entertainment expenses or not - the saga of an entertaining question continues

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© 2003 LexisNexis Asia (a division of Reed Elsevier (S) Pte Ltd)

The Malayan Law Journal Articles

2009Volume 3

[2009] 3 MLJ ix; [2009] 3 MLJA 9

LENGTH: 5009 words

TITLE: Article: ENTERTAINMENT EXPENSES OR NOT -- THE SAGA OF AN ENTERTAINING QUESTIONCONTINUES

AUTHOR: Kenneth Wong Poh Lim Advocates & Solicitors

TEXT:

INTRODUCTION

Globalisation has inevitably increased the level of competitiveness amongst businesses. Words like 'branding','marketing' and 'packaging' seem to be more commonly used by businesses. Another growing trend among companies,is the increased spending of its annual budget on expenses classified as entertainment expenses, a business strategyintended to promote better relationship with clients.

This gives rise to the question whether there are any tax benefits for companies which spend a large portion of theirbudget on such expenses.

This article hopes to help the reader to understand the deductibility of such expenses when reporting annual incometax returns.

Deductible Expenses under the Income Tax Act 1967 ('ITA')?

Section 33 of the ITA authorises certain payments to be allowable expenditure and therefore deductible asexpenses. In brief, expenditure that is wholly and exclusively incurred in the production of the gross income during thatyear of assessment will be allowed as a deduction in computing the chargeable income. n1

However, readers are reminded that there is a provision in the ITA that provides for certain expenditure to beprohibited from any deduction. Section 39 of the ITA essentially lays down a number of general principles and specifiescertain type of expenses that are not deductible in arriving at the adjusted income. n2

In Margaret Luping & Ors v Ketua Pengarah Hasil Dalam Negeri, n3 Gopal Sri Ram JCA adopted the principleestablished in the case of DGIR v Rakyat Berjaya Sdn Bhd n4 and DGIR v LTS, n5 which held that:

The relationship of these two sections as correctly pointed out by thespecial commissioners is found in the case of Director-General of

Inland Revenue v Rakyat Berjaya Sdn Bhd [1984] 1 MLJ 248; [1984] 1CLJ 108. At pp 253-254 (MLJ) Lee Hun Hoe CJ (as he then was) said:The relationship between the deduction allowing provisions of s 33 andthe deductions disallowing provisions of s 39 is explained by Chang MinTat J, as he then was, in DGIR v LTS [1985] 1 BLJ 166.

This essentially means that s 33(1) of the ITA has to be read in the light of s 39 of the ITA.

An item of particular interest in the list of expenses is entertainment expenses. Section 39(1)(l) of the ITA providesthat expenses incurred in the provision of entertainment will be afforded a 50% deduction.

On the surface, the provision is clear on the deductibility of entertainment expenses. What then, if for example,company A, being a property developer, threw a dinner for its potential clients? Will the expenditure incurred fallwithin s 33(1) or s 39 of the ITA? Will it be seen as entertainment expenditure and afforded a 50% deduction or asexpenditure wholly and exclusively incurred in the production of its income and therefore a full deduction?

The question therefore is whether the expenditure incurred was incurred wholly and exclusively in the productionof its income rather than as entertainment expenditure.

This is an important issue which ignites cases relating to deductibility of entertainment expenses into the litigationarena. Taxpayers are often at loggerheads with the tax authority, contending that the expenditure incurred by them is notwithin the scope of entertainment expenses under s 18 of the ITA and prohibited by s 39(1)(l) but being more ofexpenditure wholly and exclusively incurred in the production of gross income.

On the other hand, the tax authority will usually, if not always, be of the view that such expenses are entertainmentexpenses and, therefore, should only be given a 50% deduction rather than a full deduction under s 33(1) of the ITA.Most certainly if a company's entertainment expenditure runs into high figures, this would and should definitely be agreat cause of concern on the part of the taxpayer company.

A discussion on whether such expenditure was entertainment expenses arose in the leading Court of Appeal case ofBentleys, Stokes and Lowless v Beeson (Inspector of Taxes). n6

In the said case, the taxpayer was a legal firm. The partners in the firm incurred expenditure in entertaining theirexisting clients to luncheon at a social club and various restaurants. During luncheon, business was discussed and thelegal advice given to their clients was charged to them in the normal way. However, the fees charged did not includeexpenses of the meals and were borne by the firm.

The tax authority disallowed the taxpayer's claim for deduction on the basis that the expenses incurred wereentertainment expenses. Romer LJ in his judgment held that the circumstances in this case point to the direction that thesole object in incurring the expenses was the promotion of the business of the firm. Therefore, the monies were whollyand exclusively laid out or expended for the purposes of the profession and were not entertainment expenses per se.

Entertainment Expenses -- Prior to the Aspac case

One may then ask, what amounts to entertainment expenses in Malaysia? We first need to understand what amountsto entertainment expenses before exploring further. Section 18 defines 'entertainment' as including the provision offood, drink, recreation or hospitality of any kind and the accommodation or travel in connection with or for the purposeof facilitating entertainment of above provisions. n7

In a nutshell, the definition seems to include every expense that appears to be hospitable in nature. Meals,sponsorship of accommodation or travelling, holidays and expenditure in this genre would be caught within the purviewof entertainment expenses as long as it is provided as a hospitality gesture.


Therefore, prior to the decision in Aspac Lubricants (Malaysia) Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri,n8 (the Aspaccase) the court was of the opinion that the key to determining if an expenditure is an entertainmentexpense or not, would depend on whether it was for the provision of food, drink, recreation or hospitality of any kind.Obviously, the most ambiguous and prone to conflicting views would be hospitality of any kind provision.

At this juncture, it is no secret that the key to winning a case on deductibility of such expenses would be to baseone's argument that such expenditure is not hospitable in nature. What then, you may ask, is hospitable in nature?

The Short Oxford English Dictionary defines 'hospitality' as the act or practice of being hospitable, the receptionand entertainment of guests or strangers with liberality and goodwill. In essence, the practice of being hospitableconnotes the act of entertaining someone with nothing gained in return by the host.

Therefore, the tax authority will usually contend their cases based on such expenditure incurred did not provide anysubstantial return to the host. One of the leading cases in the 1990s in relation to deductibility of such expenses is theHigh Court case ofUnited Detergent Industries Sdn Bhd v Director General of Inland Revenue. n9

In the said case, the taxpayer was a detergent manufacturer. The taxpayer purchased some premium items in bulkand offered the same to its customers along with its own detergent product. The premium items included glass tumblers,glass bowls, dinner plates, laundry baskets, flint bowls and plastic pails. These items were to be given away (not forfree, but at a discounted price) along with the detergent products, with the option of either buying the detergent productsalone or together with the premium items.

The expenditure incurred in purchasing and giving out of the premium items were disallowed by the tax authority.The tax authority opined that these were entertainment expenses being expenses arising from acts of hospitality ratherthan expenses incurred wholly and exclusively incurred in the production of gross income.

The Special Commissioners of Income Tax held that the giving away of such items did constitute entertainmentwithin s 18 of the ITA. The definition of entertainment includes solicitous entertainment and hence the act of givingaway such items was to essentially increase the taxpayer's sale. Therefore, the expenses incurred, according to theSpecial Commissioners, were entertainment in nature. n10

The case went on appeal to the High Court, in which Abdul Kadir Sulaiman J (as His Lordship then was) held thatthe expenditure was not entertainment in nature as the said items were not given to the taxpayer's customers gratuitouslyand without consideration, but were given only upon the option made by customers to purchase at a discounted price.There was a payment involved, albeit indirectly, and as such, it could not be viewed as hospitable in nature. With thatreasoning, the expenditure incurred by the taxpayer in giving away the premium items were held not to be entertainmentexpenses and allowed full deductions. n11

Nevertheless, the gist of the argument does seem to focus on whether the items were given for free and gratuitouslyor whether the items were given in consideration for a payment in return. That seems to be the earlier focus by thecourts in deciding cases involving entertainment expenses.

In another unreported case before the Special Commissioners of Income Tax, the taxpayer developed luxuriousbungalows. Subsequently, the taxpayer purchased golf memberships. As part of its advertisement strategy, the taxpayeradvertised in its brochure that golf memberships will be given to the buyers of the bungalows. In essence, the price ofthe golf memberships was included in the purchase price of the bungalows and the prospective buyers had the option ofwhether to secure the golf membership or not.

The Special Commissioners held that the golf memberships were not given for free and the purchasers who optednot to purchase the golf memberships had the price of their bungalow reduced in accordance to the price of the golfmembership. In that respect, it would appear that the courts still relied and focused on whether such expenditure wasincurred as an act of hospitality in determining whether an expenditure is entertainment in nature or not.


The Decision in the Aspac case

It, however, remains rather uncertain as to how exactly the courts would determine whether an expenditure isentertainment in nature or not, as the meaning of hospitable is at best, ambiguous. Although there are few cases whichexamine this issue, there had yet to be a strong authority that cleared all doubts for the taxpayers.

The Malaysian tax court system is such that a decision by the Special Commissioners of Income Tax is not binding,whereas a decision by the High Court is only binding on the Special Commissioners of Income Tax. There are a largenumber of cases decided before the Special Commissioners of Income Tax that have gone on appeal to the High Court.As such, it is arguable that the High Court's decision in United Detergent Industries n12 is not an absolute authority toclear all ambiguity surrounding the issue. Only a Court of Appeal decision would be binding on all lower courts.

Therefore, when the Court of Appeal delivered its judgment on this issue in the case of Aspac Lubricants(Malaysia) Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri, n13 it was hailed as a landmark case, finally appearing tosettle the controversy regarding entertainment expenses.

The taxpayer in this case was a private limited company. It blended and sold lubricants for motorised vehicles andalso sold some equipment and other products. During the revenue assessment for the years of assessment 1989, 1990,1991 and 1992, the taxpayer gave away certain promotional items to its customers and dealers.

Firstly, there were those given to dealers ('the dealers' items') who marketed the taxpayer's products to members ofthe public. These items did not carry the taxpayer's logo on them. They included items such as electrical appliances andbeverages. At this juncture, there is no need to discuss these items as the taxpayer did not challenge the decision of theRevenue division in respect of these.

Second, there were those given away to customers ('the customers' items') who purchased the taxpayer's products.These included items such as mugs, 'T' shirts and umbrellas carrying the taxpayer's logo.

The court in the Aspac case n14 had to consider whether the monies incurred by the taxpayer in providing thecustomers' items were expenses wholly and exclusively incurred during that period by that person in the production ofgross income or were expenses incurred in the provision of entertainment.

In arriving at its decision, the court in the Aspaccase n15 relied on Romer LJ's judgment in Bentleys, Stores LLowless v Beeson n16 and held that if the sole object of the expenditure is business promotion, it is not disqualifiedbecause the nature of the activity necessarily involves some other result, or the attainment or furtherance of some otherobjective, since the latter result or objective is necessarily inherent in the act. n17 This is the first principle establishedby the court in theAspac case. n18 In addition, the Court of Appeal held that the consideration moving from thecustomer is the payment he makes while the consideration moving in the opposite direction is the taxpayer's product anda customers' item. The court went on and referred to the case of Chappell & Co Ltd v Nestle Co Ltd & Anor, n19where three wrappers of sweets were held to be consideration. This is the second principle established by the court.Even a practical advantage obtained by a promisor in a bargain is good consideration to support the promise.

Significance of the Decision in the Aspac case

We will now seek to simplify the significant issues of the decision in the Aspaccase n20 for the benefit of thereader and the taxpayer.

Expenditure incurred by the taxpayer with the sole object of promoting its business will not be categorised asentertainment expense merely because the nature of such expenditure results in the furtherance of other objectiveswhich are necessarily inherent. Whether or not such expenditure was incurred wholly and exclusively for the promotion


of business would be a question of fact. With that in mind, taxpayers would have to show evidence that it was done forthe sole aim of marketing their products, promoting their businesses or even to increasing their market base. In addition,it was encouraged that the taxpayer be able to show that such expenditure was necessary and solely intended to promotetheir businesses.

Secondly, the fact that the host obtained a minimal return or even a practical advantage would amount to goodconsideration. Essentially, the tax authority can no longer merely contend that an item was given away for free orgratuitously and therefore should be classified as entertainment expenses under s 18 and prohibited under s 39(1)(l) ofthe ITA. Instead, as long as the host or the provider could show that it obtained some practical advantage, such as anincrease in sales, an improvisation of market standing or brand awareness, it would be deemed that such provisionswere not given for free or gratuitously.

The Position After the Aspac case

The decision in theAspaccase n21 has not been put to the test in any Malaysian court as yet. n22 Nevertheless,the principles established in the Aspac case n23 were long established under comparative legislation in Australia in thecase of Commissioner of Taxation v Amway of Australia Limited. n24

In Amway, n25 the taxpayer organised an exclusive conference or seminar each year for its direct distributorsknown as Australian Leadership Seminars. They were held generally in good quality venues at a holiday destination.The majority of the Australian Leadership Seminars in question in the year of income were held overseas, although twowere held in Australia during the relevant period. Attendance was by invitation only. To be eligible for an invitation,distributors had to qualify by achieving a specified number of points based on the distributor's performance during theprevious year.

The court in Amway n26 held that the air travel and hotel expenses were not 'entertainment' but were incurred inthe production of income. Only the expenses of a gala dinner fell within the ambit of definition of entertainment andwere disallowed. The whole of the amount expended for meals (other than the gala dinner expenditure conceded not tobe deductible) and the amount expended for accommodation or travel in respect of the seminars would continue to bedeductible to Amway.

Following the decision in the Aspac case n27 and Amway, n28 the position regarding entertainment expensesappears clearer and less ambiguous to the taxpayers. At this juncture, to contend that an expenditure incurred is notentertainment in nature, taxpayers will now need show that such expenditure was incurred wholly and exclusively forthe promotion of their businesses and practical advantages were obtained. No longer is it necessary for the taxpayers tofirst establish that an act is not hospitable in nature before being able to show it was wholly and exclusively incurred forthe promotion of its business.

Closer to home, recently, in an unreported case before the Special Commissioners of Income Tax, the taxpayer, apharmaceutical company, incurred expenses in sponsoring doctors, pharmacists and health care professionals at medicalconventions. The taxpayer could not advertise or sell drugs and medicine directly to patients as they had to beprescribed by doctors. The doctors sponsored to the various conventions were in a position to decide on the type ofdrugs and medicine to be prescribed for specific health conditions or diseases. The conventions were an importantmarketing arena for the taxpayer as the taxpayer's presence and sponsorship enhanced the image of the taxpayer interms of promotion of its business.

The Special Commissioners of Income Tax held that the expenditure incurred were solely for the promotion of thetaxpayer's business and were not 'entertainment' under s 39(1)(l) of the ITA. Once again, this decision reinforced theprinciples established in the Aspaccase n29 earlier.

Food for Thought


What then, if, Mr B is an interior designer and brought his potential customer for a meal. At the same time, thepotential customer is Mr B's close friend and Mr B also intended to take this opportunity to treat his friend to asumptuous meal. So, indirectly, Mr B's intention is to promote his business and also to meet up with his close friend. MrB then claims a deduction for the expenditure so incurred. Perhaps, one can view such an act as killing two birds withone stone. For the tax authority, it is an entirely different proposition.

We need to appreciate the fact that Malaysia does not practice dual-purpose deductions and that for an expenditureto be allowed full deduction, it has to be wholly and exclusively incurred in the production of its gross income. The keyphrases are 'wholly and exclusively' thus rendering expenditure incurred for multi-purposes as falling outside thecategories of expenditure allowable for deductions.

Romer J in Bentleys, Stokes and Lowless v Beeson (Inspector of Taxes) n30 famously gave his thought on suchscenario. His Lordship said:

A London solicitor may hear that an old friend and client whom he hasnot for a long time seen has arrived in London. He says to himself: 'Iwould like to see my friend again, and I know he may wish to talkbusiness with me. I will ask him to have lunch with me and then we candiscuss any business he has at the same time. I can kill two birds withone stone.'... The expenditure could not be justified even though itturned out that the friend spent the whole of the lunch time seekingthe solicitor's advice on his private affair.

This is because the expenditure was incurred for more than one purpose and not for the sole intention of promotinghis business. Having seen the dictum in Bentleys, Stokes and Lowless v Beeson (Inspector of Taxes) n31 regardingdual purpose expenditure, what is the position in Malaysia then?

In Ampat Tin Dredging Ltd v Director-General of Inland Revenue, n32 Mohd Azmi J (as His Lordship then was)stated that:

From the clear, words of s 33(1) of the Income Tax Act 1967, in orderfor outgoings and expenses to be allowed as deductions they must bewholly and exclusively incurred in the production of gross income ...To qualify for deduction, it is not sufficient that the money incurredis related to the production of income, but it must be wholly andexclusively incurred in the production of income. In present case, forwork done, all the company's employees were paid salaries or wages forwhich deduction had been allowed. At the most, theretrenchment benefits expended can only be said to be related to theproduction of income but not exclusively in the production of income.

Evidently, His Lordship in delivering his judgment in Ampat Tin Dredging Ltd n33 reiterated the position that foran expenditure to be deductible, it must incurred wholly and exclusively in the production of income. If suchexpenditure was incurred for more than one purpose, although the main purpose is for the production of income, it is notsufficient to be deductible under s 33(1) of the ITA.

CONCLUSION

Evidently, the focus on what would amount to entertainment expenses has shifted from whether the expenditurewas incurred in the act of hospitability to whether such expenditure was incurred wholly and exclusively for thepromotion of businesses or for other purposes. Practical advantage, if can be shown, even though not necessarily inmonetary terms, would be sufficient consideration thus negating the hospitality factor.


LESSONS TO BE ADOPTED

In a nutshell, you, as taxpayer, would bear the burden of proof to establish that the expenditure incurred in hostingyour clients, friends or even family was wholly and exclusively incurred in the production of gross income. Whethersuch expenditure is within the purview of entertainment expenses or allowable deductions under s 33(1) of the ITA is aquestion of fact.

The following are some possible steps taxpayers can take to show or establish that such expenditure was whollyand exclusively incurred in the production of income include:(i) Provide evidential proof that the people who the taxpayer hosted are

potential customers of the taxpayer, ie people invited were selectedfrom a certain sector of the society and not any random strangers inthe street; and

Provide evidential proof that sales had indeed increased from such an event and that the taxpayer managed to boostits corporate branding to its customers, ie list containing the sales achieved from such events and that the customerswere directly or indirectly due to the hosting of such events (this is to show that the sole objective of such expenditure isfor the promotion of the business).

Return to Text

FOOTNOTES:

n1 See s 33 of the ITA for the full provision.

n2 See s 39 of the ITA for the full list of expenditure expressly prohibited from deductions.

n3 [2000] 3 CLJ 409 -- per Gopal Sri Ram JCA: 'To be deductible, a payment must (i) be authorised as adeduction by s 33(1), and (ii) not be disallowed by s 39.'

n4 [1984] 1 CLJ 108.

n5 [1985] 1 BLJ 166.

n6 [1952] 2 All ER 82; 33 TC 491; [1952] TR 239; 31 ATC 229; 45 R & IT 461; [1952] WN 280.

n7 See s 18 of the ITA for the exact wording in the definition of 'entertainment'.

n8 [2007] 5 CLJ 353.

n9 [1998] 1 LNS 176.

n10 Special Commissioners at p 15 of the case stated held: '... since we have found that the purpose of theconsumer premium items was to promote sales which is entertainment ... it is immaterial that there was a cost


element borne by the purchasers.'

n11 per Abdul Kadir J (as His Lordship then was): '... the said items were not given to the appellant'scustomers gratuitously and without consideration, they were given only upon the option made by concernedcustomers. For that reason ... not as a free gift but subject to the payment of the cost incurred by the appellant inthe purchasing of the items from its suppliers ... no hospitality of any kind on the part of the appellant beingextended to its customers.'

n12 [1998] 1 LNS 176.

n13 [2007] 5 CLJ 353.

n14 [2007] 5 CLJ 353.

n15 Ibid.


n17 See p 3 above for the facts of the case.

n18 [2007] 5 CLJ 353.

n19 [1960] AC 87.

n20 [2007] 5 CLJ 353.

n21 [2007] 5 CLJ 353.

n22 See para 1 p 11 below for the recent Malaysian Special Commissioners of Income Tax's decisionwhich applied the principles established in the Aspaccase.

n23 [2007] 5 CLJ 353.

n24 [2004] FCAFC 273.

n25 [2007] 5 CLJ 353.

n26 [2004] FCAFC 273.

n27 [2007] 5 CLJ 353.


n28 [2004] FCAFC 273.

n29 [2007] 5 CLJ 353.


n31 Ibid.

n32 [1982] 2 MLJ 46; [1982] CLJ 402.

n33 [1982] 2 MLJ 46; [1982] CLJ 402.


entertainment expenses or not - the saga of an entertaining question continues

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