This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on July 4 - 10, 2016.

In Malaysia, business income is taxed on an accrual basis. This means when a debt becomes payable, the amount is recognised as income for that year regardless of whether payment has been received by the company. Debt is defined as an amount owed for services rendered or property enjoyed/dealt with. 

In 2014, the High Court reversed a lower court’s decision on a case involving a golf and recreation club and held that the licence fees received in advance from its members were not income for the year of receipt because there was no debt, as the relevant services had not been rendered yet. The Court of Appeal later upheld this decision. 

In December last year, when the Finance Act 2015 was enacted, the Income Tax Act was amended — 

section 24 now provides that any sum received in the course of carrying out a business constitutes income which should be duly subject to tax in that year (basis period). 

This is despite the fact that no debt has arisen yet — services have not been rendered or property has not been used or enjoyed yet — and that the sum may be wholly or partially refundable. 

The amendment further provides that if any portion of the said sum is subsequently refunded, the amount refunded is tax deductible in the year of the refund. 

These amendments, which take effect from the year of assessment 2016, unequivocally establish that sums received in advance in the course of carrying out a business must be 

recognised as income and be subject to tax in the year of receipt. The following are some examples of advance receipts of income:

Mobile phone prepaid credit;

Stored value cards (such as Touch n Go);

Annual subscriptions paid in advance to take advantage of discounts given;

Tickets or vouchers (airline, football season tickets, concerts, beauty treatments) sold in advance; and Bereavement packages bought in advance.

(The Inland Revenue Board has clarified and confirmed that security deposits and return deposits, such as for the return of beverage crates or bottles, are not revenue in nature, are not to be treated as income and, therefore, are not subject to tax when received.)

This amendment signals a major divergence from the accounting treatment which, based on the principle of prudence and true and fair view, usually matches income with expenses. Income received before the services are rendered is routinely deferred to the period when the expenses for such income are incurred. In short, income is duly recognised accounting-wise when it has been “earned”.

The following is a simple example to demonstrate divergence.

Facts

Medico provides healthcare and medical diagnostic services. It currently provides a routine annual medical check-up for about RM800 per person. It also offers a package — with an upfront payment of RM6,000, individuals are entitled to an annual check-up for the next 10 years. 

Should the individual wish to terminate the membership, the unused portion is refunded after deducting a fee for the minimum lock-in period of three annual check-ups and a 10% administration charge. The expenses related to the annual check-up are expected to be about RM400.

Mr A took up the promotional package, paid RM6,000 in Year 1, and goes for his annual check-up in Years 1, 2 and 3. At the end of Year 3, he terminates the arrangement as he plans to immigrate to another country. Medico refunds him RM3,780 [RM6,000 minus RM1,800 minus (10% of 4,200)] in Year 3.

Treatment

Taking into account Mr A’s membership, the outcome can be seen in the table below. It is clear that the outcome under the tax treatment is wildly different from that under the accounting treatment (ignoring for the time being other customers/clients of Medico). Under the tax treatment, tax is paid way upfront, which obviously negatively impacts cash flow and takes away precious operating capital from the business. 

Additionally, if the business does not do as well in recruiting new members in the subsequent years, tax losses will likely arise because business expenses will still need to be defrayed to meet the obligations contracted earlier. Given that tax losses cannot be carried back, the business entity may face losses in the later years with little or no income to offset them.

Therefore, in the interest of fairness, one suggestion for the tax authorities to consider, at the very least, is to introduce the “loss carry back” feature in tax laws. This would provide equally for any related losses to be fully relieved in a timely manner.

It is understandable that the authorities would want to collect taxes for state coffers as early as possible, but the government should also be mindful that leaving funds in the hands of businesses would enhance liquidity and facilitate the economic multiplier effect. Admittedly, it is true that the tax treatment does not always dovetail with the accounting treatment. But it is also true that one of the objectives of the ongoing reforms of accounting standards is the convergence of the accounting treatment with the tax treatment. 

The divergence between the accounting and tax treatments will increase the cost of doing business — more tax adjustments will be needed when furnishing tax returns and complicated accounting software will be necessary to facilitate tracking and retrieval. It will also make tax laws more complicated, which in turn, will consume scarce resources in its application and implementation. 

Yong Siew Chuen has wide experience in Malaysian taxation. She now focuses on tax training and coaching. Comments: [email protected]. 

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