The Challenge of Early Termination
In the competitive restaurant industry, a well-known company faced a financial strain due to one of its outlets at KSL City Mall. After experiencing mounting losses, the company decided to terminate its tenancy agreement early, resulting in an unexpired rental expense of RM282,304.
The business decision to cut losses and stabilize profitability seemed logical. However, this strategic move quickly turned into a tax dispute when the Director General of Inland Revenue (DGIR) questioned the company’s claim to deduct this amount as a business expense under Section 33(1) of the Income Tax Act 1967.
The Audit Discovery
During the audit, the DGIR officer noted, “We see that the KSL City Mall outlet is not listed in your financial statements. Why are you claiming a rental deduction for this location?”
The company’s finance manager responded, “Although we terminated the tenancy early, the payment was part of our business operations. It was necessary to fulfill our obligations under the tenancy agreement and mitigate further losses.”
The DGIR officer questioned further, “Necessary for operations? Or was it a penalty to release your company from legal obligations? If the outlet was no longer in operation, how does this expense relate to income generation?”
As the company prepared for a formal appeal, the SCIT hearing became the next battleground. The company argued that the payment was crucial for protecting the company’s overall profitability. “Had we continued the lease, the outlet’s losses would have impacted the entire business. The RM282,304 was essential to our strategy,” the company’s lawyer insisted.
The DGIR’s lawyer countered, stating, “This payment was a settlement for breaching the tenancy agreement. It was not incurred for income production but to avoid legal consequences. Thus, it does not meet the criteria under Section 33(1) of the Income Tax Act 1967, which requires expenses to be wholly and exclusively for income generation.”
The Verdict
After deliberating the arguments and reviewing evidence, including letters exchanged with the landlord, the SCIT issued its ruling. The commissioners concluded that the payment was not wholly and exclusively expended for producing income, and therefore, it did not qualify for a tax deduction.
The appeal was dismissed on 12 January 2023, and the additional tax assessment of RM187,753.54, along with penalties, was upheld.
The Lesson in Tax Knowledge
This case serves as an important reminder for businesses that not all expenses are tax-deductible, even if they are necessary for operations. Payments made to settle obligations or avoid legal action are considered business decisions but may not qualify as expenses directly tied to income production.
Taxpayers must understand the legal requirements of deductions under the Income Tax Act 1967. Proper documentation, clear alignment of expenses with income generation, and seeking advice from tax experts are critical to complying with tax laws.
For this company, the outcome was a sobering reminder that strategic decisions must be paired with strict tax compliance to avoid costly disputes.
