How to manage your taxes in challenging economic times

Friday September 25, 2009
How to manage your taxes in challenging economic times
KPMG CHAT - By NICHOLAS CRIST



IN the current challenging economic environment, management of taxes is increasingly important. Failure to implement effective tax management can result in lost opportunities and the imposition of tax penalties.

Cash tax management

At the micro level there should be effective cash tax management. Tax instalments for corporate taxpayers should be as accurate as possible so that they don’t pay tax unnecessarily to the Inland Revenue Board (IRB), or find themselves exposed to under-estimation penalties.

Variations to instalments can be made automatically in, broadly, the sixth and ninth months of the financial year.

Further, the Income Tax Act gives the discretion to the IRB to consider applications for variations by taxpayers outside of the above months. Where profits are falling, taxpayers should consider seeking this discretionary relief.

Default by debtors

As profits are generally recognised for tax purposes on an accruals basis, businesses may be paying tax on amounts they have yet to receive. A challenge for businesses will be their ability to collect outstanding debts.

The critical issue is whether debts are bad or doubtful of recovery, or whether the debtor is simply a slow payer.

For tax purposes, the distinction is important as provisions for debts which are paid slowly will not qualify for a tax deduction.

Notwithstanding the above, bad or doubtful debts may still qualify for a tax deduction provided a number of conditions are met, and these are reflected in the IRB’s Public Ruling No. 1/2002.

To claim a deduction for a doubtful debt, taxpayers must among other things, be able to demonstrate that each debt has been evaluated separately; a general provision of say X% after Y months will not qualify. There must be evidence to show how the doubtfulness of each debt has been evaluated.

Regard must be paid to the period for which the debt has been outstanding; the financial status of the debtor; the debtor’s credit record and experience of the particular trade or industry.

These requirements must be supported by documentation and this will be key to substantiating a doubtful debt deduction.

Deteriorating inventory

Where business has slowed down, inventory may accumulate and hence the risk of deterioration (and fall in value) increases.

Where for accounting purposes a provision for deterioration in value is made, this will not qualify for a tax deduction. However, subject to various conditions, a specific write-down of inventory may qualify for a tax deduction.

Taxpayers who wish to claim a deduction have to demonstrate that the write-down is accurately calculated and represents a permanent fall in value. Again, keeping detailed records is the key to support a claim for a tax deduction.

Default on contracts

In deteriorating conditions, it may be necessary for businesses to terminate contracts which might require payment of compensation.

To determine the issue of deductibility, the starting point is to consider the nature of the contract being terminated.

Where the contract being terminated is revenue in nature, for example the purchase of inventory, this would suggest, at an initial level, that a tax deduction might be available.

Where, however, the contract is capital in nature, for example the purchase of machinery, a tax deduction for any compensation payable is unlikely to be available.

Defaults on loans

A particular concern is whether borrowers will default on loan obligations.

Where a default arises it may be necessary to work out a compromise between the creditor and the borrower which might involve the borrower being released from part of its financial obligations.

It is necessary to determine whether a release could be subject to income tax.

The Income Tax Act provides that where a tax deduction has been obtained for an amount represented by the release, the release is subject to tax.

A similar result also arises where the amount released relates to the purchase of an asset on which capital allowances have been claimed.

Where, however, the amount released has not been claimed as a tax deduction, the release should not, normally, be subject to income tax.

Retrenchment costs

Businesses that are particularly hard hit may find themselves with little option but to retrench employees. Where the retrenchment exercise is carried out in conjunction with the closure of a business, a tax deduction, based on case law, would not be available.

A different view is, however, likely to be reached where retrenchments are incurred for the purposes of enabling a business to be saved from extinction.

In the current economic environment, effective management of all costs including taxes is vital. From the tax perspective, businesses need to be aware of eligible deductions and ensure that adequate supporting documentation is maintained.

·The writer is executive director, KPMG Tax Services Sdn Bhd.


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