2020
Article
Understanding Judicial Doctrines of General Anti-Avoidance Rules (Part II)
Dr Benjamin Poh
2020
Citation: [2020] LR 413
*413 Understanding Judicial Doctrines of General Anti-Avoidance Rules (Part II)
Abstract
Part I of this article reviews the earlier common law judicial doctrines of the General Anti-Avoidance Rules (“GAAR”) developed in the US and UK. These doctrines have been adopted by the common law courts today including the Malaysian judiciary, to combat against aggressive international tax planning or avoidance schemes with little commercial justification and economic substance. In Part II of this article, the author will discuss two recent hallmark cases on GAAR decided by the Malaysian Court of Appeal, its implications for tax planning in Malaysia and the necessary tax reforms the government should focus on.
Introduction
In Part I of this article, the author reviewed the earlier common law judicial doctrines of GAAR developed in the US and UK. In Part II, the author will discuss the two hallmark cases on the Malaysian GAAR – Sabah Berjaya Sdn Bhd v Ketua Pengarah Jabatan Hasil Dalam Negeri and Syarikat Ibraco Peremba v Ketua Pengarah Hasil Dalam Negeri – both cases were decided by the Court of Appeal and raised some challenging issues in respect of the facts of each case and interpretation of the Malaysian GAAR.
Application of the judicial doctrine of GAAR in Malaysian tax cases Sabah Berjaya case
Sabah Berjaya Sdn Bhd v Ketua Pengarah Jabatan Hasil Dalam Negeri1 is a case concerning the donation of substantial profits before taxation from a company named Sabah Berjaya Sdn Bhd, to its parent entity, Sabah Foundation which is an approved tax-exempt foundation. At the time, there was no limit on tax deductibility of the amount of donation a company could claim in its tax return. Sabah Berjaya therefore, obtained full tax deduction on *414 the donations of almost all of its profits before tax for several financial years against its taxable profit, so, it had zero tax liability for several financial years and Sabah Foundation being a tax-exempt foundation, did not pay tax on the donations received from its subsidiary.
The case raised a few tax issues in the courts: (1) The arm’s length basis of the donations under s 140(1) and (6) of the Income Tax Act 1967 (“ITA 1967”); (2) The distinction between tax avoidance and tax mitigation. The first issue was discussed at length by the Special Commissioners of Income Tax and the court found that the donations were not made on an arm’s length basis and therefore it was a tax avoidance plan. The second issue was discussed by the Court of Appeal and the court found that the donations were no pretence, that the same were actually paid by the subsidiary company to the parent foundation and therefore it was tax mitigation plan permissible under s 44(6) of the ITA 1967.
The Court of Appeal cited Commissioner of Inland Revenue v Challenge Corp Ltd ,2 a New Zealand case which discussed the New Zealand tax provision under s 99 of the Income Tax Act 1976, which was in pari materia with s 140 of the ITA 1967 (Malaysian statutory GAAR). The court agreed with Lord Templeman’s judgment in which his Lordship said (at p 554 of the report):
Tax evasion also can be dismissed. Evasion occurs when the commissioner is not informed of all the facts relevant to an assessment of tax. Innocent evasion may lead, to a reassessment. Fraudulent evasion may lead to a criminal prosecution as well as reassessment. In the present case Challenge fulfilled their duty to inform the commissioner of all the relevant facts.
The material distinction in the present case is between tax mitigation and tax avoidance. A taxpayer has always been free to mitigate his liability to tax. In the oft quoted words of Lord Tomlin in IRC v Duke of Westminster [1936] AC 1 at 19: “Every man is entitled if he can to order his affairs so as that the tax attaching under the appropriate Act is less than it otherwise would be”. In that case however the distinction between tax mitigation and tax avoidance was neither considered nor implied.
Income tax is mitigated by a taxpayer who reduces his income or incurs expenditure in circumstances which reduce his assessable income or entitle him to reduction in his tax liability. Section 99 does not apply to tax mitigation because the taxpayer’s tax advantage is not derived from an arrangement but from the reduction of income which he accepts or the expenditure which he incurs. Thus, when a taxpayer executes a covenant and makes a payment under the covenant, he reduces his income. If the covenant exceeds six years and satisfies certain other conditions the reduction in income reduces the assessable income of the taxpayer. The tax advantage results from the payment under the covenant …
*415 The Court of Appeal said in this case, “ on whether there was tax avoidance, the taxpayer did not pretend to donate its entire profit to the Foundation. There was an actual donation, so no question of tax evasion actually arises. The payments made reduced the taxpayer ’ s income in circumstances in which the Act by way of s 44(6) clearly afforded a reduction in tax liability. Accordingly, this was not a case to which s 140 applied ”.
Tax implications of the Sabah Berjaya case
A number of important tax principles emerged from the Court of Appeal’s decision in the Sabah Berjaya case . First, the court used the principle of economic substance to analyse the transactions and said that the donation was actually made out to the other party, and that it was not a pretence. The financial position of the taxpayer was affected or suffered as a result of the transactions. Second, on the issue of conflict between GAAR and the specific provision under s 44(6) of the ITA 1967, the specific provision shall prevail. Again, this was consistent with the common law judicial doctrines of GAAR in recognising the choices given by the tax statute, to allow taxpayers to plan their tax affairs so as to attract the minimum tax possible.
However, the court did not address the abnormality of the donations from the subsidiary company to its parent foundation, as the amount of donations made in comparison with the profit available for distribution was “abnormal”, and contravened the predication test formulated by Lord Denning in the Privy Council case, Newton v Commissioner of Taxation3 (i.e. that the transactions should be capable of explanation by reference to ordinary business or family dealing, without necessarily being labelled as a means to avoid tax). The court did not consider whether the donations made out from the subsidiary company to the parent foundation ( “in substance both entities are considered as an economic entity”), which were still circulated and controlled within the group, had economically altered the financial position of the group. Recently, the Singapore Court of Appeal’s decision in Comptroller of Income Tax v AQQ4 made clear that in applying the economic substance doctrine on tax avoidance plan, the group was treated as one economic entity than a separate entity by itself.
Syarikat Ibraco-Peremba case
In Syarikat Ibraco-Peremba Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri ,5 the appellant is a property developer, and had disposed of a piece of land to its subsidiary company for property development in the year 1994. The subsidiary company built shophouses and a shopping complex on the land and rented out the properties for long term basis. In the year 2003, the appellant undertook a corporate restructuring exercise and sold the shares in *416 the subsidiary company to another company related to the appellant. The subsidiary company thereafter, sold the properties after the restructuring exercise and reported the gains in its real property gains tax (“RPGT”) returns. The RPGT reported was much lower than the income tax, if the properties were to be developed and sold by the appellant itself. The Inland Revenue disregarded the whole transactions by invoking s 140 of the ITA 1967 and imposed a tax penalty under s 113(2) of the ITA 1967.
This case was argued before the Special Commissioners of Income Tax (“SCIT”), the High Court and finally before the Court of Appeal which reaffirmed the judgments made by SCIT and the High Court. The High Court referred to the UK case, WT Ramsay Ltd v Inland Revenue Commissioners6 and said that the tax avoidance scheme comprised a number of specific transactions to avoid tax. The genuineness or otherwise of each individual step or transaction need not be looked at from each individual step or transaction, but it is to be looked at as a whole. As such the High Court found that there was no error committed by the SCIT to warrant intervention, as there were evidence and facts to support the findings of the SCIT in arriving at the decision that they did and hence justifying a case under s 140 of the ITA 1967.
The appellant submitted that the second (disposition of the land) and third transactions (development of the land by the subsidiary company and rented out to third party) could not be said to be “preordained” particularly when these transactions were separated in time by nine years. However, the Court of Appeal agreed with the principle enunciated in Furniss (Inspectors of Taxes) v Dawson7 and endorsed by Ensign Tankers (Leasing) Ltd v Stokes ,8 and said that the second and third transactions were in discharge of the scheme advanced as a way of avoiding tax by the appellant, even though these transactions were separated in time by nine years. The passage of time is of little consequence in the scheme of things for the appellant when taking into account the findings of facts by the SCIT. The Court of Appeal also agreed with the SCIT’ findings that the appellant had consulted its tax agent before implementing the plan with the primary purpose of minimising its tax consequences. On the issue of the tax penalty that was imposed, the Court of Appeal dismissed the appellant’s submission on “good faith” as a defence under s 113(2).
Below is what the Court of Appeal commented on the Malaysian GAAR:
The distinction between what is accepted and what is not in the way of reducing the amount of tax to be paid used to be conveniently described by the terms tax avoidance and tax evasion respectively. Section 140(c) of the Act in particular, has the effect of demolishing that convenient description. *417 The Act now empowers the Director General, without prejudice to such validity as it may have in any other respect or for any other purpose, where he has reason to believe that any transaction has the direct or indirect effect of evading or avoiding any duty or liability which is imposed or would otherwise have been imposed on any person by the Act, to disregard or vary the transaction and make such adjustments as he thinks fit with a view to counteracting the whole or any part of any such direct or indirect effect of the transaction. Thus the oft quoted words of Lord Tomlin in IRC v Duke of Westminster [1936] AC 1 and quoted by Lord Templeman in Commissioner of Inland Revenue v Challenge Corporation Ltd [1986] STC 548 “ that every man is entitled if he can to order his affairs so as that the tax attaching under the appropriate Act is less than it otherwise would be is now only partially true, for whether he succeeds or not, according to s 140(c), depends upon the determination of the Director General. We make the observation that it is for the taxpayer to demonstrate that the transaction or the arrangement by which the income was produced was so preordained by compliance with the requirements of law or accepted business practices to limit risk exposure, and that the tax savings were purely incidental …” .
Tax implications of the Syarikat Ibraco-Peremba case
The decision in this case has affirmed a number of important principles. First, even though the sale of land was at market value, the transactions could still fall under the purview of GAAR. Second, the tax saving purpose shall be purely incidental to the main business purpose of the transactions (“business purpose doctrine” as discussed in Part I of this article). Third, the series of transactions even though they were separated in time by nine years, could still be considered as “preordained” transactions or as a whole composite transaction (“step transaction doctrine” as discussed in Part I of this article). The court said that the tax penalty imposed under s 113(2) precludes the defence of “good faith”, as opposed to s 113(1) of the ITA 1967. However, the author does not agree with the court’s reasoning that the transactions were mainly for tax purposes just because the taxpayer had consulted Arthur Andersen for tax advice on the whole transactions. This is because in practice it is quite normal for a reasonable man to consult his tax adviser to understand the tax implications of any major transactions to be undertaken by him. Furthermore, the step transaction doctrine on the “binding commitment test” was not raised and discussed by the court, even though the taxpayer argued that the transactions could not be considered preordained by looking at them on a hindsight basis. The court also made the observation that it is for the taxpayer to demonstrate that the transactions by which the income was produced were so preordained by compliance with the requirements of law or accepted business practices to limit risk exposure and that the tax savings were purely incidental.
However, under s 140 of the ITA 1967, the burden of proof on tax avoidance should rest with the Revenue. In Port Dickson Power Bhd v Ketua *418 Pengarah Hasil Dalam Negeri ,9 the High Court held that if the Revenue considered the financing structure in this case, was a sham, the burden of proof would rest with the Revenue to prove its belief under s 140(1) of the ITA 1967, and that the failure to do so was fatal to the Revenue’s case. On the issue of the tax penalty imposed under s 113(2), the court should consider whether the taxpayer has exercised “good faith” in implementing the tax planning scheme and the Revenue should exercise its discretion not to impose tax penalty in this case. His Lordship Peh Swee Chin SCJ said about the Revenue’s exercise of its discretion in Ketua Pengarah Hasil Dalam Negeri v Kim Thye & Co :10 “… He is given a discretion, a discretion which to my mind he cannot exercise at whim or fancy but after due consideration of all relevant facts and circumstances … ”.
The High Court judge, Richard Talalla J went further in Kim Thye & Co v Ketua Pengarah Jabatan Hasil Dalam Negeri , Kuala Lumpur ,11 and made the following comments at p 1584 (AMTC); p 2510 (CLJ): “ The Director General may require payment of the penalty. He is not bound to require such payment. He is given a discretion, a discretion which to my mind he cannot exercise at whim or fancy but after due consideration of all relevant facts and circumstances. It seems to me that the Director General would have to consider whether the incorrect return or incorrect information was respectively made or given dishonestly with intention to evade payment of tax or possibly even negligently and then, and only then, mete out the punishment … ” . In this case, the appellant had acted in “good faith” by consulting a reputable accounting firm, Arthur Andersen before implementing the tax planning scheme. All the transactions and arrangements were implemented according to the tax planning scheme and had been properly disclosed to the Revenue in its tax returns without dishonesty or negligence. The court should not punish the appellant for giving incorrect returns or incorrect information, just because the appellant took a different stand and view from the Revenue on structuring its tax plan.
Conclusion
Malaysia’s statutory GAAR has not been reformed for more than 40 years and the courts still rely on judicial doctrines to guide its interpretation. This however, may not be in line with the prevailing international tax laws on GAAR and the parliamentary intention of enacting a statutory GAAR. The author finds the following interpretation issues could unsettle the judiciary and tax practitioners in Malaysia:
(1) Uncertainty as to whether s 140 of the ITA 1967 should be applied to a series of transactions, where some of the transactions have economic and commercial substances with third parties. Whether transactions *419 with economic and commercial substances should be recognised and artificial transactions be discarded and the end tax results if this was done?
(2) Section 140 of the ITA 1967 does not state clearly the extent of tax purpose predominant in a transaction that is required before the Revenue is allowed to invoke GAAR. Whether that purpose is subjectively or objectively measured? In Newton v Commissioner of Taxation ,12 it was held that the purpose should be objectively measured.
(3) Is abnormality against the arm’s length basis a requirement for the Revenue to invoke GAAR and how should the abnormality be measured against a standard benchmark in practice?
(4) Whether the doctrine of economic substance was ever intended by Parliament; how should the court apply the economic substance doctrine to determine whether taxpayer’s financial position has been altered as a result of the transactions; and should the economic substance doctrine apply to group level or entity level?
(5) Whether the taxpayer’s good faith is important for the Revenue and the court to consider when imposing tax penalty on any tax planning scheme which was found to be a tax avoidance plan later and whether different tax penalty regimes should be imposed on those abusive tax avoidance plans and those responsible tax planning plans with proper disclosure and consultation, so as not to deter responsible tax planning in Malaysia?
The Malaysian government should seriously study the above issues and reform the statutory GAAR so as to align with the international tax jurisprudence and trends following the OECD BEPS project. The objective of tax reform is to prevent loss of government tax revenue as a result of aggressive international tax planning and to create a conducive tax environment to attract and retain foreign and private investments to achieve the country’ economic growth.
*413 Understanding Judicial Doctrines of General Anti-Avoidance Rules (Part II)
*. Advocate and Solicitor, High Court of Malaya, specialising in tax and commercial litigation and private wealth advisory. He is a Chartered Accountant of Singapore and Malaysia, CFA Charterholder, RICS Chartered Surveyor and Fellow of Chartered Tax Institute Malaysia. He holds a PhD in Tax Law from Washington School of Law, MBA (with Merit) degree from Manchester University and LLB (Hons) from London University. He can be contacted at pcslegal.group@gmail.com. The above article was published by the Chartered Tax Institute of Malaysia in Tax Guardian, Vol 11/No. 1/2018/Q1 Issue.
- [1997-2002] AMTC 2079; (2000) MSTC 3771, CA.
- [1986] STC 548.
- [1958] AC 450.
- (2014) MSTC 70-030.
- [2017] AMTC 69; (2014) MSTC 30-084, CA.
- [1981] 1 All ER 865; [1982] AC 300, HL.
- [1984] AC 474.
- [1992] BTC 110.
- [2012] AMTC 276; (2012) MSTC 30-045, HC.
- [1979-1996] AMTC 1527, SC.
- [1979-1996] AMTC 1580; [1991] 3 CLJ 2507, HC.
- [1958] AC 450.
