Ipoh

Tony Chua+60(4) 238 [email protected]

Johor Bahru

Benedict Francis+60(7) 222 [email protected]

Melaka

Teh Wee Hong+60(3) 2173 1595

[email protected]

Labuan

Jennifer Chang+60(3) 2173 1828

[email protected]



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