GRANTING of leases and tenancies by property owners on a short-term or long-term basis is very common.
The common understanding among laymen is that all rental income received regardless of whether it is a short-term (i.e. less than three years) or more than 3 years, remains as rental income as opposed to a capital receipt.
On the opposite side, lessees regard the payment of rental for the use of property for their business as a business expense, regardless of the period of the tenancy or lease, and do not regard it as an acquisition of a capital asset.
Unfortunately, the law is not so straightforward. The Income Tax Act 1967 (ITA) and the Real Property Gains Tax Act 1976 (RPGTA) come into play in interpreting the tax treatment of the rental income to the lessor and the expenditure to the lessee.
On the surface, both legislations can catch these types of transactions. However, it goes against the fundamental principles of taxation where an item has been brought to tax under one tax legislation should not again be under the scrutiny of the other legislation.
Bringing a transaction into two sets of legislation is tantamount to double taxation. This is where the ambiguity and unfairness arises.
Where is the ambiguity on leases and tenancies?
Under the RPGTA, a granting of a lease is considered a disposal of real property. A lease includes a lease over land, and includes sublease, tenancy, or licence. The lease can be for a short-term period up to three years or could be more than three years. Under the National Land Code, leases more than three years must be registered.
From an income tax point of view, advance rentals received from long term leases and tenancies should be brought to tax at the time it is received.
The lessee or the tenant is entitled to a tax deduction if he uses the property for his business purposes. Although the lessor will be taxed on the advanced rental upfront, the lessee will only be given the deduction over the period of the lease.
The problem arises when there is a long-term lease for say 10 years. As far as the lessee or tenant is concerned, he has a choice of paying the rental monthly for 10 years, or he pays a lump sum of the total rental after a discount for the early payment which will usually be tied to the potential interest the lessor will earn over the lease period.
For RPGT purposes, there is a disposal on the granting of the lease. If there was a premium paid to acquire the lease in addition to the monthly rentals, the premium will be subject to RPGT. Where there is no premium, one should not bring the advance rental to tax under RPGT since the matter has been dealt with under the ITA.
The advance rental in the minds of any ordinary person will not be viewed as the acquisition price for the lease. In situations where only advance rentals are paid by the lessees and there are no premiums paid separately, the acquisition price of the grant of the lease should be taken as NIL.
Overlapping coverage by the ITA and the RPGTA should be avoided through the Inland Revenue Board clarifying via a practice ruling.
Although in layman’s terms it appears to be clear that if one is taxed under one tax legislation, the other legislation should not overlap and create a secondary tax burden.
This article is contributed by Thannees Tax Consulting Services Sdn Bhd managing director SM Thanneermalai (www.thannees.com).
This article was originally published on the Sun daily.