Budget 2019 credibly sets the foundation for the economy to move forward, without introducing broad-based taxes such as Capital Gains Tax or Inheritance Tax, as was widely speculated earlier. The key proposed tax changes, while quite targeted, could, however, significantly impact certain segments.
In a surprise move, the applicable Real Property Gains Tax (RPGT) rates on disposal of real property assets will be increased for properties held for more than five years:
• 10% (from 5%) for disposers that are companies, non-citizens and non-permanent resident individuals. It appears that since the 1970s, RPGT on such gains by companies had been at the rate of 5% or exempted; and
• 5% (from 0%) for other disposers (for example Malaysian citizens or permanent residents). Interestingly, it seems such individuals would not have been liable to RPGT on such disposals since the 1980s.
These proposed changes trigger thoughts around the long-standing issues and policies behind the current RPGT framework. The immediate question is whether there will be a holistic review and modernisation of the RPGT laws and rules to take into account practicalities, the current needs of business and, ultimately, the fairness and suitability of certain provisions.
This is not the forum to recount all the areas that need to be considered — the process of law reform would certainly be better handled by a focus group of technical experts and interested stakeholders because the issues involve policy (around what to tax, when and how) and technical (in terms of the language of the law, its interpretation and mechanics).
These are, however, some observations on the current state of our RPGT laws:
1. The current “gains” being taxed include inflationary effects, as gains are calculated on a nominal cost basis without allowance for price increases driven by the usual course of inflationary pressures over time. This, for example, would be felt by individuals who are upgrading their home as their family grows — under the current rules, an exemption (0% tax) would mean that individuals are better able to upgrade their dwelling. Many countries only tax inflation-indexed gains for individuals and businesses.
2. The calculation of gains on real property company share transfers does not always take into account the actual gains from the underlying value of the real property held by the company or group. There are several scenarios that raise real questions around the scope of taxation in the RPGT Act where it relates to real property companies (RPCs).
One, an RPC may in fact have large and successful non-property operations, for example, manufacturing. When the shares of such a company are sold, the consideration paid would largely reflect the value of the manufacturing operations. However, the calculation of the gain for RPGT purposes would in effect include these operations. This does not sit well in the context of the intention of the RPGT Act and the larger taxation scope of the country (we do not tax capital gains generally).
Two, in a scenario where an RPC acquires various properties over time, the calculation of gains on the sale of shares in that company may work in a way that is quite adverse, that is, the cost base of the shares may only reflect the cost of the first piece of underlying real property. Where the buyer pays market price for the shares, the effect is that the seller may be effectively taxed on the gross market value of the underlying subsequent properties (and not just the gains).
Three, depending on the timing of the issuance of shares by an RPC, the eventual sale of all the shares could result in an artificial gain or loss on different blocks of shares. This is compounded by the rule that these gains or losses (though occurring in a single transaction) cannot be set off against each other — under the RPGT law, losses on disposal of real property shares are permanently foregone.
3. The “rollover” provision for the deferral of the tax (where real property assets are transferred purely within a wholly-owned group) is too narrow. Currently, the rollover only applies where it is “to achieve greater operational efficiency”. In practice, transfers involving RPC shares would not qualify and the meaning of “operational efficiency” is quite ambiguous and has been narrowly interpreted by the authorities. For example, the requirement that the “efficiency” must be enjoyed by the transferor — this provision could not apply where, as part of the group reorganisation, the transferor company will be liquidated. The further requirement under the current law that the consideration needs to be at least 75% in shares means that the rollover will not likely be used where the real property assets need to be moved from a subsidiary to a holding company or between “sister” companies, as this would create an unwieldy corporate structure. All this means that there are tax cost barriers for a corporate group seeking to reorganise itself to address business or investor needs. This has caused consternation as tax is payable even though “gains” have not been realised from a group perspective. It would be good to have the rollover provision broadened and in some way mirror the exemptions in the Stamp Act.
In each of the above examples, we can see that the scope of the RPGT Act seems to be wider than just taxation on gains from real property alone — there is a tax on “inflation”; it may inadvertently impose a capital gains tax on business operations; there could even be a tax where there is no “real” gain derived from a third party — a mere accounting gain within a group. We also see how the RPC calculation mechanism can result in unfairness. These are but some of the incongruities commonly encountered. Certainly, a thorough review of the law, its scope and its practical operation is now timely with the budget proposals that draw our focus to the RPGT.
Yeo Eng Ping is a tax partner with Ernst & Young Tax Consultants Sdn Bhd and the EY Asean Tax managing partner. The views reflected above are the views of the author and do not necessarily reflect the views of the global EY organisation or its member firms.