What is the difference between tax evasion and tax planning? The two terms are occasionally muddled up by people who think that they mean the same thing. In fact, they are vastly different as one is illegal while the other is skirting on the side of legality, or using benefits set out by the law to achieve better utilisation of resources.

Tax planning is the process of looking at various tax options in order to determine when, whether, and how to conduct business transactions so that taxes are eliminated or reduced. As a taxpayer, and as a business owner, you will often have the option of completing a taxable transaction by more than one method. The courts strongly back your right to choose the course of action that will result in the lowest legal tax liability. In other words, tax planning is entirely proper and above board. On the other hand, tax avoidance, which is prohibited in Malaysia pursuant to Section 140 of the Income Tax Act, 1967, includes acts by companies to intentionally withhold information from the Inland Revenue Board (IRB) which would be relevant to tax assessment.

A company may not reduce its income taxes by labelling a transaction as something it is not. It is the substance, not the form, of the transaction that determines its taxability.

How tax planning works
There are countless tax planning strategies available. But regardless of how simple or how complex a tax strategy is, it will be based on structuring the transaction to accomplish one or more of these often overlapping goals:

• Reducing the amount of taxable income;
• Reducing your tax rate;
• Controlling the time when the tax must be paid;
• Claiming any available tax deductions; and
• Avoiding the most common tax planning mistakes.

In order to plan effectively, you need to estimate your business income for the next few years. This is necessary as many tax planning strategies will save tax at one income level, but will create larger tax bills at other income levels. You will want to avoid having the “right” tax plan made “wrong” by erroneous income projections. Once you know what your approximate income will be, you can take the next step: estimating your tax bracket.

The effort to come up with crystal-ball estimates may be difficult and, by its nature, will be inexact. On the other hand, the better your estimates, the better the odds that your tax planning efforts will succeed. The following are some examples of tax planning.

Example 1
Company A intends to set up a property development business. Many might have the perception that the procedures involved in setting up such a business would be fairly straightforward. Company A would have to draw up its Memorandum & Articles of Association, decide on its business structure and work on a strategy in procuring development projects.

However, had Company A engaged the services of a tax expert when setting up its business, it could have resulted in a substantial amount of tax savings in the long run. One of the many strategies which would have been adopted by a good tax planning expert, despite being seen as something minor, is to insert a few clauses in Company A’s Memorandum & Articles of Association. By simply stating that one of Company A’s objects is investment holding, it could have a bearing in contending that certain disposals of land by Company A are disposals of capital assets rather than disposals of stock-in-trade, which makes a difference when it comes to the assessment of the tax payable.

The main aim of every business is, inevitably, to maximise its profits. The simple example above is just one of the many methods that could be implemented to minimise the tax payable by Company A. Although the amount of savings in the scenario above cannot be accurately ascertained at the outset, the long-term savings would surely be worth the hassle. Companies should bear in mind that taxes payable can run into huge amounts, sometimes even millions of ringgit. Balanced against that, the hassle of spending some time and a comparatively small amount of cash to engage a good tax expert does not seem a tough decision to make.

Example 2
Company A (a property developer) purchased a plot of land for RM10 million in Area X, which it has no intention of developing in the near future. Company B earmarks Area X for development into a business park with ultramodern facilities. Company B purchases the said plot of land from Company A for RM50 million, resulting in Company A making a handsome profit of RM40 million. Company A files for the profits to be assessed as Real Property Gains Tax, that is zero tax (Real Property Gains Tax has been suspended by the government, and gains obtained from the disposal of capital assets are not taxable).

It is highly likely that the IRB will raise an assessment against Company A for the profit obtained, classifying it taxable as corporate tax. Company A could appeal against the assessment, but in most cases, the appeal would be rejected and be forwarded for full trial before the Special Commissioners of Income Tax. It should also be noted that, pursuant to Section 103 of the Income Tax Act, 1967, tax payable as stated in the notice of assessment shall be due and payable irrespective of an appeal against the assessment, failing which penalties will be imposed. 

In the absence of proper tax planning procedures from the outset, Company A would have great difficulty in convincing the authorities that the land is a capital asset rather than its stock-in-trade. Although having the appropriate measures in place prior to the purchase of the land would not automatically prevent the IRB treating the profit as liable to corporate tax, it would increase Company A’s chances of a successful appeal in discussions with the IRB

Tax evasion
Although tax avoidance planning is legal, tax evasion — the reduction of tax through deceit, subterfuge, or concealment — is not. Frequently, what sets tax evasion apart from tax avoidance is the IRB’s finding that there was some fraudulent intent on the part of the taxpayer. The following are four of the areas most commonly focused on by the IRB as pointing to possible fraud:

• A failure to report substantial amounts of income;
• A claim for fictitious or improper deductions on a return, when no verification exists; and
• Accounting irregularities, such as a failure to keep adequate records, or a discrepancy between amounts reported on a corporation’s return and amounts reported on its financial statements.

Tax incentives
Other than the preliminary work mentioned in the above case studies, there are various tax incentives offered by the government which could further reduce a company’s tax liability. The Income Tax Act provides incentives in categories such as reinvestment allowance, approved service projects, international procurement centres, regional distribution centres, biotechnology and approved businesses. Further, there are also various tax incentives provided under the Promotion of Investment Act 1986, such as investment tax allowance, infrastructure allowance and pioneer status companies.

Identifying the appropriate incentives available could be a difficult and tedious task for companies. Not only are such incentives aplenty, the legal jargon and technical language in the taxation statutes require careful consideration. By engaging experts in taxation law and tax planning, companies will be able to accurately identify the incentives available.

Conclusion
As companies look for various methods to cut down expenditure and implement extreme cost-cutting measures in light of the global recession, tax planning could be a better way, moving forward. Companies generally part with a quarter of their profits annually to the IRB (based on the corporate tax rate of 25% for year of assessment 2009). Investing a little time and money in engaging taxation legal and planning advisers could yield an unexpected boost to a company’s coffers.

Kenneth Wong Poh Lim is an associate at Mah-Kamariyah & Philip Koh, Advocates & Solicitors



This article appeared in The Edge Malaysia, Issue 755, May 18-24, 2009