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Following the issuance of the Income Tax (Restriction on Deductibility of Interest) Rules 2019 (“Rules 2019”), the Malaysian Inland Revenue Board (“MIRB”) has issued Guidelines to provide further clarifications and information in applying the ESR. 

The objective of the Guidelines is to explain the determination of the amount deductible and restricted in relation to:

(a)    business interest expenses; and

(b)    other payments which are economically equivalent to interest.

The ESR will only be applicable on a business source where the basis period of a person starts on or after 1 July 2019.

Some of the notable clarifications are set out below:

Scope of Application

Consistent with the MIRB’s clarification in the Minutes of the Dialogues and Responses to the Joint Memorandum on Issues Arising from 2019 Budget Speech & Finance Bill 2018, the ESR is applicable to cross-border related party financial assistance only (but including financial assistance from a foreign related party which operates through a permanent establishment in Malaysia).  Any financial assistance arrangement with a foreign third party lender that is guaranteed by the holding company or any other enterprises under the same multinational enterprises group (regardless of tax residency of the guarantor) also falls under the scope of application of the ESR.

Scope of Interest

Interest expenses under the Guidelines include:

Interest expenses exclude any interest expenses incurred which are not allowable in ascertaining the adjusted income under the Income Tax Act 1967 (“the ITA”) before any restriction under the ESR.

Payment economically equivalent to interest” includes:

(a)    Profit or loss sharing concept used in Islamic financing as defined in Section 2(7) of the ITA; and

(b)    Any discount or premium (capital gain / loss) on issuing or subscribing debt instruments that will be amortised through the interest expenses.

De Minimis Threshold

In the instance where a person has multiple business sources, the threshold of RM500,000 should be accumulated from all business sources while the calculation of interest restriction shall be made separately on each of the business source.

Maximum Amount of Interest Expenses Allowable

The below table illustrates the determination of interest restriction under Section 140C of the ITA:

Computation of Interest Restricted under ESR

Adjusted income/loss from a business before restriction under ESR

(i.e. income subject to paragraph 4(a) and ascertained by applying Sections 33, 34, 34A, 34B, 34C, 35 and 39 of the ITA without applying Section 140C of the ITA)

A

Add: Qualifying deductions

  1. Amount of expenditure incurred where a double deduction has been claimed (i.e. 100% adjustment)
  2. Special deduction made under Income Tax Rules issued under Section 154(1)(b) of the ITA

B

Add: Interest expenses subject to ESR

C

= Tax-EBITDA

(Negative tax-EBITDA will be considered as NIL.)

A + B + C

Fixed Ratio

20%

Maximum amount of interest expenses allowable

[Tax-EBITDA x 20%]

X

Carry Forward of Excess Interest Expenses
(Subject to the substantial shareholding test)
[If C is more than X]

C - X

Note: In the case where the tax-EBITDA is NIL, all interest expenses subjected to restriction would be restricted in ascertaining the adjusted income.

Persons Excluded from the ESR

There is a slight distinction in respect of the list of persons excluded from the ESR in the Guidelines as compared to the list set out in the Rules 2019:

Subject Matter

Rules 2019

Guidelines

Special purpose vehicle (“SPV”) as defined under subsection 60I(1) of the ITA (i.e. SPV set up to issue sukuk excluding company set up to issue asset backed securities)

Not in the list

In the list

A person who has been granted an exemption under subsection 127(3)(b) or 127(3A) of the ITA

In the list

Not in the list

Notwithstanding the above, both lists should be made reference to in determining whether the ESR applies.

In addition, the Guidelines provide further clarification that the non-application of the ESR is only confined to the income of a property developer from the property development business and income of a construction contractor from the construction business as specified under the Income Tax (Property Developer) Regulations 2007 and Income Tax (Construction Contracts) Regulations 2007 respectively.  In other words, other business income which is not specified under these Regulations are subject to the ESR.

Examples of Calculation

The Guidelines provide several examples on the calculation of the interest restricted based on the ESR. The Guidelines can be accessed via the above link. As a recap on the ESR, kindly click here for our earlier Tax Whiz for more information.

Summary of Key Features

Below is the summary of the key features of ESR based on the Rules and the Guidelines:

Key Features

 

Effective date

Basis period for a year of assessment (“YA”) beginning on or after 1 July 2019

Scope of application

ESR is generally applicable to cross-border financial assistance in a controlled transaction as set out in the Guidelines, subject to the exclusion lists in the Rules 2019 and Guidelines

De Minimis threshold

ESR is not applicable if the interest expenses from all business sources are not more than RM500,000 in a basis period for a YA

Definition of interest expenses

  1. Interest in all forms of debt; or
  2. Payments economically equivalent to interest, including:

(i)      profit or loss sharing concept used in Islamic financing;

(ii)    any amortised discount or premium (capital gain / loss) on debt instruments; and

excluding:

  1. expenses in connection with the raising of finance, e.g. guarantee fee
  2. interest expenses not allowable under the ITA

Maximum Amount of Interest Deduction

20% of Tax-EBITDA

Carry forward of interest expenses restricted

Interest expenses restricted in a YA can be carried forward to deduct against the adjusted income from business(es) for subsequent YA(s), subject to the substantial shareholding test

Steps to be Taken

Companies will need to commence assessing whether the ESR is applicable and consider its tax impact.  Where it is determined that ESR is applicable, it would be essential to understand, amongst others, the mechanism of ESR and the prescribed formula to ascertain the tax-EBITDA, in order to determine the amount of interest restricted.

After evaluating the tax impact, companies would have to review their debt profiles and look at options to restructure existing borrowings and to formulate strategies for future financial assistance, where necessary.

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

Contact KPMG

Should you have any questions or require further clarification, please do not hesitate to contact any of our Executive Directors, Directors, Associate Directors or Managers whom you are accustomed to dealing with or who are responsible for the tax affairs of your organisation at the following telephone numbers for respective offices:

Petaling Jaya Office

Tai Lai Kok
Executive Director –
Head of Tax and Head of Corporate Tax
ltai1@kpmg.com.my
+ 603 7721 7020

Long Yen Ping
Executive Director –
Head of Global Mobility Services yenpinglong@kpmg.com.my
+ 603 7721 7018

Bob Kee
Executive Director –
Head of Transfer Pricing
bkee@kpmg.com.my
+ 603 7721 7029

Ng Sue Lynn
Executive Director –
Head of Indirect Tax
suelynnng@kpmg.com.my
+ 603 7721 7271

Soh Lian Seng
Executive Director –
Head of Tax Risk Management
lsoh@kpmg.com.my
+ 603 7721 7019

Nicholas Crist
Executive Director –
Corporate Tax
nicholascrist@kpmg.com.my
+ 603 7721 7022

Dato’ Leanne Koh
Executive Director – 
Corporate Tax
leannekoh@kpmg.com.my
+ 603 7721 7026

Neoh Beng Guan
Executive Director – 
Corporate Tax
bneoh@kpmg.com.my
+ 603 7721 7025

Ong Guan Heng
Executive Director – 
Corporate Tax
guanhengong@kpmg.com.my
+ 603 7721 7027

Chang Mei Seen
Executive Director – 
Transfer Pricing
meiseenchang@kpmg.com.my
+ 603 7721 7028

Ivan Goh
Executive Director – 
Transfer Pricing
ivangoh@kpmg.com.my
+ 603 7721 7012

 

 

 

Evelyn Lee 
Executive Director –
Penang Tax
evewflee@kpmg.com.my
+604 238 2288 (ext. 312)

Regina Lau
Executive Director –
Kuching & Miri Tax
reglau@kpmg.com.my
+6082 268 308 (ext. 2188)

Titus Tseu
Executive Director –
Kota Kinabalu Tax
titustseu@kpmg.com.my
+6088 363 020 (ext. 2822)

Ng Fie Lih
Executive Director –
Johor Bahru Tax
flng@kpmg.com.my
+607 266 2213 (ext. 2514)

Crystal Chuah Yoke Chin
Tax Manager –
Ipoh Tax
ycchuah@kpmg.com.my
+605 253 1188 (ext. 320)