Income tax within the Malaysian tax environment

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Income tax is a very broad subject which it can be differentiated into several categories. Income tax is a crucial source of income for government to undertake the development of a country. As a developing country, Malaysia also implements income tax in law where there are two main agencies responsible to collect the taxes. The agencies are The Inland Revenue Board and The Royal Custom and Excise Department. There are various taxes applicable to individuals, partnerships and limited companies, for example, sales tax and service tax are applicable for business income and they are collected by The Royal Custom and Excise Department. The Malaysian tax environment will be discussed further below.

1.1 The Malaysian Tax Environment

Malaysian tax environment is governed by The Income Tax Act 1967. A transaction must fall within the ambit of 'scope of charge' to be liable to income tax. Otherwise, it is tax free. Section 3 of the Act provides:

'' subject to and in accordance with this Act, a tax to be known as income tax shall be charged for each year assessment upon the income of any person accruing in or derived from Malaysia or received in Malaysia from outside Malaysia."

The Act does not define an 'income' but instead categories the income under section 4 and section 4A. These two sections are being used in determining the sources of income of the taxpayer.

1.1.1 Scope of charge

Income tax shall be charged for each year assessment upon the income of any person that chargeable to pay tax. Under section 3, there are two conditions that income tax liability arises which are:

The income of any person accrue in or derived from Malaysia

This means an income will be subject to Malaysia tax if the source of income is in Malaysia.

The income of any person from outside Malaysia ( foreign source income)

In this source of income, a foreign source of income would not be subjected to Malaysian tax, unless that foreign income has been remitted to Malaysia and received by a resident individual (with effective from year of assessment 2004, such income is exempt from tax)

However, there is income that is not charged to income tax in respect of:

Any offshore company that carrying on an offshore business activity.

This exemption is includes in section 3B of the Act. According to Fatt (2009), the law governing the tax for such offshore business activity is the Labuan Offshore Business Activity Tax Act, 1990 (LOBATA 1990). This income is not chargeable to income tax unless an election is made to assess under income tax.

Any income received by a Malaysian resident company from outside Malaysia (with effect from year assessment in 1995).

Exempt dividend can be distributed from such foreign income, which is received in Malaysia by a resident company. However, where a person is not a resident for a basis year of assessment, income arising from sources outside Malaysia and received in Malaysia will be exempted from income tax.

1.1.2 Source of income

Section 4 of the Income Tax Act 1967, has listed down the classes of income which chargeable to income tax in respects of:

Section 4 (a) Gains or profits from a business, for whatever period of time carried on

Section 4 (b) Gains or profits from an employment

Section 4 (c) Dividends, interest or discounts

Section 4 (d) Rents, royalties or premiums

Section 4 (e) Pensions, annuities or other periodical payments not falling under any of the foregoing paragraphs

Section 4 (f) Gains or profits not falling under any of the foregoing paragraphs

1.2 The Nature and Purpose of Taxation

Tax is very important and taxpayer should pay in particular year assessment based on the group of the taxpayer. The nature of taxation is certain percentage of a person earning will be taken by the government for tax purpose. The percentage is affordable for the people and government never charge more than that. In taxation, there are 2 types group of tax which is Direct and Indirect tax. Direct tax is directly paid to the IRBM such as Income Tax. There will be no third party involve to collect the tax. Meanwhile indirect taxes involve the third party to collect tax such as service tax, sales tax and excise duty. For example we take service tax. We can see how the service tax working clearly usually at the fast food restaurant such as Mc Donald. Mc Donald restaurant is on behalf of government and the tax will be collected by the Mc Donald restaurant or the service provider. Both types of tax are the most important source of government revenue. Income tax is always treated as contribution for the benefits received that provided by the government such as medical centre to the people. However, they are not paid in exchange for some specific thing, such as the sale of public property.

The purpose of taxation is to develop the country by using the tax received. In other words, it funds the government spending for different purposes. For example, the government gives certain amount of tax revenue to the Ministry of Health to manage and spend it in the best way for their medical treatment, to buy medicines, improve medical technology and to help people. These benefits are enjoyed by public citizens and gives positive impact on their daily life. The same goes to other benefits enjoyed by citizens such as good infrastructure. The tax revenue is used to develop the infrastructure in the country such as to repair some public road or add another highway for easier way to go to other destination. These improvements are relying on Public Works Department. Public transport also important for the people and this responsibility rely on the Ministry of Transport. They build the airport for air transportation and port for the sea transportation. Good transport systems will show that Malaysia is developing positively. Other purpose of taxation is the government spend the money from tax revenue to subsidize students for higher level education in public universities. The money spend on this purpose are very helpful for the poor to get proper education and develop intellectual nation. All these improvements are based on the tax revenue paid by the citizen.

2.0 Answer to scenario 1- Income tax computation for Encik Daniel

Based on the scenario given, Encik Daniel is an employee where he currently working for his friend's company as a director. He is a taxable person since he obtains annual income more than RM25, 501. Thus Encik Daniel is entitled to pay employment income under section 4(b) income.

In January 2009 until 30th June 2009, Encik Daniel was worked with private company and earned RM60, 000 gross salaries after deducting EPF contribution of 11% and tax of RM300. The calculation is as follows:

W1: Gross salary = RM8600 + RM300/0.89

= RM60, 000

In Encik Daniel's case, he is exempted from gratuity of RM100, 000 that he receives upon retirement because of fulfilling the conditions of gratuity exemption that effective 2007 onwards. The conditions are retirement, age of 55 and he has been working for the company more than 10 years. The exemption of gratuity is state under Para 25, 25A, 25B of Sch 6.

According to Income Tax Act 1967, under s 13(1)(b), watch is treated as a gift which is exempted from tax where it is mere present and not income in nature. The same goes to mobile phone which was provided by his employer while he is working for the second company starting 1 August 2009. For furnishing under a semi-furnished house, Encik Daniel receives RM160 monthly. But the value of benefits is up to RM140. Thus, the calculation is as follows:

W2: Furnishing = RM140 x 4months (1 January 2009 - 30 April 2009)

= RM560

Medical expenses that Encik Daniel receives which provided by his employer is exempted where this benefit is effective from year assessment 2008.

For holiday package which treat under leave passage, the tax exempt subject to the limits of RM3000. This means that, the air fare is taxable after deducting RM3000 and the amount taxable is RM10, 000 (W3: RM13, 000 - RM3000). According to Income Tax Act 1967, accommodation is not taxable due to the phrase 'leave passage for travel' quote under Act 591/98 which only restricted to cost of passage such as air fares, insurance and transit costs.

According to Income Tax Act 1967, under s 13(1)(c) , accommodation provided by the employer is taxable based on the lower amount of defined value of living accommodation or 30% of Encik Daniel's gross income under s 13(1)(a) [s 32(2)]. Thus, the calculations are as follows:

W4: Defined value of living accommodation = RM1, 200 x 4months (1 January 2009 - 30 April 2009) = RM4, 800

30% of Encik Daniel's gross income = 30% x RM 60, 000 x 4/6

= RM12, 000.

For unapproved fund under s 13(1)(d) income, the amount assessable would be RM50, 000 (W4) which comes from RM40,000 of the employer contribution and RM10,000 of the interest earned. Amount contributed by Encik Daniel is capital in nature and would not be taxed.

For the second company that Encik Daniel currently working with, he will be assessed under section 4(b) employment income as a director. Since he started working with the company started 1 August 2009, the months involved in calculating his income is going to be 5 months which is applicable until the end of year 2009. Thus, the director fees and entertainment allowance that he receives monthly under s 13(1)(a) income will be multiply by 5.

Under s 13(1)(b), company car that Encik Daniel receives costing RM140,000 which according to prescribed method for motor vehicle table, the annual value of private usage of the car fall under RM5,000. No is no fuel provided and the calculation is done as follows:

W5: RM5, 000 x 5/12 months = RM2, 083.

Other than that, Encik Daniel also was provided a driver which according to Income Tax Act 1967, the provision of driver is RM600 per month. This benefit is calculated effective from 1 August 2009 until 30 December 2009. Thus, the provision of driver for the year assessment 2009 is RM3, 000 (W6). Meanwhile the provision for domestic servant and gardener that provided to Encik Daniel, the amount is RM400 and RM 300 a month respectively even though the salary they receive is more than that. The calculation is as follows:

W7: Domestic servant = RM400 x 4 months (effective from 1 September 2009)

= RM1, 600

W8: Gardener = RM300 x 4 months (effective from 1 September 2009)

= RM1, 200

Under s 13(1)(c) , accommodation in a hotel with daily room rate of RM250 that provided for Encik Daniel in August is calculated as flows:

W9: RM250 x 31 days = RM7, 750 (the 30% is not applicable because Encik Daniel is not a service director)

Meanwhile for unfurnished house provided for Encik Daniel on 1 September 2009, the monthly rental benefit that he receives is RM8, 000. (RM2, 000 x 4 months)(W10).

2.2 Income Tax Computation for Puan Sara

Puan Sara's income basically depends on rental income which falls under section 4(d) income. Annual rental income for Puan Sara is RM10, 800. This rental income will be deducted with the expenses incurred in 2009. Below is the income tax computation for Puan Sara.

2.3 Details about submitting and payment of income tax by Encik Daniel and Puan Sara

Based on the information provided by Inland Revenue Board of Malaysia (IRBM) the details are as follows:

The dateline for submitting Encik Daniel's tax return for the year of assessment 2009 is 30th April 2010.

The tax payments of Encik Daniel's employment income will be deducted by the employer under Scheduler Tax Deduction (STD).

The due date for paying the balance of any tax due is 30th April 2010.

The timeframe for a valid appeal against an assessment is 30 days.

In case of an appeal Encik Daniels appeal will be forwarded for determination to Special Commissioner of Income Tax.

BE form can be viewed at the end of this task.

2.4 Recommendation on tax planning opportunity available for Encik Daniel and Puan Sara to minimize the tax payable legally

The tax planning opportunities provided in the scenario is Puan Sara can elects joint assessment where Encik Daniel and her income can be combined together and the tax computation will be done based on the aggregate total income. Based on the tax computation for joint assessment that we have done above, we found that the tax payable is lesser compare to separate assessment for Encik Daniel and Puan Sara. The different between these two assessments is RM 134. This means that both of them can save RM 134 if Puan Sara elects for joint assessment. In addition, if they go for separate assessment, the chargeable income for Puan Sara appeared negative. This shows that, she can save the money if she elects joint assessment.

2.4.2 Make use of the personal reliefs available

In order to minimize the income tax legally, Encik Daniel can make use of the personal reliefs where he can claim for:

Medical expenses for his parents.

This expense is limited to RM5, 000. Instead of using only RM4, 500, Encik Daniel should use it up to RM5, 000. It is important for his parents to get better medical services since they become older and the chances of getting unhealthy is high.

Education fees.

For continuous learning and improvement, we think that Encik Daniel should continue his study for higher level of education since he already involve in business. For his age, self actualization is important for him as he already achieve the other needs. By doing this, Encik Daniel can make use of the relief up to RM5, 000.

Purchase of books, journals and magazines.

Encik Daniel should buy more books and make use of the relief up to RM1, 000. He can buy books and journals for his children that still studying. Journals are very good sources of information and Encik Daniel should read it a lot to maximize his general knowledge.

Amount deposited into Skim Simpanan Pendidikan Nasional (SSPN).

Encik Daniel has a 16 years child which still studying in secondary school. It is useful if Encik Daniel deposit amount of money in this scheme as an early step for preparing his child for higher level education. If Encik Daniel uses this scheme, RM3, 000 of the chargeable income is allow to be deducted.

Purchase of sports equipment.

As Encik Daniel become older, it is significant for him to keep fit and healthy. He should involve in sports such as badminton, tennis and jogging. To do this, suitable sports equipment such as shoes is important. He should buy the sports equipment up to RM300, so that the amount can be deducted from his chargeable income for tax purpose.

If Encik Daniel makes use the above reliefs for year assessment 2009, he can save up RM2, 402. It is much more than doing joint assessment. We recommend Encik Daniel to choose this method as the tax planning opportunity to minimize the income tax. The tax computation will be as follow:

3.0 Partnership

According to Fatt (2009), a partnership is defined as an association of any kind between parties who have agreed to combine any of their rights, powers, property, labour or skill, for the purpose of carrying on a business and sharing the profits therefrom. These combination results in rights and partners usually hold their own ratio for sharing profits and loss

Partnership is under section 2 of the Act. It defines 'person' to include a company, a body of person and a corporation sole. So, there are some following factors need to be present before a partnership is said to exist which is carrying on business, distribution of rights and responsibilities, a view to profit and element of risk and reward for each partner. However, partnership may also exist without ''partnership agreement" which it also can be in verbal but the risk is on their responsibilities. Fatt added that partnership is not a chargeable person for income tax purpose

3.1 How the partnership is taxed

Partnership is taxed individually where profits made are added to the individual's personal income and are individually liable for the profit under personal income tax. This means that tax will be charged to the individual partners in their share of business income and will be taxed on their own names. Partners that are mention here is refer to individuals or companies. Thus, partners will pay income tax on their business activities and other income sources at the valid personal tax rate for the particular year assessment.

The assessment of partnership business income is divided into three categories which are provisional adjusted income, divisible income, and adjusted income of partner.

Provisional adjusted income

According to Fatt (2009), a partnership is presumed to be a sole proprietorship for the purposes of computing partnership adjusted income which also known as 'provisional' adjusted income. They are deductable expenses and non-deductable expenses in the profit and loss account for provisional adjusted income.

Divisible income

For divisible income, the income and capital allowances are computed base on the profit sharing ratio as their agreed in the partnership agreement. According to scenario 2, Ng and Siow shared profits equally up to 31 March 2006. However, from 1 April 2006, they change the profit sharing ratios to 60% for Ng and 40% for Siow. Because of the changes in their profit sharing ratio occurred during 1 April 2006, an apportionment of divisible income on the time basis will be carried out. Double deduction is allowed by government for divisible income.

Adjusted income of partner

If divisible income is divided among partners based on their respective profit sharing ration, partner's expenses such as private expenses in adjusted income of partner would be allocated to the respective partner in accordance with their actual consumption. According to scenario 2, 20% of private use of the car will be allocated under Siow partnership expenses account.

3.2 The Computation of the Total Income for Each Partner for the Year Assessment 2006

Below is the Profit and loss account of the partnership for the year ended 31 December 2006.

3.3 Explanation Regarding the Above Computation

1.1.2006 - 31.03.2006 (3Months)

According to the partnership agreement, Ng and Siow has a shared profit equally up to 31 march 2006. From 1st April 2006, the shared ratio has changed to 60% for Ng and 40% for Siow.

Moreover, Siow has use of a car owned by the company for private expenses. Thus, Siow has amounted to 20% for private use car. From the 2,400 Ng and Siow has to divide by 4 because the computation has provided 3months of each partner income.

Private use of car =

12,000 x 20% = 2,400

Interest of capital per annum for Ng and Siow is RM 10,800. To Ng, interest of capital for 31 December 2006 that he has to pay is RM6,000 per annum and to Siow, he has to pay RM4,800 per annum. In first computation of each partner income, Ng and Siow, has to pay the interest of capital by divide by 4 because the computation has provided 3months of each partner income.

= 1,20

According to Income Tax Computation for NS Educational Partnership Year Assessment 2006, the total divisible income is RM160,000. Meanwhile, the sharing ratios in the first 3month of the year are equally, so we have to divide equally to Ng and Siow.

1.4.2006 - 31.12.2006 (9Months)

Private expenses for each partner at 1.4.2006 - 31.12.2006 (9Months) is 1,800 because has to minus with the 3 months.

Private expenses: Ng 2,400-600 = 1,800

Siow 2,400-600 = 1,800

Salaries for each partner for the year ended 31 December 2206 should minus with the answer of 3 months because want to know the balance of the salaries at 1.4.2006 - 31.12.2006.

Salary: Ng 90,000 - 22,500 = 67,500

Siow 60,000 - 15,000 = 45,000

Interest on capital for each partner for the year ended 31 December 2206 should minus with the answer of 3 months because want to know the balance of the salaries at 1.4.2006 - 31.12.2006.

Interest on capital: Ng 6,000 - 1,500 = 4,500

Siow 4,800 - 1,200 = 3,600

The total divisible income 160,000 minus 40.000 from the 3 months and after get the answer we should divide that for each partners.

Divisible income: 160,000 - 40,000 = 120,000

Ng: (120,000/5) x 3 = 72,000

Siow: (120,000/5) x 2 = 48,000

From the scenario has an approved donation is 13,000. And the approved donation also should divide for each partner.

Approved donation: Ng: (13,000/5) x 3 = 7,800

Siow: (13,000/5) x 2 = 5,200

From the scenario has an annual allowance is 9,000. And the annual allowance also should divide for each partner.

Annual allowance: Ng: (9,000/5) x 3 = 5,400

Siow: (9,000/5) x 2 = 3,600

4.0 Research on Tax Planning Opportunities for Individual with Business Income

It is important for the taxpayers to aware of the options available to them in order to maximum the benefits in running the business and at the same time can minimize the tax payable legally. To minimize, eliminate or defer the income tax, the source of income must fall within the ambit of the law which is the Act. According to Victor (2010), since revenue expenditure is usually absorbed in the period in which it is incurred, it is usually an allowable expense that a business can write off against its chargeable income.

According to the case study, NS Education participates in a trade exhibition that was approved by MATRADE for the purposes of promoting the export of the partnership's services. This means that they are planning to expand the business overseas by offering their services broadly. In order to export their services, there are many things to be done such as export the resources from Malaysia to outside country in order to set up their business. First thing first, they have to make sure that all documents and resources being export are safe during the exportation. To do that, insurance is needed. Insurance is revenue expenditure as it represents an expense wholly and exclusively incurred in the production of gross income. Let say NS Education will be operated in Australia. This means that they have two choices whether to buy the insurance in Malaysia or Australia. In order to minimize the tax, we recommend NS Education to buy the insurance from Malaysia rather than Australia because the Income Tax Act 1967 allows double deduction for this expense.

Other tax planning opportunity is the commencement of the business must be done before the expenses incurred. Expenses can be in the form of hire employees to renovation, as long as the expenses are wholly exclusively incurred in the production of income. This is because these expenses are deductable against the gross income.

Other than that, individual with business income can go for training or courses to improve the skills in running the business. This expense is also deductable at the time of commencement.

4.1 Conclusion

As a conclusion, income tax gives a lot of benefits to the citizens and help developing the country. Income taxes which come from business sources is considered much more compare to the employment income. Both computations involve different calculation and adjustment, so that all the taxes collectable are affordable by the people.