High net worth individuals are under the spotlight by the tax authorities from a number of angles.
These include large remittances in and out of Malaysia, balances at foreign financial institutions such as banks, insurance companies and stockbrokers, movements of director accounts in local companies, and sale and purchase of assets such as real properties, expensive cars and other luxury goods.
It is becoming easier for the tax authorities to build an estimated net worth of individuals as they have the digital tools to mine their internal data sources and pull in information about the information from external sources such as private and public databases.
Why is the growth of net worth a problem? It becomes a problem when the tax authorities find that there is a large discrepancy between the increase in the net worth of the individual for the year and the amounts declared for tax purposes in Malaysia.
When such discrepancies come to light, the tax authorities will normally call upon the individual to explain the discrepancy by requesting for a capital statement for perhaps up to five years which is the normal period of limitation to issue assessments.
However, in cases where the tax authorities have evidence of fraud, negligence or wilful default, they can ask for capital statements beyond the five years.
In simple terms, a capital statement is a combination of a statement of the net worth of an individual which represents the assets and liabilities of the individual at the year end and an income and expenditure statement for each year.
This is equivalent to a balance sheet and a profit and loss account of a company.
Net worth statement
For the purposes of preparing a net worth statement, the assets and liabilities will include both local and international balances and this will include: bank balances, properties, fixed deposit balances, investments and insurances and loan balances.
At the moment, the tax authorities may not have easy access to information on overseas real property and certain unique assets such as artworks, stamp/coin collections and antiques.
In the future, we anticipate that real property in particular located overseas will become more visible to the local tax authorities as they are widening the range of information being exchanged between the different tax authorities of the world.
Income and expenditure statement
In preparing the income and expenditure statement, the tax authorities will take into account all movements from your bank accounts, fixed deposits, credit card statements and loan accounts.
They will compare that against your normal lifestyle, the number of children being educated locally and overseas, and in some instances, your overseas travels which will indicate extra spending beyond your normal living expenses.
Capital statements (prepared on a hindsight basis) are a headache
The basic problem with most taxpayers is "memory loss." After many years, taxpayers cannot recollect the details and usually documentary evidence is missing.
Even if the documents are available, the movements in the bank accounts cannot be explained by the taxpayers.
In the event the taxpayer cannot explain the movements, the tax authorities have an advantage in assuming that unexplained differences equate to unreported income taxable in Malaysia.
Defending such a position against the tax authorities requires indirect evidence or other corroborative arguments and will be an uphill task.
Some of the other problems include: double counting of monies circulating between different accounts of the same person which can be erroneously taken up by the authorities as income, estimation of private expenditure can be subjective as each person's spending patterns can be very different, gifts can be mistakenly taken up as unreported income, unexplained withdrawals and deposits into bank accounts, etc.
Be ready to account for your sources of funds
In the event there is an increase in your net worth during the year, you need to prove where you obtained the money to fund the growth of your net worth.
Sources of funds could be both taxable and non-taxable income. Taxable income sources include business income, employment income, rental income or miscellaneous income such as commissions.
Non-taxable income sources include exempted interest, dividends, pensions, capital gains, inheritances and gifts from family and friends that do not need to be disclosed in your income tax return forms.
However, proper documentation such as bank statements and dividend vouchers need to be kept to prove to the tax authorities that these are non-taxable income.
Gifts are not taxable if they are given by one person to another gratuitously without expecting any payment or consideration in return. It is a voluntary transfer of property without compensation. It is also given out of love and affection without expecting any anything in return.
There is a shift in the direction of the tax authorities in scrutinising gifts. Currently, the burden of proving any property or money received as gifts lies entirely with the taxpayer.
If you're not able to satisfy the tax authorities, it is likely to be treated as taxable income. As to whether such a position will acceptable to the courts is a different matter.
Watch movements in directors' accounts
The director's account is a notional balance between a company and its directors. It is not a real bank account. It records monies drawn by the director, director's personal bills paid by the company, salary, dividends and expense re-reimbursements.
It is not uncommon for family-owned companies to use the director's account for purposes beyond the above such as clearances of unexplained inter-company accounts, transferring discrepancies within the company's accounts to the directors account, etc.
Some of the movements within the director's account could be a cause for concern as such transactions may have an impact on the taxation on either the individual or the company. This is an area that the tax authorities are now increasingly focusing their attention on.
How to avoid this headache?
The minimum that high net worth individuals need to do is prepare annually a net worth statement. Any increase in the net worth should be supported by a statement that details the sources of the funds (both taxable and non-taxable).
If you want to be absolutely in the clear, it will be best to go one step further and account for all movements of your assets, liabilities, income and expenditure throughout the year.