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Determination of Section 40(8) income

22 Aug 2017 at 04:00 / NEWSPAPER SECTION: BUSINESS

<> Determination of Section 40(8) income

The government recently introduced a tax incentive programme to encourage individuals, including ordinary partnerships and groups of persons, to reorganise their businesses and operate them in the form of a company limited or a juristic partnership. This would make it easier to screen them for tax compliance, given the need to prepare statutory accounts.

To encourage operators to make the change, authorities have reduced some of the tax advantages these businesses previously enjoyed. For example, standard deductible expenses that used to be as high as 65-85% have been reduced to 60%, but progressive tax rates in the range of 5-35% have been maintained, which is somewhat less attractive than the corporate income tax rate of 20% on net profits.

Even so, a number of businesses may not be ready to change and will continue to be operated in the names of individuals. In that case, they should be cautious about specific tax issues that can arise due to their individual status, such as classification of income.

In a recent revenue ruling, a non-life insurance agent sought advice from the Revenue Department about whether the commissions she earned should be classified as "income from business, commerce, agriculture, industry, transport or any other activities not specified under (1) to (7)" under Section 40(8) of the Revenue Code. If so, she would be entitled to deduct the actual amount of her expenses. However, if they were treated as service fee income under Section 40(2), they would need to be included in the salary base under Section 40(1) and entitled only to the standard expense of 40%, to a maximum of 60,000 baht. (The deduction was changed for 2017 to 50% but no more than 100,000 baht.)

The Revenue Department generally advises that commissions received by an individual must always be treated as income under Section 40(2) unless the taxpayer can prove that his or her activities were carried out as an independent business under the following criteria:

  • The taxpayer is registered for value-added tax.
  • The activities are formally conducted in a business premise -- either directly owned or leased by the taxpayer.
  • There is investment and expenditure for the business.
  • The taxpayer hires employees with evidence of withholding taxes and social security on the payroll.
  • The insurance company must issue a letter confirming that it does not subsidise the taxpayer's business.

In this case, the taxpayer had not registered her business for VAT because her income did not reach the required threshold amount of 1.8 million baht per year. Consequently, her commissions were categorised as income under Section 40(2) and the standard expense deduction was capped at 60,000 baht.

The answer could have been different if the taxpayer had opted for VAT registration, even if her income was lower than the threshold amount. While this ruling seems to adopt VAT registration as the main criterion for determining whether the activity should be classified as a service business under Section 40(8), one should not forget that other criteria still need to be met.

A similar situation was the subject of a recent Supreme Court case. The Revenue Department had assessed an individual for failure to pay income tax and VAT on his earnings from planting and caretaking on a rubber plantation. The taxpayer challenged the department's claim, saying it did not net his income with expenses before computing tax.

As for VAT, the taxpayer asserted that the earnings in question were made as an employee of a company, which was a transaction exempted from the VAT base, not in the ordinary course of business.

In respect of the assessment of income tax, the Supreme Court stated: "The Revenue Department had already deducted the actual expenses before computing tax, and it did not appear how such a deduction was wrong. The assessment was not incorrect as claimed by the plaintiff."

As for VAT, the court took into consideration the terms of the agreement, which required the taxpayer to plant 76 rubber trees per rai on a total of 1,000 rai and to charge the employer at 15 baht per tree. Thus, the transaction was viewed as a hire-of-work.

Further, since the taxpayer arranged for the materials, equipment and labour himself, the court said: "It was obvious that the individual managed his own business, and the terms under the agreement did not require him to be under control of the hirer -- which is the significant characteristic of employment under the labour laws. Thus, the transaction was not the employment of an employee but was subject to VAT as per to the assessment of the Revenue Department."

Both of the above cases serve as a timely warning to individual taxpayers who conduct business under their own names and choose not to form a company or a juristic partnership. The deadline for changing their registration is the end of this year, after which they could be exposed to closer scrutiny by tax auditors for compliance matters, as well as reclassification issues. Hence, they should be ready or should reconsider their legal status before it is too late.

By Rachanee Prasongprasit and Professor Piphob Veraphong. They can be reached at admin@lawalliance.co.th

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