One of the tax cases which have caught the attention of property developers in recent years is the case of Prima Nova Harta Development Sdn Bhd ["Prima Nova"]. The case concerns the tax deductibility of payments made to the State Authority for the release of Bumiputra quota.
We wish to bring to your attention the background and latest development of the Prima Nova case which would be of interest to you.
Background Facts
On 14th December 2006, Prima Nova applied to the Selangor Land and Mines Office ["SLMO"] to reduce the Bumiputra quota for their development project in Selangor. Prior to obtaining an approval from SLMO, Prima Nova has sold the subject Bumiputra units to non-Bumiputra. On 6th February 2007, SLMO partially approved Prima Nova's application subject to Prima Nova paying to the State Government (through Lembaga Perumahan dan Hartanah Selangor) a penalti/denda totalling 12%/15% on the selling price per unit which consists of:
| (a) |
Bumiputra discounts of 7% or 10% ["Discount"]; and |
| (b) |
Fine for non-compliance with the requirement imposed by the State Authority ["Fine"]. |
On 18th August 2015, SLMO waived the Fine portion of the required payment by Prima Nova.
The expenditure in dispute refers to the sum paid by Prima Nova to the State Authority of Selangor which represents the Discount portion (7%) where a claim for tax deduction was made by Prima Nova in the year of assessment ["YA"] 2010 and YA 2011.
Parties' Contentions
The Inland Revenue Board ["IRB"] referred to SLMO's Circular No. 3/2007 and contended that the Discount was part of the penalty imposed by the State Authority for not complying with the Bumiputra quota prior to the approval (i.e. selling Bumiputra units to non-Bumiputra without SLMO's approval). The Discount was a penalty or pecuniary punishment. It was not allowable for tax deduction under Section 33(1) of the Income Tax Act 1967 ["the Act"] (i.e. not incurred wholly and exclusively in the production of gross income) and prohibited under Section 39(1)(b) of the Act (i.e. not being money wholly and exclusively laid out or expended for the purpose of producing the gross income).
Prima Nova, on the other hand, contended that the Discount was not a penalty (unlike the Fine), but a payment made to obtain SLMO's approval to sell Bumiputra units to non-Bumiputra. The Discount was wholly and exclusively incurred in the production of income and shall be allowable for tax deduction under Section 33(1) of the Act.
Special Commissioners of Income Tax's Decision
The Special Commissioners of Income Tax agreed with the IRB's contention and dismissed Prima Nova's appeal.
High Court's Decision
The High Court agreed with Prima Nova's contention and found, among others, that the Discount was incurred to enable Prima Nova to sell the unsold Bumiputra units to non-Bumiputra, which was closely connected to Prima Nova's business as a property developer. Had Prima Nova not paid the Discount, they would not have been able to generate income from the unsold Bumiputra units. The Discount was therefore wholly and exclusively incurred in the production of gross income and tax deductible under Section 33(1) of the Act.
Court of Appeal's Decision
The IRB appealed to the Court of Appeal against the High Court's decision. On 21st September 2021, the Court of Appeal allowed the IRB's appeal and overturned the High Court's decision. The Court of Appeal has not furnished their grounds of judgment to date. Nevertheless, given the limited issues raised in the case, it may be assumed that the Court of Appeal in allowing the appeal has agreed with the IRB's submission that the Discount paid by Prima Nova is a penalty that is not tax deductible.
Our Comments
One of the distinct facts to be noted in the Prima Nova case is that the Discount was imposed in respect of Bumiputra units sold to non-Bumiputra prior to obtaining the approval from the State Authority. The Discount was contended by the IRB as being part of the penalty set out in the SLMO's Circular No. 3/2007 for non-compliant developers.
Nevertheless, based on the IRB's submission in the Prima Nova case as well as other on-going tax cases involving payment made for the release of Bumiputra quota, compliant developers (i.e. those who obtained approval before selling Bumiputra units to non-Bumiputra) would also be required to pay the Discount in the form of contribution to the State Authority and may not be able to escape from the same fate as non-compliant developers.
At this point, it is expected that the IRB would take the following stance:
| (a) |
Discount plus Fine paid to State Authority for selling Bumiputra units to non-Bumiputra before obtaining approval from the State Authority: |
| |
| (i) |
Regarded as penalty not wholly and exclusively incurred in the production of gross income and hence, not tax deductible; |
| (ii) |
Supported by the Court of Appeal's Decision in the Prima Nova case. |
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| (b) |
Discount (contribution) paid to State Authority for selling Bumiputra units to non-Bumiputra after obtaining approval from the State Authority: |
| |
| (i) |
Regarded as capital expenditure for the right to sell Bumiputra units and hence, not tax deductible (there are on-going tax cases disputing on this treatment); |
| (ii) |
May be allowed for deduction under Section 44(6) of the Act if the contribution made to the State Authority fulfills the test of "gift" (this has yet to be tested in Courts). |
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Please feel free to approach our engagement team if you wish to discuss further on the above. In the meantime, as the Discount and/or Fine paid to the State Authority for the release of Bumiputra quota may not be apparent from the audited financial statements and/or management accounts, we would appreciate it if you could kindly bring to our engagement team's attention should your company has incurred such expenses.