Topic 6 Business Income

ATAX1113 – Principles of Taxation
Topic 6 – BUSINESS INCOME
TOPIC 6
BUSINESS INCOME
School of Accounting and Taxation 1

LEARNING OUTCOMES
By the end of the topic, students should be able to:
•Define various types of business income.

•Differentiate various types of business income.

Introduction
 Income tax is imposed under sec 4(a) of ITA 1967 on the gains or profits
of a business.
 The tax is imposed not on business itself BUT on the person carrying on
the business or trade.
 To tax a person under sec 4(a), it is important to establish that the

taxpayer has derived gains or profits from the carrying on of a business.

Definition of Business
 Profession
 Not defined in the Act.
 Intellectual skill or manual skill controlled by intellectual skill.
 Carried out by a company or an individual.
 Trade – repetitious buyinggoods and selling such goods

with intention to make profit.
 Vocation
 Analogous to the word “calling”.
 Means the way in which a person passes his or her life.
 Eg: musicians, dramatists, persons who attends race and engaging
themselves in systematic bets.
Definition of Business
 Manufacture
 Transforming original material so that a new and different article or
product emerges.
 Adventure or concern in the nature of trade

 Deal with isolated buying and selling transactions.
 It is difficult to hold such transaction as trade activities due to isolated
nature.
 However it is possible to hold them as an adventure or concern in the
nature of trade and apply income tax upon them – referring to badges
of trade.

Badges of Trade
Badges of trade are to determine whether income derived is “trade” income

(i.e. business income).
The Radcliffe Commission (UK) listed 6 BADGES OF TRADE:

1. Subject matter
2. Period of ownership
3. Frequency of transactions
4. Supplementary work on asset
5. Set up to dispose of goods
6. Motive for transaction

Badges of Trade
 It is well-defined characteristics of trade which can be act as a guide in

differentiate gains arising from the disposal of an investment and gains
from trading or from an adventure or concern in the nature of trade.
 The former is not subject to income tax but gains from trading or from an
adventure or concern in the nature of trade are taxable.

Badge 1: Subject Matter

 The intention of the acquirer at the point in time that the subject matter was
acquired is the important consideration to determine whether a gain
derived is capital or revenue in nature.
 If intention mainly to resell the subject matter at a profit, then the gain
received is revenue in nature and liable to be taxed.
 Where the property does not itself yield income or personal enjoyment to
its owner merely by virtue of its ownership, it more likely to have been
acquired for the purpose of resale.

Badge 1: Subject Matter

Rutledge vs I.R.C
where a taxpayer bought a large quantity of toilet paper, an act which not part
of his normal business. It was said that “as the purchase was made for no
other purpose, except that for resale at a profit, thus the deal was in the
nature of trade”.

Badge 2: Period of Ownership

 If period of ownership of asset is a short one, it may interpreted that the
asset was acquired for trading and not for investment.
 It implies that longer the period of ownership of asset, the less likely to
have a trade.
 Wisdom v Chamberlain (1968)
 Mount Elizabeth (Pte) Ltd v The Comptroller of Income Tax

Badge 3: Frequency of Transaction

 If a particular transaction is one of a series of such transactions and if there
is evidence of a systematic and methodical activity, it will constitute an
adventure in the nature of trade.
 Distinction must be established between a number of transaction spread

over a considerable period of time and that is closely related to each other
to form a series.
 A number of transactions in the same kind of property raises the

presumption that the particular property was purchased for resale at a
profit.
 Pickford vs Quirke

Badge 4: Supplementary Work Done Prior to Sale

 When subsequent processing of an asset has taken place, such
processing indicate an intention to trade.
 This includes material improvement to an asset after acquisition so that it

becomes more marketable.
 Cape Brandy Syndicate vs I.R.C

 The company after purchasing a large quantity of brandy, proceeded
to blend and re-case the brandy before selling it in lots.
 It was held that the transaction was a trading transaction.

Badge 5: Organization Set-up to Dispose of the Goods

 If special exertion is made to find or attract purchasers such as the
opening up of an office or extensive advertising such facts will indicate the
presence of a profit making undertaking.
 Martin v Lowry
 KLE Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri – the subject’s land
commercial potential was a very good ready made advertisement in
itself.

Badge 6: Motive of the Transaction

 Circumstance surrounding the transaction:
 Sale due to sudden emergency or unanticipated need for funds indicate
that property was not acquired for purpose of resale at a profit.
Steven v Hudson Bay Co
HCM v DGIR (1993)
 Profit motive as a factor.
 Intention to trade.
 Simmons v IRC

Additional Badges of Trade
Three additional badges of trade from case law:

1.Circumstances surround the transaction.
Eg: A person sells his house to pay for his son’s education abroad vs A
person sells his house when there is a high demand for properties.
2.Profit motive as a factor.
3.Intention to trade.

Mutual Transactions
• The mutuality principle rests on 2 concepts:

• A person cannot trade with himself; and
• The surplus of contribution over expenditure cannot be income.
• It follows that the surplus of mutual fund cannot be treated as income for
income tax purposes. (Styles v New York Life Insurance Co,
2 TC 460)

Factors Influencing the Mutual Concept
• There must be complete identity between the contributors and the

participators.
• The dealing should not be by way of trade or even in the nature of trade.
• Even if there is trading, it should be mutual.
• Receipts from non-members would be taxable.

Illegal Activities
• S. 4(a) does not distinguish between a legal and an illegal business
income.
• The crux of the issue is if the activity carried on has the characteristics of
a business, then the income will be assessed under S.4(a)
notwithstanding its illegal or immoral character.

Hobbies, Gambling, etc.

• Will be taxable if it can be shown that what was done is a business, is in
the nature of a trade, or is an adventure in the nature of trade.
• In Partridge v Mallandaine [(HL) 2 TC 179], it was held that profits from

systematic and habitual betting on horses were held to be profits from
carrying on a vocation, and properly assessable to tax.

Trading in Shares: Is it a Trade or Adventure in the Nature of Trade?
The DGIR will consider the following factors:

• Nature of occupation of individual.
• Is he a speculator?
• Background of taxpayer and there is a possibility of insider trading.
• If he holds himself as a dealer in stocks and shares.
• If his share operations are organized .
• Does he have expert acquaintance with computer technology?

Trading in Shares: the Test in Leeming v Jones

The test for the positive existence of trade should incorporate 3 factors:
1.Organization,
2.Special skill; and
3.The subject matter lending itself to commercial transaction.
The various badges of trade must also be applied to the above factors.

Trading in Shares: Companies
• The fact that companies are formed with a view of making profits make it
difficult to prove that their share transactions are merely investments.
• Burden of proof lies on companies to prove that the share transactions

are mere realization of investments.
• The badges of trade and the Leeming v Jones test apply in establishing
the existence of trade.

Taxability of Grants
• General rule on taxability is to apply a test to determine the main

purpose of the grant.
• If it is to assist him to perform his trading operations more profitably, then

it will be taxable as a trading receipt.

Derivation of Business Income in Certain Cases

S. 12(1)(a), ITA 1967:
•Gross income from the business as is not attributable to operations of the
business carried on outside Malaysia shall be deemed derived from
Malaysia.
•Therefore, if the gross income is related to the work performed outside

Malaysia and the taxpayer wishes to treat it as foreign source income, the
taxpayer would need to substantiate that it is attributable to operations of
business carried on outside Malaysia.
•Foreign-sourced income is NOT subject to tax in Malaysia, except for

certain activities, such as banking, insurance, and air and sea transport
operations.
Whether Business Income is Deemed to be Derived from Malaysia
The following activities (one or more) would determine whether the business
income is deemed to be derived from Malaysia:
•Contract concluded in Malaysia.
•Stocks maintained in Malaysia from which orders are fulfilled.
•Ownership and risk passes in Malaysia.
•Sale proceeds received in Malaysia.
•Services rendered in Malaysia.

Commencement of Business
For tax purposes, it is important to identify the actual commencement date

for several reasons:
i.To determine the basis period in relation to the assessment year.
ii.To identify the expenditure incurred before the date of commencement.
iii.To identify capital expenditure incurred.
iv.To allow capital allowance against the business income in relation to the
relevant assessment year.
General guide:
•When it embarks on activities directly related to the generation of income
from the business.
•When everything is in place for the activity to commence.
Commencement of Business
The following are some examples of the date of commencement of different

business sectors:
Nature of Business Commencement date of business

Hotels The date the hotel is opened to the public.
Manufacturing The date on which raw materials are received for
manufacturing operations.
Plantation The day on which the seeds are sowed.
Retail business The day on which the trader opens the door to customers or
entertains clients.

New Business or Continuation of an Existing Business
• The distinction is important because it has an impact on the deduction

of capital allowance and allowability of business losses in the computation
of taxable income.
• Each case has to be decided on its own facts and circumstances.
• Considerations:
• Customers – whether customers consider that two trades exist;
whether their dealings with one department are influenced by other
department(s)?
• Management – under separate management or not?
• Accounting methods – separate accounts or not?

Cessation of Business
• Even when a company is taking steps to cease trading, such “winding

down” could constitute a trading activity and not an activity relating to the
realization of the business’s assets.
• It is important for tax purposes to determine the exact date of cessation of

a business as receipts before the cessation will constitute income but
receipts after cessation will be capital.

Advance Receipts
• With effect from YA 2016, S. 24 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.
• If any portion of the said sum is subsequently refunded, the amount

refunded is tax deductible in the year of the refund.
• Therefore, 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.
Advance Receipts
• Some examples of advance receipts of income: mobile phone prepaid

credit; stored value cards (e.g. 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;
bereavement packages bought in advance.
• The IRB has clarified 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.

Taxation of Gains from Foreign Exchange Exposure
In distinguishing capital account from revenue account, the following issues

must be considered:
•Devaluation of currency.
•Recognition of gains or losses.
•Differentials arising from income earning operations.
•Adjustments for foreign cash balances.

Taxation of Gains from Foreign Exchange Exposure

Derivative Financial Instruments

• Common forms of derivatives: futures, options trading, currency and
interest rate swaps, forward exchange contracts.
• In analyzing tax implications on derivatives, it is pertinent to identify the

classification of the taxpayer: Hedger, Trader or Speculator.
• If a transaction is carried out in the course of trading of such commodities,

the gains made from the speculative transaction would be assessable to
tax.
• The profits will be taxable.
• DGIR v Central Sugars Sdn Bhd [1978) 2 MLJ 71]

“Trading with” and “Trading in” Malaysia
• A company that “trades in” Malaysia as opposed to merely “trading with”

Malaysia, is liable to tax on the income derived from that trade.
• Direct physical presence in Malaysia (incorporation) in Malaysia clearly

establishes the carrying on of a business in Malaysia.
• The essential test is not whether the profits concerned arose from a
business carried on in Malaysia but whether the operations from which
the profits arose took place in Malaysia.

“Trading with” and “Trading in” Malaysia
• Factors to be considered in determining if a business is carried on in

Malaysia:
• Place where contracts are executed.
• Place where the business operations from which the profits in substance
arose are carried out.
• Place where the title to the goods passes from seller to buyer.
• Place where the proceeds of sales are received.
• These factors are not conclusive on their own but should be collectively
considered in arriving at a final decision.

THE END

Topic 6 Business Income

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ATAX1113 – Principles of Taxation

Topic 6 – BUSINESS INCOME

School of Accounting and Taxation 1

Topic 6 – BUSINESS INCOME

By the end of the topic, students should be able to:

•Define various types of business income.

School of Accounting and Taxation 2

Topic 6 – BUSINESS INCOME

 To tax a person under sec 4(a), it is important to establish that the

School of Accounting and Taxation 3

Topic 6 – BUSINESS INCOME

 Trade – repetitious buyinggoods and selling such goods

Topic 6 – BUSINESS INCOME

 Adventure or concern in the nature of trade

School of Accounting and Taxation 5

Topic 6 – BUSINESS INCOME

Badges of trade are to determine whether income derived is “trade” income

The Radcliffe Commission (UK) listed 6 BADGES OF TRADE:

School of Accounting and Taxation 6

Topic 6 – BUSINESS INCOME

 It is well-defined characteristics of trade which can be act as a guide in

School of Accounting and Taxation 7

Topic 6 – BUSINESS INCOME

Badge 1: Subject Matter

School of Accounting and Taxation 8

Topic 6 – BUSINESS INCOME

Badge 1: Subject Matter

School of Accounting and Taxation 9

Topic 6 – BUSINESS INCOME

Badge 2: Period of Ownership

School of Accounting and Taxation 10

Topic 6 – BUSINESS INCOME

Badge 3: Frequency of Transaction

 Distinction must be established between a number of transaction spread

 A number of transactions in the same kind of property raises the

School of Accounting and Taxation 11

Topic 6 – BUSINESS INCOME

Badge 4: Supplementary Work Done Prior to Sale

 This includes material improvement to an asset after acquisition so that it

 Cape Brandy Syndicate vs I.R.C

School of Accounting and Taxation 12

Topic 6 – BUSINESS INCOME

Badge 5: Organization Set-up to Dispose of the Goods

School of Accounting and Taxation 13

Topic 6 – BUSINESS INCOME

Badge 6: Motive of the Transaction

 Profit motive as a factor.

School of Accounting and Taxation 14

Topic 6 – BUSINESS INCOME

Additional Badges of Trade

Three additional badges of trade from case law:

2.Profit motive as a factor.

School of Accounting and Taxation 15

Topic 6 – BUSINESS INCOME

• The mutuality principle rests on 2 concepts:

School of Accounting and Taxation 16

Topic 6 – BUSINESS INCOME

Factors Influencing the Mutual Concept

• There must be complete identity between the contributors and the

• Even if there is trading, it should be mutual.

• Receipts from non-members would be taxable.

School of Accounting and Taxation 17

Topic 6 – BUSINESS INCOME