Property Transactions - Income Tax or Real Property Gain Tax

Audit | Tax | Advisory
Crowe Horwath AF 1018
Member Crowe Horwath International
Property Transactions
- Income Tax or Real Property Gain Tax
April E-Newsletter | 8 April 2013
A tax case recently landed on my table which
involved the disposal of two pieces of land by a
company. Normally, I would cursorily glance
through the contents and the decision made by
the judges. That day, curiosity got the better of me
so I decided to read it in detail. It would be a good
opportunity for me to pit my tax skills against the
judgment of the Special Commissioners who were
the judges in this case. Who knows? I just might
be able to correctly predict the decision of the
Special Commissioners.
The taxpayer in this instance had disposed of a
property which it had acquired 6 years ago. There
were many arguments in its favour to support the
contention that it had purchased the property for
long term investment. One of the arguments was
that the company did not do anything to enhance
the value of the land for example by subdividing
or converting the status of the land since the date
it was purchased. Instead, the land was disposed
of as a result of the ultimate holding company's
restructuring exercise. There was also no history
of disposals of properties, no application for a
developer's license and the property owner did
not take special efforts to dispose of this property.
Even its principal object in the Memorandum and
Articles of Association was, amongst others,
investment holding. However, the only drawback
was that property development was listed as one
of the principal activities in its audited accounts.
Furthermore, the land was classified as "property
development expenditure" under non-current
assets which could connote that the property was
held for property development purposes and not
as a long term investment.
What was the outcome of the case? Did the IRB
or the taxpayer win? Personally, after reading
through the case, I had a strong feeling that the
taxpayer would win.
Here was the decision. The Special
Commissioners in their judgment stated that it
was necessary to determine the intention of the
taxpayer which must be judged against the
background of its acts and conduct and the
circumstances of the case. They held that due to
no frequency of transactions, no physical
enhancement to the land, no organised effort to
promote the sale and the unique circumstances of
the sale, the taxpayer had acquired the land for
long term investment. Hence, the taxpayer won
the case.
Three Groups
This is where the dilemma lies - Malaysian tax law
still has a large grey area as to how gains from
the disposal of properties will be taxed. Will
taxpayers be taxed under income tax or real
property gains tax? As the Special
Commissioners have so aptly stated, it depends
on “the intention of the taxpayer which must be
judged against the background of its acts and
conduct and the circumstances of the case”.
Every case is therefore judged based on the facts
of the case.

Generally, all gains on disposals of properties and
the relevant tax implications thereon may be
categorized into 3 groups:
a) Gains on sale of a long term investment
These gains are treated as capital gains and
will be subjected to real property gains tax.
The tax rates applicable are 15% for
disposals within 2 years of acquisition, 10%
for disposals after 2 years but less than 5
years and nil tax for disposals after 5 years
of acquisition. The question on everyone’s
mind is how long should the holding period
be before it is considered as “long term”. Is
there a legal definition for long term? In the
stock market, it is not uncommon for
investors to refer to long term as “one month”
because to them, short term means to sell
within T+3 days! Obviously, there will be
difficulties in determining the meaning of
“long-term”. Besides, there is no fixed period
in law to determine when an investment is
deemed long-term. It is all a matter of one’s
judgment and that can be very subjective!
b) Gains on sale of stock-in-trade
Stock-in-trade means raw materials, work-inprogress
or finished goods held with the
intention for sale at a profit. In the context of
properties, stock-in-trade would mean land
that is meant for conversion into completed
units for sale, land that is partly converted
into completed units, completed units
pending sale or completed units purchased
expressly for resale. These gains are treated
as trading gains which are subjected to
income tax. The tax rates applicable will
depend on whether the seller is an individual
or company and the relevant rates will apply
(scale rates of up to 26% for individuals and
25% flat rate for companies).
Audit | Tax | Advisory
Crowe Horwath AF 1018
Member Crowe Horwath International
c) Gains from an “adventure in the nature of
trade”
The phrase “adventure in the nature of trade”
refers to isolated one-off transactions which
have the semblance of trade and are carried
out with a profit motive. These gains are
treated as trading gains and will be taxed
under income tax. Ordinarily, one-off
transactions are not considered as trading in
nature because they are not frequent and do
not have the character of trade which
involves “frequency of transactions”.
However, if the one-off transaction has the
characteristic of being a trading transaction,
it can be caught as such and will be
subjected to income tax. Experts would use
the “badges of trade” as points of reference
but it is common for views to be different.
How one differentiates these transactions
from sale of long-term investments remains a
grey area. In the classic toilet rolls case of
Rutledge v CIR (14 TC 490), a person had
purchased a large quantity of toilet rolls in a
consignment which was later sold to an
individual for a profit. The taxpayer’s
argument that the toilet rolls were not bought
for profit reasons was over-ruled by the
Inland Revenue and affirmed by the Court.
The taxpayer was deemed to be engaged in
an “adventure in the nature of trade” and
thus, any profits were liable to income tax.
Gains such as this are unlike those from the
acquisition and sale of whisky, a painting or
jewellery which may be acquired for personal
enjoyment or use.
Complications
From the above, one can conclude that
complications can arise from the overlap of the
words “long term investment”, “stock-in-trade” and
“adventure in the nature of trade”. When does a
property cross the line from being an investment
into being stock-in-trade? Is it the date of the subdivision
of the land, conversion of the land,
obtaining of layout plan, obtaining of building plan
approval or carrying out of earthworks? What
about isolated one-off property transactions?
What if a person buys a piece of land and sells it
off within two years? When does one cross from
an “adventure in the nature of trade” to a “long
term investment”? The short answer to all these
questions is “it all depends on the facts of the
case” and can only be evaluated by judgment.

Certainly, there is much ambiguity and different
interpretations of the words used. A person may
view a property investment as a long term
investment whereas another may view it as an
isolated one-off transaction made with a profit
motive. Yet another person may consider it as a
stock-in-trade. You can be sure that 10 different
persons will have 10 different opinions on this
subject. It depends on each person’s perspective
and their interpretations of the words above.
How do we then identify the different tax
implications on disposals of property? It would
certainly require a closer look and the necessary
expertise.
Distinguishing The Three
Nevertheless, we can try to use the following
principles to distinguish between the 3 groups of
property transactions above.
Intention
The paramount principle for distinguishing
between the 3 categories is “intention” - what was
the intention of the purchaser when he first
purchased the property? Was it for long term
investment or was it for development into
completed units or was it for a quick sale? All
these questions can only be answered by the
purchaser. It is not possible to reach into the mind
of the purchaser to determine his exact motives
unless he has penned down his thoughts in
writing.
Most purchasers would not have done so or may
not be aware of the importance of doing so.
Purchasers can say whatever they wish but the
tax authorities will not accept their reasons unless
there is documentary proof.
Documentary proof or evidence is therefore one
of the primary sources for determining the
intention. For example, if a company is
incorporated with the principal object of property
development according to the Memorandum and
Articles of Association of the company, it will be
difficult to refute this assumption. In the Penang
Realty case, the company disposed of some
property units which it had held for 17 years but
the courts held that the gains on disposal were
subject to income tax because the company was
engaged in property development.
Audit | Tax | Advisory
Crowe Horwath AF 1018
Member Crowe Horwath International
Generally, the courts have over the years held
that a company is incorporated with the implied
intention to be engaged in business or to have a
profit motive. Hence, the likelihood of companies
being held to be engaged in trading activities is
stronger than that for individuals. This would also
be a consideration when analyzing the tax
consequences of disposals of properties.
Notwithstanding whatever proof of intention,
subsequent conduct will throw light on the
purchaser’s intentions. Even though a purchaser
may assert that his intention is for long term
investment, his subsequent conduct may show
otherwise. For example, if a company purchases
a piece of land and disposes of it within a few
months, it is difficult to accept the company’s
contention that it had purchased the property for
long-term investment.
Badges of trade
If subsequent conduct is an indicator of intention,
the badges of trade would be the standard
against which the conduct is measured. A badge
is defined in a dictionary as “a device or emblem
worn as an insignia of rank, office, or membership
in an organization; an emblem given as an award
or honor; a characteristic mark”. A badge is
therefore a characteristic that indicates the
property transaction has the character of a trading
transaction. It is also right to assert that the more
that any of the subsequent conduct have the
badges of trade, the more likely the transaction is
caught under income tax.

What are the badges of trade?
The major badges of trade would include:
The period of holding. The longer the period
of holding, the more likely the investment is a
long term investment.
Frequency of transactions. The more
frequent the transactions, the more likely that
the transaction is held to be trading in nature.
Whether there’s anything done to enhance
the value of the investment. If some activity
had been carried out to enhance the value of
the investment, the more likely the
investment will be treated as a sale of stockin-trade
or as an adventure in the nature of
trade.
Ability to hold the investment for the long
term. This would depend on the method of
financing and whether the investor had the
means to hold the investment without having
to sell it within a short holding period.
Method of sale. If the seller has an organized
method of selling, it would indicate a higher
likelihood of being a trading transaction. In
the case of Martin v Lowry, the taxpayer set
up a sales organization and employed staff
to advertise and sell the linen goods it had
purchased. The Commissioners decided that
the taxpayer had carried on a trade and that
the profits therefrom were assessable.
Putting all these together and conjuring an
answer would be the road to an accurate
diagnosis. It is not very different from a doctor
having to diagnose a person based on the
symptoms of cold, cough, fever and aches. There
can be many answers but probably only one is
right. Good diagnosis will depend on sufficiency of
experience, knowledge of the law and deep
understanding of the applicable tax court cases.
Change of intention
Taking the matter further, is it possible for a
person to have an original intention and a change
of intention? Certainly this is possible. It will not
be uncommon for a person to have an intention to
purchase a piece of land for long term investment
and subsequently to change the intention to that
of property development.
Audit | Tax | Advisory
Crowe Horwath AF 1018
Member Crowe Horwath International
The tax implications would be found in Para 17A
of the RPGTA where the land in question can be
transferred to stock-in-trade at the date of change
in intention. The “transfer” would be deemed to be
at market value and the gains on the transfer
would be subjected to real property gains tax
whilst the market value of the land will be used as
the cost of the land for the property development
activity. However, the change of intention should
be evidenced by necessary proof. In the case of
Penang Realty, the taxpayer contended it had a
change of intention but the accounts did not
reflect the change. Hence, it lost the court case.
The reverse in change of intention can also be
possible. For example, a person may purchase a
property for property development but
subsequently changes his intention to that of
“property investment”. This change of intention
will cause the taxpayer to be treated as having
“withdrawn stock for his own use” in accordance
with Section 24(2) of the Income Tax Act 1967
and be taxed on the gains based on the market
value of the property less the cost.
Conclusion
Being able to identify the problem is a good start.
It will be more valuable if a solution can be found.
For this, please feel free to contact our tax
partners at fennie.lim@crowehorwath.com.my or
yewhoe.poon@crowehorwath.com.my.
Written by:
Poon Yew Hoe
Managing Partner/Tax Partner
8 April 2013