THE basic principle for claiming a tax deduction is that the expenditure must incurred wholly and exclusively in the production of income, which can be against business income or non-business income such as employment, rental, interest, royalties, and others.
There are instances where the Internal Revenue Board (IRB) is attempting to disallow expenses on the grounds that the expenditure incurred appears to be ambiguous. Ambiguity in their minds appear to arise when the description of the expenditure claimed by the taxpayer does not reconcile with the facts. An example is where the IRB may be of the view that the payment is not a contract payment, but a salary payment. Another example could be where transactions occur between related companies where the IRB believes that such transactions were organised to shift income from one company to the other.
Should ambiguity be the basis for disallowing expenses?
There are always two sides to an argument. The IRB through its findings may have a view can be contradictory to the evidence produced by the taxpayer. In situations where there is a dispute, there is a tendency for the IRB to call upon the recipient party to their office to cross-verify the information relating to the transaction.
Since the recipient is not the party that is being subject to disallowance and scrutiny, there is a tendency for the recipient to agree with the position by the IRB. Consequently, this leads to the suggestion that the expenses are ambiguous. The facts provided by the recipient may be contradictory to the facts provided by the claimant.
There is a possibility that in such circumstances, the IRB may issue an assessment to collect the extra tax based on the grounds that the expenditure does not meet the “wholly and exclusively incurred in the production of income” rule.
Is there such a principle of ambiguity in the tax law? There is no such rule. If there is suspicion that the expenditure has not been incurred or the expenditure is fictitious, artificial or a sham, the proper way to proceed with such a matter is to prove that the taxpayer has committed a fraud/wilful default or has been negligent. Here the responsibility lies with IRB.
Assessments should not be raised on the grounds of “ambiguity” when the expenditure has been incurred for the business purposes, but the description may not be in alignment with the supporting evidence. Unless the expenditure has not been incurred for business purposes, it should be allowed for tax deduction. An example would be where the IRB says that the expenditure is an employment expenditure whereas the taxpayer says it is a subcontract payment to an individual. At the end of the day both items are deductible, and ambiguity should not be used as a reason to disallow the expenditure.
There will be instances where taxpayers attempt to claim deductions where the expenditure has not been incurred, or create transactions which are fictitious, sham, or artificial. In such instances, the IRB should punish such taxpayers by raising assessments using the anti-avoidance provisions and bringing such taxpayers to court.
Advice to taxpayers
It is absolutely important that any claims for tax deduction should be supported with clear evidence of the payment is being made for services rendered or goods received. The climate is changing and the direction the IRB could be taking in the future could be much stricter in the form of charging taxpayers for fraud where taxpayers have attempted to claim tax deductions on fraudulent transactions. It is the duty of IRB to enforce the law strictly against recalcitrant taxpayers.
This article is contributed by Thannees Tax Consulting Services Sdn Bhd managing director SM Thanneermalai (www.thannees.com).