Treading the fine line between tax planning and tax avoidance

Recently in Australia, the world's biggest technology, accounting, media and mining companies – from Google, Apple and Microsoft to BHP Billiton, Glencore and News Corp – have come under fire for their tax avoidance strategies, which involved transferring revenue to offshore countries that provide more generous tax rates. It is believed the multinationals involved transferred AU$31.4 billion offshore in 2011–12 to avoid taxes, costing the Government millions of dollars in tax revenue. This has led to the Government trying to impose a tighter leash on these corporations by proposing a law that requires corporations to disclose their Effective Tax Rates using a formula based on total income derived in Australia, regardless of where it is recorded.

Now, why have these corporations been forced to face the firing squad despite engaging in legal methods to minimise their tax liability?

TAX PLANNING, TAX AVOIDANCE & TAX EVASION - THE DIFFERENCE

Tax planning is the art of arranging one’s financial affairs or transactions to minimise tax liability using available means provided by the law. Tax avoidance, on the other hand, is the legal utilisation of the tax regime to one’s own advantage, to reduce the amount of tax that is payable by means that are within the law (ie taking advantage of the loopholes to minimise tax liability).

Tax evasion happens when one intentionally under-declares income earned and/or claims excessive deductions. Tax evasion is easily differentiated from tax avoidance by equating of the former to breaking the rules and the latter to one bending the rules.

However, the problem arises when one tries to distinguish between tax planning and tax avoidance. Theoretically, it can be told apart by saying that tax planning is concerned with complying with the letter and spirit of the law whereas tax avoidance is only concerned with complying with the letter of the law. However, some would argue that tax avoidance is simply ‘successful tax planning’.

Below are some examples of tax planning, tax avoidance and tax evasion:

There are many shades of tax avoidance. The methods are not illegal but ultimately, tax authorities have the power to invoke anti-avoidance rules if they are able to prove that the transactions entered into does not make commercial sense, amongst others.

ANTI-AVOIDANCE RULES IN MALAYSIA

In Malaysia, general anti-avoidance rules are provided under Section 140 of the Income Tax Act 1967 (ITA 1967). The provision grants the Director General of Inland Revenue the power to disregard arrangements/transactions that he deems to be entered into with the purpose of tax avoidance. However, the burden of proof lies with the Inland Revenue Board (IRB) to show that the transaction the taxpayer has entered into has an element of tax avoidance.

Despite the above, Section 140 does not apply where the taxpayer obtains a tax advantage due to a provision in the tax law which affords a reduction in tax liability. In Sabah Berjaya Sdn Bhd v Ketua Pengarah Jabatan Hasil Dalam Negeri (1999), the Commissioners held that certain donations made by the company could be disregarded under Section 140(1) as it amounted to tax avoidance. However, the Court of Appeal held that the donations made were not a method of tax avoidance as Section 44(6) of ITA 1967 clearly provided a means for taxpayers to reduce tax liability.

Apart from the general anti-avoidance rules, the ITA 1967 also provides specific anti-provision rules for certain situations such as transfer pricing, sales between associated persons, etc. These anti-avoidance rules are not just limited to income tax; similar rules may be found in other tax-related Acts such as Real Property Gains Tax Act 1976, Petroleum (Income Tax) Act 1967, Promotion of Investments Act 1986 and Stamp Act 1949.

WHAT HAPPENS NOW?

Given that tax avoidance schemes are back under the spotlight, how does this bode for Malaysian taxpayers?

The issuance of transfer pricing rules in 2012 and issuance of the tax audit framework in 2013 and 2015 (the first being in 2007) indicates that the IRB is taking a more proactive approach in detecting and preventing tax avoidance and/or tax evasion.

Apart from that, the recent unveiling of the 11th Malaysia Plan has also unveiled a colossal cost of RM260b as development expenditure. Deputy Finance Minister Datuk Ahmad Maslan believes that the burden of this cost can be partially alleviated through the improvement of the IRB’s tax system. One of the steps mentioned was stepping up in terms of tax audits and enforcement to ensure those who circumvent the law are penalised accordingly.

Perhaps it would be prudent for taxpayers to evaluate their financial arrangements, business structures and transactions entered into and/or consider seeking an advanced ruling from the IRB to prevent any exposure to heavy shortfall penalties under the various Acts in Malaysia.