Member Article

Faced with the current Covid-19 pandemic and the consequential economic ramifications, it is inevitable that affected businesses are put under increasing financial strain. Affected businesses would at some point consider a restructuring of the business to manage the tide and stay afloat, with the last resort being liquidation for businesses operating in industries that are the most impacted by this pandemic.

As business operations slow down or come to a halt, a business restructuring could take place by reducing headcount, for example. In such cases, subject to applicable employment laws, contractual terms and company policy, certain sums of money would generally be disbursed to affected staff and employees as a form of monetary compensation or benefit for sudden or early termination.

Under section 33(1) of the Income Tax Act 1967 (“ITA”), all outgoings and expenses wholly and exclusively incurred during a specified period by the business in the production of gross income from a source is deductible. From a plain reading of section 33(1) of the ITA, the requirements to be satisfied are twofold:

1. expense/(s) wholly and exclusively incurred; and
2. production of gross income

The applicability of this statutory principle of deductibility had been the subject of many disputes and would essentially depend on the facts of the case.

The tax treatment regarding retrenchment benefits was considered in the case of Ampat Tin Dredging Ltd v Director General of Inland Revenue¹(Ampat Tin).

Mohamed Azmi J held that retrenchment benefits paid to the company’s employees before a winding up of its business could not be said to have been “wholly and exclusively incurred in the production of gross income” within the ambit of section 33(1) of the ITA on the reasoning that the retrenchment benefits were not exclusively incurred in the production of income.

On the facts, there were two agreements with trade unions which expressly stated that the benefits were to be given if the employees were retrenched due to closure of the tin mine. Therefore, the retrenchment benefits were not made exclusively to produce income but pursuant to the closure of business.

Mohamed Azmi J in Ampat Tin made a distinction between employee wages and retrenchment benefits, the former being deductible:

In the present case, for work done, all the company’s employees were paid salaries or wages for which deduction had been allowed. At the most, the retrenchment benefits expended can only be said to be related to the production of income but not exclusively in the production of income.

The deductibility of expenses incurred with a view to liquidate the company and retrenchment benefits was considered by the High Court in Ketua Pengarah Hasil Dalam Negeri v International Foods Sdn Bhd²(International Foods). A feasibility study was conducted by the respondent’s (International Foods Sdn Bhd) parent company which led to International Foods Sdn Bhd’s retrenchment exercise 16 days before the voluntary liquidation of the respondent.

Azmel J held that the efficiency study was not wholly and exclusively for the purpose of enhancing the efficiency of International Foods Sdn Bhd and thereby increasing its income generating capacity as there was another purpose of the efficiency study undertaken, which is to liquidate International Foods Sdn Bhd.

Azmel J held that as International Foods Sdn Bhd was placed in voluntary liquidation 16 days after the feasibility study, the irresistible conclusion to be derived is that the retrenchment exercise was done for the benefit of International Foods Sdn Bhd’s successor (acquirer) which is a completely different legal entity who took over the business of International Foods Sdn Bhd. On the facts, Azmel J concluded that the intention of carrying out the efficiency study was to facilitate the takeover of International Foods Sdn Bhd by its acquirer.

On the deductibility of retrenchment benefits, Azmel J in International Foods applied the principle established in Ampat Tin and held that the retrenchment benefits are not deductible.

The factors considered by Azmel J in concluding that the retrenchment exercise was done for the benefit of International Foods Sdn Bhd’s acquirer (instead of production of International Foods Sdn Bhd’s gross income) include:

1. the timing of the retrenchment exercise that was very close to the date of the takeover exercise of International Foods Sdn Bhd by the acquirer;
2. the liquidation of International Foods Sdn Bhd was voluntary;
3. the intention for which the retrenchment expenses were incurred was not for the production of gross income of International Foods Sdn Bhd;
4. the intention of incurring the efficiency study leading to the retrenchment expense was to liquidate International Foods Sdn Bhd and for International Foods Sdn Bhd’s business be taken over by the acquirer; and
5. the intention to liquidate International Foods Sdn Bhd existed well before the efficiency study was conducted.

The two cases above show that the facts of each case played pertinent roles in the final decision reached by the courts.

In deciding whether an expense is incurred wholly and exclusively in the production of income, the purpose or intention for which an expense is incurred would be taken in account and is an indicator of whether an expense satisfies the requirements of section 33(1) of the ITA.

Written By:

Sharon Lau Foong Yee

Tax and Revenue Practice Group

For further information regarding tax and revenue matters, please contact our Tax and Revenue Department.

Endnotes:

1. [1982] 2 MLJ 46
2. [2000] 7 MLJ 102