Private and confidential

RHB Bank Berhad

Group Taxation Department
Level 6 OTC Block, RHB Complex
No 8 Jalan Institusi, Kawasan Institusi
43000 Bandar Baru Bangi / Sg. Merab
Selangor Darul Ehsan

Attn: Mr Chee Choong Wai /

Mr Chan Wee Lim

24 February 2016

Dear Sirs

Re: Comment on the Tax Deductibility of Expenses Incurred on the Proposed

Information Technology (“IT”) Projects

We refer to the above matter.

1. Background

We understand that RHB Bank Berhad (“the Bank”) would be carrying out a number of
major IT projects under the RHB Banking Group’s transformation programme “IGNITE
2017”. IGNITE 2017 programme represents the RHB Banking Group's transformation
vision to ignite its journey towards the RHB 2020 vision, and turn aspirations into
impactful outcomes that will enrich the organisation, customers, industry and community.
It will accelerate RHB's journey towards achieving its 2020 ambition of being a Leading
Multinational Financial Services Group in the region. The programme is expected to
utilise a large amount of internal resources. The Bank is expecting to increase its revenue
from the programme as it would be able to explore new customer segments and new
channels of revenue.

The Bank has purchased or would be purchasing software systems and computer hardware
to carry out various individual projects under the programme. These have been or would
be capitalised as fixed assets. The Bank would then have to make modifications and
customisation to the software system to meet the specific operational needs of the Bank.
In this respect, the Bank would not only need the assistance of its existing staff to provide
the user requirements but it would also need a dedicated full-time team to manage the
projects and to study the user requests being submitted in order for them to design,
customise, implement and conduct testing on the software systems to make them
operational.
 RHB Bank Berhad
Engagement for Tax Services
Comment on the tax implications / deductibility of the proposed
Information Technology (“IT”) Project Expenses

In this respect, the Bank anticipates that to make the software systems operational, it
would incur the following expenses in respect of these IT projects (hereinafter known as
“IT Project expenses”):-

i) staff costs (i.e. salaries, bonus, EPF, overtime, meal and staff allowances and
medical expenses for full time employees) and the proportionate staff cost of the
existing employees who are only partially working on the IT projects;

ii) hardware and software maintenance costs incurred before the project goes live;

iii) network line rental specifically for the new IT Projects; and

iv) legal, professional and consultancy fees that are incurred specifically for the new IT
Projects

We understand that due to the size of the undertaking, the Bank’s current workforce would
be insufficient to support these IT projects. As such, the Bank has recruited additional
individuals to work on these IT Projects. These individuals recruited and some of the
Bank’s existing staff would be reassigned to work full-time along with the external
consultants to design, customise, test and implement these software systems and these
additional headcount and staff costs would not have been incurred if the Bank had not
decided to embark on the IT Projects. Once the IT Projects are completed, the Bank is
hopeful that these additional full-time staff would be able to maintain the software systems
and make any change requests from the users without having to engage the services of
external consultants.

Meanwhile, the Bank also anticipates that there would be a number of existing staff that
would on a part-time basis be working on these IT Projects. On top of carrying out their
day-to-day duties, these existing employees would also spend a portion of their time on
these IT projects (i.e. part time employees) such as coming up with the user requirements
and conducting the user acceptance tests (“UAT”), etc.

You have indicated that for accounting purposes, the Bank will capitalise the above IT
Project expenses from the relating operating expenses accounts in the Income Statement to
the Project WIP in the Balance Sheet in accordance with the accounting standards (i.e.
Malaysian Financial Reporting Standard (“MFRS”) 138: Intangible Assets). For the
financial year ended 31 December 2015, the Bank anticipates that the IT Project expenses
to be incurred would be in the region of RM4 million to RM8 million.

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 RHB Bank Berhad
Engagement for Tax Services
Comment on the tax implications / deductibility of the proposed
Information Technology (“IT”) Project Expenses

Based on the above, you would like us to comment on the tax treatment of the IT Project
expenses that would be capitalised to the Balance Sheet and the risk / likelihood of a
challenge by the Inland Revenue Board (“IRB”) in the event that the Bank goes ahead and
claims a tax deduction of the IT Project expenses incurred.

Our written tax advice is at a conceptual level only and do not include costs of
implementation work (e.g. applications to any authorities, preparing a detailed computation
of the potential tax exposure, etc.). Please note that our tax advice is limited to corporate
income tax and we will not be commenting on individual taxes, stamp duty, real property
gains tax, legal and regulatory issues.

2. Our Comments

 Pursuant to Section 33(1) of the Income Tax Act, 1967 (“the Act”), expenses wholly
and exclusively incurred in the production of gross income would be allowed as a
deduction unless such expenses are capital in nature or specifically prohibited under
the Act.

Please note that if the expense is capital in nature, it will not be tax deductible.
Instead a claim for capital allowance can be made if the capital expenditure is
incurred on qualifying plant expenditure. Qualifying plant expenditure is defined in
the Act as capital expenditure incurred on the provision of machinery or plant used
for the purposes of a business including capital expenditure incurred on the
reconstruction of that machinery and plant. It should also include expenditure
incurred for the installation of the machinery or plant and other expenditure incurred
incidental to the installation.

 The determination on whether an expense is a revenue expenditure or capital

expenditure would depend on the evaluation of the facts of the case.

 Where a company purchases an asset which is in an imperfect condition and

reconditions it before using it for the purpose of the trade, the expenditure on
reconditioning is generally regarded as a capital outlay. This principle can be
seen in the UK case of The Law Shipping Co Ltd v CIR where the expenditure
incurred to turn a secondhand ship that was acquired in an unusable condition
into a merchant ship capable of carrying cargo was held to be capital
expenditure.

Based on the above, IT Project expenses incurred in modification and

customisation of software systems albeit newly acquired, to bring into an
operational and useable stage should be capital in nature.

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 RHB Bank Berhad
Engagement for Tax Services
Comment on the tax implications / deductibility of the proposed
Information Technology (“IT”) Project Expenses

 Furthermore, an expense would be deemed to be capital in nature if it is made

once and for all (not necessarily in a single sum and at one time) for bringing
into existence an enhanced asset or an enduring benefit to the business as
distinguished from a recurring expense in the nature of operational expenses
incurred in running a business. That principle was established in the UK case of
British Insulated and Helsby Cable Ltd v Atherton where Viscount Cave
formulated the test as follows:-

“When an expenditure is made, not only once and for all, but with a view to
bringing into existence an asset or an advantage for the enduring benefit of a
trade, there is very good reason (in the absence of special circumstances
leading to an opposite conclusion) for treating such an expenditure as properly
attributable not to revenue but to capital…”

In this respect, as the IT Project is likely to bring about an enhanced asset and an
enduring benefit to the Bank’s business, the expenses directly incurred in
bringing the whole computer software system into an operational stage would be
considered as capital in nature.

 As IGNITE 2017 has been identified as a major step towards achieving the 2020
ambition, it is only natural that a lot of emphasis and importance have been
placed on the major underlying IT projects identified to support the IGNITE
2017 programme.

Where the IT Project expenses result in a significant improvement in the entire

IT system and/or creation of a new IT system, it is likely that the expenses
would be deemed to be capital in nature. Whether the expenditure merely
represents the piecemeal improvement of an existing computer system (arguably
revenue in nature) or a stage within something sufficiently major to constitute
capital expenditure will depend on a detailed consideration of all the
circumstances.

Among the circumstances that have to be borne in mind is the fast-changing

nature of the computer software industry and the fact that a computer
programme does not wear out. Therefore it is hard to envisage any repair which
does not involve some element of upgrading of the software system. In this
respect, it would be appropriate to consider the expenses as being capital in
nature where computer system which has been improved is itself a capital asset
of the business and that the system, viewed as a whole, has been sufficiently
improved to make the capital treatment appropriate and where the work on the
system is itself part of a major project which is capital in nature.

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 RHB Bank Berhad
Engagement for Tax Services
Comment on the tax implications / deductibility of the proposed
Information Technology (“IT”) Project Expenses

 Where the IT Project expenses are incurred on improving the purchased software
systems for more advantageous use and for changes to the operational structure of the
business, it is likely that the expenses would be deemed to be capital in nature.

 As noted above, IGNITE 2017 and the improved software systems play a very
important role in the RHB Banking Group’s vision and would strengthen its
businesses and thus lead to increased revenues as the Bank would be able to
explore new customer segments and new channels of revenue. Therefore, the
importance of the improved software systems and the economic or functional
role that the software systems would play in the RHB Banking Group’s
businesses is undeniable. In view of the impact of the IT Projects on the profit-
yielding subject of the business, expenses incurred directly on IT Projects may
be considered as capital in nature.

 The degree of change intended in the business structure or the way operations
are carried out as a result of the project may also play a part. The more radical
the changes to the structure, the more likely the expenditure would be
considered to be capital in nature. As IGNITE 2017 is a major transformation
programme for the RHB Group, the programme and the multiple IT Projects
identified would undoubtedly bring about radical changes in the way the Bank’s
operations are carried out and hence such expenditure may be viewed as being
capital in nature.

 It is therefore likely that the IRB will treat any direct expenses incurred on the IT
Projects as capital expenditure. In this respect, any costs incurred by the Bank
directly for the modification and customisation of the new software systems acquired
to bring them to their operational state which would be used as an integral part of the
Bank’s business for the RHB Group’s transformation programme would be
considered as capital in nature.

 We understand that the Bank will capitalise the IT Project expenses from the relating
operating expenses accounts in the Income Statement to the Project WIP in the
Balance Sheet as intangible assets in accordance with the accounting standards (i.e.
Malaysian Financial Reporting Standard (“MFRS”) 138: Intangible Assets. An
intangible asset is defined in MFRS 138 as an identifiable non-monetary asset
without physical substance. Pursuant to MFRS 138, an intangible asset shall be
recognised if, and only if it is probable that the expected future economic benefits
that are attributable to the asset will flow to the Bank and the cost 1 of the asset can be
measured reliably.

1
The cost of an internally generated intangible asset comprises of all directly attributable costs necessary to create,
produce and prepare the asset to be capable of operating in the manner intended by the management. This would
include:-
a) costs of materials and services used or consumed in generating the intangible asset;
b) costs of employee benefits arising from the generation of the intangible asset;
c) fees to register a legal right; and
d) amortisation of patents and licences that are used to generate the intangible asset.

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 RHB Bank Berhad
Engagement for Tax Services
Comment on the tax implications / deductibility of the proposed
Information Technology (“IT”) Project Expenses

 You would no doubt be aware that the accounting treatment does not necessarily
dictate the tax treatment of a particular expense nor does it change the nature of
an expense. However, it may be indicative as to what was the effect and lend
credence to the tax treatment to be adopted. The courts may also be swayed
based on the accounting treatment adopted. By capitalising the relevant IT
Project expenses as part of the Bank’s intangible asset, it would appear that the
Bank considers these IT Project expenses as part of the cost of generating the
intangible asset (i.e. capital in nature). Hence, the IRB could challenge the
deductibility of the IT Project expenses.

The likelihood that the IT Project expenses would be treated as being capital in
nature would also be increased where new computer hardware and / or
equipments are acquired to run the new software systems. This is especially so
where the new hardware is not merely desirable but necessary for the purposes
of operating the new software system and to bring the software system to an
operational and useable stage.

 Expenses such as staff costs, maintenance costs and rental expenses are day to day
operational expenses and recurring in nature. Hence, such expenses would generally
be considered to be revenue in nature. Arguably, only the staff cost relating to
employees and expenses directly involved in the design and customisation of the
software system to be used in operations should be treated as capital in nature.

 As such, the staff cost in relation to the staff (existing and newly recruited staff)
working on designing and customising the software together with the consultant
costs are likely to be treated as being capital in nature as these costs were
directly incurred in the modification / improvement of the new software systems
which would bring into existence of an intangible assets and enduring benefit to
the RHB Group. That was the position adopted in the UK case of McVeigh v
Arthur Sanderson & Sons Ltd 2where it was held that the cost of acquiring
designs from freelance artists and producing designs by staff for production of
wallpapers and fabrics was attributable to the capital cost of the physical plant
(i.e. patterned equipment).

2
In the McVeigh case, the company was a manufacturer of wallpaper and printed furnishing fabrics. It printed
patterns on the materials by means of either wood blocks on which the patterns were cut or of silk screens to
which they had been transferred or of machines equipped with pattern-bearing rollers. The designs were in
part acquired by the company from freelance artists and in part produced in its own studios. The hand blocks,
silk screens and rollers required by the company for its manufacturing activities are made by its own
employees and the most intricate and expensive part of the work involved in making these items of equipment
was that of patterning them.
The company contended that the costs incurred in producing or acquiring the designs formed part of the
expenditure incurred on the provision of the patterned blocks, screens or rollers, or alternatively, that the
designs were in themselves plant. It was held that the designs were not themselves plant but that the
Company’s expenditure on the provision of blocks, screens and rollers must include something for the cost of
the designs.

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 RHB Bank Berhad
Engagement for Tax Services
Comment on the tax implications / deductibility of the proposed
Information Technology (“IT”) Project Expenses

The proportionate staff cost of the existing employees who are only partially
working on the IT projects by merely providing their input on the user
requirements and subsequently conducting the UAT on the new system should
not be considered as costs directly incurred for the design and customisation of
the software systems (i.e. creation of the intangible assets). Providing user
feedback and requirements would generally be a normal part of the job scope of
any employees.

 The hardware and software maintenance costs incurred (excluding upgrading

cost) before the project goes live and the network line rental should be
considered revenue in nature as they are generally recurring in nature and not
directly incurred in creating the intangible assets. However, where these
expenses are solely and directly incurred for the design and customisation of the
software system, the expenses could be seen as incidental to the expenditure
incurred on the provision of the plant and machinery.

 If the IT Project expenses are deemed to be capital expenditure, a claim for capital
allowance can be made if the expenditure is incurred on the provision of machinery
or plant used for the purposes of a business.

 The IRB has issued Public Ruling No. 12/2014: Qualifying Plant and
Machinery for Claiming Capital Allowances.

The objective of the Public Ruling is to explain whether an asset is a qualifying

plant and machinery in determining the statutory income from a business.

Based on the Public Ruling, qualifying expenditure incurred on the costs of

provision of computer software (i.e. software systems or software packages)
would be eligible for capital allowances. Software package or software systems
means the computer software purchased together with the computer equipments
from a supplier or purchased separately from a software supplier. These
computer software are considered to be part and parcel of the information
technology equipment.

 The Public Ruling No. 12/2014 referred to above seeks to explain the provisions
of the Income Tax (Accelerated Capital Allowance) (Information and
Communication Technology Equipment) Rules 2014 (“Rules 2014”). Under
Rules 2014, the capital expenditure incurred on purchase of information and
communication technology (“ICT”) equipment (including software packages or
software systems) would be entitled to claim capital allowance of 100% (i.e.
20% for initial allowance and 80% for annual allowance) in the year of
purchase.

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 RHB Bank Berhad
Engagement for Tax Services
Comment on the tax implications / deductibility of the proposed
Information Technology (“IT”) Project Expenses

Further, the Rules 2014 specifically state that ICT equipment includes banking
systems and the term “purchase of any ICT equipment” is defined to include the
cost of installation of such equipment.

Thus to the extent that a case can be made that the costs incurred in the
modification and customisation of the software systems are installation costs in
connection with the purchase of the banking systems, then the capital allowance
claim of 100% could be made under Rules 2014 provided that the Bank is not
subjected to the non-application rules specified in Rules 2014.

 However, in the Public Ruling No. 12/2014, payments for developing software
such as consulting fees, right to use the software such as licence fee and other
incidental charges would not be considered to be part of the cost for the
provision of computer software. It should be noted however that a Public
Ruling is only the Director General of Inland Revenue’s interpretation of the
law; Public Rulings are not legislation.

It is unclear precisely what is intended to be covered by the ruling.

Nevertheless, expenditure on the purchase of ICT equipment (i.e. banking
systems, software systems and software packages) and expenses related to that
purchase should be part and parcel of qualifying expenditure for capital
allowance purposes.

Arguably, the expenses on the provision of the new software systems should
include costs directly incurred in the modification and customisation of the
systems to make them operational.

3. Conclusion

As the Bank will be capitalizing all the IT Project expenses as part of the cost of the
intangible asset (i.e. the software), it is likely that the IRB would challenge a claim for tax
deduction on the expenses. Although the accounting treatment does not necessarily dictate
the tax treatment of a particular expense, it may be indicative of the nature of the expense
and lend credence to the tax treatment to be adopted. In this respect, as the deductibility of
the IT Project expenses could be challenged by the IRB, you may wish to consider not
capitalising the costs that are not directly incurred for designing and customising the new
software system.

Any incidental revenue expenditure which is deductible under Section 33(1) of the Act
would still qualify for an outright tax deduction in the arriving at the adjusted income of
the Bank. On the other hand, expenditure related to the purchase of software used for the
purpose of a business should qualify for capital allowance. It may be argued that the
expenses should include those directly incurred in the design, customisation and
implementation of the new software systems purchased to make them operational.

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 RHB Bank Berhad
Engagement for Tax Services
Comment on the tax implications / deductibility of the proposed
Information Technology (“IT”) Project Expenses

The consultant fees and the staff cost of the staff fully engaged in the designing and
customising of the new software systems purchased would be directly related in bringing
the software systems into operational and usable state and as such it would be capital in
nature. In this respect, the Bank may arguably claim capital allowances on these expenses
on the basis that these expenses are part of the cost of enhancing the asset and incidental in
the provision of the new software system. Any IT Project expenses which could be
identified as being costs of installation of the software systems may also qualify for capital
allowances.

However, it is unclear to what extent the MIRB will restrict the type of expenses that will
form the provision of computer software based on the Public Ruling No. 12/2014.

The staff costs for those staff merely providing input on the user requirements and UAT,
hardware and software maintenance costs (excluding upgrading cost) and network line
rental may arguably be considered as recurring expenses which are revenue in nature as
these staff would generally not be considered to be directly involved in designing and
customising the new software system to bring the improved system to a useable and
operational state.

The Bank could be eligible to claim accelerated capital allowance (“ACA”) pursuant to the
Income Tax (Accelerated Capital Allowance) (Information and Communication
Technology Equipment) Rules 2014 on any ICT equipment (as listed in the Schedule of
the Rules 2014 to include banking systems, computer software and computer packages)
purchased and used for the purposes of the business subject to the non-application rules.
Purchase would include the installation of such equipment. Any IT Project expenses
incurred that could be described as being costs of installation of the software system
should qualify for ACA as provided for under the Rules 2014.

Please also note that the comments in this letter have been prepared solely for RHB Bank
Berhad and should not be circulated to other advisors or third parties without the prior
permission of KPMG Tax Services Sdn Bhd.

Please take note that the liability of our firm shall be limited at any time to the amount of
our fees in respect of the portion of our services giving rise to that liability. Our comments
above are based on the completeness and accuracy of the facts and/or representation
provided by you. If any of the aforementioned facts, representation or assumption is not
entirely complete and accurate, it is imperative that we be informed immediately, as the
inaccuracy and incompleteness could have a material effect on our conclusions. In
rendering our advice, we have relied upon the relevant provisions of the Malaysian tax
legislation, the regulations thereunder, and judicial and administrative interpretations
thereof. Such authorities are subject to change, retrospectively or prospectively, and any
such changes could affect the validity of our advice. We will not update our comments for
the subsequent changes or modifications to the legislations, regulations thereunder, and
judicial and administrative interpretations thereof.

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 RHB Bank Berhad
Engagement for Tax Services
Comment on the tax implications / deductibility of the proposed
Information Technology (“IT”) Project Expenses

The terms of this advice shall be governed by, and construed according to the laws of
Malaysia.

Meanwhile, please do not hesitate to contact the undersigned (ext. 7027) or Ms Sharon Wong
(ext. 7280) should you require any further information or clarification.

Yours faithfully

Ong Guan Heng

Executive Director

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