SUNWAY COLLEGE

DIPLOMA IN ACCOUNTING
TX 4014 MALAYSIAN TAXATION

Tutorial 2: Business Expenses - Deductibility of Business Expenses

Question 1

Yummy Wok Sdn Bhd (Yummy) owns a chain of popular and famous restaurants. It has
a paid up share capital of RM3 million. In the year ended 31 December 2020, Yummy
incurred legal expenses in respect of the following:
– Defence against a suit brought by a restaurant customer who alleged
discrimination by the restaurant staff.
– Legal action taken against a contractor for supplying sub-standard food
ingredients to Yummy.
– Registration of ‘Yummy Wok’ as a trademark in Malaysia.

Required:

Explain whether each item of legal expense is tax deductible in arriving at the
adjusted income of Yummy Wok Sdn Bhd.

Deductibility of legal expenses

Defense against a customer’s suit

- As the suit was brought by a customer who alleged discrimination by a staff of the
restaurant, the subject matter pertains to the core service offered by the restaurant.
Therefore, the expense is in direct connection with the income-generating activity.
- Regardless of the outcome of the legal action, the expense fulfils the ‘wholly’ (i.e. the
quantum) and ‘exclusively’ (i.e. the purpose and subject matter) tests as well as the
‘process’ test in that it is incurred in the production of gross income.
- Therefore, the legal expense in defending the suit is tax deductible.

Legal action against a contract supplier

– Food ingredients constitute inventory to a restaurant. Legal action against a supplier
regarding the quality of the inventory is closely connected to the income generating activity
of providing quality food to its customers. The expense is incurred in the process of the
production of gross income from the restaurant business.
- Therefore, this item of legal expense is tax deductible.

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Registration of ‘Yummy Wok’ as a trademark
- Yummy has built up its name to the extent that it is popular and famous. The trademark
‘Yummy Wok’ is therefore a brand name, which constitutes a fixed asset, albeit an
intangible one, to the company. Expenditure to create, crystalize or formalize a fixed asset
is clearly capital in nature.
- The expense to register the trademark is therefore not deductible in arriving at the adjusted
income of Yummy.

Question 2

Teen Girl Clothings Sdn Bhd (TGC) is a distributor of branded teenage girls’ clothes
imported from United States, Britain and France. The company has agreements with
manufacturers from these countries to be their sole distributor in Malaysia and has over
20 outlets in Kuala Lumpur, Penang, Malacca and Johor Baru. TGC discovered in 2019
that a local company was copying the clothes of its French brand and selling it in
Malaysia under a different but similar brand name and at cheaper prices. TGC incurred
RM120,000 in legal costs to stop this company from competing with TGC. It was
unsuccessful. In December 2019, TGC bought the rights to use the competitor’s name for
RM500,000.

REQUIRED:

Explain with reasons whether these expenses would be tax deductible for TGC Sdn Bhd
in year of assessment 2019. Your answer should be supported by relevant case law.

The legal expenses were incurred to get rid of competitor, to stop imitation of the
product. The benefit is not because it will have to be spent every time a new competitor
arrives on the scene. Case: Port Elizabeth Electric Tramway v CIR (1935) 8 SATC 13. It
does not matter that the claim is unsuccessful. The legal expenses are tax deductible. The
purchase of the competitor’s brand name is capital in nature. Therefore, it is not
deductible under sec 39(1)(c). There is enduring benefit. Case: Sun Newspapers Ltd v FC
of T (1938) 61 CLR 337.

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 Question 3

RJ Sdn Bhd is involved in the manufacture of luxury furniture using Meranti wood in the
district of Pekan. Due to weak demand from European and American markets, the
company’s revenue has been dropping steadily since 2015. The company was forced to
downsize its workforce before continuing its business operations. Several of its
employees were retrenched and an amount of RM1.2 million was paid in a lump sum to
the retrenched employees.

REQUIRED:

Would the lump sum payment made by RJ Sdn Bhd for retrenchment of employees be
tax deductible under the Income Tax Act 1967?

Since the payment of RM1,200,000 was incurred as part of a retrenchment exercise to

enable the company to remain in business, the lump sum payment would be tax deductible.
The payments were incurred in the interest of the business. The expense was incurred
wholly and exclusively in the production of income (sec.33). However, if the company had
ceased business, the retrenchment payments to employees would not be deductible. The
expenditure would not be incurred in order to produce income as there is no longer an
operating business. Case law that can be cited in permanent the answer is Ampat Tin
Dredging Ltd v DGIR [(1982) 2 MLJ 46] or IRC v Patrick Thompson Ltd (1956) 37 TC
145 or KPHDN v International Foods Sdn Bhd (2007) MLJ 102

Question 4

Sri Ram Car Rental Services Sdn. Bhd runs a car rental business in Penang. The company
bought a badly damaged two-year old car for RM10,000 from Mr. B whose son met with
a bad accident while driving the motor vehicle. The market value of the car would have
been RM60,000 if it had not been for the accident. A sum of RM15,000 was then spent
on repairs and reconditioning to make it road-worthy and to comply with Road Transport
Department requirements before using it in the business

REQUIRED:

How would the sum spent on repairing the car be treated in the accounts of Sri Ram Car
Rental services?

It is obvious that the car was purchased at very much below its market value because it
needed serious repairs to make it road worthy again. The sum of RM15,000 spent by Sri
Ram Car Rental Sdn. Bhd. could be considered ‘initial repairs’ as it was spent immediately
on purchase. Based on the Law Shipping Principle the repairs would not qualify for
deduction as ordinary repairs carried out in the course of running a car rental business.
However, the cost of repairs could be claimed as additional capital expenditure qualifying
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for capital allowances under Schedule 3 ITA.

Question 5

Ms K is an accounting clerk employed by Kiddy’s Fashions Sendirian Berhad. The

manager noticed that three cheques located in the office premises were missing during
the year 2020. It was later discovered that Ms K had cashed the cheques with forged
signatures of the manager and misappropriated RM12,000 over a period of 3 months. She
was dismissed by her employer.

REQUIRED:

Advice Kiddy Fashion Sdn Bhd whether RM12,000 is allowed for tax deduction under
Income Tax Act

Loss of cash by theft, defalcation or embezzlement by an employee is an allowable expense

under the Income Tax Act. This is because the loss arises directly from the necessity of
delegating certain duties of the business to subordinates. Theft or embezzlement by sole
proprietor, partner, director or administrator is not allowable as a deduction. Reference
could be made to Public Ruling 5/2005 Deduction for loss of cash and treatment of
recoveries.

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