Is waiver of debts taxable?

 

 

Companies write off bad debts for a multitude of reason: the debtor has gone bankrupt or is under liquidation, disproportional effort to recover the money owed or just simply to recover as much as possible and get on with life. For the debtor, there are 2 ways that this write off might affect them: it can be taxable and it can also not be taxable.

The difference is what makes a write off debt to be taxable is normally if it is revenue in nature and trade-related whilst it is not if the reverse applies. Under Section 30(4) Income Tax Act 1967, where a taxpayer had previously claimed a tax deduction or capital allowance and the amount of debt is then released, it would be treated as being part of the debtor’s gross income and hence taxable in the Year of Assessment in which the debt was forgiven. Similarly, if the taxpayer had not claimed a tax deduction or capital allowance previously, the release of debt should not be brought to tax.

  1. FT v MIRB 

In FT v MIRB, the waiver of loan was taxable as an income. The loan given was used to fund the operational expenses of the company and hence when it was waived, it should have been rightly brought to tax, which the taxpayer failed to do. Salient facts of the case are as below:

  • FT was given a loan totalling RM30mil by the holding company in 2004.
  • The money was used up within minutes to pay off the trade creditors.
  • In 2006, the holding company agreed to waive the debt.
  • The purpose for the loan was stated as to be “utilised exclusively … for the purpose of financing the accounts payable of the company”

The contention made by FT was that it should not be considered as s4(a) as it is not a gain or income as it was used to pay off the creditors, it was a form of support to the subsidiary, it had recorded the man as contribution to capital and thus had been credited into the Appellant’s capital reserve and not subject to tax.

The IRB questioned that the loan was contributed as capital because there was no increase in the FT’s share capital and that the loan is a gain because it was used to fulfil FT’s business obligations and is, therefore, part of its business gains and profits under s4(a) ITA.

Held: it was taxable. It was found that the loan was never intended to be treated as capital or to be converted and is written off as operating expense by the holding company. When the loan was waived, FT’s obligation to repay the loan did not arise any more and thus following the House of Lords decision in HM Inspector of Taxes v Lincolnshire Sugar Co Ltd, the loan ought to be rightly taken into account when computing the adjusted income.

The loan was also not a gift which was unconnected with FT’s business activity but was part of the income-producing activity and hence part of its operating expenses.

  • Comment: Personally, I find it quite bizarre why the IRB did not pursue the case under section 30(4) which is a more specific provision for taxing waiver of debts but went under the general provision of s4(a) as gains and profits. Nevertheless, the case decision is in line with the spirit of the Income Tax Act that waiver of debt from a business source income is taxable in the year that it was waived. To prevent this, taxpayers should distinguish on the facts by properly documenting the purpose of the loan and capitalising the said loan.

 

2. KPHDN v Bandar Nusajaya Development

However, a contrasting outcome is seen in KPHDN v Bandar Nusajaya Development which went up all the way to Court of Appeal on point of tax law but to Federal Court on point of judicial review (Federal Court generally do not entertain to tax cases). In this case, the IRB sought to have the waiver of debt to be taxed under section 22(2)(a) instead of section 4(a) as falling under “any sums receivable or deemed to have been received”.

In Bandar Nusajaya, the holding company provided a loan to the taxpayer in which the taxpayer took a deduction for the interest against two types of income: business and non-business pursuant to section 33(1). However, the holding company then waived the interest expense payable and as such, the taxpayer brought a part of it to income tax pursuant to section 30(4) but did not bring RM181 million as it was of the view that it did not fall under section 30(4). Section 30(4)(a) reads: “Where a deduction has been made under subsection 33(1) in computing the adjusted income of the relevant person… the amount released shall be treated as gross income of the relevant person from that business for the relevant period.” The question was whether section 22(2)(a) enabled the IRB to compel the RM181 million to be taxed despite the fact that it was waived against its non-business income.

A heated debate was what interpretation should’ve been taken when interpreting Section 22(2)(a). Section 22(2)(a) reads: “the gross income … shall include any … insurance, indemnity, recoupment, recovery, reimbursement or otherwise” The IRB claimed that the word “otherwise” is wide enough to capture the waiver of debt in the non-business income of the taxpayer. However, the taxpayer contested the IRB’s understanding of the word “receivable” and “otherwise”. It contended, amongst other disagreements, that the word “receivable” included a debt which was, in common sense, not something to be “receivable” and the word “otherwise” was limited to payments of similar nature as the words used before it.

On the first point of whether a debt is something “receivable”, both the High Court and Court of Appeal answered in the negative. They referred to the natural definition of the “receivable” as “capable of receiving” (Oxford English Dictionary) or “awaiting receipt of payment (accounts receivable)” (Black’s Law Dictionary). It should mirror the characteristics of an income that “comes in” and not something that is saved from (Tenant v Smith). The common treatment of when a creditor waives a debt, the Court of Appeal agreed and a purposive approach ought not to have been taken which will render the section superfluous and redundant and Parliament does not pass law in vain.

On the point of whether the word “otherwise” is wide enough to claw back the RM181 million to income tax, the High Court and Court of Appeal agreed that it isn’t. The High Court held that the word “otherwise’ must be confined to things of the same kind as the preceding words. In the case of section 22(2)(a), the preceding words shared a common character connoting a receipt, something “receivable”. On the other hand, a release of debt is a discharge of an obligation. The case relied upon the IRB for the interpretation of the word “otherwise” was also inconsequential in the present case. In Norliana bte Sulaiman (the cited case by IRB), the word “otherwise” under Section 114 of the CPC was preceded by only the word “caution”. In the present case, the word “otherwise’ is preceded by five other words which can form a genus. Therefore, otherwise should also be understood in light of the words before it and not standalone to be a “capture all” net. (It should be noted that the Federal Court overturned the decision on the basis that the taxpayer ought to have commenced from the Special Commissioners of Income Tax and not by way of judicial review.)

  • Comment: A holding that I find to be particularly compelling by the High Court was that “there is no other section that deals with the release of debt in the ITA”. I find this to be slightly at odds with the previous case above which proceeded the taxing of debt under section 4(a). Although it would not produce a different outcome, it would’ve been clearer had IRB been more consistent in their approach.

However, tax being tax, it’s not the most easily understandable subject in the world. It was noted that the IRB has also acknowledged that section 30(4) is not relevant to the present factual circumstances and as such, proceeded to bring it to tax under another section. I wouldn’t call this a frivolous demand but rather a taxing statute, being one that imposes an obligation, must be understood in its plain and natural meaning. Furthermore, Section 30(4) is a specific provision which ought to take precedence over a general provision like section 4(a) or section 22.

 

Conclusion

I personally find these cases to be very useful in shedding light on the issue of whether a waiver of debt is considered as a form of income in the books of the debtor. It also reinforces the underlying understanding that only a release of debt in the business income of the taxpayer, and not in the capital account/ capital reserve or non-business income, is taxable. Section 33 allows deduction of expense wholly and exclusively incurred in the production of gross income, it does not specify that it must specifically be income from a source of business. Therefore, a deduction pursuant to section 33 but subsequently forgiven in the non-business income of another is not taxable.

The differences between Income Tax Act, Public Rulings and PU order

Unknown to most, the Income Tax Act 1967 is not the only piece of document that has the force of law. When determining the deductibility of expenses and whether income from a certain source is subject to tax, tax consultants (me) would refer to several places and with reference to various other documents to make a rational judgment for the client. To supplement the Income Tax Act, it is common, amongst others, to refer to the Public Rulings and PU orders.

What are Income Tax Act, Public Rulings and PU orders?

The Income Tax Act requires no extensive introduction. It is the authority which mandates taxpayers to pay taxes, the types of income subjected to tax and where the IRB draws its power and jurisdiction from. It is also perhaps the only Act which is amended almost every single year following the passing of a new Finance Act every year owing to the always highly-anticipated Budget announced by the government each year.

The lesser-known nephew of the Income Tax Act called the Public Ruling can be found on the IRB website. These are guidance to taxpayers on the interpretation of the Income Tax Act and its various treatments. The preamble of every Public Ruling provides that “A Public Ruling is published as a guide for the public and officers of the Inland Revenue Board of Malaysia. It sets out the interpretation of the Director General in respect of the particular tax law and the policy as well as the procedure applicable to it.”

On the other hand, the Income Tax Act’s child called the PU order is a piece of subsidiary legislation that has passed through parliament and has the force of law. PU stands for “Pemberitahu Undangan” or “Legal Notification”. PU(a) contains all Royal Proclamations, orders, rules, regulations and by-laws, whilst the PU(b) contains all subsidiary legislation other than that which is required to be published in the Legislative Supplement A and generally deals with appointments and notifications.

What are the differences between the Income Tax Act, Public Rulings and PU order?

Now that I’ve outlined a very brief description of each, we’ve come to the main crux of this blog post.

  1. Force of Law

If you had been reading meticulously till here, you would have noticed that I called the Public Ruling as a “nephew” of the Income Tax Act whereas the PU order is the “son”.

This is the first difference: PU order and the Income Tax Act carries the force of law whilst the Public Ruling doesn’t. The PU order is a supplementary legislation of the Income Tax Act hence why it is “child” of the PU order whereas the Public Ruling, whilst deriving its power from Section 138A of the Income Tax Act 1967, is merely an interpretation of the Income Tax Act and a lawyer’s job is to always dispute on “interpretation” of the law. It is a guideline, opinion, point of view or advice by the IRB.

Therefore, whilst the Public Ruling’s interpretation of various issues are non-binding, any deviation from the public ruling would attract a tax audit, tax investigation and tax penalty. If aggrieved or discontent with the Public Ruling, taxpayers will always have the choice of challenging it via the legal route (which if you didn’t know, goes to the Special Commissioners of Income Tax, High Court and ends at Court of Appeal. The Federal Court does not hear tax cases.)

2. The contents

The contents of each document also differ and it is only when a taxpayer reads all three comprehensively would he have a better understanding of whether an item is taxable or not.

The Income Tax Act is first, an outline about the rights and responsibilities of taxpayers, secondly, a source of power for various bodies (most notably the IRB) and thirdly, a provision for institutional mechanisms. It is separated into 2 parts: the main body and the schedules. Just to briefly provide some example of its contents: Section 4 provides the types of income to be taxed, Section 20 conveys the basis period for a year of assessment of taxes, Section 33 is about the deductibility of expenses and encapsulates the “wholly and exclusively”, Section 42 aggregate income, Section 43 statutory income and Section 45 chargeable income. Schedule 6 concerns the deductibility of expenses and Schedule 7 is about capital allowances.

The PU order supplements the Income Tax Act as subsidiary legislation and it provides clarity on certain issues in which taxpayers can be 90% sure that the treatment will be correct (90% because anything can be an issue on interpretation). The contents are usually very short and sweet and deal with one issue per notification.

An example on the interaction between Income Tax Act and PU Order is on the deductibility of certain expenses. For example, under S33 on determining whether an expense is deductible or not, Audit fees, Tax services fees and Secretarial fees are non-deductible. This is because section 33 provides that for an expense to be deductible, it must be “wholly and exclusively in the production of gross income”. Audit fees, Tax services fees and Secretarial fees whilst being a requirement under law to continue operation, is not in itself involved in the “production of gross income” and hence would be added back in the computation of chargeable income. Audit fees, Tax services fees and Secretarial fees can be very substantial especially to a public listed company with various statutory obligations to obliged by. Hence after lobbying by various parties, a PU order called Income Tax (Deduction for Expenses in relation to Secretarial Fee and Tax Filing Fee) Rules 2014 and also Income Tax (Deduction For Audit Expenditure) Rules 2006 to provide for this deduction.

As mentioned previously, Public Rulings are guidelines and interpretations of the Income Tax Act. The contents are simple to read and understandable to the masses. It provides many examples and scenarios, how the treatment of various issues should be and breaks down the statutes into piecemeal by interpreting the statute into common English parlance (that lawyers may or may not agree haha).

3. Relief procedures

If say you made a mistake on your tax returns based on interpretation of the law, appeal against the IRB on their judgement on your tax return or if you wish to object to the treatment of certain items under the public ruling, each would entail a different process.

The relief procedure is more or less the same depending on the type of relief sought.

  1. Appeal against assessment

Under the Income Tax Act, the IRB has the power to conduct tax audit and perhaps issue a notice of assessment which will increase the tax payable on an entity with the penalty added. This is when the IRB is of the opinion that you have under-declared your income, claimed deductions in excess of what should be permitted etc.

Under Section 99 of the Income Tax Act, a person aggrieved by the decision may make an application to the Director General within 30 days upon service of the Notice of Assessment stating the grounds of appeal (except for Advanced Assessment, the application would need to be done 3 months). Extensions are allowed under Section 100.

However, the right to appeal under Section 99 is disallowed if it is to claim relief against a deemed assessment or deemed assessment on amended return from 24 January 2014 onwards unless it was made in disagreement with the public ruling made under section 138A or any practice of the Director General generally prevailing at the time when the assessment is made. Therefore, according to PR 7/2015, what is allowed to be appealed under this is section are:

  • Assessment/ additional assessment/ advanced assessment/ notification of non-chargeability (NONC) by the IRB
  • Best judgement assessment made without ITRF or late submission of ITRF
  • Deemed assessment and deemed amended assessment where the taxpayer does not agree with the tax treatment stated in any PR made under section 138A of the ITA or known stand, rules and practices of the DGIR prevailing at the time when the assessment is made.

Reduced assessment is also allowed if there are issues in the notice disputed by the taxpayer.

B) Relief on mistake and error

A taxpayer may make an application for relief under section 131 in respect of error or mistake in the in his Income Tax Return Form. The determination of whether a taxpayer has made an error or mistake is a question of fact and law.

The conditions under subsections 131(1) and (4) of the ITA are:

(a) Application for relief under Section 131 of the ITA will not be considered if the ITRF is made in accordance with the known stand, rules and practices of the DGIR prevailing at the time when the assessment is made. (b) The taxpayer must pay all taxes that have been made for the year of assessment in which an application in respect of the error or mistake is made. (c) The taxpayer must make a written application by way of a letter or Form CP15C to the DGIR within five (5) years after the end of the year of assessment in which the assessment is deemed.

Previously, it was assumed that if you willingly and knowingly followed a Public Ruling without knowing that the treatment in the Public Ruling is wrong or challenging it, you are prevented from appealing. This was interpreted under Section 131(4) which provides that “No relief shall be given … in respect of an error or mistake… if the return … was in fact made on the basis of … the practice of the Director General generally prevailing at the time…” where “practice of the Director General” was understood to be referring to the Public Ruling. This was overturned on appeal in RGTSB v Ketua Pengarah Hasil Dalam Negeri where it was held that “practice of the Director General” does not include the Public Rulings. The basis was that the preamble of the Public Ruling does not mention that it is a Practice of the Director General, a distinction between the Public Ruling and practice of the Director is made under Section 99(4) and on the basis of fairness. Therefore, where taxpayers have erroneously followed a public ruling, relief is allowed.

C) Relief other than in respect of error or mistake

Introduced in the Finance Act 2017, Section 131A supplements the Act by providing more avenues for relief for a taxpayer on the basis that the return is excessive by reason where any exemption is approved AFTER the year of assessment in which the return is furnished or issues regarding the deduction of withholding tax.

The conditions under this new provision are: the Tax Return must be in accordance with S77 and S77A (which means the Tax Return must be filed on time) and all taxes for the relevant year of assessment has been made.

To be eligible for the relief, the application must be made within 5 years, after the end of the year, from which the exemption was Gazetted or approval was granted (whichever later) but in the case of withholding tax, 1 year after payment was made. A taxpayer will resort to this provision when he is, for a year assessment, eligible to claim exemption, allowance or deduction but the approval for such is only granted after the end of the year of assessment. For example, Company A ends its accounts on 30 June 2016 and submits it’s Form C (Income Tax Return Form for Companies) on 30 November 2016. It had applied for pioneer status and approval was granted on 30 May 2018 for the period 1.1.2016 to 31.12.2020. The taxpayer may apply for relief under S131A to have its tax paid for YA 2016 and YA 2017 to be reduced accordingly before the end of 5 years from 31st December 2018, which is 31st December 2023.

Exclusion clause, a turning point ?

So I was just casually browsing the web when an article piqued my interest. ‘Bank can’t use exclusion clauses to escape liability, court rules’. This piqued my interest for several reasons. However, let me simply explain what is exclusion clause and what this ruling means.

The word ‘exclusion clause’ would be familiar to law student. It is of general knowledge that when parties to contract sign a contract, they are bound by the terms of the contract. This is based on the reasoning that both parties have negotiated the contract, and provided their consent and willingness to be bound by the terms of the contract. Hence, if a party refuses to follow or abide by the terms of the contract, the other party would be able to claim legal action.

Having said that, it is also common fore a standard contract today, to have an exclusion clause, or at least a limitation clause. Depending on how the clause is worded, the party is able to exclude any liabilities in the event that something happen. A typical example would be if a person is staying in a hotel room. There is usually an exclusion clause, stating that the hotel will not be liable for any losses of items in the hotel room. Thus, if a person’s camera is stolen in the hotel room, the hotel will not be liable or responsible for the loss. If the person claims legal action, the hotel would merely claim that ‘look, you signed the contract. the contract has an exclusion clause. The exclusion clause says that we are not responsible for any loss suffer during your stay. Thus, we are not responsible for the loss.

In Anthony Lawrence Bourke v CIMB (2017), The appellant alleged that CIMB has breached the contract for not releasing progressive payment as per the contract. CIMB in respond, relies on the exclusion clause.

Learned counsel for the Appellant raised 3 grounds in regards to the interpretation and construction of the exclusion clause. At Para [44] of the judgment,

“The three grounds raised were that Clause 12 is void under Section 29 of the Contracts Act 1950; it is against public policy and it is not an absolute exemption on the liability of the Respondent Bank.”

In response, the Learned Counsel for the Respondent, relying on CIMB Bank v Maybank Trustees Berhad and other Appeals [2014] 3 MLJ 168 that the exemption clause must be enforced, however unreasonable the court may think.

Section 29 of the Contracts Act 1950 reads the followings:

Every agreement, by which any party thereto is restricted absolutely from enforcing his rights under or in respect of any contract, by the usual legal proceedings in the ordinary tribunals, or which limits the time within which he may thus enforce his rights, is void to that extent.

In other words, Section 29 renders a contractual clause which prohibits absolutely the right to enforce a contract by usual legal proceedings void. At para [52], the court noted that:

“It is obvious to us as well as to the learned counsel of the Appellants, and so to the Respondent, that Clause 12 has the effect of excluding the liability of the Respondent bank for any cause of action arising out of the Loan Agreement. Consequently it is a clause that negates the right of the Appellants herein to a suit for damages; the kind spelled out in that clause, which encompass all form of damages under a breach of contract or under a suit of negligence.”

After further consideration of primary and secondary obligation, the court noted that:

we are of the considered view that Clause 12 contravenes section 29 of the Contracts Act, because in its true effect it is a clause that has effectively restrained any form of legal proceedings by the Appellants against the Respondent bank. It can be clearly demonstrated by the current appeal that despite our findings on the breach by the bank in this case if Clause 12 is allowed to stay it would be an exercise in futility for the Appellants to file any suit against the Respondent bank.

The court is effectively noting that the Bank could not rely on the exclusion clause to exclude or avoid liabilities as ‘that particular exclusion clause’ contravenes Section 29. As Lawyer Ong Yu Jian, the learned counsel for the Bourkes noted that the ruling remove the ‘bulletproof vest’ of banks that prevent clients from filing suits on equal ground. He further noted that

“This decision would improve the standards of the banking industry as a whole, as it would make banks more careful and accountable to their customers in their day-to-day dealings,”

In addition to the legal interpretation of the applicability of the exemption clause, Judge Balia Yusof Wahi explains that “Parties are not on equal levels. In today’s commercial world, the customer has to accept the contract as prepared by the other party.” There is effectively an unequal bargaining power by both parties unlike the hypothetical scenario mentioned earlier. In the event where there is unequal bargaining power by both parties, it is of the public policy for the court to interfere to protect the public. If the public suffers unfairness, the court ought to intervene.

It is said that the commercial very much value certainty. Thus, in interpreting any contract between parties, the court would often want to uphold the contract rather than striking it down since it is a contract made with the consent of both parties. Thus, this decision can be seen to be a turning points of sort where the court is willing to rule the exemption clause to be void, despite being a term to a contract which both parties consented to. However, it is important to note that based on the judgment, it would seem that not all exclusion clause would contravene Section 29. It very much depending on the wording of the clause, and the bargaining power of both parties.

Budget 2019 Malaysia for the Malaysian Millenials

Last Friday, 2 November 2018, marks the first national Budget by the new government ever since the independence of Malaysia. As much as this is a historic and monumental event it is, it is also a day which would affect 32 million people coupled with a balancing act to solve the growing national debt hence many eyes and pressure are on this Budget. With the Budget being revealed, there were many mixed reactions as some were surprised with certain changes being made whilst others were disappointed.

This is an overview of some points in the Budget 2019 that may or may not affect you as a Malaysian Millennials.

  1. RM100 unlimited travel pass

There was a study done by Cent-GPS on a study of the MRT which highlights the problems about public transport namely that the locations were not strategic, cost relating to travel using the MRT is too high which discourages consumers from switching from their private cars as a mode of transport.

I strongly welcome this initiative by the government to encourage people to take the public transport more and ease the traffic on the roads. The current status quo is that the opportunity cost of driving instead of commuting to work is not significant enough for people to abandon their cars and squeeze themselves into the tight train carriage for an hour’s ride. With this, the citizens can have more disposable income to spend with approximate RM200 savings on transportation and also it would lighten the traffic on the road.

However, the government would need to increase the number of trains available during peak time as from personal experience, it is currently insufficient to meet demand. To meet the expected surge in demand next year, more trains is urgently necessary to have the desired effect or any positive effect at all.

Note: there are several reports where the Transport Ministry intends to team up with Grab to solve the “last mile” problem but nothing solid has been given so far.

2. PTPTN

PTPTN has its own fair share of criticism by the nation especially on the topic of loan default. According to NST, only half of loan PTPTN are repaying their loans and the total outstanding debt is around RM39 billion. The government has time and time again tried to incentivise PTPTN repayment but the needle has not shifted significantly.

Finance Minister YB Tuan Lim Guan Eng had announced that the deferment of the PTPTN loans until borrowers earn RM4000 and above is too much of a strain on the country’s financial burden and as such, a scheduled deduction of 2% – 15% would go towards repayment of their debt when they earn more than RM1000.

Additionally, no more discounts staring 2019 will be given to PTPTN borrowers. However, discounts will be given to B40 households who have successfully obtained first class honours as compared from the previous government’s regime where students were exempted from repaying their PTPTN loans upon earning first-class honours for their bachelor’s degree, upon meeting certain conditions.

3. First House Buyers

The government endeavours to encourage Malaysians to purchase their first home and to curb the problem of overhang in residential properties and thus several initiatives have been launched as a means of solution.

First, there is a 100% stamp duty exemption for properties up to RM300k on the instrument of transfer and loan agreement. For properties above RM300k but below RM500k*, the 100% stamp duty exemption is limited to the first RM300k of home price on the instrument of transfer and loan agreement. For properties above RM300k but below RM1mil, the 100% stamp duty exemption will only apply on the instrument of transfer.

* Purchase of first residential home from housing developers.

Additionally, the government has launched the FundMyHome, the peer-to-peer (P2) home financing exchange platforms. This is a crowdfunding platform which serves as an alternative source of financing for first-time home buyers. Under this scheme, the purchaser will be able to acquire a property whilst paying only 20% of the price of the property and the remaining 80% will be borne by potential investors, mainly financial institutions. In this case, the purchaser need not source for a loan from the beginning since it is understandably difficult should the purchaser lack the financial capabilities to do obtain one. However, after 5 years, the property is either sold off and the proceeds are divided according to a prescribed ratio or the purchaser can then obtain a loan to service the remaining amount. (There is an interesting discussion on this circulating social media here where it highlights problems about this system.)

4. Sugar Tax

We Malaysians consume large amounts of sugar daily without most of us even knowing. From the morning’s Teh Tarik to break time’s kueh to dessert’s cendol, it’s no wonder that in 2017, Malaysia was dubbed most obese in the region. It is reported that one in two Malaysians is overweight or obese.

Starting April 2019, a new excise tax known as “sugar tax” of RM0.40 per litre will be imposed on sugar-sweetened beverages. This will be on beverages that contain sugar exceeding 5g per 100ml, as well as juices that contain more than 12g per 100 ml.

My only concern about this is inflation and that demand for sugar-sweetened beverages in Malaysia is very inelastic but we’ll see how this plays out.

5. Digital Tax

I’ve talked about Digital Tax in a brief in a blog post earlier here. Basically, it’s a tax on services provided online which escapes most countries’ taxation regulatory framework. To ensure the competitive level of local players, governments across the globe have trying to tax this intangible economy that exists in the clouds.

It is proposed that the current Sales and Service Tax regime would be extended to include imported services such as digital advertising (Facebook advertisement and Google advertising), online streaming platforms (Netflix and Spotify) and downloaded software. For consumers, service tax imported by individuals will be effective 1.01.2020 whilst it is a year earlier for Malaysian businesses.

6. Minimum wage

Let’s just say that if you’ve graduated from a tertiary education and is currently earning more than RM3000, congratulations! You’re already well above the median of Malaysian employees which was last recorded at RM2160 in May 2018. That means, there are plenty of those who are earning well below RM2160 and at the national minimum wage.

In the Budget 2019, the government proposes to increase the national minimum wage to be raised to RM1,100 nationwide effective 1 Jan 2019. This is an increase of 10% from the previous administration. This is a measure by the government to reduce the income gap which has doubled for the B40s and T20s between 1995 and 2016. It was reported by The Star that households earning less than RM2000 will only have RM67 in savings after paying for daily expenses just to get by.

In my humble opinion, this is a good step to reduce income inequality by increasing B40s income at a rate faster than income level increase, I’m slightly sceptical about the fact that the amount applies nationwide which ignores the different cost of livings and also the fact that this will contribute to more inflation for 2019.

7. Personal Tax relief

Starting from the Year of Assessment 2019, Budget 2019 proposes that the combined tax relief for EPF contributions and life insurance premium/ Takaful contributions would be increased by RM1,000 to RM7000. However, the relief is now broken down and separated into 2 distinct amounts whereby a maximum of RM4,000 is given for EPF and RM3,000 for Takaful & Life insurance premiums. This would result in a lower tax relief where the individual does not make any Takaful/ Life insurance premium.

 

Personal comments:

YB Lim Guan Eng first described the Budget 2019 as one being of “sacrifice” and it does appear to be so to a certain extent. There are some tax hikes, for example, the Real Property Gains Tax, Digital Tax and Sugar Tax but overall, the Budget seems promising but hopefully, we will see a better Debt-GDP ratio next year. The only concern I have is that it may have a snowball effect which results in a high inflation next year due to rising business cost.

Understanding RPGT

Most of us at some point in life would like to own a house(s). Most of us would also have moved house at some point in our life now. However, do you really know what are some of the tax implications of moving houses and selling off the previous residence?

 

Real Property Gains Tax (RPGT) in Malaysia is a tax levied upon disposal of a real property, mainly to do with land, paid to the IRB. Since it is paid upon disposal, it is applicable to the vendor of the transaction.

  1. Introduction

Under section 3 of the RPGT Act 1976, it states that

Real property is defined as “any land situated in Malaysia” and any interest, option or other rights in or over such land”. If you have any knowledge of the National Land Code, this includes leases, licenses and charges where you have “disposed” of them.

Depending on when you sell the piece of land, you will be charged different RPGT rates:

Cr: MahWengKwai & Associates

2. How is RPGT calculated?

In arriving the tax payable upon disposal, the following three-step equations are used.

Step 1: Chargeable Gain = Disposal Price – Purchase Price – Miscellaneous Charges

Step 2: Net Chargeable Gain = Chargeable Gain – Exemption waiver (RM10k or 10% of chargeable gain, whichever is higher)

Step 3: RPGT payable = Net Chargeable Gain x RPGT Rate

3. Items exempted from RPGT

Since RPGT is charged upon a gain from disposal, it is important to first determine when the acquisition and disposal actually happened, at what consideration both events were completed and whether a loss or gain was made. This is to prevent any fraud/ tax evasion because parties may purposefully conduct the transaction at below market value price to make what is actually a profitable transaction to a loss-making one and for the party to claim allowable losses. There are a few instances where you can get RPGT exemptions or deductions.

(a) Allowable loss is defined as under section 7 subsection (4)

And subsection (b) deals with where you have no gains to be reduced, it will be brought forward to subsequent years until the allowable loss has been fully absorbed, even if it was done 5 years after acquisition.

(b) Incidental cost: The RPGT Act 1976 allows certain incidental costs of the acquisition of the property and disposal of the property to be taken into account. This is where expenditure wholly and exclusively incurred by the disposer for the purposes of the acquisition or the disposal such as legal fees for the acquisition and disposal of the property and estate agency fees.

(c) No gain no loss: You also do not need to pay RPGT where acquisition cost equals disposal cost at which you are in a no gain no loss situation.

(d) Private residence: Accordingly, every citizen in Malaysia (and also PR residence) is entitled to a “once in a lifetime” exemption on disposal of a private residence. A private residence is a building or part of a building in Malaysia owned by an individual and occupied or certified fit for occupation as a place of residence.

Only residence/ persons are able to claim for this exemption. This does not apply to companies holding private residence.

(e) Transfer of property between family members as gifts

Transfer of real property as gifts between parent/ children, husband/ wife or grandparents/ child is also exempted.

For the donor, if he is a Malaysian citizen, he is deemed to have received no gain and suffered no losses.

For the receiver, if the gift is made within five years after the date of acquisition by the donor, the recipient shall be deemed to acquire the asset at an acquisition price equal to the acquisition price paid by the donor plus the permitted expenses incurred by the donor.

4. How is RPGT paid?

Upon disposal of a property, it is the duty on the part of the acquirer’s lawyers to retain and remit 3% of the purchase price from the deposit to the Inland Revenue Board (IRB) within 60 days upon disposal. If the 3% is found to be higher than the tax payable, the IRB will refund; If the 3% is lower than the tax payable, the vendor might be charged an additional penalty of 10% of the amount outstanding upon failure to furnish the outstanding amount within time.

It might be noteworthy to add that owing to the Finance Act 2017, the amount to be retained by the acquirer had increased from 3% to 7% of the purchase price where the vendor is not a Malaysian citizen nor a permanent resident.

Where a transaction is conducted consists not wholly in money, the acquirer shall either retain the whole of the money or a sum not exceeding 3% of the total value of consideration, whichever is lower.

Conclusion:

After listening to a podcast on RPGT on BFM89.9, it is noted that RPGT contributes only 0.7% of the total revenue received by the government. That being said, it is reported that Capital Gains Tax will not include gains on shares in Budget 2018. This is to keep Bursa Malaysia competitive and attractive for investors thus the only Capital Gains Tax in Malaysia is only on Real Property at the moment.

To be honest, I am very much surprised by how little RPGT contributes to the government’s revenue considering that land prices can be very steep at times. I think this is the reason why there are many case law on even if people hold real property for more than 5 years, they may be charged the income tax rate of 24% as oppose to RPGT rate of 5% because they are deemed to be trading properties instead of investing. Note that the IRB does not consider 5 years to be a substantially long period for an investment. So take note of this if you plan to invest in real property in the future or else you might end up having to pay more than you think.

5 Survival Tips for Students Awaiting CLP Results

It is only a couple of days away from the release of the long-awaited Certificate In Legal Practice (CLP) examination that was held in July 2018.

What is the CLP exam?

Every year, many hopefuls take the CLP exam in hopes of becoming a “qualified person” under the Legal Profession Act 1976 (“LPA”), which is a precursor (for foreign law graduates) to becoming a lawyer in Malaysia without having to go overseas to obtain a qualification.

If you are a CLP candidate this year, you are probably worried about your results.

Here are 5 tips to help you keep your sanity.

#1 Keep busy

Whether it is swamping yourself with work, preparing for a marathon or binging a new series on Netflix, everyone knows that time flies when you’re occupied.

Vectors at Vecteezy - https://www.vecteezy.com
Play sudoku. With a pen. Live dangerously.

You know the proverb, ‘an idle mind is the devil’s workshop’?

Don’t let the devil set up shop there. Sue him for trespass.

Also, for goodness sake, don’t contribute to the mass hysteria that is the speculation of a leak of the exam results. Go do something unrelated to CLP.

#2 Get enough sleep

If you have been deliberately depriving yourself of proper rest, then this is relevant to you. Otherwise, if you have sleep problems from the sheer anxiety of waiting for the results, then skip this bit.

There are good reasons for getting a full night’s sleep running up to the big day.

For one, you’re going to need enough energy to deal with the outcome. If you pass, then you will be well-rested enough to drive to LPQB to collect your certificate. If you fail one paper, then you have enough energy to hit the ground running in preparation for the upcoming resit on 1 Nov 2018. If you fail more than one paper, then you will need all the help you can get to move on with life.

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Tip: The more time you spend sleeping, the less time you spend worrying.

#3 Breathe

This may seem incredibly intuitive for most people, but many Malaysians are in denial about experiencing depression or anxiety. While some level of anxiety prior to an important event is normal (and beneficial), excessive feelings of anxiety can be debilitating and should not be downplayed.

Even if you don’t have severe levels of anxiety, it helps to use breathing techniques to stay calm during this period. There are many breathing techniques out there. Here are some of them.

My personal favourite is the 4-7-8 technique.

#4 Challenge your own expectations

I know of many people who are focusing on the worst possible scenario i.e. in the event that they do not pass the exam. Some scenarios involve their family members disowning them, or being a greater burden to their family.

Firstly, I want to say that I think that most of these concerns are based in reality. No one should be told that their fears are manufactured or invalid.

Nevertheless, in trying times such as these, it is natural for most people exaggerate the potential impact of a negative outcome. Although there is some use in this, in that it helps us prepare for the worst case scenario, we should challenge our expectations of what will really happen.

Perhaps it will not be as bad as you think.

vector-self
Don’t spend too much time swimming in your own thoughts.

In any case, whatever the outcome, you will be able to get through it, eventually.

Which brings me to my last point.

#5 Know that there is nothing you can do at this stage and that failing the CLP exam does not spell the end of your life. It may bring about unpleasant consequences, but like many things in life, those too will pass.

Of course, the stakes are different for everyone. Some still have the option of taking the Bar Professional Training Course (BPTC), while others may have to seriously consider a career in another profession altogether.

No matter what the outcome is, remember that your self-worth is not tied to a single life event. Even when it came to preparation for the CLP exam, it took a million small acts to get to where you are today. The acceptance of this Wednesday’s outcome is simply one of the acts that you must do. In due time, you will have moved past this.

You’re going to be OK.

Post–Uber/ Grab merger: Better or worse?

A few days ago, my friend and I decided to head to Sri Hartamas from KL Sentral for a healthy brunch at lunchtime. Prices during lunch hour are often higher because (of course) demand/ supply so we weren’t expecting it to be cheap but neither did we expect it to be so high. For Grab, it was RM20 which made us reconsider if the brunch was worth the trip (it’s the price of an entire meal!) For MyCar (another ride-hailing app), it was only RM11 so we were still able to get our smoothie bowls without a major heart pain. Comparing the price between Grab and MyCar, it was a massive 81% increase! Additionally, Grab used to offer many discounts and rebates in the past through text messages to its users but however, these are now nowhere to be seen.

However, as we were planning to head to Bukit Bintang for tea time after brunch, we could not book a MyCar and were forced to book a Grab which the price was higher compared to the former. This may be due to the fact that the area we were in was relatively secluded and not very convenient so the availability of MyCar was very scarce. However for Grab, being the bigger player in the market, it has more drivers hence higher coverage area so we had to use Grab instead.

I am sure many Grab passengers were disappointed with how Grab is now compared to how it was pre-merger. The price had increased but Grab claims that the prices were due to multiple factors such as surge pricing during peak hours, the algorithm to set the price based on driver availability and the number of bookings from a particular location. Weather is also an important factor taken that it was previously claimed that Malaysians would only take metered taxis during raining days or else it would be too expensive.

So what did the merger do?

In Malaysia, the MyCC has (belatedly) announced an intention to study the merger. Currently, Putrajaya is studying the risk of monopoly within the country’s ride-hailing market, which has been triggered by the merger between Grab and Uber.

A new player called Diffride has an interesting operating strategy which appears to be different from the conventional ride-hailing strategy where the company says it will only charge drivers a fee of RM5 per day to use the platform, and no commission. It will be interesting to see if this model is sustainable for the company considering that they only have 2000 drivers at the moment with an anticipated 4000 to join by the end of the year.

As reported previously, the Competition and Consumer Commission of Singapore (CCCS) and Vietnam Competition Commission had both stalled the merger citing “anti-competitive concerns”. Our counterpart across the border has done much more scrutiny and checks which has led to the CCCS to provisionally determine that ride-hailing firm Grab’s acquisition of American rival Uber’s South-east Asian business is an infringement of competition laws. On 24th September 2018, they have imposed a combined fine of S$13million of their infringement! (It was also revealed that the Uber/ Grab had even provided for a mechanism to apportion eventual antitrust financial penalties so it can be said that they saw this coming).

Honestly, it should have been a shining red light in the face of competition authorities that such a merger would cause competition concerns so I am *very very* glad that the CCCS finds that the merger had substantially lessened competition. Some of the provisional findings by the CCCS were interesting such as:

  • Uber would not have left the Singapore market in the near to medium term in the absence of the Transaction.
  • Uber had entered into an agreement to collaborate with ComfortDelGro with the introduction of UberFlash to compete with Grab, and the collaboration was only withdrawn after the Transaction.
  • Market share of taxi booking service was only at 15%. Grab holds a market share of 80%.
  • Fares have increased between 10-15%.
  • Parties have not been able to show that the Transaction gives rise to efficiencies that would outweigh the harm to competition.

Potential remedies and penalties

Reading the press release, I was particularly intrigued where the CCCS boldly said “CCCS may require the Parties to unwind the Transaction”. Such a move is often threatened but rare in practice but it is within their jurisdiction. Under Singapore’s merger notification regime, the Parties had the option of notifying the Transaction for CCCS’s clearance or seeking CCCS’s confidential advice prior to completing the Transaction. In the EU, parties were required to inform any intention of a merger which had an EU dimension.

Measures were ordered by CCCS to allow lower barriers to entry and improve market contestability which includes:

a. The removal of exclusivity obligations on all drivers who drive on Grab’s platform including rentals

b. The removal of Grab’s exclusivity arrangements with any taxi/CPHC fleet

c. The maintenance of Grab’s pre-Transaction pricing algorithm & commission rates until competition

d. Requiring Uber to sell all or part of Lion City Rentals assets to any potential competitor who makes a reasonable offer and preventing Uber from selling to Grab without CCCS’s prior approval.

Furthermore, CCCS said it may suspend the measures on an interim basis if a rival could garner over 30% of total rides in the ride-hailing services market in a month. It would remove the restrictions if the rival could maintain it for 6 months.

In Vietnam, the deal remains under competition authorities review which has warned that it could be blocked if the firms’ combined market share in Vietnam exceeds 50%.

In the Philippines, where the merger has been approved, the competition authorities will continue to monitor Grab’s compliance with conditions intended to improve the quality of service, with any breaches possibly resulting in fines.

Conclusion:

For now, worse. I find it hard to believe that Grab would charge an outrageous 81% higher than a smaller market player (where are the economies of scale theory here?). This also proves that the larger the firm, the more they likely they will consider consumer welfare. I echoed my previous post about the benefits a merger can bring: better resources, saving failing firms, barriers to exit and more. However, mergers have a much more, almost irreversible, impact on the competition market than say an abuse of dominant position. You can then later penalise an undertaking for an abuse post-merger, but not having a dominant position is always better because “prevention is always better than cure” so preventing the root of the problem is more ideal.

I would like to say that I am very impressed with CCCS’s media release by detailing the theory of harm and specifying the remedies that should be undertaken by Grab. Competition authorities are always trying to balance whether should they on one-hand empower smaller entities to raise competition or encourage growth and innovation by having less scrutiny over larger enterprises. Regardless, I am still of the view that it’s better to be safe than sorry and that the competitive levels are more contestable in the near future.

Can I say no?

A recent decision issued by the Malaysia Competition Commission (MyCC) imposed what I saw one of the heftiest penalty on a single entity for an infringement of Section 10 of the Competition Act 2010 – RM17mil. For some reason, this is much lower than the collective sum of RM33k in the earlier proposed decision on 7 tuition and day care centres for price fixing conduct, you can read my post on it here (which I am still waiting for any updates/ appeal/ decision *cough cough*).

The recent decision concerns the MyCC proposing to fine Dagang Net Sdn Bhd for abuse of its monopolistic decision (full proposed decision can be read here). Dagang Net seems to intend to challenge the Commission’s’ proposed decision and has also indicated to MyCC its intention to make an oral representation before the commission.

  1. The alleged infringement

Dagang Net Technologies Sdn Bhd is a wholly-owned subsidiary company of Dagang NeXchange Berhad (“DNeX”) and has a dominant position for Trade Facilitation under the National Single Window. According to the website, its’ e-services for trade facilitation include as follow:

Dagang Net Technologies is in the business of eService Trade Facilitation in which the exchange of trade documents among businesses and approving authorities and agencies is done electronically. An initiative by the Government in 2009 was to launch the National Single Window in order to simplify clearance procedures, facilitate the electronic exchange of trade-related data, reduce the cost of doing business and thereby enhancing trade efficiency and national competitiveness. Dagang Net Technologies had a contract and is now extended to 31st August 2019 for the said trade facilitation business.

Under the proposed decision, Dagang Net had provisionally infringed section 10 CA 2010 which subsection 10(1) reads: “ An enterprise is prohibited from engaging, whether independently or collectively, in any conduct which amounts to an abuse of a dominant position in any market for goods or services.” The proposed decision assumes a “monopoly” position by Dagang Net with restrictive conducts such as refusing to supply and imposing barriers to entry.

2. Refusing to supply

Normally the first step is to identify the relevant market to determine its’ market position to determine if it really is in a monopoly position as claimed. However, based on this phrase taken from their website: “In Malaysia, the NSW for Trade Facilitation system is developed, operated and managed by Dagang Net Technologies Sdn Bhd (Dagang Net).” I think I am safe to say that it is in a monopoly position for most of the process.

(Disclaimer: I don’t have hard evidence to prove or determine if they are indeed abusing their dominant position but merely analysing if they are based on the proposed decision and stating out the relevant law to it. Ps, I am waiting for MyCC cases judgment to be substantial enough to be quoted in each other’s cases…)

On Refusing to Supply, the Commission claims: The investigation has provisionally found that “Dagang Net … (refused) to supply new and/or additional electronic mailboxes to end users who utilized front-end software from software solutions providers which were not considered to be Dagang Net’s authorised business partners.” It was established in Commercial Solvents v Commission that a refusal to supply could amount to an abuse of dominant position as the reasons given for the refusal is often anti-competitive such as affecting competition on another market, dealings with a rival firm etc.

However, Refusal to supply is also difficult hard to be claimed as anti-competitive because there are equally good reasons as well. In Bronner, Advocate General Jacobs pointed out that the right to choose one’s trading partners and freely to dispose of one’s property are generally recognised principles in the laws of the Member States and incursions on those rights require careful justification. Hence the laissez-faire economic system dictates that parties are free to contract with whomever they choose and the terms to contract on.

→ Dagang Net currently holds a monopoly position and parties, therefore, have no other party to obtain the required services.

Secondly, sometimes duplication of facilities of a network is not feasible and may result in a loss-making situation for both parties. This is why most of the more regulated industries in the country such as water in Selangor is provided only by Air Selangor, electricity is only by Tenaga Malaysia and others.

→ This is unclear as the NSW for Trade Facilitation is still relatively new and it is not an essential facility per say since corporations may still use the longer and more tedious manual process.

Thirdly and most importantly, stated also in Bronner, it decentivises corporations to innovate and improve if it means that they would need to share it to ‘free riders’. In the Guidance, an obligation to supply and provide information or service may undermine an undertakings’ incentive to invest and innovate, even for a fair remuneration.

→ As provided in Dagang’s website, “the NSW for Trade Facilitation system is developed…. by (Dagang Net)” hence by forcing it to supply more may be detrimental to Dagang Net who perhaps invested a lot into developing the system and platform in which the NSW now runs on.

3. Deeper analysis

Now, onto the facts of the case. The basis that the Commission had identified as the reason for refusal to supply is because the “end users who utilized front-end software from software solutions providers which were not considered to be Dagang Net’s authorised business partners”. On a plain reading with no other facts given, this is prima facie an abuse of dominant position because

(1) It restricts what end users can choose as being their front-end software,

(2) It wants to affect the competition in another market by using its’ monopoly position in the trade facilitation market and

(3) it may or may not be a situation of tying/ bundling where only if the end users used software solution providers which were Dagang Net’s authorised business partners would Dagang Net provide new or additional mailboxes.

In Commercial Solvent, the factors leading to the finding of abuse were (amongst others):

  1. Using its dominant position on the raw material market to affect competition in the derivatives market
  2. Refusing to supply to an existing customer because it wanted to compete it downstream and the refusal risked eliminating the customer from the downstream market.

This seems to be quite apt to the current situation where Dagang Net where it seems to refuse to supply to again, affect competition in the front-end software by only providing services where the entities use their business partners services and it risked eliminating competition downstream. The distinguishing factor, however, is that in Commercial Solvent, it had a subsidiary who was also competing in the downstream market as the complainant and it refused to supply so that the complainant could not continue to produce a drug-related to the treatment of tuberculosis but its’ subsidiary could. In Dagang Net, the downstream was by its business partners hence not the same entity. Regardless, it seems pretty convincing to me that Dagang Net wanted to restrict competition perhaps because it was obtaining monetary benefits.

3.1 Essential facility doctrine

Also, “With great power comes great responsibility” (yes, I just quoted Uncle Ben from Spiderman) A quote apt to describe what monopoly players should note about the market obligations and responsibilities their position puts them in. Entities in a dominant position generally have an unspoken special obligation to maintain, protect or improve competition.

Currently, Dagang Net holds an “essential facility”. In Sealink, ‘essential facilities’ were defined as ‘a facility or infrastructure without access to which competitors cannot provide services to their customers’. This definition provides only a starting point. The challenge is to uphold the right of the undertakings under contracts and ensuring competition levels is maintained. In determining whether a refusal to supply amounts to abuse, a few issues must be addressed:

  • Is there a refusal to supply?
  • Does the accused undertaking have a dominant position in an upstream market?
  • Is the product to which access is sought indispensable to someone wishing to compete in the downstream market?
  • Would a refusal to grant access lead to the elimination of effective competition in the downstream market?
  • Is there an objective justification for the refusal to supply

And more.

Most often, this doctrine comes into play in the realm of patent and infrastructure. Dagang Net’s refusal to supply is very much like Bronner where it wanted to have access to the highly developed home-delivery distribution system of its much larger competitor, Mediaprint. The court preferred to use the term “indispensability” instead of “essential facility”. It stressed that the refusal must be likely to eliminate all competition from the undertaking requesting access, not merely making it harder to compete. Access must also be indispensable, not desirable or convenient and there must be no actual or potential substitute for the requested facility (Jones & Sufrin). It might be arguable that Dagang Net’s services were not “indispensable” because it was merely a simplification of the process from application to approval under the NSW system. Corporations and enterprises may still use the preceding method to obtain approval.

3.2 The balance between promoting competition and upholding contractual rights

On the contrary, other situations to consider are whether it is justifiable to force Dagang Net to provide new/ additional mailboxes for end-users who utilized front-end software who are not their business partners? There may be reasons such as to provide a more holistic and integrated to improve user experience because they are more familiar with business partners services and maybe some functions are catered to the needs of their business partners.

A prime example of streaming end-to-end processes is that you will never find an iPhone which runs on an Android system or an Android phone running on the iOS system. This is because Android phones are catered to maximise the user experience by only using the Android system whilst Apple users who prefer the iOS system will opt for the iPhone instead. One complements the other hence it makes sense to not deviate from the current business strategy.

Secondly, MyCC should not be concerned is because what Dagang Net holds is a contractual right given by the government for its’ exclusivity. In return for this exclusivity, Dagang Net may have invested a lot of money, manpower and time to develop the Trade Facilitation system in which forcing it to share with others might frustrate its’ incentives for further innovation.

However, it is not so straightforward and these arguments can fail. There is clear logic why the intervention of competition law to mandate shared access to a property is controversial. For example in Magill, only a hypothetical secondary market was affected but despite this, the courts ruled against its’ intellectual property rights and granted access. Magill is like the Genesis of Refusal to Supply under Competition law. Really, it all comes to where a balance can be obtained.

So… Can I say no?

Maybe (The most truthful answer you’ll get from every lawyer). In law, there is no hard and fast answer. This is even more where there are other elements such as economics and intellectual property rights into play. Competition law being the watchdog over the conduct of all industries will have to balance various stakeholders’ concerns and determine is a fair and just manner whether there was an infringement.

Monopoly or not, most corporations are profit-seeking but not all profits are obtained with an infringement of competition law. Here, I think there was an infringement if the Commission could prove that the infringement was due to the non-usage of business partners product. Additionally seeing as the monopoly position was ‘granted’ by the government, Dagang Net should not that it is not completely shielded by contract and impose restrictions to its’ whims and fancies.

I anticipate seeing more development in the case in the coming months/ years and also for the outcome of My E.G. Services Bhd & My E.G. Commerce Sdn Bhd’s infringement of Section 10 CA 2010.

The Tea Tiff

La Kaffa International Co Ltd v Loob Holdings Sdn Bhd and Another

chatime.jpg

Franchise Law

Franchising is simply defined as a tit for tat strategy where on one side it helps smaller companies to develop and prosper under the guidance of a bigger company while simultaneously allowing the bigger company to increase and expand their distribution. Guidance in this scenario encompasses being bound by rules of the franchise agreement.

Franchising in Malaysia is governed by the Franchise Act 1998 (Franchise Act), as amended by the Franchise (Amendment) Act 2012 which came into force on 1 January 2013, and the Franchise Regulations 1999 (amended by the Franchise (Forms and Fees) (Amendment) Regulations 2007).

Loob Holding Sdn Bhd (“Loob Holding”) was appointed as a Chatime franchisee in 2011 by La Kaffa International Co. Ltd (“La Kaffa”) and entered into a franchise agreement called Regional Exclusive Representation Agreement (RERA). Chatime outlets mushroomed across Malaysia with 165 outlets being owned and operated by Loob Holdings. Loob Holdings is the master franchisee with the outlets being either directly owned, sub-franchised or a joint venture with sub-franchisee.

“Due to disagreements with Loob Holdings, we have no choice but to make this painful decision”

Teresa Wang

Executive Vice President, La Kaffa

On 5th January 2017, despite having 24 more years to go, La Kaffa terminated RERA with Loob Holdings. Among others La Kaffa alleged that :

  1. Loob Holdings has violated Article 7 of RERA which states that Loob Holding can only purchase raw materials from La Kaffa.
  2. Loob Holdings has violated Article 10 of RERA by delaying and denying La Kaffa’s request to exercise its rights to inspect and audit.
  3. Despite repeated demands, Loob Holding has failed to comply with the terms of RERA and/or failed to make payment of, amongst others, the purchase of raw materials from the Plaintiff.

The dispute between the parties was to be resolved through arbitration in Singapore. This is due to Article 18 of the RERA which states that the RERA is governed by Singapore laws and any disputes regarding the RERA shall be arbitrated at the Singapore International Arbitration Centre.

“The three franchisees with four stores will maintain the Chatime name. The rest will be rebranded into Tealive from Feb 18 onwards”

Bryan Loo

CEO, Loob Holdings

Following the termination of RERA, in what appeared to be a well calculated and well maneuvered move, Loob Holdings was able to convince 95% of existing Chatime outlets to join them in new venture under the Tealive brand. At the time of the takeover, Chatime Malaysia accounted for 20% of La Kaffa’s total revenue. La Kaffa therefore commenced proceeding in the Malaysian High Court to obtain injunction (prohibitory and mandatory) against Loob Holdings pursuant to section 26(1) and 27(1) of the Franchise Act 1998. The interlocutory proceeding was issued pending the disposal of the Singapore Arbitral Proceedings under provision relating to application for interim injunction under section 11 of the Malaysian Arbitration Act 2005. As La Kaffa did not seek a perpetual injunction, if the Court grants interim injunction, it would last until the disposal of the Singapore Arbitral Proceeding.

The High Court held that it could not close Tealive down because provision s. 27 of the FA 1998 was not incorporated into the RERA and Loob Holdings and its related parties did not give a written undertaking to cease business for two years. The High Court was of the view that Tealive does not need to close down because Loob Holdings did not promise to close down after the termination of the RERA. The High Court Judicial Commissioner Wong Kian Kheong (as then he was) was of the view that the issue before the Court was whether La Kaffa is entitled to an interim injunction so that it can be used to support, assist, aid or facilitate the Singapore Arbitral Proceedings. Further, the high court found that the balance of convenience lies against the granting of the interim injunction in view that it carries a higher risk of injustice than a refusal of the interim injunction. As such, La Kaffa’s claim was refused.

“the following third parties will be adversely affected by interim restraining injunctions awarded against Loob

(iia)  161 Tealive Franchisees have to close shop immediately;

(iib)  the livelihood of about 800 employees of Loob and 161 Tealive Franchisees (Tealive Employees) will be jeopardised;

iic)  the families and dependants of Tealive Employees; (iid)  the suppliers and contractors of Loob and 161 Tealive Franchisees;

(iie)  the bankers and creditors of Loob and 161 Tealive Franchisees; and

(iif)  the landlords of the office and business premises of Loob and 161 Tealive Franchisees”

WONG KIAN KHEONG

Judicial Commissioner High Court (Commercial Division)

 

La Kaffa appealed to the Court of Appeal next and in granting the prohibitory injunction, overturned the High Court’s decision. The Court of Appeal held that firstly, a simple construction of Article 15 of the RERA as well as s. 27 of FA 1998 will demonstrate that there is an obligation for Loob not to compete with La Kaffa’s business even after the termination of the RERA. In simple terms, The Court of Appeal said that the franchise agreement and the Franchise Act both state that the franchisee (Tealive) cannot carry on a competing business after terminating the franchise agreement. The creation of Tealive was, on the face of it, in contravention of the prohibition (doing something despite not being allowed to do it) under the franchise agreement and the Franchise Act. Secondly, In light of Article 15 of the RERA and s. 27 of FA 1998, the High Court ought not to have refused the prohibitory injunction. When parties have agreed not to do certain acts and a statute also provides for such protection, the court is obliged to give effect to ensure the salient terms of the agreement as well as the statute is not breached. The Court of Appeal held that the court should not allow someone to continue doing something that they aren’t legally allowed to do in the first place. Moreover, The Court of Appeal found it unjustifiable for the High Court to rely that the Tealive bubble tea business consisting of 161 outlets and the livelihood of 800 employees will be affected.

“Courts should not lend its hand to persons who on the face of records are seen to be cheats”

Hamid Sultan Bin Abu Backer, JCA

(Majority Decision)

Court of Appeal

 

Fortunately for Loob Holdings, despite being dismissed on a majority of 2-1, the stay of execution was granted by the Federal Court. Nevertheless, Tealive will be forced to close down until the disposal of the Singapore Arbitral Proceedings if the Federal Court were to refuse leave for Loob Holdings to appeal to the Federal Court.

[UPDATE] 

In a joint statement released on the 30th August 2018, Loob Holding Sdn Bhd (Tealive) and La Kaffa International Co Ltd (Chatime) announced that both companies have reached an out- of court settlement to amicably resolve all disputes arising from their one time franchise relationship of the Chatime bubble tea brand.

In light of the amicable resolution, both parties have agreed to withdraw all ongoing proceedings in Malaysian courts as well as arbitration in Singapore.


Related or not related?

Identifying a related party transaction (RPT) is similar to playing detective and spotting the difference. If you’ve ever watched Suits (or the ongoing case of 1MDB), these transactions go from bank accounts to bank accounts, countries to countries and ending up settling in an offshore bank account. Tracing the chain of transactions is challenging at its simplest and are complicated to weave through the webs of thousands of transactions.

RPT is not always damaging to the companies as they might mutually benefit. For example, the principal company might award a contract to its subsidiary because of financial reasons and to save cost. However, RPT’s bad reputation and connotation stem from the fact that it is the most common way Directors and Trustees syphon out money from the company for personal benefit and money laundering.

  1. What is Related Party Transaction

As a basic and simple definition, a related-party transaction refers to any transaction involving the acquisition or disposal of interests in securities/assets by a company or any of its subsidiaries from or to a related party. The interest need not be financial or monetary interest. The Companies Act 2016 loosely defines “related” between corporation as:

Read that 3 times and see if you understand. Especially subsection (c ).

Interpretation:

  1. A and B are deemed related because A is the holding company of B (assuming full control). Nothing difficult.
  2. A and B are deemed related because A is the subsidiary of B. Nothing difficult.
  3. C and B are deemed related because C is the subsidiary of the holding company A of another corporation B.

(C ) is obviously the most contentious one because the question is then how far can you stretch this concept? Is C’s subsidiary’s subsidiary’s subsidiary deemed related to B? This would be the moot point of most RPT.

2. Who are related parties?

In addition to the above, transactions between the corporation and individuals/ other corporations which the directors of the company or substantial shareholder are connected to are considered a Related Party Transaction. Companies Act 2016 defines the how a person can be connected:

However, under section 221(3), a director shall NOT be deemed to be interested in any contract or proposed contract by reason only (a)relates to any loan to the company that the director has guaranteed or party to the loan; or (b) for the benefit of a corporation by virtue of section 7 is deemed to be related to the company that he is the director of that corporation.

As mentioned earlier, RPT are dangerous and are scrutinized because directors may enter into certain transactions at a grossly overvalued or undervalued price in which the director gets a personal benefit to the companies’ detriment. For example, Director A sells a piece of land to Individual B at 40% the market price who then sells it to Individual C at market price and splits the profit with Director A. This transaction, however, will be caught under the following provision:

This means that the transaction would be void unless shareholder approval is obtained at a general meeting or company approval at a Board meeting.

3. When and how is approval needed and obtained?

By default, RPT of any value requires a shareholders’ approval. At the general meeting,

  • An interested director in a RPT, must inform the Board of Directors of the Company the details of the nature and extent of his interest, including all matters in relation to the proposed transaction that he is aware or should reasonably be aware of, which is not in the best interest of the Company.
  • The director with interest, direct or indirect must abstain from deliberation and voting on the relevant resolution in respect of the RPT at the Board meeting. In a general meeting to obtain shareholders’ approval, a director or major shareholder, with any interest, direct or indirect, or person connected to them must not vote on the resolution approving the transaction.
  • Votes are to be taken on poll.

A similar provision to section 228 is encapsulated under section 223 Companies Act 2016. This deals with substantial transactions rather than RPT but I’m including this if RPT also happens to be a substantial value transaction which has additional requirements.

What approval procedures to follow would depend on the type of company involved in the transaction.

  1. Where a company’s shares are listed on the stock exchange

Under Chapter 10.08 of the Listing Requirements, “where any one of the percentage ratios of a related party transaction is 0.25% or more, a listed issuer must announce the related party transaction to the (Bursa Malaysia) as soon as possible after terms of the transaction have been agreed”. The valuation for the percentage ratio is calculated from the value of the assets compared to the net assets of the corporation so for example, the value of a piece of land a company intends to sell to the net asset of the corporation.

However, exceptions apply where the value is less than RM0.5mil or that it is a Recurrent Transaction.

If the percentage ratio is more than 5%, the corporation must announce the transaction to Bursa Malaysia + send a circular to shareholders + obtain approval at a general meeting + appoint an independent advisor before the transaction is agreed upon.

If the percentage ratio is more than 25%, the corporation must, in addition to the above requirements, also appoint a Principal Adviser who, inter alia, advise whether such transaction is carried out on fair and reasonable terms and conditions, ensure that such transaction complies with the relevant laws & regulations, ensure full disclosure and all the necessary approvals have been obtained, that it has discharged its responsibility with due care in regard to the transaction.

More regulations apply where it is a very substantial transaction (close to 100%) and where the company is a property developer with core business in development and real estate with development potential,

B. Where it is an unlisted subsidiary whose holding company is a listed company

Directors of the Holding company would obtain a shareholders’ approval in a general meeting in addition to shareholders’ approval of the unlisted subsidiary.

C. “Dan Lain-lain”

A substantial value undertaking or property or a substantial portion is when it either:

  1. Exceeds 25% of the value of the assets of the company
  2. The net assets attributed to it amounts to more than 25% of the total net profit
  3. The value exceeds 25% of the issued share capital

Whichever is highest

For this, approval procedure for substantial value transaction and RPT are the same– shareholders’ approval at a general meeting.

4. What is not a RPT?

Under the Chapter 10.08 of the Listing Requirements, the below are not normally regarded as RPT:

  • The payment of dividend, issue of securities by the Company by way of a bonus issue or for cash
  • An acquisition or disposal by the Company or its subsidiaries, from or to a third party, of an interest in another corporation, where the related party holds less than 10% in that other corporation other than via the Company;
  • The provision or receipt of financial assistance or services by a licensed institution upon normal commercial terms and in the ordinary course of business;
  • Directors’ fees and remuneration
  • the entry into or renewal of tenancy of properties of not more than 3 years, the terms of which are supported by an independent valuation

…. And more.

The case is less clear for “Dan Lain-Lain” but we can gain some inspiration from the Listing Requirements about what is expected.

Conclusion:

RPT particularly acute hence it is highly regulated and scrutinised to ensure the company has its’ checks and balances on its’ directors under the required rules and regulations. A breach of these regulations entails not only civil liability but also under criminal law where the director can be imprisoned and have a heavy fine upon them. Corporations must ensure that they are conducting business in an ethical, moral and legal manner hence the Companies Act 2016 places much more responsibility and liability on directors compared to Companies Act 1965.