History
In addition to the basic anti-avoidance measures that were already in place, Malaysia began enforcing the Thin Capitalisation restrictions that are outlined in section 140A of the Income Tax Act 1967 ("ITA") on January 1, 2009.
Under section 140A, if the Director General of Inland Revenue ("DGIR") believes that the value or aggregate of the financial assistance given by a person to an associated person who is a resident is excessive in relation to the person's fixed capital, the excess portion of the following will be subject to taxation:
interest
finance charges
other considerations, or
losses suffered in respect of the financial assistance
will not be allowable for tax deductions.
From January 1, 2018, Section 140A(4) of the ITA was repealed. This rule disallowed the deduction of excess interest, finance charges, and other similar expenses. It was succeeded by the Earning Stripping Rules, and Section 140C of the ITA went into effect on January 1, 2019, to implement these rules.
The Income Tax (Restriction on Deductibility of Interest) Rules 2019 were gazetted and effected on July 1, 2019. This is being done to put section 140C into operation. Please Read:
Income Tax (Restriction on Deductibility of Interest) (Amendment) Rules 2022
The "Restriction on Deductibility of Interest" Guidelines were provided by the Inland Revenue Board (IRB). These guidelines offer examples of the calculation of the interest expenses to be restricted under section 140C.
Revision of "Restriction on Deductibility of Interest" Guidelines
The new Guidelines take precedence over the older Guidelines that were initially released to the website of the Inland Revenue Board of Malaysia (IRBM) on July 25, 2019.
On page 18 of the Guidelines is a list of the updates and revisions, and the date the amendments took effect is February 1, 2022.
The new Guidelines:-
The older Guidelines:-
Amongst others, the new Guidelines also take into account the Income Tax (Restriction on Deductibility of Interest) (Amendment) Rules 2022 [P.U. (A) 2712022], which came into operation on February 1, 2022.
Base Erosion and Profit Shifting (BEPS) Action 4
This legislation on interest restriction is based on the Base Erosion and Profit Shifting (BEPS) Action 4 of the Organisation for Economic Cooperation and Development (OECD), where the aim is to prevent base erosion through the use of excessive interest expense or any payments which are economically equivalent to interest claimed by businesses.
Part of this legislation has been adopted directly from the OECD BEPS Action 4, and there are parts which have been customised to ensure adherence to the Act and Inland Revenue Board of Malaysia’s (IRBM) procedures as well as domestic circumstances.
The Objective of "Restriction on Deductibility of Interest" Guidelines
The objective of this Restriction on Deductibility of Interest Guidelines (the Guidelines) is to provide an explanation of and determine the amount that is deductible and restricted in relation to:-
business interest expense; and
other payments which are economically equivalent to interest for the basis period beginning on or after 1.7.2019 and subsequent basis periods.
Under section 140C, there will be limitations placed on the ability to deduct interest expenses incurred in connection with controlled transactions involving financial assistance (excluding those between individuals).
The amount of interest that will be considered excessive (and therefore not deductible) will be the one that exceeds the maximum amount of interest that will be allowed by the rules issued following section 154 of the ITA.
When we talk about "financial assistance," we'll be referring to:
loan;
interest-bearing trade credit;
advance;
debt;
the provision of any security; or
the provision of any guarantee.
For the sake of this discussion, the term "interest expense" will be defined as follows:
interest in all forms of debt; or
payments economically equivalent to interest.
20% Rule
According to the Rules, the maximum amount of interest that can be claimed for deduction under section 140C is an amount that is equivalent to 20% of the amount of tax-Earnings Before Interest, Taxes, Depreciation and Amortisation (EBITDA).
The Rules apply to any type of financial assistance that is used in a controlled transaction and has an interest charge that is greater than RM500,000.
The following formula, which is provided by the Rules, can be used to calculate the amount of tax-EBITDA: A + B + C
“A” refers to the amount of the adjusted income of the person from business sources for the basis period of a year of assessment before any restriction on deductibility of interest under s 140C is made.
“B” refers to the total amount of qualifying deductions allowed in ascertaining the adjusted income in A.
“C” refers to the total amount of interest expense incurred in relation to the gross income of the person for any financial assistance in a controlled transaction from his/her business sources.
Non-Application
The interest restriction under section 140C of the Act and the Rules do not apply to:-
An individual;
A person who is licensed under the Financial Services Act 2013 [Act 758] to carry on banking business, investment banking business, insurance business or reinsurance business.
A person who is licensed under the Islamic Financial Services Act 2013 [Act 759] to carry on Islamic banking business, takaful business or retakaful business.
Labuan banks and Labuan investment banks licensed under Part VI of the Labuan Financial Services and Securities Act 2010[Act 704] (LFSSA);
Labuan Islamic banks and Labuan Islamic investment banks licensed under Part VI of the Labuan Islamic Financial Services and Securities Act 2010 [Act 705] (LIFSSA);
Labuan insurers and reinsurers, including Labuan captive insurance business licensed under Part VII of the LFSSA;
Labuan takaful and retakaful operator including Labuan captive takaful business licensed under Part VII of the LIFSSA;
A development financial institutions (DFIs) prescribed under the Development Financial Institutions Act 2002 [Act 618].
A person who is carrying on a business as a construction contractor who is subject to the Income Tax (Construction Contracts) Regulations 2007 [P.U. (A) 276/2007]*
A person who is carrying on a business as a property developer which is subject to the Income Tax (Property Development) Regulations 2007 [P.U. (A) 277/2007]*
A person who has been granted an exemption under paragraph 127(3)(b) or subsection 127(3A) of the Act in respect of the adjusted income of the person.
* Where a person has other business income which is not specified under this Regulation, that business income will be subjected to section 140C of the Act and the Rules
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