The High Court in Ketua Pengarah Hasil Dalam Negeri v Persatuan Nelayan Kebangsaan (WA-14-6-04/2022) held that commission for bank guarantee facility is not tax deductible because it is an expenditure incurred prior to the commencement of business which is capital in nature and not incurred to earn profit but in setting the profit earning machinery in motion.

The salient facts of Persatuan Nelayan (supra) are as follows:

a. The Taxpayer acquired diesel supplies from Shell Malaysia Trading and Petronas Perdagangan Berhad (“Suppliers”).
b. According to the agreement entered between the Taxpayer and the Suppliers, the Taxpayer was required to obtain a bank guarantee prior to the commencement of the agreement.
c. Hence, the Taxpayer secured a bank guarantee from Bank Islam Malaysia Berhad and incurred commission for the same.
d. Pursuant to a tax audit conducted by the Inland Revenue Board of Malaysia (“IRB”), the IRB issued a notice of additional assessment and disallowed the said commission.
e. Being aggrieved, the Taxpayer appealed to the Special Commissioners of Income Tax (“SCIT”) and the SCIT ruled in favour of the Taxpayer.
f. Subsequently, the IRB appealed against the SCIT’s decision to the High Court.

In allowing the IRB’s appeal and setting aside the SCIT’s decision, the High Court held that, amongst others:

a. Section 33(1) and Section 39 (1) of the Income Tax Act 1967 (“ITA”) must be read in tandem – the expenditure must first pass the test under Section 33(1) of the ITA and must not be disallowed by Section 39(1) of the ITA (see Director General of Inland Revenue v LTS [1974] 1 MLRH 6; [1974] 1 MLJ 187).

b. The commission incurred by the Taxpayer for obtaining the bank guarantee is not tax deductible because it is capital in nature given that:
i. it is an expenditure incurred prior to the commencement of business.
ii. the bank guarantee itself was not made directly for the purposes of buying the diesel.
iii. the bank guarantee was merely a pre-condition imposed to enable the Taxpayer to buy the diesel.
iv. it was not incurred to earn profit but in setting the profit earning machinery in motion.

Fernrite Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri [2004] 7 MLJ 600 was distinguished as in Fernrite (supra) the commission for bank guarantee was not a pre-condition to the purchase of shares and warrant.

COMMENTS
This case discussed the nature of the commission incurred for obtaining a bank guarantee and it appears that so long the bank guarantee was prescribed as a pre-condition in the agreement with the bank(s), it will be capital in nature and thus not tax deductible.

It was rather unfortunate that the key point of “whether the commission is indeed an expenditure incurred prior to the commencement of business” was not discussed. Getting a bank guarantee for business purposes is not uncommon and thus taxpayers should be aware of what ought to be negotiated with the bank(s) in obtaining a bank guarantee. This case again demonstrates the importance of factoring in tax consideration at the drafting and negotiation stage.

This article is intended to be informative and not intended to be nor should be relied upon as a substitute for legal or any other professional advice.

About the author
Desmond Liew Zhi Hong
Partner
Tax
Halim Hong & Quek
desmond.liew@hhq.com.my