by Jonathan Wong, bizhive@theborneopost.com. Posted on April 28, 2013, Sunday
The property scene in the country is going through dynamic changes with the revised Real Property Gains Tax as well as the coming implementation of the Goods and Services Tax on the horizon. In terms of accounting standards, taxes and legal matters, many real estate companies are still scratching their heads over details pertaining to these matters.
BizHive Weekly takes a look at the more technical issues being faced by property players and how new policies may affect one of the country’s top economic contributors.
Property Scene: Dealing with the intricate numbers
The property scene in Malaysia is growing more dynamic with more developments spilling over from a multitude of government projects, painting a vibrant and positive picture for the sector.
However, despite the robust scene, the administrative system comprising legal, tax and accounting aspects of the property sector does not boast the same growth or efficiency.
With property sales expected to inch up one per cent for 2013 along with the expected recovery in the global economy, more sales might not necessarily mean better prospects on the administration front.
The chasm between accounting standards in the local and international markets leaves a lot to be desired as well as the additional challenge of the Inland Revenue Board (IRB)’s more outdated way of viewing tax collections.
With the real property gains tax (RPGT) set in place to help address property speculation, its effectiveness has been questioned time and again and that does not take into account the upcoming implementation of the goods and services tax (GST).
Industry sources opined that the GST was set to captured tax at every stage from downstream to upstream, unlike the sales and service tax which brought about a compounding effect as it went down the value chain.
To counter this, the government has come up with a proposed GST model which consists of a standard- rated supply, zero-rated supply and exempt situations.
However, the issue with the GST now is – how will it affect property players and how the rated situations impact the industry.
Sources also pointed out that another issue that needed to be addressed would be the legal aspect of it as the sector followed two main public rulings which could about the accounting, legal and tax treatments very well.” “However, as those in the industry know, it is not straightforward and audit accounting has its own set of requirements while tax has another.” Chai Tze Chek of Crowe Horwath explained, “A development can consist of wath explained, “A development can not cater to all different scenarios consist of hence leading to a multitude of disputes.
Directors and partners of Crowe Horwath further elaborated, “We feel that the there is still a lack of awareness among property players as the tax department with the self assessment system means that tax payers (property players) are required to know a mixture of properties with different natures and profitabilities such as low cost portion, school, shophouse, recreational area, commercial, retail or office lots.
“The accounting and tax treatment for the entire project over a financial period can be complex and contentious especially in the environment of price volatility.” Chai further added, “under the interpretation issued by International Financial Reporting Interpretations Committee ‘IC Int 15’, a developer may only recognise revenue and profit when it has transferred full control to the buyer.
The current domestic practice is that it is based on percentage of completion.
“This interpretation would substantially affect the company’s financial results and thus evaluation of its financial performance by stakeholders, bankers and authorities.” With so many vague areas to be addressed in the accounting, legal and tax aspects of the business, BizHive Weekly takes a look into these issues plaguing the property sector that are overlooked by the current boom.
Weeding out the glitches in the development arena
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| Fennie Lim, executive tax director for Crowe Horwath |
The accounting and tax treatment for a property development over a financial period has always been a complex issue that has kept the number crunchers awake.
A majority of property developers are not fully aware on how to recognise their income and their profits taking into account the price volatility from ground breaking to completion of a particular development project.
Sources familiar with the industry commented that because of the confusion, they had somehow unintentionally under recognised their profits which had led them to unintentionally under recognise their tax.
Thus when the tax man made his appearance under the self assessment system and discovered the mistakes, a huge penalty was subsequently imposed on the company itself.
James Chan, partner for Crowe Horwath stated in an exclusive interview with the BizHive Weekly that, “for accounts, Malaysia is generally complying with international standards but currently there are two areas that are the exceptions, both in property development accounting.
“Take for example the new International Financial Reporting Interpretations Committee (IC Int 15), which is a standard for property development, states that you must recognise profits only upon completion.
Imagine using this set of accounts for submission to a bank, it will definitely question the profit figures.” Chan explained that while the local accounting bodies had given players a two year transitional period, they had maintained the current percentage to completion for the duration.
“The percentage of completion method is consistent with the tax treatment meaning that when you sell the property it is recognised by tax but not in accounting.
“The thing about this is that, for companies with multiple projects, they could afford to use previous projects to cover the cost under the accounts however, for companies with a single project it would be very difficult to generate income as everything is banked on that one project.
The company would not have any profits coming in to justify the loan,” Chan explained.
To substantiate, Chan said, “the example I gave was on a single project.
How about a mixed development that includes a shopping complex, hotel, common area and carparks? For tax purposes, which entity are you going to tax for the common area? Who is this ‘Mr Common’ and how do we tax this entity?.
“The developer recognises the area as an investment property, same as the carpark where the developer would gain rental yield.
These are just a few examples of the accounting grey areas that most developers do not know how to handle.” Chan further explained that the accounting standards were getting more and more precise but the tax system was lagging behind.
“When we talk about fair value or net present value, the Inland Revenue Board (IRB) does not comprehend these terms in its calculations.
So that is where the gap is getting bigger and begs the questions of how does one reconcile the tax from an accounting point of view as well as a legal point of view.” Fennie Lim, executive tax director for Crowe Horwath added to this saying that this was the reason why for taxes, the tax department tried to make it simple.
It would disregard all accounting standards and just follow public rulings.
There are two public rulings that are generally used in the property sector where one caters for property developments while the other is for construction companies.
“The company can implement whatever accounting treatment that it favours but at the end of the day, it has to adhere to those two public rulings.
That’s where the disputes start for the tax payers.
“The developer would have done its accounts according to the accounting principle and then the tax department comes in issuing a public ruling, all the ambiguous areas are then left for the lawyers to step in and fight for the tax payer.
“In a nutshell, the tax payer would follow or try to follow tax treatment to minimise the penalty but that’s where it ends.” Chan factored in the main factor that differentiated Malaysia’s accounting as compared with international standards was the implementation of a goods and services tax (GST).
Lim elaborated on this by stating, “touching on the GST, for property developers, GST is rather scary because if you are the property developer, and your company is going to build residential houses, you will have to cough up the extra (assuming GST at five per cent) additional cost of five per cent.
“Reason being is that somehow based on the proposed GST law, if you are building residential properties, it is labelled as ‘exempt rated’, meaning it is not subjected to GST as you are selling it to individuals.
But if they are commercial units, these are called ‘standard rated’ as they are sold to businesses.
“The problem now is that as a businessman, you do not want your products to be ‘exempt rated’ mainly because you forfeit the output tax, meaning you can’t claim back the tax.
Compared with commercial units, when you charge the customers, you have the ability to charge GST for the units sold hence claiming the tax back.
“AS far as the output tax is concerned, the developer does not need to pay for the whole lump sum, just the net tax, meaning you take the gross output tax and minus the input tax that is incurred when purchasing raw materials, rentals or whatsoever which makes it more attractive for the developer.
“This leads to another potential problem namely would this deter developers from building residential housing.” Despite the issue brought up, Lim was positive that developers would still continue introducing new residential projects, even without GST the property market was already relatively on the rise and that the additional few per cents from the GST regardless of the increasing price, would also increase the market value for current properties.
Chan added that, “I believe that the market mechanism would adjust itself to compensate for it because property is a basic necessity.” Hudson Chua, partner for Crowe Horwath shed some light in this matter by stating that the government did state that upon introduction of GST, income tax for developers or for companies would potentially drop so in that sense the cost might set each other off and compensate itself in the price.
“It is a common practise for property developers to make payment of fees to certain parties for soliciting or securing projects.
“Whether such fees are tax deductable or not depend very much on the purpose, nature and circumstance of the fees paid.” With so many ‘grey’ areas within the confinements of the interpretation of the law, it is only a matter of time before the pending issues are sorted out and fine tuned.
Dealing with the grey areas
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| S Saravana Kumar, a partner at Lee Hishammuddin Allen & Gledhill |
Touching on the legal complications in the property development scene, S Saravana Kumar, a partner at Lee Hishammuddin Allen & Gledhill expressed his views.
Talking on the effectiveness of the real property gains tax (RPGT), Kumar stated, “I don’t see any major impact because the rates are quite nominal and thus, for a corporation to pay 15 per cent to sell off an asset within two years, it is not much of an amount to pay comparing it with income tax which is 25 per cent.
So it is not much of a deterrent for companies to sell off property.
“I feel that unless the government reintroduces the earlier rate which is a maximum of 30 per cent and goes all the way to zero, the current RPGT is not an effective for controlling speculation in the market.”
“However, the government also can not introduce such a high rate as it is not business friendly and will not encourage the growth of the property development sector.”
He added that, “We must understand that the property development has a spillover effect to other industries – construction, contractors, subcontractors, manufacturers of the raw material so I guess its down to drawing a balance but on the overall, the RPGT collection in Malaysia is nominal compared with in- come tax collection.”
Kumar noted that the two systems namely accounting and tax had little to no synergy between them stating, “leaving real, practical business issues to developers to recognise.”
“One moment I got my tax issues that I need to resolve with my auditors second I got a tax problem with the Inland Revenue Board (IRB) and as a businessman, the last thing I want is the contradictions between tax and audit.”
“Another matter to highlight is mixed development projects that have dual intentions.
The developer builds the shopping malls for rental, builds a hotel for rental, but the residential tower is for immediate sale.
“The issue to contend with is to manage the tax treatment.
Because residential units are considered stock in trade, which means these units are for sale, meaning it is considered a taxable income, but the mall, office block or hotel is for long term investment, yielding rental income.
“So the developer would pay income tax on the rental income throughout the rental period but after 10 years, should another company come in wanting to buy the entire property, or to issue a real estate investment trust (REIT) which is exempted from real property gains tax (RPGT) but not income tax, the question is whether or not income tax is repeated?” Kumar illustrated a case where a tax payer bought a plot of land, it was a subsidiary owned by a developer but kept the land as investment.
The IRB decreed that it was taxable.
“The IRB does not recognise that taxpayers can keep two types of assets.
One is trading stock, buying and selling which is taxable, and the other is long term investment.
The current framework does not take this into consideration, though legally the courts have favoured developers in the past by drawing a distinction.
“From a tax law perspective, carparks are another area that need to be addressed.
Carparks cost a lot of money to construct and a necessity that developers can’t run away from.
“The local council usually prescribes to the planning commission the number of carpark lots that need to be built.
In Kuala Lumpur, a basement carpark costs about RM100,000 per lot, an elevated carpark cost between RM60,000 to RM80,000 per bay.
“In the past, taxpayers were not able to claim any sort of tax benefits from that.
It is not a deductable expenditure neither is it eligible for capital allowance.
It is a lost cost for developers.
“Last year we handled a case and the court of appeals, the highest court for tax related matters, ruled that taxpayers who build a multistorey carpark are entitled to claim capital allowance on the costs incurred.
The case is very recent (less than six months ago).” Kumar concluded that property developers needed to understand how to find a balance between the accounting and grey tax zones, and hopefully the issues within one of the nation’s largest economic contributors would b e addressed.
