Amid staggering national debt due to COVID-19, the tax treatment of waiver debts is a major concern. Well, a moneylender is allowed to guarantee an assessment finding for a waiver of the obligation to its borrower or not. Also, amid the COVID-19 pandemic, whether the credit waiver is available in the hands of the borrower.
Organizations are at the brink of a tearing economy where their financial performance is affected adversely. Moreover, concerns about the global recession are on the rise, which was extended twice because of the Malaysian Restriction on Movement Order (RMO). Later on, the movement was relaxed from 4th May 2020 with the Conditional Movement Control Order.
Many organizations can’t proceed with activities, limited face income, and challenges in servicing their debts because of the COVID-19 pandemic and the ongoing RMO.
Can you deduct a waiver of debts?
Companies are working on different models to write off doubtful and bad debts. They are increasingly allocating provisions for the same. Well, there are many prominent reasons they are doing this, goodwill seems to be one of them. None of the organizations want to keep money at the cost of their goodwill. Even if a debtor is bankrupt/wound-up or if a disproportionate effort is required to recover the amount, it should not affect the goodwill.
Waiver of debt is the provision where a taxpayer has to prove that his debt is irrecoverable on reasonable terms. He has to prove that his debt was treated as the taxpayer’s gross income to qualify for a waiver-related tax deduction under s 34 of the Income Tax Act 1967 (Act).
However, whether the reasonable efforts were made for the debt or not will be determined by the court by estimating the irrecoverable amount. The courts have the power to issue reminder notices, have a debt restructuring scheme, or enter into a debt settlement after looking at the sound commercial considerations. The taxpayer cannot obtain a debt waiver due to any financial crisis. To determine the taxpayer’s bona fide intention and efforts to recover the debt, he must prove whether he took legal action.
The High Court found in Sastep Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri (KPHDN) (2017) MSTC ¶30-143 emphasized that the whole case was time-barred around 13 years later. No matter the taxpayer took legal action and had sent notices of demand to recover the debt. Delay in the debt recovery action and writing off the debt was neither bona fide nor based on prudent commercial business considerations. However, the taxpayer and the debtor had conflicts of interest in financial management, though both the companies were related.
A taxpayer can claim for deductions only if he has made legitimate attempts for debt recovery. In Ireka Corporation Berhad v KPHDN, the taxpayer had taken actions to negotiate and submit the matter for arbitration. As a result, the court favoured them. It permitted a deduction for the difference between the original debt and settlement amount. Moreover, the courts usually favour taxpayers who take legitimate actions for the recovery of debt.
Is a waiver of debts taxable?
When we talk about taxing the waiver of debts as income, then, yes, usually, they are taxable.
A waiver of debts is taxable under s 30(4) of the Act. If the debts relating to the taxpayer’s business and the taxpayer either take a tax deduction under s 33 of the Act or claim a capital allowance under s 42 and Sch 3 of the Act.
However, if the debt doesn’t relate to the above two categories, it is not taxable. Still, there are challenges with the legal test presently. As a result, the Malaysian case law lacks clarity.
This issue was considered by the Special Commissioners of Income Tax (SCIT) in FT Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri (2016) MSTC ¶10-057 (FT case). According to the Inland Revenue Board (IRB), the waiver of intercompany loans granted to a subsidiary by its holding company, in this case, was taxable under s 4(a) of the Act.
Even though the business income was not taxable under s 30(4) of the Act, the SCIT and the IRB came on common ground and found that these amounts were gains or profits from a business. The amount was used to pay the trade creditors and fulfill their business obligations. Since there was a business obligation involved, it was therefore taxable.
This business obligation was taken as the ground, and the SCIT rejected the taxpayer’s argument. The taxpayer argued and said that the loan was a gift as the amounts received from the loan were utilized to settle its trade debts. After the amount was waived, it became the taxpayer’s income.
The s 4(a) of the Act has some general taxing provisions. These provisions take into consideration the income obtained from a source of business. The business sources may include receipts from the sale of goods/provision of services. The SCIT had considered the waiver of loans provided to a subsidiary and income received from the course of its business similar. Moreover, they didn’t apply s 30(4) of the Act. Well, the decision was not overturned, and the ratio stands binding on all taxpayers.
However, the Court of Appeal in Ketua Pengarah Hasil Dalam Negeri v Bandar Nusajaya Development Sdn Bhd (Bandar Nusajaya) (2016) MSTC ¶30-117 emphasized s 30(4). It said that it is the only provision that tax authorities should rely on to obtain a release of debt.
In this case, the taxpayer had claimed a tax deduction for the interests payable on the loan that he was provided for holding a company. He wanted the deduction against the business income and non-business interest income. Subsequently, the holding company waived the interests payable. The taxpayer brought to tax the income portion according to s 30(4), but did not bring the waiver regarding the non-business interest income which didn’t fall under s 30(4).
The IRB issued an additional assessment against the taxpayer. They asked him to bring to tax the waiver of interests payable from loans, which was advanced by the holding company to the subsidiary under s 22(2)(a) of the Act. The waiver of interest was considered as the income from a non-business source. The Court of Appeal agreed with the High Court judge in Bandar Nusajaya and stated that:
By applying the ejusdem generis rule, the word “otherwise” ought to bear the same meaning as the terms had before. Therefore, the waiver of interest payable was not to be considered as sums receivable or deemed to have been received in the hands of the taxpayer for s 22(2)(a).
The maxim generalibus specialia derogant states that a particular provision on a state of law overshadows a general provision. Consequently, s 30(4) ought to be applied as it is a specific or unique provision for the tax authorities to recover a debt from a business source to tax specifically in this case. The s 30(4) predicts the release of debt that will be brought to tax in restricted conditions, that’s when it is the income from a business source. It was not taxable as the waiver of interest payable emerged with regards to the taxpayer’s non-business income.
The High Court in Bandar Nusajaya referred to the equivalent statutory provision in England of Malaysia’s s 30(4). It was found that it was made to tax the waiver of debts acquired in getting income from selling products or rendering services. The claim that the Court of Appeal ruled was toppled by the subsequent appeal to the Federal Court. The claim was, however, made on other specific and technical grounds. Well, after considering all, the Court of Appeal’s written ground stays helpful in guiding the use of s 30(4) in cases with respect to the taxability of debt waivers.
Planning Points
Organizations must be wary while managing the waiver of obligations as the COVID-19 pandemic poses considerable challenges. The taxpayers might be required to face the IRB’s scrutiny of a business decision made. This is especially when the decision is made during or due to the epidemic. It will be regarding the tax audits and investigations in the future.
YH Tan & Associates PLT can help you in tax audit and investigation matters.
They must know the preconditions if they are to claim deductions on waiver of debts, particularly for intercompany advances. Taxpayers must assess the strength of each receivable they get. It will assure whether the claims made are genuine, whether it has compelling reasons for claiming it or not. There’s a need to provide sufficient documentation with all the claims.