THERE is no distinction in the treatment of tax losses between a normal business and a holding company carrying on a business of holding investments and carrying on other businesses such as providing management services or carrying on the business of renting properties.
However, if a holding company whose activities consist mainly of the holding of investments and the business income does not exceed 20% of the total gross income of the company, the losses in such companies cannot be carried forward.
To avoid being labelled as an investment holding company and to exceed the 20% threshold, such companies will usually provide their back-office support services such as accounting, legal, tax, human resources, treasury, internal audit and, in some cases, they will also centralise their higher-end services such as technical support, cybersecurity and procurement.
Key activities of holding companies
Generally, holding companies perform two sets of business activities. Primarily, they hold and manage investments with the intention of maximising the returns either through dividends or realisation of gains upon the disposal of the investments. Secondarily, they function as a central point to provide shared services to support the subsidiaries and associates they control with the same intention of maximising their returns.
Problems with the losses
Holding companies carry high costs of employing the senior management and the overheads associated with them to manage the investment segment of the business. The income from this business source is from dividends and interest income from the active lending of monies to the companies within the group. In accounting terms, this business segment will be financially profitable. However, for tax purposes, since the dividend income is exempt from tax, the expenses including costs, will become losses.
A further twist at this juncture is that the tax law specifically prohibits any deductions in relation to such dividends. Consequently, if a holding company generates only dividend income, all expenses relating to that segment of the business, including interest costs, will be disregarded and therefore the losses will disappear.
However, in practice, there is a tendency for holding companies to assume that this restriction is only confined to interest costs and all other expenses can be carried forward as losses. Such carry forward of losses could be challenged by the Inland Revenue Board (IRB) and therefore these losses may be in jeopardy.
The other business segment of providing shared services to support the subsidiaries and associates in many cases generate losses. The reason being there is usually an under-recovery of cost on providing such services. Normally such services should meet the arm’s length rule under the transfer pricing legislation which requires such providers to generate profits. Here, the losses generated under this segment can also disappear if the holding companies do not meet the arm’s length rule.
The other issue that can complicate matters for holding companies is the allocation of costs between the two business segments.
What is the allocation key to segregate the costs? Is it income, cost incurred, time spent, or any other allocation key?
The choice here will determine the correct alignment of profits between the two business segments. The allocation key chosen must be consistently followed year to year.
The way forward
Holding companies should carefully review their past positions and take stock of where they stand. In case their losses are not defendable and such losses have been used for group relief purposes or other purposes, they may need to seriously consider going in for a voluntary settlement with IRB to avoid additional taxes and penalties. However, if their positions are defendable, they should prepare themselves to defend any challenges by IRB.
This article is contributed by Thannees Tax Consulting Services Sdn Bhd managing director SM Thanneermalai (www.thannees.com).
Source: The Sun Daily
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