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IT'S ALL A QUESTION OF INTENTION

S. Saravana Kumar discusses the distinction between income tax and real property gains tax.

In property transactions, profits derived upon disposal of a property by a taxpayer are subject to income tax or real property gains tax. This distinction depends on the taxpayer’s intention to hold the parcel of property either as a trading stock or as an investment.

It is important to identify this intention as the tax treatment between the two types of property is different and disputes can occur between the taxman and taxpayer about the nature of the profits derived upon disposal of the property.

Any profits arising from disposal of a trading stock are subject to income tax at the rate of 25%. Meanwhile, any gains arising from the realisation of an investment are subject to real property gains tax (RPGT) at the rate of 5%, if it was owned for a period of less than 5 years. If the investment was owned for a period of more than 5 years, it is not subject to RPGT.

So how does one distinguish between a property held as trading stock or investment? The Malaysian Courts have decided in a number of recent cases that the distinction simply depends on the intention of the taxpayer.

The Courts have held that the mere realisation of investment is not income under the ordinary concepts and usages of mankind. However, profits arising from the sale of any property acquired for the purpose of trading are subject to income tax.In these circumstances, the focal point of enquiry by the Courts is the dominant purpose for which the particular property was originally acquired. It is encouraging that the Courts have commented that the mere presence of an intention to sell property at a profit at some future date is not of itself, sufficient to cause the profit to be taxable if the dominant motive in purchasing the property was not the expectation of profit by sale.

So how does one distinguish between a property held as trading stock or investment? The Malaysian Courts have decided in a number of recent cases that the distinctions imply depends on the intention of the taxpayer.

The Courts have held that the mere realisation of investment is not income under the ordinary concepts and usages of mankind. However, profits arising from the sale of any property acquired for the purpose of trading are subject to income tax. In these circumstances, the focal point of enquiry by the Courts is the dominant purpose for which the particular property was originally acquired.It is encouraging that the Courts have commented that the mere presence of an intention to sell property at a profit at some future date is not of itself, sufficient to cause the profit to be taxable if the dominant motive in purchasing the property was not the expectation of profit by sale.

The Courts are guided by the badges of trade as the criteria for distinguishing between profits subject to income tax and those subject to RPGT. The main badges of trade are the dominant purpose of acquiring the property, subject matter of transactions, period of ownership, frequency of transactions, circumstances for sale, motive or intention of taxpayer and methods of sale.

On the other hand, trading requires an intention to trade. The question to be asked is whether that intention existed at the time of the acquisition of the property. Was the property acquired with the intention of disposing of it at a profit, or was it acquired as a permanent investment?

Often, it is necessary to ask further questions: an investment may be sold in order to acquire another investment thought to be more satisfactory and that does not involve an operation of trade notwithstanding whether the first investment is sold at a profit or at a loss.

The Courts have held that a purpose so qualified and suspended does not amount to an intention to trade. At best, it is a mere contemplation until the materials necessary to a decision on the commercial merits are available and have resulted in such a decision.

In one case [1], the Courts held that the gains arising from the disposal of the land were subject to RPGT. It was commented that the evidence showed that the property was the only property bought and kept by the taxpayer for investment. There was no evidence to show that the tax payer had been dealing in land before they acquired the property. In fact, there was no evidence to show that the taxpayer had other transactions in property before. 

There was also no evidence to show that the taxpayer was a developer before the transaction. The purchase of the said property was the only transaction carried out by the taxpayer. In those circumstances, the Courts held that it could not be said that dealing in land was the principal activity of the taxpayer.

Similarly, the Courts had also held that where a tax payer takes no serious effort to obtain a loan facility from a financial institution and has no capabilities to develop land [2], such land is held to be the taxpayer’s investment. The gains are then subjected to RPGT.

The mere fact that a taxpayer made a gain because the land was near the main road or a good location does not automatically make the gain liable to income tax. In another interesting case [3], it was held that the taxpayer had invested in the property by reason of its proximity to a nearby town. The value of the taxpayer’s land merely appreciated in the course of time due to the development of the surrounding areas.

The factors highlighted above were not seen by the Courts as factors alluding to trading but rather investment. In this regard, it is crucial that a taxpayer is aware of the potential tax implication in managing his tax affairs prudently.

[1] ALF Properties Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri [2005] 3 CLJ 936

[2] Au How Cheong Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri (No.R(3)(1)-14-02-2006

[3] E v Comptroller-General of Inland Revenue (1950-1985) MSTC 106

Source from Property Quotient - A Malaysia Property Incorporated Publication (June 2011 issue 13)