Is it really ‘incidental’?

November 2016

by Kevin Ong Kian Hua

The inclusion of “any investment holding company” (“IHCs”) into the scope of Regulation 41 of the GST Regulations 2014 has potentially altered the status of an IHC from a fully taxable supplier to a mixed supplier. Revenue generated by an IHC may also consist of interest income or other income from financial supplies such as gain in foreign exchange. With the inclusion of IHC in Regulation 41, these income streams can no longer be treated as incidental exempt supplies by an IHC. When the IHC has other revenue streams such as management fees which are treated as taxable supplies, the IHC will become a mixed supplier. The implications to IHCs are as follows:-

• inability to claim input tax credit in full
• unable to form GST group with their subsidiaries

The introduction of this rule has thrown up many challenges. Firstly, those businesses affected by the amendment will have to change processes and implement new systems to deal with the impact of partial exemption. This includes, but is not limited to, allocation and apportionment of input tax credit for each GST return, annual adjustments and potentially a capital goods adjustment. But one other key issue is that IHC is not defined under the existing GST legislation. Therefore businesses are unsure as to what criteria will define them as an IHC or otherwise.

Despite the changes being effective from 1 January 2016, it is noted that some IHCs are being denied their GST refunds prior to 1 January 2016 by the Royal Malaysian Customs Department. This is not because the rule is applied retrospectively, but because of the quantum of incidental exempt supplies made was significantly higher than the quantum of taxable supplies made and thus, the financial supplies are not considered as ‘incidental’.

What is ‘incidental’ then?

While there is no definition of ‘incidental’ in the Malaysian GST legislation, the Oxford English Dictionary defines ‘incidental’ as “happening as a minor accompaniment to something else” or “happening as a result of (an activity)”. The definition of ‘incidental’ does not specify a particular quantum but would require that, to be incidental, a supply cannot be the main activity of the business.

Now, assuming a property holding company, Company A, has 3 properties that generates rental of RM50,000 per month and decides to sell his high value property for RM5,000,000 and deposits the proceeds from the sale in a high interest deposit account for 6 months before reinvesting in more properties. The implications of the example above are illustrated as follows:-

Based on the example above, does it mean that Company A cannot treat the interest income, as a result of depositing money, as to an ‘incidental’ exempt supplies just because of its quantum, although the business’ intention has not changed? That certainly should not be the case based on the meaning described above.

Summary

Nevertheless, it is also important to consider all factors in order to determine whether or not the meaning of 'incidental' can be rightfully applied to your business, such as:-

• The principal activity of the business. Is it by nature an IHC?
• The nature of the financial exempt supplies. Do they fall under Regulation 40(2) of the GST Regulations 2014?
• The type of business. Does it fall specifically under the exclusion list of Regulation 41 of the GST Regulations 2014?

If you feel that this issue has not been adequately addressed in your business, please feel free to speak to us.

Kevin Ong Kian Hua is a Senior Consultant, Indirect Tax Advisory Group at PwC Malaysia.