Tax Case Study: Keysight Technologies Malaysia Sdn Bhd v. Director General of Inland Revenue

The case concerns an additional assessment for YA 2008 issued by the Director General of Inland Revenue (IRB) on 13th June 2017, amounting to RM311,057,602.46, for the sale of IP rights in the  form of technical know-how by Keysight Technologies Malaysia Sdn Bhd (the “Taxpayer”) to Agilent Technologies International (“ATIS”) for RM821,615,000.  

Prior to the transfer of the IP rights, the Taxpayer had carried on business as a full-fledged manufacturer. After the sale, ATIS granted a limited licence to the Taxpayer as a contract manufacturer to provide manufacturing services for ATIS’ products.  

The Taxpayer had declared the proceeds of sale as non-taxable capital gain, while IRB contended that the proceeds were taxable income under Section 4(f) of the Income Tax Act 1967 (“ITA”) and imposed a penalty of 45% under Section 113(2) of the ITA. 

It was an agreed fact that the additional assessment was time-barred. However, the IRB contended that the bar could be lifted under Section 91(3) of the ITA, as the Taxpayer had been negligent. 

Both the SCIT and the High Court had dismissed the Taxpayer’s appeal on the following grounds: 

1. the “outright sale” test applied in this case, and not the badges of trade test, which only applies to acquisition of property;
2. there was no transfer of legal title in the IP;
3. the sale of IP rights was compensation for the Taxpayer’s loss of future income;  
4. the Taxpayer was still using the IP rights post-sale; the Taxpayer had been negligent in failing to prove the outright sale, to declare the income from the sale, and to provide the valuation report during the audit phase. 

The issues before the Court of Appeal were therefore as follows:- 

1. whether the High Court and the SCIT were right in holding that the Taxpayer’s receipt from the disposal of IP rights was income in nature, without applying the badges of trade test; 
2. whether the IRB’s additional assessment for YA 2008 was time-barred, and whether the IRB had proved that the Taxpayer was negligent in order to lift the time-bar; and
3. whether the IRB was correct in imposing penalties at the rate of 45% under Section 113(2) of the ITA against the Taxpayer.

The Court of Appeal unanimously allowed the Taxpayer’s appeal with costs of RM20,000.   

1. Disposal was capital in nature  

• The cases cited by the Taxpayer demonstrated that the “badges of trade” test was the proper test to apply in distinguishing between capital and revenue income in this case, and its application was not limited to land transactions.  

• Applying the badges of trade test, the Court of Appeal found that the disposal of the IP rights was a disposal of capital assets and was not an income in nature, hence it was not taxable.  

• Among other things, the  Court of Appeal found that the Taxpayer was in the business of manufacturing products, not buying and selling IP. The transferred IP was not stock-in-trade, but a capital asset used in the production of the Taxpayer’s products when it was previously a full-fledged manufacturer. 

• There was no support in law for the “outright sale” test applied by the IRB.  

• Unlike patents, technical know-how is not capable of registration due to its confidential nature, and is protected instead by the laws of confidentiality and contract. Therefore, the issue of transfer of legal title did not arise.   

• The Court of Appeal rejected the IRB’s argument that the Taxpayer had retained reversion of intangibles. In this regard, the High Court and SCIT had failed to consider the fact that the Taxpayer was granted a limited licence by ATIS post-sale.  

• The IRB’s argument that the receipt from the sale was compensation for loss of the Taxpayer’s future income directly contradicted its allegation that there had been no outright sale of the IP rights. ATIS had compensated the Taxpayer on a cost-plus basis. This argument was also clearly an afterthought, as IRB’s argument was premised on the valuation methodology used in the valuation report – which the IRB had not sighted during the audit phase. 

• The IRB had also failed to invoke anti-avoidance provisions under Sections 140 or 140A of the ITA. 

2. IRB’s Assessment Time-Barred 

• The burden to prove negligence under Section 91(3) of the ITA is on the IRB. 
• As the Court of Appeal had dismissed the “outright sale” test and applied the badges of trade test, it was clear that the proceeds from the sale was capital in nature. 
• The Taxpayer had declared the proceeds as non-taxable income under professional advice. It could not be said that was no declaration, or that the Taxpayer had done so nilly-willy.  
• Merely applying a tax treatment that IRB disagrees with does not amount to negligence.
• The chronology of events showed that the IRB had only requested for the valuation report a year after the assessment was raised. The IRB’s witness had also confirmed at trial that the valuation report had no bearing on the IRB’s decision. Therefore, the absence of the valuation report during the audit phase was raised as an afterthought.

3.Penalty incorrectly imposed 

• Thus, the penalty imposed by the IRB was incorrect.