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Abstract
Judicial review - reinvestment allowance - definition of manufacturing
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The latest tax case that has made the round last week was the High Court's decision to allow Tenaga Nasional Berhad's ["TNB"] judicial review application to quash a RM1.8 billion tax bill issued by the Inland Revenue Board ["IRB"]. The case concerns the IRB's decision to disallow TNB from claiming reinvestment allowance ["RA"] under Schedule 7A of the Income Tax Act 1967 ["ITA"].
Background Facts
TNB claimed RA on expenditure incurred to purchase certain items (e.g. transmission lines, transformer, cables, lines, capacitor, switchgear and substation) ["Disputed Items"] in the year of assessment ["YA"] 2018. The IRB disallowed the TNB's claim for RA on the Disputed Items on the basis that TNB is not involved in manufacturing activity within the context of Schedule 7A of the ITA.
On 13th July 2020, the IRB issued a notice of additional assessment to TNB demanding for payment of additional taxes of approximately RM1.8 billion. TNB then proceeded to challenge the additional assessment by way of a judicial review application at the High Court.
The Law
Schedule 7A of the ITA provides that a company is entitled to claim RA on expenditure incurred for the purpose of a qualifying project. The term qualifying project is defined under Paragraph 8(a) of Schedule 7A of the ITA as:
"a project undertaken by a company, in expanding, modernising or automating its existing business in respect of manufacturing of a product or any related product within the same industry or in diversifying its existing business into any related product within the same industry."
At the material time when TNB first claimed RA in the YA 2003, the term manufacturing was not defined in Schedule 7A of the ITA. The definition was only inserted under Paragraph 9 of Schedule 7A of the ITA effective YA 2009.
Parties Contentions
In essence, TNB submitted that they are eligible to claim RA on the Disputed Items as they are in the business of manufacturing electricity. They referred to various legal authorities to contend that generating, transmitting and distributing electricity should be characterized as manufacturing electricity, including making reference to the case of Majlis Perbandaran Seberang Perai v. Tenaga Nasional Berhad where the Federal Court has settled that TNB is in the business of manufacturing electricity. They also submitted, among others, that the term manufacturing should not be construed narrowly.
The IRB, on the other hand, cited Paragraph 9 of Schedule 7A of the ITA and submitted that the activity of generating, transmitting, distributing and selling electricity does not fall within the definition of manufacturing within Schedule 7A of the ITA. This is because there is no conversion of material into a new product by changing the composition - the electrical composition remains and has no changes. The activity merely involves extraction of electricity. It is the IRB's contention that TNB is carrying out utility services (or an approved service) and therefore, should have claimed for Investment Allowance under Schedule 7B of the ITA (and not RA under Schedule 7A of the ITA).
High Court's Decision
On 8th February 2022, upon hearing both parties, the High Court allowed TNB's judicial review application and quashed the additional assessment. The High Court has not issued any written grounds for its decision. Nevertheless, based on the comments made publicly by TNB's solicitors, the High Court gave the following broad oral grounds when delivering its decision:
| (a) |
TNB's distribution project consists of installation of new lines and substations to increase capacity for distribution to new areas; |
| (b) |
TNB cannot be said to be a utility or service provider company per se. It has expanded and diversified its business activity into manufacturing for it has to. Otherwise, the distribution of electrical supply in this country will never attain efficiency; |
| (c) |
Citing the case of Canada (Deputy Minister of National Revenue, Customs and Excise-MNR) v Quebec (Hydro-Electric Commission); and |
| (d) |
The definition of manufacturing that came into effect from the YA 2009 cannot be imposed on TNB since TNB has vested its right by virtue of its first claim of RA in the YA 2003 (before the enactment of the definition of manufacturing). |
Our Comments
Based on the submissions filed by both parties, we note that the main issue in dispute is on the meaning of manufacturing (i.e. whether generating electricity can be construed as a manufacturing activity). In defining the term, the Court:
| (a) |
relied on the judgment in the Canada case which, in essence, provides that the electrical energy produced is not a commodity which is ordinarily used by or sold to its customer until it has been transformed. The act of turning electrical energy into a form that can be used by the customer must be considered to be part of the manufacture and production of electricity; and |
| (b) |
disregarded the definition of the term manufacturing provided under Paragraph 9 of Schedule 7A of the ITA, as the first RA was claimed in the YA 2003 prior to the incorporation of such definition in the ITA which only took effect from the YA 2009. |
It appears that the High Court has decided on the TNB case based on its particular set of facts (i.e. generating electricity, and first RA claimed before the YA 2009). The decision may not be relevant to other cases involving the generation, transmission, or distribution of other types of energy, or RA first claimed in the YA 2009 and beyond.
In any event, kindly note that the High Court's decision in the TNB case is not final as the IRB has on 8th February 2022 filed an appeal against the decision delivered by the High Court. We will continue to monitor the developments and provide further updates when necessary. In the meantime, please feel free to approach our engagement team if you wish to discuss further on the above.