A CAPITAL statement is a summary of your assets and liabilities for a tax year to assess whether your declared income for that same period matches the increase in your wealth. This involves preparing a “balance sheet” of an individual each year, and determining the increase or decrease in his wealth which must be reconciled against the income declared by the individual.
Although it appears to be simple, there are many complications that can arise which will lead to disputes with the tax authorities. To prepare a comprehensive capital statement, one has to gather bank statements, credit card statements, company accounts, sale and purchase agreements of all type of properties, loan agreements, insurance policies, documents to support your various types of investments such as unit trusts, bonds, fixed deposits, shares, documents to support gifts received, friendly loans, lottery or gambling winnings, inheritance, interest in trusts, etc.
You should also include local and overseas assets, liabilities, income and expenditure in your capital statements. The tax authorities can ask you to prepare the capital statement for a maximum of five years in accordance with the limitation period provided in the Income Tax Act 1967.
Problems that arise
In recent years, proving that a person has received gifts has become much tougher. The starting point appears to be that gifts are not easily accepted as non-taxable items. The burden of proving the gift is a genuine gift lies with the taxpayer, and he must show evidence in writing that the donor gratuitously gave the cash gift and has the financial capacity to give the gift. The gift is also usually given out of love and affection and is given between close friends or relatives. In the event the gift is given by third parties, the burden of proof increases and the donor must clearly declare in a deed stating the reason for the gift. It should be unconnected to any business dealings or not received while exercising an employment.
The tax authorities are also frequently questioning loans received from third parties on whether the loan is genuine or is it a form of income. They are asking the taxpayers to obtain information from the lender on the source of his funds. Effectively, they want the taxpayer to get the information from the lender which is normally beyond the control of the borrower. If you cannot provide the information, they are attempting to convert the loan from a third party into income of the taxpayer. This does not resonate with the law since the taxpayer cannot force the lender to disclose the source of his funds.
A big headache for taxpayers in preparing a capital statement is explaining the debit and credit entries in the bank statements since the transactions would have occurred many years prior to the preparation of the capital statement. Generally, taxpayers may not have been diligent in reviewing their bank statements and keeping documents to support the specific transactions over the years. The tax authority has the tendency to take credit entries in the bank statement as taxable income and debit entries as private expenditure which may not be correct as the credit entries may represent reimbursements, capital receipts, interbank transfers, etc. The debit entries may represent purchases of capital assets, interbank transfers, providing loans, etc.
If the information is not available to back up your positions, the capital statement will reflect larger discrepancies which will result in under declaration of income, and additional taxes. Overall, capital statements are never accurate since both parties will make assumptions which may not be supported by evidence.
The burden of proof here is largely with the taxpayer. However, the tax authorities cannot be unreasonable as they will have to substantiate their position if the matter goes to court. Generally, capital statements are settled prior to the matter being referred to the courts. .
This article is contributed by Thannees Tax Consulting Services Sdn Bhd managing director SM Thanneermalai (www.thannees.com).