An Anatomy of Wilful Evasion

An Anatomy of Wilful Evasion

Choong Kwai Fatt

Introduction

Under the self assessment system, taxpayers are required to submit an income tax return honestly (in good faith) to comply with the Income Tax Act 1967 (“the Act”). However, the Act is a treaty that is never easy to understand even by counsel, and in addition the complexity of the Act is compounded each year by the Finance Act and Income Tax (Amendments) Act changes. There are instances where the taxpayer’s interpretation is not accepted by the Inland Revenue Board (“IRB”) during a tax audit visit, resulting in a shortfall in tax. The IRB would issue a notice of additional assessment (Form JA) to recoup the tax undercharged.

		RM
	Tax payable (computed by IRB) via Form JA	xx
–	Tax payable submitted by taxpayer via self assessment	(xx)
	Tax undercharged (shortfall in tax) (A)	x

The IRB may impose a penalty on the tax undercharged if evidence reveals an incorrect return under s 113 of the Act being submitted. The debt owe to Government would be:

	Tax undercharged (A)	x
Add:	Penalty on incorrect return (45% x A) [s 113(2)]	x
	Debt due to Government	xx

In practice, the IRB would exercise its discretion and take into consideration relevant circumstances before imposing the penalty. The penalty is always less than the maximum amount stipulated in s 113(2) due to co-operation during tax audit period, adequate explanation and disclosure in audited accounts and tax computation. In 2013, the IRB prescribed the general penalty rate to be 45% on tax undercharged in para 10.1 of the tax audit framework 2013. The maximum penalty imposed under s 113(2) is 100% of tax undercharged.

In some cases the IRB may contend that the taxpayer, in reporting income or claiming tax deduction, was attempting to defraud the Government, and thus a heavier penalty under s 114 for wilful evasion will be imposed:

	Tax undercharged (A)	x
Add:	Penalty on wilful evasion (100% x A) (s 114)	xx
	Debt due to Government	xx

The penalty under s 114 for wilful evasion can be three times (300%) of tax undercharged although in practice it is 100% of tax undercharged. The penalties in s 114 vary according to the size of the delinquent taxpayer’s default, his blameworthiness, and the gravity and duration of the offence committed.

The scope of s 114

Wilful evasion involves arrangement outside the ambit of the Act where liability to income tax, having been incurred, is wilfully concealed. It generally employs the use of a mechanism or device for the purpose of escaping the tax imposed by the Act. In short, it is illegal and not sanctioned by the Act.

Section 114 on wilful evasion lists six activities carried out by a taxpayer or his agent as amounting to wilfully evading tax. It states:

114. Wilful evasion

(1) Any person who wilfully and with intent to evade or assist any other person to evade tax—

(a) omits from a return made under this Act any income which should be included;

(b) makes a false statement or entry in a return made under this Act;

(c) gives a false answer (orally or in writing) to a question asked or request for information made in pursuance of this Act;

(d) prepares or maintains or authorises the preparation or maintenance of false books of account or other false records;

(e) falsifies or authorises the falsification of books of account or other records; or

(f) makes use or authorises the use of any fraud, art or contrivance,

shall be guilty of an offence and shall, on conviction, be liable to a fine of not less than one thousand ringgit (RM1,000) and not more than twenty thousand ringgit (RM20,000) or to imprisonment for a term not exceeding three (3) years or to both, and shall pay a special penalty of treble the amount of tax which has been undercharged in consequence of the offence or which would have been undercharged if the offence had not been detected.

The words of s 114 formulating the offence must be read in their context and purpose, and their application to a particular case very much depends upon the factual matrix of the case. Section 114 uses the words “wilfully … to evade” rather than “evasion” alone.

Wilful evasion in s 114 connotes underhand dealing and is normally associated with acts or omissions which are designed to obtain an unwarranted tax advantage.

Evasion in general term, it has two sides of meaning: one which denotes underhand dealing which is illegal, and another intentional avoidance via a tax planning scheme, that is legal.

Lord Lindley explained that the word “evade” has two sides of meaning in Bullivant v A-G for Victoria [1901] AC 196, HL, at 207:

There are two ways of construing the word “evade”; one is, that a person may go to a solicitor and ask him how to keep out of an Act of Parliament—how to do something which does not bring him within the scope of it. That is evading in one sense, but there is nothing illegal in it. The other is, when he goes to his solicitor and says, “Tell me how to escape from the consequences of the Act of Parliament, although I am brought within it”. That is an act of quite a different character. … the word “evade” has the double meaning to which I have referred.

The word “evade” can include tax planning where it is within the legal parameters, and wilful evasion that is illegal. This explains the use of “evade” in s 140 where it involves legal permissible transactions. Section 140 deals with tax authorities’ power to disregard a legal tax planning scheme. The activities listed in s 114(1)(a) to (f) were to defraud the Government, wilfully or with the intention wilfully to avoid payment of income tax.

Section 114 employs the word “wilfully” in the opening sentence, which means that an act is done deliberately and intentionally, as opposed to accidentally. The mind of the person who does the act goes with it. It connotes an element of intention and knowledge of the wilful act. Lord Russell in The Queen v Senior [1899] 1 QB 283 at 290:

wilfully means that the act is done deliberately and intentionally, not by accident or inadvertence, but so that mind of the person who does the act goes with it.

In conclusion, a taxpayer deliberately providing misleading facts and information, or omitting some relevant facts in his tax return resulting in:

(a) income being omitted or concealed;

(b) excess deduction of expenses

arising from the participation of a sophisticated tax scheme, will be liable for s 114 offences.

Evasion and fraud

The head note to s 114 is wilful evasion, and s 114(1)(a) deals with omissions, s 114(1)(b) deals with a false statement or entry in a return, s 114(1)(c) deals with false answers, s 114(1)(d) deals with false books of accounts or false records, s 114(1)(e) deals with falsified books of account and s 114(1)(f) deals with making use or authorising the use of any fraud. Reading s 114 as a whole one would conclude that evasion must mean something other than fraud, otherwise it would be redundant to list out s 114(1)(a) to (f) with highlighting the words fraud and evasion. Evasion would have to mean something less serious than fraud because otherwise s 114 would have employed the word fraud throughout paragraphs (a) to (f) defining the offence in s 114.

In Foo Loke Ying & Anor v Television Broadcasts Ltd & Ors [1985] 2 MLJ 35 at 43:

… The court however is not at liberty to treat words in a statute as mere tautology or surplusage unless they are wholly meaningless. On the presumption that Parliament does nothing in vain, the court must endeavour to give significance to every word of an enactment, and it is presumed that if a word of phrase appears in a statute, it was put there for a purpose and must not disregarded.

The use of “false” in s 114(1)(b) to (e) widely was held in Federal Commissioner of Taxation v Turner 84 ATC 4161 to mean incorrect or inaccurate, and the offender’s subjective belief in its accuracy is irrelevant.

The meaning of “false” in s 114 is deceitful as it has to be read together with “wilfully”. In relation to s 114(b) (false statement or entry), Lord Goddard held in R v Hudson [1956] 1 All ER 814 that the making of a false statement tending to prejudice the Government with intent to defraud the IRB is an offence. In this case, the taxpayer falsely stated the profit from a fruit growing and farming business for seven years by giving false accounts to the Revenue. These documents as found by the jury were not only false but the taxpayer knew that they were false. In Donnelly v CIR [1960] NZLR 469, the Supreme Court of New Zealand held that a false return of income is wilfully made if it is completed with knowledge of its inaccuracy as a fact affecting the taxpayer’s liability to taxation. There must be an element of active dishonesty on the taxpayer’s part as opposed to a merely negligent completion of an erroneous return.

In Challenge Corp v CIR [1987] 1 AC 155, HL, the law lords held that tax evasion occurs when the tax authorities are not informed of all facts relevant to an assessment of tax. This statement applies only in a formal assessment of tax, where a tax return, tax computations and audited accounts are submitted to the IRB together with a tax return for an assessment of tax payable. However, in a self assessment regime, if the taxpayer with the assistance of tax agents submits only a tax return with honest belief that it fully complies with the Act, he cannot be held liable for wilful evasion in s 114 so long as the tax computation and audited accounts have adequate disclosure on the contentious issues and the taxpayer has provided information and accounts with full co-operation during tax audit.

Tax evasion in s 114 refers to wilful evasion. It involves concealment or non disclosure of true facts of the commercial transactions. It has dishonest intention. As compared to fraud, the gravity or size of the offence is relatively small. In a self assessment system, the taxpayer is given the mandatory and statutory duties to maintain books for seven years to facilitate a tax audit. His duties are only to submit a tax return with careful computation of tax and payment of tax within the time prescribed. There is no requirement to submit audited account, tax computation or business agreements to the tax authorities. So long as these documents are made available during a tax audit, the taxpayer cannot be held not to be informing the authorities on any vital facts relating to the return.

Fraud involves a mechanism of cheating the public revenue. In R v Mavji [1987] 2 All ER 758, Michael Davies J held, at 762:

… cheating can include any form of fraudulent conduct which results in diverting money from the Revenue and in depriving the Revenue of money to which it is entitled.

Similar to tax evasion, fraud involves substantial concealment or non disclosure of the true facts of an arrangement or transaction. Fraud depends on the factual matrix of the case, varies in circumstances and is peculiar to its own facts. A mere omission (failure to act) of the taxpayer is not tantamount to fraud, as fraud requires a positive act of deceit such as false representation, false books of accounts etc.

A sham is a fraud, pretence, something which pretends to be other than it really is. Lord Wilberforce in W T Ramsay Ltd v IRC (1981) 54 TC 101 explained the meaning of “sham” and distinguished it from genuine, at 184:

In this context to say that a document or transaction is a “sham” means that while professing to be one thing, it is in fact something different. To say that a document or transaction is genuine, means that, in law, it is what it professes to be, and it does not mean anything more than that.

In PJTV Denson (M) Sdn Bhd & Ors v Roxy (Malaysia) Sdn Bhd [1980] 2 MLJ 136 Raja Azlan Shah CJ (Malaya) held at 138:

Whether fraud exists is a question of fact, to be decided upon the circumstances of each particular case. Decided cases are only illustrative of fraud … fraud must mean actual fraud, i.e. dishonesty of some sort … fraud implies a wilful act, on the part of one whereby another is sought to be deprived, by unjustifiable mean, of what is entitled.

Mens rea and actus reus

Mens rea and actus reus are two essential elements to be established before a person can be convicted of a s 114 offence. Mens rea refers to the mental state of the taxpayer at the time of committing the offence. The use of “wilful” in s114 is reflective of legislative intent that the concept of mens rea is of primary importance. It indeed is an essential element of an offence beyond question. It implies that a taxpayer of his free will knows what he is doing and intends to do what he is doing. The intention implies motive. The intention to evade taxation is of the first importance. Section 114, in particular s 114(1)(f), is a criminal offence. To constitute an offence under s 114, the action (actus reus) must be one of those listed out in s 114(1)(a) to (f) and the mental state (mens rea) must be proved before the taxpayer can be convicted.

The intention for wilful evasion refers to a state of affairs knowing with clear comprehension what will result from the wilful acts. It must be more then contemplation. In Sweet v Parsley [1969] 1All ER 347, HL, Lord Reid opined at 350:

It is firmly established by a host of authorities that mens rea is an essential ingredient of every offence …

Wright J in Sherras v De Rutzen [1895] 1 QB 918 at 921, shared the same view:

… there is a presumption that mens rea, an evil intention, or a knowledge of wrongfulness of the act, is an essential ingredient in every offence …

Asquith LJ propounded the judicial interpretation of intention or intent in Cunliffe v Goodman [1950] 2 KB 237 at 253 as:

An intention to my mind, connotes a state of affairs which the party “intending”—I will call him X does more than merely contemplate. It connotes a state of affairs which, on the contrary, he decides, so far as in him lies, to bring about, and which, in point of possibility he has a reasonable prospect of being able to bring about by his own act of volition.

Lord Goddard CJ succinctly summarised the meaning of “wilful” in Lomas v Peek [1947] 2 All ER 574 at 575:

if a man permits a thing to be done, it means that he gives permission for it

to be done, and if a man gives permission for a thing to be done, he knows

what is to be done or is being done, and if he knows that, it follow that it

is wilful.

Wilfulness implies knowledge proved by circumstantial evidence, to be gathered from acts and conduct of the taxpayer at that material time. The question whether or not the guilty intent exists is one of fact to be decided by trial judge.

For a taxpayer to be charged on s 114, the taxpayer must have knowledge that what he did was illegal or not permitted by the Act. He must knowingly and wilfully incorporate in the return a material false statement so to result underpayment of tax. There has to be a deliberate conduct of dishonesty by the taxpayer to prejudice the IRB’s right to the tax in question, knowing clearly that he has no right to do so. A taxpayer keeping false records with intention to mislead the Revenue can be held liable under s 114.

In IRC v Gold [1956] NZLR 422, McGregor J held at 471:

… a clear degree of proof is required to establish that the acts were done wilfully; … the term “wilful” connotes the element of knowledge of the wilful act … the term conveys the concept of intentional, as opposed to accidental, wrong doing, and the courts recognise that when the term is used in a statue there must be a proof of mens rea.

Actus reus means the taxpayer’s act as in s 114(1)(a) to (f) while mens rea refer to his mental state at that time of committing the offence. Both elements must be established and proved before the taxpayer is held guilty of an offence under s 114. A clear degree of proof is required to establish that the acts within s 114(1)(a) to (f) were done “wilfully”. The term “wilfully” connotes the element of knowledge of such wilful act, a concept of intentional as opposed to accidental wrongdoing. The taxpayer charged with s 114 shall be presumed innocent until proved guilty according to the Act. The prosecution under s 114 requires a culpable mental state on the part of the taxpayer in respect of the act charged as an offence.

In the Singapore decision of Public Prosecutor v Cleanseal Pte Ltd [2002] MSTC 7435, the company was carrying on the business of manufacturing gaskets and seals for hard disk drives. In view of the 1997 financial crisis, the company created false invoices for the purchase of equipment and the supply of services when neither such purchases were made nor such services rendered.

For year of assessment (YA) 1999, three false invoices dated January 15, January 30 and February 15, 1998 were created. The wrongful deductions ranged from $23,800 to $40,000. For the YA 2000, seven false invoices were created. These were dated April 1, April 27, May 29, June 17, July 8, July 24 and September 18, 1998 respectively. The wrongful deductions ranged from $9,705 to $44,500. The total wrongful deductions for the two YA amounted to $277,100. The total tax undercharged amounted to $69,412.20. The Singapore tax authorities found that the company had acted wilfully with intent to evade tax, and the High Court ordered the company to pay treble penalty in addition to the tax undercharged.

In JK Synthetics Ltd & Ors v NC Sharma 1995 Tax LR 33, the company had claimed a tax incentive for the installation of new plant and machinery where no plant and machinery at all was installed as claimed. Various supporting ledgers and a project register were created. The Indian High Court held that the company had evaded tax as the books of account contained false entries.

Burden of proof

The legal position in wilful evasion concerning burden of proof is that at all times it rests with the Revenue. The only time the burden of proof shifts to the taxpayer is where the taxpayer is pleading the defence of mistake or seeking remission of tax or penalties under s 125 of the Act. The Revenue has to establish that fraudulent conduct took place with intention to defraud the Government. Dishonesty must be present at the time of the conduct. In prosecution, the Revenue counsel has to establish guilty intent, knowledge or belief of the taxpayer on such fraudulent conduct.

The law on evidence is that he who alleges fraud must clearly and distinctly prove it. It is trite law that whether fraud is charged in a civil court for tax recovery or as a criminal matter for prosecution, the standard of proof remains at beyond reasonable doubt. A fact is said to be proved only when the court believes it to exist beyond reasonable doubt and not merely when its existence is established by a preponderance of probability. In Chu Choon Moi v Ngan Sew Tin [1986] 1 MLJ 34, Syed Agil Barakbah SCJ held, at 38:

We agree that fraud whether made in civil or criminal proceedings must be proved beyond reasonable doubt and cannot be based on suspicion and conjecture (Narayanan v Official Assignee, Rangoon AIR 1941 PC 93; Saminathan v Pappa [1981] 1 MLJ 121). Proof beyond reasonable doubt does not mean proof beyond the shadow of doubt. The degree of proof need not reach certainty but it must carry a high degree of probability. What it means is that the evidence adduced is such that the Court believes its existence or a prudent man considers its existence probable in the circumstances of the particular case. If such proof extends only to a possibility but not in the least a probability, then it falls short of proving beyond reasonable doubt.

In Yong Tim v Hoo Kok Chong & Anor [2005] 3 CLJ 229, the Federal Court held that where fraud is alleged in civil proceedings, the alleged fraud has to be proved beyond reasonable doubt. Steve Shim CJ (Sabah and Sarawak) held, at 235:

… the standard of proof for fraud in civil proceedings is one of beyond reasonable doubt which has been consistently applied by the Courts in Malaysia. We see no reason to disturb that finding.

In order to determine whether the taxpayer had committed wilful evasion under s 114 such as by consciously concealing the particulars of the income or had deliberately furnished inaccurate particulars in the return, it is the entirety or totality of facts and circumstances, not each or some of the factors, which should be taken into consideration. In summary the tax investigation officer must be satisfied, on examination of the cumulative effect or the entirety of circumstances, that the only reasonable inference from such factors or material that could be drawn was that the taxpayer was indeed liable for one or more offences under s 114(1)(a) to (f). The evidence has to be positive to warrant such inference, else no penalty is exigible.

In Vertelman v IRC (NZ) 1 ATR 447, the taxpayer was born in Holland and conducted a cash photography business in New Zealand. Following an investigation, it was found as a matter of fact that he was understating his income and the understatement was repetitive and continuous for nine years.

The taxpayer had deliberately understated his income and wilfully made false returns. The understatements of income were sufficiently substantial and sufficiently repetitive over nine years themselves alone to warrant an inference of guilt. Inexperience, lack of knowledge of local practice, language difficulties and failure to understand book keeping provided no excuse.

Fraudulent evasion

Section 114(1)(f) refers to fraudulent evasion. Fraudulent evasion employs illegal means to reduce tax and erodes the revenues of the Government which are essential for public expenditure on the welfare of the people. It consists of some blameworthy act of a taxpayer. Lord Templeman in IRC v Challenge Corp Ltd [1987] 1 AC 155, HL, attempted to segregate innocent evasion and fraudulent evasion. Fraudulent evasion is within the jurisdiction of s 114 while innocent evasion is within s 140 of the Act.

Fraudulent evasion may lead to a criminal prosecution as well as reassessment of tax. It attracts criminal sanction in penalties and/or imprisonment. The notable examples would be using fictitious employees to claim salary deductions, fraudulent concealment of income, blatantly not reporting income, false accounts presented to the IRB, or deliberately putting false sales credit notes through the taxpayer’s company so to reduce tax.

Fraudulent evasion involves a positive act carried out by the taxpayer with clear intention to defraud the Government. A positive act of deception must be established and it normally involves the use of a mechanism or device to defraud the Government. Fraudulent evasion cannot be inferred generally from the fact that the taxpayer fails to submit its tax return. Failure to submit merely amounts to a pure omission of income. It does not amount to false representation or employment of any artful device to defraud the Government.

Fraudulent evasion is criminal conduct when the taxpayer deliberates does not comply with the Act and this results loss of revenue to the Government. As fraud is a criminal offence, the intention (mens rea) and action (actus reus) must be concurrently fulfilled before he is held liable. The legal principles for fraudulent evasion are where all the following are satisfied:

(a) there exists a scheme deliberately to evade tax;

(b) the scheme has been carried out for a period exceeding three years;

(d) the scheme results in a reduction of tax substantially, i.e. at least 30% of net profit.

Innocent evasion

Innocent evasion is a concept promulgated by Lord Templeman in Challenge Corp v IRC [1987] 1 AC 155, HL, where his Lordship held that innocent evasion merely allowed the IRB to reassess the assessment and recoup tax undercharged. There was no penalty on the additional tax and it is dealt with in 140(1)(c). The distinction between innocent and fraudulent evasion lies in the intention to deceive the Government, the time-span of the offence, the gravity of the tax involved and the existence of a system, method or scheme to evade tax.

Innocent evasion includes the situations where the taxpayer failed to submit the return in respect of tax due without any intention (mens rea) to defraud the Government, the taxpayer faithfully submits the return but incorrectly computed the tax owing, the taxpayer applies an incorrect rate of capital allowance which is not ex facie immediately obvious etc. All these innocent acts are unsustainable to hold the taxpayer liable for defrauding the Government and to be classified as wilful evasion as in s 114. An honest mistake as to the existence of any knowledge or act is a defence.

If the size and gravity are absent, innocent evasion is dealt with in s 140 (anti avoidance) or alternatively amounts to submission of an incorrect return under s 113(2) of the Act. Innocent evasion at most times is due to negligent acts of the taxpayer.

Negligence

A taxpayer who omits to submit the tax return cannot be held as committing tax evasion. At most the taxpayer is held to be negligent. Evasion is more serious than mere omission to pay but less serious than attempting to defraud IRB. Negligence does not amount to evasion as evasion connotes a positive act, exercising the will in avoiding the payment of tax, whereas a mere failure to submit a return or payment may be due to mistake or accident. Similarly the mere non disclosure of a fact or information in the return will not automatically amount to evasion and there must be evidence pointing towards an attempt to evade tax to create liability. The inference of guilty intent cannot be drawn from omission due to carelessness.

Negligence means the omission to do something which a prudent and reasonable taxpayer would do. Negligence in reporting the actual profit at most amounts to submitting an incorrect return. It however does not amount to wilful evasion or fraud. A person lacking knowledge who keeps incomplete records so that not even he knows his true profit is said to be negligent in tax. This includes mere omission, honest mistakes, confusion of law, oversights and innocent error being committed, negligence in recording turnover, or an honest mistake in applying higher rate in claiming capital allowance must be established to support the explanation of such error.

In the Canadian case of Alex Pashovitz v MNR 61 DTC 1167, Thurlow J held, at 1171:

A taxpayer’s ignorance of what is required of him, rather than an intention to evade, may account for the errors and absolve him from liability. To take another example, for purposes of liability for tax a taxpayer, failing to keep adequate records, may find himself in the unfortunate position of being unable to disprove the correctness of an assessment. But the failure to keep records is not necessarily accompanied by an intention to avoid payment of tax.

There are situations involving interpretation of the Act such as where the IRB held that repairs are capital expenditure while the taxpayer contended that they were a revenue expense, which are very much subjective and judgmental. They involve interpretation of technical points, where several views are tenable or there exists bona fide uncertainty in the Act. Therefore it should not amount to submission an incorrect return. Likewise, no offence is committed if the taxpayer was merely inadvertent or entertained an honest belief that the amount which he omitted was not income.

At times, this technical adjustment due to interpretation may be due to negligence of the taxpayer in keeping abreast of the latest law developments. Then a penalty on an incorrect return due to negligence is justifiable. Where the taxpayer is obviously wrong, unreasonable or contrary to the settled case law principles, it would be negligence.

Section 114 requires an intention (mens rea) as a necessary element of an offence on the part of the taxpayer to embark on tax evasion; there has to be in fact conscious intention on the part of taxpayer. Therefore, such an intention could not be inferred from negligence in submitting the tax return. A return may be incorrect due to ignorance or inadvertence; it can never amount to a false return.

In Hurley v Taylor 71 TC 268, Justice Park held that honest inadequacy cannot amount to fraudulent conduct but is negligence conduct. To be evasion, it involves more than a mere omission or neglect to pay tax. The intention of escaping the tax and the knowledge that the taxpayer is under the obligation to pay must be clearly established.

In conclusion, where a taxpayer is able to demonstrate good faith and that income is omitted from his return inadvertently and not deliberately, he is not to have imposed on him any penalty on incorrect return. The onus is on the taxpayer to sustain the defence of good faith, and show that the taxpayer acted honestly and reasonably in submitting the return under the self assessment regime.

Tax planning and wilful evasion

The complexity and uncertainty of the Act have in many instances blurred the distinction between tax planning and wilful evasion. In this highly commercial, complex environment, there is a hairline distinction between tax planning and wilful evasion which is difficult to recognise in practice. It is a question of law to be decided by the court. Unlike wilful evasion, tax planning employs legitimate methods or schemes which have commercial realities to reduce income tax, deferment of income tax or even elimination of income tax. It is a settled principle that a taxpayer may as of right arrange his tax affairs to attract the minimum of tax so long it is within the ambit of the revenue law and that in so doing the taxpayer does not employ unlawful means.

Wilful evasion is entirely distinct from tax planning. It involves misrepresentation, concealment with deceitful intent. Since a taxpayer may plan his finances in such a manner within the four corners of the revenue statue, that income tax liability is minimised or even made nil, then if tax planning is implemented and complies with the revenue statue, by no stretch of the imagination can it be said that payment of tax has been wilfully evaded.

Tax planning has to be supported by commercial realities. If the transaction of a scheme has been carried out and reflected in its essence shown in agreements signed, disclosed in the audited accounts, correct information has been given to IRB during a tax audit, then such scheme has commercial realities and is legal. IRB has to acknowledge the tax planning scheme and accorded the tax savings within the scheme, as it is entirely within the Act.

However, in the event the IRB finds that those transactions have no commercial justification (no bona fide commercial purpose) and are implemented solely for tax planning reasons, that would not make them illegal. The transactions remain real and legal even when what is being carrying out is a blatant attempt to exploit the loophole in the revenue law. IRB is empowered under s 140 of the Act to disregard the transaction and recoup the tax undercharged.

Section 140 provides:

140. Power to disregard certain transactions

(1) The Director General, where he has reason to believe that any transaction has the direct or indirect effect of –

(a) altering the incidence of tax which is payable or suffered by or which would otherwise have been payable or suffered by any person;

(b) relieving any person from any liability which has arisen or which would otherwise have arisen to pay tax or to make a return;

(c) evading or avoiding any duty or liability which is imposed or would otherwise have been imposed on any person by this Act;

(d) hindering or preventing the operation of this Act in any respect,

may, without prejudice to such validity as it may have in any other respect or for any other purpose, disregard or vary the transaction and make such adjustments as he thinks fit with a view to counteracting the whole or any part of any such direct or indirect effect of the transaction.

A tax planning scheme or restructuring arrangement although highly artificial which has no purpose other than avoidance of tax, so long the transactions are genuine, and not act as a smokescreen for the realizing any business loss, remains a legal scheme or arrangement. It is not a sham and it can never amount to a wilful evasion. In short, a genuine transaction even there is no bone fide commercial reason remains legal. The scheme at most is ineffective with the sole reason of avoiding tax, and additional tax is paid to IRB upon invocation of s 140. This invocation of s 140 would not amount to an incorrect return.

Example 1

Tahan (Mfg) Sdn Bhd manufactures smart phone covers for “san chai” brand, a popular medium price brand in Malaysia. It sets up Kuan Yew (Singapore) Ltd, a wholly owned subsidiary company in Singapore to procure raw materials from various suppliers in China and India and pays it commission.

The IRB found that the Singapore company is a scheme having only an employee doing the administration. All orders are placed, prices negotiated, quantities, delivery date and contract concluded in Malaysia with the overseas China and India suppliers. The Singapore company merely acts as a conduit to receive invoices from suppliers and billed to Tahan (Mfg) Sdn Bhd for a fee of commission.

The function of the Singapore company has no commercial benefit but remains a genuine business and a legal entity which carries out business with Tahan (Mfg) Sdn Bhd. The scheme has real transactions although they may not have

bona fide commercial benefits. It is a genuine business. Such a scheme is not tantamount to wilful evasion. As the Singapore company does not order the goods but acts as an intermediary solely for tax reasons, the IRB is entitled to invoke s 140 anti avoidance to disregard the transaction, to recoup tax undercharged.

On the other hand, if the Singapore company genuinely orders the goods for the Malaysian company from India and China suppliers, and this is further evidenced by the cost savings and efficiency in the Malaysian company, then the setting up of Singapore company is in effect tax planning supported by commercial benefits. The sales made to Malaysia are bona fide commercial transactions. This is a tax planning scheme accorded to the taxpayer under the Act.

However, if such Singapore company is purported to be set up but in fact it was not, and the payment of commission is made to directors’ individual bank accounts in Singapore or Malaysia, such misrepresentation is a sham and may be tantamount to tax evasion, depending of the quantum of tax lost to the Government. Whether this is a fraudulent evasion to cheat public revenue or merely innocent evasion very much depends on facts and circumstances. Wilful evasion in s 114 necessarily means to try illegally to avoid paying of tax.

Anti avoidance and tax evasion

Section 140(1)(c) allows the IRB to disregard the transactions if the IRB has reason to believe that the transactions have the direct or indirect effect of “evading or avoiding any duty or liability …”. The Court of Appeal in Ketua Pengarah Hasil Dalam Negeri v Sabah Berjaya Sdn Bhd [1979–1996] AMTC 1207 has affirmed that tax evasion and tax avoidance fall within s 140. It is submitted that tax evasion referred to means innocent evasion as envisaged by Lord Templeman in Challenge Corp v IRC [1987] 1 AC 155, HL. Cases of wilful evasion are dealt with in s 114.

Tax planning, tax avoidance and evasion mean to cause the Government to lose revenue, but the means to achieve it can be distinguished significantly. Tax planning is perfectly a taxpayer’s right and it is within the ambit of tax law. A taxpayer may plan his tax affairs or finances in such a manner, strictly within the four corners of the revenue statute, that the tax liability is minimised or even nil. Tax avoidance though legal lacks commercial realities, and would be denied by s 140(1)(c). Innocent evasion which results from misinterpretation or misinformation where the taxpayer has no intention to commit an offence in the Act is dealt with in s 140(1)(c) and not s 114. The guilty mind is absent in these offences despite such an action resulting in illegally avoiding the tax. A penalty on incorrect return may be imposed on innocent evasion.

	Tax being reduced	IRB can disregard and impose additional tax under s 140(1)(c)	Penalty on incorrect return s 113(2)
(a) Tax planning	Yes	No	N/A
(b) Tax avoidance	Yes	Yes	N/A
(c) Innocent evasion	Yes	Yes	Yes

Tax planning is wholly within statue and case law, and although it may aim to avoid certain provisions of the Act, it is permissible so long there exist commercial justifications.

Payment of tax

At times, the taxpayer may agree to the additional income tax and penalty imposed by s 113(2) or s 114. The acceptance of the Form JA with the payment of tax and penalty cannot amount to the taxpayer accepted that he had filed a false return, or deliberately furnished inaccurate particulars or concealed any income. In the Supreme Court case of Sir Shadilal Sugar and General Mills Ltd v CIT [1987] 168 ITR 705, the court held, at 713:

From the assesse agreeing to additions to his income, it does not follow that the amount agreed to be added was concealed income. There may be a hundred and one reasons for such admission, i.e., when the assesse realizes the true position, it does not dispute certain disallowances but that does not absolve the Revenue from proving the mens rea of a quasi-criminal offence.

Conclusion

Wilful evasion in s 114 means intentionally, knowingly to deprive the tax authorities of the rightful amount of tax. It is punishable on conviction with severe monetary penalties and with imprisonment. Where intention is lacking, it will be dealt with in s 140(1)(c) being innocent evasion as the taxpayer has negligently evaded the tax. Penalties under s 113(2) for incorrect return are imposed where the taxpayer’s defence of mistake or inadvertence is not accepted by the tax authorities. The assistance of professional tax agents is therefore important to assist in submitting the tax return to avoid falling into tax evasion instead of tax planning, given the complexity of the business environment. The use of a professional is a defence to a return being labelled as incorrect, a defence to mitigate the penalty of 45% of tax undercharged.