Restriction on Deductibility of Interest - Section 140C
Section 140C is a new section in Malaysian Income Tax Act, 1967 (ITA), introduced via Finance Act 2018, effective from 1 July 2019.
1. Section 140C
This is an ESR (earnings stripping rules) which implement the restriction on deductibility of interest for the following types of interest expense;
interest on all forms of debt; or
payments which are economically equivalent to interest
incurred by a person in respect of his business income.
The ESR is applicable only to foreign related party financial assistance but including financial assistance from a foreign related party which operates through a permanent establishment in Malaysia.
Pursuant to Section 140C, no deduction will be allowed for any interest expense in excess of the maximum amount of interest expense allowed.
This rules applies to a person who receives any financial assistance in a controlled transaction granted directly or indirectly to that person, where the total amount of any interest expense exceeds RM500,000 in the basis period for a year of assessment (YA).
2. Interest expense
Interest expense includes any interest expenses incurred which are allowable in ascertaining the adjusted income under the ITA before any restriction under Section 140C.
Interest expense excludes:
a) any interest expenses incurred in connection with the raising of the financial assistance; or
b) any interest expenses incurred which is not allowed in ascertaining the adjusted income under ITA.
3. Date of commencement of Section 140C
Effective in respect of basis period beginning on or after 1 July 2019 for a YA.
"Financial assistance" refers to loan, interest-bearing trade credit, advance, debt, the provision of any security or the provision of any guarantee.
"Interest" is the return for the use by a person of a sum of money owed to another person.
"person" includes a company and an individual
"Controlled transaction" shall be construed as financial assistance occurred between a) persons one of whom has control over the other; or b) persons both of whom are controlled by some other person
EBITDA means Earnings before interest, tax, depreciation and amortisation.
5. Scope of application
The Section 140C rules apply to a person having interest expenses from financial assistance which is deducted in ascertaining the adjusted income before any restriction on the deductibility of interest is made under Section 140C of the ITA from business source which is paid or payable to:
a. its associated person outside Malaysia
b. its associated person outside Malaysia which operates through a permanent establishment in Malaysia
c. a third party outside Malaysia where the financial assistance is guaranteed by its holding company or any other enterprises under the same MNE Group (regardless of the tax residence country of the guarantor)
The section 140C of the Act and the rules is not applicable to the following persons:
specified banks, insurers, reinsurers, takaful and retakaful operators, development financial institutions
a construction contractor as defined under the Income Tax (construction contracts) Regulations 2007
a property developer as defined under Income Tax (property developer) Regulations 2007
a person who has been granted exemption under Section 127 (3) (b) or Section 127 (3A) of the Income Tax Act, 1967 in respect of the adjusted income of the person
7. De minimis threshold
The section 140C is only applicable if the interest expense is more than RM500,000 in the basis period for a YA.
8. Maximum amount of interest expense allowed
The maximum amount of interest expense allowed is:
20% X [ Tax-EBITDA ]
9. Rules on carry forward of the interest expense
Since the total interest that can be claimed in a YA is limited to 20% of the Tax-EBITDA, the restricted interest expense in a YA can be carried forward and deducted against adjusted income from business source for subsequent YA.
The eligibility to carry forward is not subject to the 7-year limit rule that is currently placed on unabsorbed business losses, but subject to the condition that the shareholders of the company are substantially the same in the following YA.
All information contained herein is summarised based on Technical Guidelines issued by the IRB/LHDN on 5 July 2019 which is readily available in IRB/LHDN website. The above article is intended to provide a general guide to the subject matter and should not be regarded as a basis for ascertaining the liability to tax in specific circumstances. No responsibility for loss to any person acting or refraining from acting as a result of any material in this publication can be accepted by Gunalan & Associates. Readers should not act on the basis of this publication without seeking professional advice.
Should you require further clarification, please do not hesitate to contact us at firstname.lastname@example.org. Thank you.