THE The basic principle for claiming a tax deduction is that the expenses must be incurred entirely and exclusively in the production of income, which may be against business income or non-business income such as employment, rental, interest , royalties and others.
There are instances where the Internal Revenue Board (IRB) attempts to disallow expenses on the grounds that the expenses incurred appear ambiguous. The ambiguity in their minds seems to arise when the description of the expenses claimed by the taxpayer does not correspond to the facts. For example, where the IRB may be of the view that the payment is not a contract payment, but a salary payment. Another example could be where transactions take place between related companies when the IRB finds that these transactions were arranged to transfer income from one company to another.
Should ambiguity be the basis for rejecting spending?
There are always two sides to an argument. The IRB through its findings may have an opinion that may be contradictory with the evidence produced by the taxpayer. In situations where there is a dispute, the IRB tends to summon the beneficiary party to its office to cross-check the information relating to the transaction.
Since the recipient is not the party being rejected and reviewed, the recipient tends to agree with the IRB’s position. Therefore, this leads to suggest that the expenditures are ambiguous. The facts provided by the beneficiary may be contradictory with the facts provided by the applicant.
In such circumstances, the IRB may issue an assessment to collect the additional tax on the grounds that the expense does not meet the “entirely and exclusively incurred in the production of income” rule.
Does such a principle of ambiguity exist in tax law? There is no such rule. If the expense is suspected not to have been incurred or if the expense is fictitious, contrived or fictitious, the proper course of action is to prove that the taxpayer committed fraud/willful default or was negligent . Here the responsibility lies with the IRB.
Ratings should not be based on “ambiguity” where expenses were incurred for business purposes, but description may not be consistent with supporting evidence. Unless the expenses were incurred for business purposes, they should qualify for a tax deduction. An example would be when the IRB says the expense is an employment expense while the taxpayer says it is a subcontract payment to an individual. Ultimately, both items are deductible and ambiguity should not be used as a reason to disallow the expense.
Responsibility of the IRB
There will be instances where taxpayers attempt to claim deductions when expenses have not been incurred or create fictitious, spurious or contrived transactions. In such cases, the IRB should punish these taxpayers by increasing assessments using the anti-avoidance provisions and bringing these taxpayers to justice.
Advice to taxpayers
It is absolutely important that any tax deduction claim be supported by clear evidence of payment made for services rendered or goods received. The climate is changing and the direction the IRB may take in the future could be much stricter in the form of making taxpayers pay for fraud where taxpayers have attempted to claim tax deductions on fraudulent transactions. It is the duty of the IRB to strictly enforce the law against recalcitrant taxpayers.
This article was written by Managing Director of Thannees Tax Consulting Services Sdn Bhd, SM Thanneermalai (www.thannees.com).