01 March 2018, by Anand Raj, Chairperson, Tax Subcommittee of the Corporate and Commercial Law Committee
Circular No 058/2018
Dated 1 Mar 2018
To Members of the Malaysian Bar
Tax Treatment of Insurance Proceeds and Compensation |
Inland Revenue Board Public Ruling No 8/2017 on Professional Indemnity Insurance
We refer to the Bar Council General Statement dated 4 July 2011 entitled “General Information on Matters Discussed at the 4th BC Meeting Held on 18 June 2011”, and Circular No 137/2013 dated 18 June 2013 entitled “Inland Revenue Board Public Ruling on Professional Indemnity Insurance (“PR 3/2009”) — Tax Treatment of Insurance Proceeds and Compensation”.
The Director General of Inland Revenue (“DGIR”) had taken the position that insurance proceeds and compensation paid to a claimant under a Professional Indemnity Insurance (“PII”) policy would be taxable as income received by the Member of the Bar against whom the claim has been made.
As Members may be aware, a test case was commenced by the Malaysian Bar in 2011. This case took some time to progress, due to various procedural issues raised by the DGIR. After much discussion with the DGIR and overcoming those issues, the test case was eventually resolved under section 102 of the Income Tax Act 1967, with the execution and recording of a settlement agreement dated 27 Nov 2017.
The terms of the settlement agreement are favourable to Members. Following the amicable resolution of the test case, the DGIR replaced his Public Ruling No 3/2009 with Public Ruling No 8/2017 on Professional Indemnity Insurance (“PII”), dated 19 Dec 2017, to reflect the agreed terms and principles.
A copy of Public Ruling No 8/2017 is attached for your reference.
Please note section 8 of Public Ruling No 8/2017, which provides as follows:
8. Tax Treatment on Insurance Proceeds and Compensation
8.1 Where a professional has been allowed a deduction for the PII premium paid, any proceeds received in connection with the PII will be subject to tax. The proceeds are taxed under subsection 22(2) of the ITA.
8.2 Compensation to a claimant can be made in the following manner –
(i) the insurance company pays the proceeds to the professional and the professional pays that amount to the claimant; or
(ii) the insurance company pays directly to the claimant.
The compensation paid in both of the above manner [sic] is allowed a deduction under subsection 33(1) of the ITA as it is incurred in the ordinary course of the business of a professional who is constantly exposed to the risk of being sued by his clients for negligence, error or breach of duty.
Example 10
Mohd Fahrin is an architect who practises his profession in the architectural consulting firm, Arkitek Asyraf & Goh (AAG). AAG purchased a PII policy for him to cover himself against the risk of being sued. In the year 2017, a dissatisfied client sued AAG for damages to the bungalow caused by faulty design by Mohd Fahrin. The insurance company concerned made a payment of RM200,000 to AAG and AAG then paid the amount as compensation to his client (the claimant).
The proceeds received by AAG totalling RM200,000 will be subject to tax, whilst the amount paid as compensation to the claimant is allowed as a deduction under subsection 33(1) of the ITA against the gross income of the AAG’s business.
Example 11
Same facts as in Example 10 except that the insurance company made the compensation payment of RM200,000 directly to the claimant.
The compensation amounting to RM200,000 paid directly to the claimant is deemed received in the books of the architectural firm and is subject to tax. The amount of proceeds paid as compensation to the claimant is deemed paid out from the firm’s accounts and is allowable as a deduction under subsection 33(1) of the ITA against the gross income of the AAG’s business.
8.3 A professional will bear the shortfall of compensation if the amount of compensation claimed by the claimant exceeds the amount of proceeds received from the insurer. The amount of shortfall is allowed as a tax deduction under subsection 33(1) of the ITA.
Example 12
Bernard, the sole-proprietor of a legal firm received proceeds amounting to RM200,000 from an insurance company and this amount could not cover the compensation of RM250,000 to be paid to a customer who had made a claim against him. Therefore, Bernard had to bear on his own RM50,000 to cover the shortfall of compensation payment to the claimant.
Proceeds amounting to RM200,000 will be subject to tax. When the proceeds are paid out as compensation to his client, the amount is allowed as a tax deduction. The compensation totalling RM50,000 incurred by Bernard is also allowable as a deduction from the gross income of his business.
While the DGIR seems to be under the misapprehension that insurance payouts on PII policies are customarily routed through the very law firms or professionals against whom claims have been made, this should not affect the substance of Public Ruling No 8/2017, which is now more favourable to Members of the Bar and other professionals.
Thank you.
Anand Raj
Chairperson
Tax Subcommittee of the Corporate and Commercial Law Committee
This circular and the attachment may also be accessed here.
1 Attachment
IRB Public Ruling No 8-2017.pdf