Tax Treatment of Digital Currency Transaction: Updated Guidelines by the Inland Revenue Board(IRB) dated 26 August 2022
09 Nov 2022
R v Ketua Pengarah Hasil Dalam Negeri (High Court)
27 Oct 2023Tax Treatment of Digital Currency Transaction: Updated Guidelines by the Inland Revenue Board(IRB) dated 26 August 2022
09 Nov 2022R v Ketua Pengarah Hasil Dalam Negeri (High Court)
27 Oct 2023
It may seem pedantic to state that income tax is a tax on income only: “Income tax, if I may be pardoned for saying so, is a tax on income” ¹. It is neither a tax on revenue, Government grants, nor capital injection for shares. This elementary principle, which was regarded as a truism by the House of Lords even 120 years ago, was applied by the Supreme Court in Lower Perak Cooperative Housing Society Bhd v KPHDN ². Most recently, the High Court saw the need to reaffirm this again. Essentially, this appeal is the first decision to confirm that capital receipt in return for shares is not an income. It would seem that this case is the first reported case in Malaysia that elucidates this principle of law.
Brief Facts
The Taxpayer is a public infrastructure developer who received capital injections from the Government to construct and manage a public infrastructure project. In consideration for the capital injections, the Taxpayer issued shares to the Government, thereby increases the Government’s shareholding and equity stake in the Taxpayer. The monies received from the Government were recorded as equity in the Taxpayer’s books, and the Taxpayer would not pay any income tax on these receipts. Due to the long gestation period of the project and large operating expenses (“OPEX”) incurred, the Taxpayer incurred significant business losses. The Taxpayer set-o / deducted these losses against its aggregate income.
The IRB disallowed the deduction of OPEX by invoking Paragraph 3(1) of the Income Tax (Exemption) (No. 22) Order 2006 (“Exemption Order”). Paragraph 3(1) of the Exemption Order provides that deductions of expenditure incurred out of the income / grant under Paragraph 2(1)(a) would be disallowed. In this regard, the IRB contended that the capital injection by the Government into the Taxpayer in return for shares should be considered as an “income” or a “grant” under Paragraph 2(1)(a), and therefore the deduction should be disallowed.
The Issues at the SCIT and the High Court
- The Taxpayer’s appeal to the SCIT was dismissed. Consequently, the Taxpayer appealed to the High Court.
- The predominant issue to be determined by the High Court was: “Did the capital injected by the Government into the Taxpayer, in return for shares, constitute both (a) an income and a grant within the meaning of Paragraph 2(1)(a) of the Exemption Order?”
- If both of these conditions are not met, Paragraph 3(1) of the Exemption Order cannot be invoked by the IRB and the Taxpayer’s appeal should be allowed.
The High Court’s Decision
Upon hearing both parties, the High Court decided in favour of the Taxpayer and held, amongst others, that: -
- The ITA only imposes taxes on the income of the taxpayer. It does not impose tax on a capital receipt. This fundamental principle is reflected in Section 3 of the ITA. Further, a receipt is either a revenue or capital in nature, and it is not possible to be both³.
- As it has been agreed that the funds from the Government were capital injections recorded as equity in the Taxpayer’s audited financial accounts, the capital injection cannot possibly be an income within the meaning of Paragraph 2(1)(a) of the Exemption Order. In this regard, the High Court referred to multiple foreign authorities which showed that capital injections in consideration of the issuance of shares are capital receipts and not income subject to tax.
- The High Court reaffirmed the principle of law that parties / courts are bound by the Statement of Agreed Facts. The SCIT is not entitled to regard otherwise when parties have agreed that the funds were capital injections.
- As such, when no tax is eligible, there is no necessity for the taxpayer to utilise the Exemption Order. In this regard, the Exemption Order cannot be invoked by the IRB to disallow the Taxpayer’s deduction of OPEX.
Additional Notes –
The Importance of this decision
- This is a landmark decision strengthening the legal position by shedding light on the definition of “income”.
- The IRB’s power to raise assessments and impose penalties are not unfettered and should not be exercised arbitrarily, at its own whims and fancies. The courts remain the gatekeeper of the legality of these assessments, ensuring that the IRB’s power is exercised judiciously in accordance with established laws and principle.
- The High Court’s decision is a welcome addition to the income tax law jurisprudence, balancing the need of Government’s revenue with safeguards for taxpayers against arbitrary assessments. It aligns with the Supreme Court’s decision in Gov’t of Malaysia v Jasanusa Sdn Bhd 5, which cautions against incorrect assessments that may be influenced by collection targets.
Conclusion
Notwithstanding the above, it must be borne in mind that no single badge of trade is decisive on its own. As such, all the facts and circumstances would have to be carefully considered when determining whether the gains / losses from a transaction (whether involving real property, shares or digital currencies) are taxable / deductible under the ITA.
It is advisable to seek legal advice at the earliest opportunity, perhaps even before engaging in trading, to minimise exposure to taxes and penalties under the ITA.
1 The London County Council and others v The Attorney-General [1901] AC 26 per Lord Macnaghten
2 Lower Perak Cooperative Housing Society Bhd v KPHDN [1994] 2 MLJ 713
3 Mamor Sdn Bhd v Director-General of Inland Revenue [1981] 1 MLJ 117
4 Ketua Pengarah Hasil Dalam Negeri v Perbadanan Kemajuan Ekonomi Negeri Johor [2009] 4 MLJ 682