Lawyers pay income tax on accrual basis i.e. income recognized upon issuance of invoice instead of upon collection.

Circular No: 40/2008

Date: 15 February 2008

Dear Members,

IRB Ruling - Recognition of Income Subject to Tax: Update

As members would be aware, we have been having an ongoing dialogue with the Inland Revenue Board ("IRB") regarding the basis of recognising the income of legal practitioners for tax purposes.

Under Malaysian law, the self-assessment system of taxation has been applicable to legal practitioners from the Year of Assessment ("Y/A") 2004.

Many members have been submitting their tax returns on the "cash" or "receipts" basis of income recognition. The IRB has taken the position that the income of legal practitioners should be recognised and subject to tax on the basis of accruals.

The Bar Council had received information from some members that they were being audited by the IRB for previous Y/As and were told that they would be subjected to penalties. The audit process forms part of the self-assessment system which came into force from Y/A 2004.

The Bar Council set up an Ad-Hoc committee comprising of tax lawyers and chaired by Ragunath Kesavan, Vice-President of the Bar. The Bar Council also appointed a tax consultant, Taxand Malaysia Sdn Bhd ("TAXAND") to act for the Bar. Thereafter, comprehensive representations were made by the Bar to the IRB.

The IRB and the Director General of Inland Revenue (DGIR) have maintained that Section 24 of the Income Tax Act 1967 ("ITA") provides that gross income derived from a business should be recognised on an accruals basis. For tax purposes, legal firms are required to report their income as business income, as "business" has been given an extensive meaning under the ITA to include, amongst others, any "profession, vocation and trade ...".

On 28 January 2008, TAXAND received a letter dated 22 January 2008 from the DGIR in response to the submissions made by the Bar. The DGIR's position is as follows:

recognition of both income and expenses for 'contentious' and 'non-contentious' matters will be on an accrual basis;
where 'non-contentious' matters are subject to the Solicitors Remuneration Order 2005, the date of income accruing to the firm will be the date of the invoice issued by the firm;

where there is no dispute on the fees for contentious matters, the income will be taken to accrue on the date the invoice is issued;

where there is a dispute on the fees in respect of contentious matters, the income will be taken to accrue when the taxed costs are determined by court i.e. upon the issuance of the registrar's certificate;

as such, even if the payment of fees is staggered (or agreed to be made by way of instalments) , the income of the firm therefrom is to be recognised as being accrued upon taxation. As such, the DGIR views fee instalments as merely a "payment arrangement" between a legal firm and its clients;

The above applies for the Y/A 2008 and subsequent Y/As. Please note that the IRB has taken the position that they still reserve their right to audit legal firms and adjust the basis of income recognition for Y/As prior to Y/A 2008. In such situations, whilst the DGIR has said that the "cash" or "receipts" basis will be substituted for the accruals basis, no penalties will be imposed by the IRB.

Whilst the Bar Council has not agreed to any position taken by the IRB, some aspects of the DGIR's letter require clarification. Accordingly, the Bar Council and TAXAND are still in an ongoing dialogue with the DGIR on this matter and will update members as soon as there are further developments.

Lim Chee Wee

Secretary

My Comment: How come we pay income tax if we ourselves never receive the payment from our clients. Our invoice is not our income and it should not be liable for tax purposes. Calculation of income tax should be based on receipt of legal fee paid by the clients. The above rule is quite fair to practice if lawyers charge interest 8% per annum if the clients fail to make payment after one month from the date of the invoice/bill as provided under Solicitor Remuneration Order which I think most of the lawyers are not enforce it.