Taxation: Badges of Trade

Question 2

To determine whether the RM 2 million is liable to Malaysia income tax, we need to identify whether the transaction of RM 2 million is a business income or a capital gain. Malaysia income tax impose tax on business income, which are transactions fell under ‘trade’ or ‘adventure in nature of trade’.

To determine whether a transaction is an ‘adventure of trade’, Leeming v Jones (15 TC 333) laid out the presence of conditions that is sufficient to establish the existence of the adventure of trade.

Together with the principles above, there are also acid test which is badges of trade in deciding whether the transaction is a business income or a capital gain.

Badges of trade

1. Intention / motive of taxpayer

The initial plan to purchase the land was to build homes for the families and the children of the two brothers, Calvin and Alvin, upon retirement. This shows that the purchase of the land is an investment. As two years after purchasing the land the brothers were approached by a used car dealer who wanted to buy the land but the brothers refused to sell it. It is clear that the brothers do not have the intention to resale for profit.  

1. Subject matter of transaction

Subject matter is the nature of the assets. Where the subject matter is treated as trading transaction, then the sales of that transaction would be taxable to the income tax. On the other hand, if the subject matter is an investment, the profit from the disposal will not be subjected to income tax.

The purpose of purchasing the land was for personal enjoyment which is to build homes for the families of Calvin and Alvin. This can be seen in the approached of the used car dealer who wish to buy that piece of land but was rejected by the brothers. However, the brothers agreed to rent the land to the used car dealer for a period of three years. Upon the expiry of the tenancy agreement, a portion of the land was planted with fruit which were distributed among the brothers’ relatives and friends. There is no further information as to what the other portion of the land is for.

1. Length/period of ownership

Generally the longer the period of ownership of the subject matter before its disposal, the greater the possibility that the subject matter is held for investment.

In this case the land was held by the brothers for 10 years. There is no mention of the use of the land for the first two years but after two years, the brothers agreed to rent the land to the used car dealer for a period of three years. After the expiry of the tenancy, the land was planted with fruits which were distributed to the friends and relatives of the brothers. This indicated that the land was then used for personal benefit.

1. Frequency of transactions

Frequency of transactions means how many times the same transaction being made. If there were a number of transactions made on the same kind of assets, it is possible that the transaction is of trading purposes.

The question clearly stated that that was the first transaction for the sales of that piece of land.  

1. Formation of organization

It is assumed that the main purpose for the forming of an organization is of profit making, even though the company may hold assets for a long period but the disposal may still be viewed as business income.

There is no evidence of the formation of an organization in the cases of the brothers, Calvin and Alvin.

1. Financing arrangement

The method of financing is important in indicating whether the taxpayer is trading the asset or just an investment. When a person borrows more than he could afford to buy a property, there is a possibility that the person hopes to resell the property at a profit within a short period of time. The period of financing also determine whether the transaction is a business transaction or an investment. The longer the period of financing, the higher the probability that the transaction establishes is an investment.