MULTI SQUARE SDN BHD v Ketua Pengarah Hasil Dalam Negeri (WA-14-11-04/2021)

(a) Management fees in the sum of RM316,500 that were paid to Sersol for YA 2010; and

(b) Management fees in the sum of RM728,500 paid to Sersol for YA 2011. The DGIR then raised the notices of additional assessment (“NAAs”) dated 4.8.2015 for YAs 2010 and 2011 inclusive of penalty. [7] Aggrieved, the appellant filed the notices of appeal in Form Q dated 21.4.2016 for the YAs 2010 and 2011. At the SCIT [8] The issues for the determination of the SCIT were as follows:

(a) Whether the amount claimed by the appellant as management fees under the MSA in YAs 2010 and 2011 is allowable for the deduction under s 33(1) of the ITA; and

(b) Whether the imposition of penalty under s 113(2) of the ITA for YAs 2010 and 2011 is correct. [9] As to the first issue, the SCIT held that the management fees incurred by the appellant were not wholly and exclusively in the production of its income. For the aforesaid reason, SCIT was of the view that the requirements of s 33(1) of the ITA had not been fulfilled by the appellant and therefore, not allowable for the deduction. [10] S 33(1) provides that the adjusted income of a person from a source for the basis period for a year of assessment shall be an amount ascertained by deducting from the gross income of that person from that source for that period all outgoings and expenses wholly and exclusively incurred during that period. [11] In its finding, the SCIT took cognisance that SP1, Lau Lee Cheng, the general manager of the appellant company in her evidence, testified that there were no documents to substantiate that Sersol duly rendered the services to the appellant. [12] The witness for the respondent, Saiful Azwan bin Mohamad Ghazali, in his evidence, testified that:

(a) The management services that include corporate function and strategic planning rendered by Sersol were part of the responsibility of a holding company to its subsidiary.

(b) There are employees listed in Sersol’s payroll. One of them rendered his services to the appellant as an internal auditor, although technically, he is Sersol’s employee.

(c) The appellant failed to justify the increase of 130% in the Management Fees paid to Sersol, although the scope of works was the same in 2010 and 2011. [13] Based on the evidence adduced at the trial, the SCIT held that the management fees incurred by the appellant were not wholly and exclusively in the production of its income. It further held that the appellant had failed to fulfil the requirement under s 33(1) of the ITA. [14] As to the penalty imposed, the SCIT referred to the judgment of the Supreme Court in Ketua Pengarah Hasil Dalam Negeri v Kim Thye & Co [1992] 2 MLJ 708 SC and further held that the filing of incorrect returns attracts penalty under s 113(2) of the ITA. On the facts, the SCIT further held that the appellant had filed an incorrect return understating its income by deducting the unsubstantiated management fees from its income. [15] To summarise, the SCIT held that:

(a) The amount claimed by the appellant as management fees under the MSA in YAs 2010 and 2011 is not allowed for the deduction under s 33(1) of the ITA; and

(b) The DGIR was correct in exercising his discretion in imposing the penalty under s 113(2) of the ITA for YAs 2010 and 2011 since the appellant had filed an incorrect return. At the High Court [16] Before me, learned counsel for the appellant submitted that in order to enhance its profitability, the appellant had dispensed with its in-house management. Instead, the appellant arranged for its holding company, Sersol, to provide exclusive management services. [17] In short, the Management Fees, according to learned counsel, were motivated by commercial expediency to generate the gross income. The “commercial expediency” reason was explained by the appellant’s tax agent Messrs UHY Tax Advisory Sdn Bhd (“Messrs UHY”), in its letter dated 24.11.2014 to the DGIR. [18] In the said letter, Messrs UHY asserted the appellant and Sersol had followed the industry practice of centralising several functions at the holding company level. Hence the payment of management fees. [19] Messrs UHY further explained that the main purpose for the payment of management fees is for Human Resources, Accounting and Information Technology:

(a) As for Human Resources, it was agreed that the Group HR of Sersol would manage the recruitment and other HR aspect of the appellant.

(b) The Group Accountant would manage and review the Financial Statement prepared by the appellant.

(c) The Group IT department would provide maintenance and technical support to the appellant. [20] The applicant’s position is that the DGIR did not challenge or question whether Sersol rendered the management services to the appellant company. Instead, according to learned counsel, the main complaint by the DGIR is that it is Sersol’s duty to provide such services. [21] Learned counsel for the appellant submitted that the appellant could have appointed a third party to provide management services to the appellant. In so doing, the appellant would still be obliged to pay management fees to the third party for their management services. As such, according to learned counsel, it will be absurd if management fees paid to a 3rd party can be allowed while management fees paid to the appellant’s holding company are disallowed. [22] As to the increase in the management fees of 130% in 2011, learned counsel for the appellant highlighted that, based on the appellant’s audited financial statements, there was a substantial increase in revenue from 2010 to 2011. According to learned counsel, the appellant's total revenue in 2010 was RM18,922,013.00. In 2011, the revenue increased to RM23,775,508. [23] Learned counsel submitted that the increase in the management fees corresponded with the marked increase in revenue. [24] As to the penalty imposed, learned counsel for the appellant, citing Kim Thye & Co, contended that the DGIR could not exercise his discretion at whim and fancy but after due consideration of all relevant facts and circumstances. [25] Learned counsel further submitted that the DGIR had failed to consider the fact that there is no omission of information by the appellant as everything is transparently laid out in the audited account in the appellant’s tax returns. [26] For the aforesaid reason, the appellant’s position is that the SCIT had erred in concluding that DGIR was correct in exercising his discretion in imposing the 45% penalty under s 113(2) of the ITA. Analysis [27] Let me begin with the first issue as regards to the management fees. [28] For any expenses to be allowed as a deduction under s 33(1) of the ITA, the expenses must fulfil the two tests:

(a) Wholly and exclusively; and

(b) In the production of the gross income. [29] There are two separate MSAs executed between the parties. The first MSA (“MSA-1”) was dated 1.1.2010, while the second MSA (“MSA-2”) was dated 1.1.2011. The two agreements are identical, except for the fees charged by Sersol to the appellant. [30] While the MSAs are meant to be a legal document, I take note that they were not stamped by the parties. While the failure to stamp the documents does not affect their legality, I also find that the terms and conditions stated therein are very terse and lack details. It is only a one-page agreement. [31] One example can be seen in the service to be provided by Sersol in respect of Human Resources. It says: To hire, dismiss or relocate the executives. To ensure their competitiveness, knowledge and management skills [meet] are meeting the market’s demand through continuous learning and development. The question that arises is, what has Sersol done to ensure all these? If indeed Sersol conducted trainings for the members of the appellant’s executives, when were they conducted? How many times were the training conducted in 2010? How many executives were involved? [32] Learned counsel for the appellant submitted that the appellant could have appointed a third party to provide management services to the appellant and that a similar amount of fees could have been incurred. However, a proper management service agreement would have such terms as the duty of the consultant to keep proper books of records relating to the services performed thereunder. I hasten to add it would normally include the extent of the consultant’s liability to the client. [33] It is also normal for the management fees to be pegged to a certain percentage of the total revenue of the client. The question that arises is how would the parties know when they signed the MSA-2 on 1.1.2011 that there would be an increase in revenue for that year? [34] These factual matrices lend credence to the argument that they were a sham. ‘Sham’ has been defined as “a false label in which the express purpose does not correspond with the true purpose”. In Kuppusamy v Anggamah & Anor [1992] 1 MLJ 602 Lim Beng Choon J referred the judgment of Lord Diplock in Snook v London and West Riding Investments Ltd [1967] 2 QB 786 CA: As regards the contention of the plaintiff that the transactions between himself, Auto Finance and the defendants were a "sham," it is, I think, necessary to consider what, if any, legal concept is involved in the use of this popular and pejorative word. I apprehend that, if it has any meaning in law, it means acts done or documents executed by the parties to the "sham" which are intended by them to give to third parties or to the court the appearance of creating between the parties legal rights and obligations different from the actual legal rights and obligations (if any) which the parties intend to create. [35] For the aforesaid reasons, I am of the view that the MSAs are sham agreements designed to give third parties the appearance of creating legal rights and obligations between Sersol and the appellant when it was indeed the obligation of Sersol as the holding company to ensure that its subsidiaries to comply to the requirements of Bursa Malaysia. [36] I am, therefore, in complete agreement with the SCIT that the management fees incurred by the appellant were not wholly and exclusively in the production of its income within the meaning of s 33(1) of the ITA. [37] As to the penalty imposed, it should be borne in mind that an incorrect return without more does not per se attract the application of s 113(2) of the ITA. The DGIR is required to prove the existence of some form of intentional wrongdoing on the appellant’s part. In agreeing to the exercise of the discretion of the DGIR, the SCIT should have stated in its ground of judgment that an element of mala fide had been established. There was no such finding made. [38] In Ketua Pengarah Hasil Dalam Negeri v Classic Japan (M) Sdn Bhd [2021] 9 MLJ 870, the learned JC, after referring to a line of authorities that carry the proposition that for the penalty under s 113(2) cannot be imposed if the appellant was not shown to have submitted incorrect information and/or incorrect returns, had made full disclosures pertaining to the method of computations in recognizing its income and it is a matter of interpretation or difference of opinion with respect to which method was to be adopted. [39] To my mind, submitting the MSAs in the genuine belief that they are deductible expenses within the ambit of s 113(2) does not fall into the category of mala fide. It falls within the context of the interpretation of the difference of opinion, which does not justify the exercise of discretion by the DGIR. Findings [40] For the reasons aforesaid, the result of this appeal is this:

(a) The SCIT was correct in holding that amount claimed by the appellant as management fees under the MSA in YAs 2010 and 2011 is not allowed for the deduction under s 33(1) of the ITA.

(b) However, the SCIT erred in affirming the penalties imposed under s 113(2) of the ITA without first making a finding of mala fide on the part of the appellant. [41] To that extent, the penalties imposed are set aside. [42] There shall be no order as to costs. Tarikh: 24 November 2022 (WAN AHMAD FARID BIN WAN SALLEH) Hakim Mahkamah Tinggi Kuala Lumpur. Pihak-pihak: Bagi Pihak Perayu : Ting Lee Ping Tetuan Ringo Low & Associates Bagi Pihak Responden : Noor Kamaliah binti Muhamad Japeri SRC, Siti Aisyah bt Yusoff @ Md Nasir RC, Nur Aina Mohd Jaffar RC, Syarifah Saffa’ Syed Abd Kadir RC Lembaga Hasil Dalam Negeri (LHDN), Cyberjaya