Interest Deductibility Restrictions in Malaysia
The introduction of Earning Stripping Rules (“ESR”) limiting the interest deduction for financial assistance between related persons were announced in the Budget 2018.
Through the Section 140C, Income Tax Act (“ITA”) 1967, the rules on the interest deductibility has been implemented and gazetted on 28 June 2019. On 5 July 2019, the Malaysian Inland Revenue Board (“MIRB”) released the Guidelines on ‘Restriction on Deductibility of Interest’.
The legislation has been adopted directly from the OECD Base Erosion and Profit Shifting (“BEPS”) Action 4 - ‘Limitation on Interest
aimed to limit base erosion through the use of interest expense to achieve excessive interest deductions or to finance the production of
exempt or deferred income.
Who is subject to the restriction on interest deduction rules?
The chart below illustrates the interest expense transactions which fall within the scope of this legislation.
This legislation for restriction on the deductibility of interest is applicable to:
- a person within the charge to tax under the Act (except for specific categories of persons listed in Para 9 of the Guidelines); and
- 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 Act of the person from each of the business source which is paid or payable to:-
- its associated person outside Malaysia;
- its associated person outside Malaysia which operates through a permanent establishment in Malaysia;
- 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).
De Minimis Threshold
The interest restriction is not applicable to a person where the total amount of any interest expense for all financial assistance from all
business sources is not more than RM500,000 in the basis period for a year of assessment.
Calculation of Tax-EBITDA
Tax-EBITDA of a person for the basis period for a year of assessment is as follows:
Adjusted income [A]
This is the amount of adjusted income before any restriction on the deductibility of interest is made under section 140C of the Act of that
person from his source consisting of a business for the basis period for a year of assessment.
Qualifying deductions [B]
This is the total amount of qualifying deductions allowed in ascertaining the total amount of the adjusted income before any restriction on
the deductibility of interest is made under section 140C of the Act in [A].
Interest expense [C]
This is the total amount of interest expense incurred in relation to the gross income of a person for financial assistance from business
source for the basis period for a year of assessment.
Negative Tax-EBITDA will be considered as NIL for the calculation under the Guidelines.
Maximum Amount of Interest Expense Allowable
The maximum amount of interest expense referred to in section 140C of the Act shall be an amount equal to 20% of the total amount of the Tax-EBITDA of that person consisting of a business source for the basis period for a year of assessment.
The allowable interest expense is restricted to Fixed Ratio or Interest Expenses, whichever is lower from each of business sources.
Carry Forward of Excess Interest Expense
Interest expense which is in excess of the maximum amount which is ascertained in the Rules, shall be carried forward to be utilized in the
subsequent year which is subject to the maximum amount of interest allowable for that year.
The restriction on deductibility of interest under Section 140C of the Act and the Rules will only be applicable on a business source where
the basis period of a person start on or after 1st
The interest restriction under Section 140C of the ITA and the Rules do not apply to:
- An individual
- A special purpose vehicle (SPV) as defined under Subsection 60I(1) of the ITA.
- A construction contractor who is subject to Income Tax (Construction Contracts) Regulations 2007
- A property developer which is subject to Income Tax (Property Developers) Regulations 2007
- A person who is a tax-exempt entity (exemption under Section 127(3)(b) or Section 127(3A) of the Act
- Licensed financial institutions who are:
- Carrying banking business, investment banking business, insurance business or reinsurance business
- Carrying on Islamic banking business, takaful business or retakaful business.
- Labuan banks and Labuan investment banks
- Labuan Islamic banks and Labuan Islamic investmentt banks
- Labuan insurers and reinsurers including Labuan captive insurance business
- Labuan takaful and retakaful operator
- A development financial institutions (“DFIs”) prescribed under the Development Financial Institutions Act 2002.
There are inconsistencies in relation to the scope in covering the domestic and cross-border related party financial assistance as depicted by Section 140C, ITR 2019 and the Guidelines.
Although the Guidelines do not have force of law, they provide guidance on how Section 140C, ITA1967 and the Rules will be administered and
will be binding on the Director General of Inland Revenue (“DGIR”).
Contact Transfer Pricing Solutions. We can assist with the preparation of transfer pricing documentation locally and regionally, Master File and Local File to comply with the OECD and also local legislation.
+61 (3) 59117001
+ 603 2298 7153
Contributed by our Consultant Mun Yee Wong
Mun Yee Wong has over four years of experience in transfer pricing. She played a role in working closely with the clients in developing the transfer pricing practices in Malaysia, Singapore and Australia.
She specialises in the area of transfer pricing where she handles various transfer pricing engagements for companies from a broad range of industries such as mining; electrical and electronics; construction and property development; hotels; real estate; oil and gas; food and beverages amongst others.
She has prepared transfer pricing documentation (Master File and Local File) for the Asia Pacific region, in particular, Australia, Malaysia, Singapore and the Philippines.
Mun Yee is also a piano teacher in Yamaha and she enjoys teaching. She spends her free time practising yoga. She speaks and writes well in Mandarin, Cantonese and Malay.