PwC Alert Local versus foreign sourced income

Issue 109
November 2013
PP 9741/10/2012 (031262)
PwC Alert
Local versus
foreign sourced
income
– A continuous
debate
www.pwc.com/my
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 country’s 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
Scope of taxation
Malaysia adopts a territorial
scope of taxation. Section 3
of the Income Tax Act 1967
(“the Act”) provides that only
income that is accruing in or
derived from Malaysia, and
income remitted to Malaysia
from outside Malaysia is
subject to tax. In ongoing
efforts to encourage Malaysian
businesses to venture overseas
and thereafter repatriate
their profits to Malaysia, the
government had since 1995,
introduced various legislations
which exempts from tax, foreign
sourced income remitted to
Malaysia except for taxpayers
carrying on banking, insurance,
sea or air transport businesses.
The current law is provided in Paragraph 28, Schedule 6 of the Act
which exempts from tax,
“… 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.”
The word “source” is not defined in the Act and guidance is often
sought from case laws. However, the derivation of business income
is further dealt with under Section 12(1)(a) of the Act. This section
deems an item of income to be derived from Malaysia and hence
taxable in Malaysia, unless it can be proven that the income is
attributable to the operations of the business carried on in a foreign
country.
PwC Alert Issue 109, November 2013
Local versus foreign sourced income - A continuous debate 3
Broad guiding principle
The concept of “source” is a difficult area of tax law which has been
much debated in the regional courts over the years - from the courts
in New Zealand (the Philips case, 1954) to Hong Kong (Privy Council
cases of Hang Seng Bank and Hong Kong-TVB in the 90s followed by
numerous other cases), to Singapore (Chandos Pte Ltd v Comptroller of
Tax (1987) 2 MLJ 670) and Malaysia.
It has been well recognised in the tax circles that the broad guiding
principle for determining where income is sourced from is as
enunciated by Lord Bridge in the landmark Privy Council case*,
Commissioner of Inland Revenue v Hang Seng Bank Ltd (1990) STC 733:
“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 activity
carried 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 …”
This article will focus on the developments of Malaysian tax cases and
seek to examine if the Hang Seng Bank principle has been adopted by
the Malaysian courts.
* Refer to page 13 for a summary of the Commissioner of Inland Revenue v Hang Seng
Bank Ltd (1990) STC 733 case
4 Local versus foreign sourced income - A continuous debate
PwC Alert Issue 109, November 2013
Malaysian case laws
The issue of “source” had been
deliberated by the Malaysian
courts from as early as the
1980s with cases such as
ROD Co Ltd v Director General
of Inland Revenue (1990) 1
MSTC 422, and OA Pte Ltd v
Pengarah Hasil Dalam Negeri
(1996) MSTC 2752 in the
1990s.
The issue in the first case was
whether payments for the
rental and hire of a rig made
by a Malaysian company to
ROD Co Ltd (incorporated
in Hong Kong), was taxable
in Malaysia. The Special
Commissioners of Income
Tax (“SCIT”) decided that
the income was derived
from outside Malaysia under
Section 12 of the Act as
central management and
control of ROD Co Ltd was
exercised in Hong Kong. The
decision was upheld by the
High Court.
PwC Alert Issue 109, November 2013
In 1996, the SCIT dismissed
OA Pte Ltd’s appeal against the
assessment of fees received
from a bareboat charter to a
Malaysian company. OA Pte Ltd
(incorporated in Singapore), in
its argument that the fees were
foreign sourced, drew support
for its position by relying on the
ROD decision. The SCIT however,
rejected this argument and
instead applied the broad guiding
principle of the Hang Seng Bank
case in deciding that the income
was derived from the place where
the ship was let, i.e. Malaysia.
The 2000s saw a series of appeals
to the courts against the Inland
Revenue Board’s challenge of the
treatment of income received
by taxpayers as foreign sourced
income: Aneka Jasaramai
Ekspress Sdn Bhd, Cardinal
Health Malaysia 211 Sdn Bhd and
Kyros International Sdn Bhd. All
three cases advanced to the Court
of Appeal, the highest court for
tax appeals under the Act.
Local versus foreign sourced income - A continuous debate 5
Aneka Jasaramai Ekspress
Sdn Bhd
In AJE Sdn Bhd v Ketua
Pengarah Hasil Dalam Negeri
(2001) MSTC 3357, the
taxpayer is in the business of
operating express bus services.
The issue in contention with
the Inland Revenue Board
(“IRB”) was whether income
from the sale of bus tickets in
Singapore for single journeys
from Singapore to Malaysia for
the years of assessment 1990
to 1998 was income accruing
in or derived from Malaysia or
Singapore.
The taxpayer’s appeal was
allowed by the SCIT. Matters
taken into consideration by
the SCIT were the fact that the
contract, sale and payment
of the tickets took place in
Singapore. They also took into
account the interpretation
and application of Sections
3 and 12 of the Act; and the
6 Local versus foreign sourced income - A continuous debate
ambiguity of the legal position
prior to the introduction of
Section 3C (which provided the
specific exemption of foreign
sourced income for the years
of assessment 1995 to 1997),
leading to the SCIT adopting a
position which was favourable
to the taxpayer.
Both the High Court and the
Court of Appeal upheld the
decision of the SCIT. However,
the Court of Appeal’s written
judgement is not available.
Cardinal Health Malaysia 211
Sdn Bhd
Cardinal Health Malaysia
211 Sdn Bhd (CHM), part
of the Cardinal-Allegiance
group, is a manufacturer and
exporter of latex and synthetic
gloves. It invested its surplus
business profits by way of
loans to a related company,
AH BV, a Dutch investment
holding company which acts
PwC Alert Issue 109, November 2013
as a treasury company for the
group. CHM treated the interest
income received from the loans
as foreign sourced income on
the basis that the income arose
from the provision of loans in the
Netherlands. The IRB however,
contended that the interest
income was sourced in Malaysia
as the funds lent were generated
from CHM’s Malaysian business
activities.
The case was decided in the
favour of the taxpayer at all three
levels of judiciary appeal but
there was no written judgement
of the Court of Appeal’s decision.
The SCIT found that this
case clearly fell within the
circumstances envisaged by
Lord Bridge in the Hang Seng
Bank case, i.e. “where profit
was earned from the lending of
money, the profit will have arisen
from where the money was lent.”
PwC Alert Issue 109, November 2013
The High Court in concurring
with the SCIT, concluded that
it was the supply or provision
of credit to AH BV (and not the
source of the credit), that was
the originating cause or source
of the interest received by CHM.
This was further supported
by Watermeyer CJ’s quote
in 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 the
lender 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”
Local versus foreign sourced income - A continuous debate 7
Kyros International Sdn Bhd
The case of Kyros International Sdn Bhd v Ketua Pengarah Hasil
Dalam Negeri (2013) MSTC 30-056 is the most recently decided
Malaysian case on foreign sourced income. Kyros International
Sdn Bhd (“Kyros”), the registered owner of trademark, KYROS,
granted sole and exclusive rights to franchisees in foreign countries
to establish and operate kebab fast food outlets in those countries.
The IRB challenged Kyros’ treatment of the franchise fees as foreign
sourced income as it was of the view that the franchise fees were
derived from Malaysia under Section 12(1)(a) of the Act.
The SCIT concluded that the franchise fees were foreign sourced
income as the business operations of the foreign franchisees took
place outside Malaysia. The SCIT applied the principles established
in the Hang Seng Bank case in concluding that the fees received
from its foreign franchisees were akin to “profit earned ….by letting
of property” where “ …. the profit will have arisen in or derived from
where the property was let ….”.
The High Court overturned the SCIT’s decision as it did not think it
was 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 Court’s decision
as it found that the High Court did not have sufficient reason to
interfere with the SCIT’s finding of facts.
8 Local versus foreign sourced income - A continuous debate
PwC Alert Issue 109, November 2013
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 “birth”
of the broad guiding principle. The courts focused on the place
where business acumen, judgement, intuition, knowledge and
experience were exercised and employed, i.e. where the central and
management control of the business was. Although the facts of the
OA Pte Ltd case are somewhat similar to the ROD Co Ltd case, the
court’s decision in the OA case that the income was sourced from
outside Malaysia was made based on the Hang Seng Bank case.
The courts in the Aneka Jasaramai case did not discuss the Hang
Seng Bank case. They appear to have placed more reliance on
the finding of fact that the activities of the taxpayer were outside
Malaysia, i.e the sale and payment for the bus tickets were in
Singapore, in applying Section 12(1)(a).
Subsequent cases had generally applied the “broad guiding
principle.” In the CHM case, the court found that the originating
cause that produced the interest income was the provision of loans
in the Netherlands. In the Kyros case, the Hang Seng Bank principles
were also considered and applied by the Courts. The SCIT found in
favour of the taxpayer based on the finding of fact that the operations
of the foreign franchisees took place overseas. In making the decision,
the operations of the franchisor were not examined.
PwC Alert Issue 109, November 2013
Local versus foreign sourced income - A continuous debate 9
A variation of the broad
guiding principle?
In considering the source of income especially income from
intellectual property, the case of Commissioner of Inland Revenue v
HK-TVB International Ltd (1992) STC 723 should be reviewed. It is
another Hong Kong case which was decided by the Privy Council
after the Hang Seng Bank case.
The issue deliberated in this case was whether sub-licence fees
received by HK-TVB International Ltd (HK-TVB), from its customers
abroad were taxable in Hong Kong. HK-TVB (incorporated in
Hong Kong) was granted by its parent company the rights to grant
sub-licences for Chinese dialect video films to others to exploit the
derivative rights in the films. HK-TVB granted the sub-licences to
customers abroad in consideration of fixed sums (which may be
10 Local versus foreign sourced income - A continuous debate
PwC Alert Issue 109, November 2013
agreed abroad) paid in Hong
Kong. In carrying out the
sub-licensing business, HKTVB may send representatives
abroad to solicit customers. The
sub-licence agreements were
prepared in Hong Kong and
sent abroad for the customer’s
signature or signed by both
parties abroad.
The approach adopted by the
Privy Council in this case was
not exactly the same as the
approach taken in the Hang
Seng Bank case. Instead, the
Hang Seng Bank broad guiding
principle was expanded as
follows:
“The proper approach is
to ascertain what were the
operations which produced
the relevant profits and
where those operations took
place.”
PwC Alert Issue 109, November 2013
Applying the above test, the Privy
Council held that the sub-licence
fees were taxable in Hong Kong
as “the relevant business of the
company was the exploitation
of film rights of exercisable
overseas and it was a business
carried on in Hong Kong.”
It is interesting to note that
the Privy Council dismissed
HK-TVB’s analogy between the
licensing of intellectual property
rights abroad and the letting
of property (per Lord Bridge
in the Hang Seng Bank case).
The reason for this was that
intellectual property does not
have a situs similar to immovable
property. More food for thought
- The Privy Council was also of
the view that while the profitmaking activity of the sublicensees was carried on outside
Hong Kong, the grant of the sublicenses took place in Hong Kong
where the company operated.
An analysis of both the Hang
Seng Bank and HK-TVB cases
seems to differentiate the
tests adopted – a focus on the
specific transaction (in the
Hang Seng Bank case) versus
operations (in the HK-TVB
case), that gave rise to the
income in question. It is noted
that the HK-TVB decision was
not discussed and distinguished
in the Kyros case.
Local versus foreign sourced income - A continuous debate 11
Conclusion
The determination of the source of income is a complex and
contentious area of law. It is observed that the Malaysian courts
have generally applied the broad guiding principle of the Hang
Seng Bank case. However, in applying case precedents, our specific
legislation should be considered e.g. the deeming provision under
Section 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 be
considered separately in determining the tax treatment to be
adopted. The continuous development of cases taken to the courts
both overseas and in Malaysia, indicates that the concept of source
of income is indeed difficult and often open to interpretation. With
this, the debate on this issue will continue.
12 Local versus foreign sourced income - A continuous debate
PwC Alert Issue 109, November 2013
Appendix
Commissioner of Inland Revenue v Hang Seng Bank
Ltd (1990) STC 733
Hang Seng Bank Ltd carried on its banking business in Hong Kong. It invested its
excess holdings of foreign currencies in certificates of deposit (CDs) in Singapore
and London. These CDs were normally sold before maturity. The Singapore and
London banks would give instructions for the purchase and sale of the CDs. The
required funds for these transactions were debited and credited to the bank’s
accounts with other overseas banks.
The issue was whether the bank was liable to profits tax on the profits arising
from the purchase and sale of the CDs.
The Privy Council held that the income was not taxable in Hong Kong. In
arriving at this conclusion, Lord Bridge had outlined a broad guiding principle in
determining the source of an income:-
“But the question whether the gross profit resulting from a particular
transaction 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 CDs
in the Singapore and London markets and hence the income was not derived
from Hong Kong.
PwC Alert Issue 109, November 2013
Local versus foreign sourced income - A continuous debate 13
Let’s talk
If you would like further information in relation to the issues outlined
earlier, please call the Corporate Tax senior executive directors and
executive directors of PricewaterhouseCoopers Taxation Services Sdn Bhd:
Kuala Lumpur
Jagdev Singh
+60(3) 2173 1469
[email protected]
Lim Phaik Hoon
+60(3) 2173 1535
[email protected]
Wan Heng Choon
+60(3) 2173 1488
heng [email protected]
Jennifer Chang
+60(3) 2173 1828
[email protected]
Pauline Lum
+60(3) 2173 1059
[email protected]
Clifford Yap
+60(3) 2173 1446
[email protected]
Steve Chia
+60(3) 2173 1572
[email protected]
Dorothy Ooi
+60(3) 2173 1444
[email protected]
Lorraine Yeoh
+60(3) 2173 1499
[email protected]
Fung Mei Lin
+60(3) 2173 1505
[email protected]
Phan Wai Kuan
+60(3) 2173 1589
[email protected]
Penang / Ipoh
Khoo Chuan Keat
+60(3) 2173 1368
[email protected]
Frances Po
+60(3) 2173 1618
[email protected]
Heather Khoo
+60(3) 2173 1636
[email protected]
Lavindran Sandragasu
+60(3) 2173 1494
[email protected]
Margaret Lee
+60(3) 2173 1501
[email protected]
SM Thanneermalai
+60(3) 2173 1582
thanneermalai somasundaram@
my.pwc.com
Theresa Lim
+60(3) 2173 1583
[email protected]
14 Local versus foreign sourced income - A continuous debate
Teh Wee Hong
+60(3) 2173 1595
[email protected]
Tony Chua
+60(4) 238 9118
[email protected]
Johor Bahru
Benedict Francis
+60(7) 222 4448
[email protected]
Melaka
Teh Wee Hong
+60(3) 2173 1595
[email protected]
Labuan
Jennifer Chang
+60(3) 2173 1828
[email protected]
PwC Alert Issue 109, November 2013
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