close
Share with your friends

The anticipated rules on Malaysian ESR, namely the Income Tax (Restriction on Deductibility of Interest) Rules 2019 (“the Rules”) has been gazetted on 28 June 2019. 

The Rules came into operation on 1 July 2019 and are applicable for the basis period for a year of assessment (“YA”) beginning on or after 1 July 2019.  It can be accessed via the above link.

Quick Recap of ESR

ESR is one of the Organisation for Economic Co-operation and Development (“OCED”)’s action plans under the Base Erosion and Profit Shifting (“BEPS”) project to tackle an area identified by the OECD as being prone to abuse i.e. excessive interest deduction.

The introduction of ESR is effected with the enactment of Section 140C in the Income Tax Act 1967 (“the ITA”) to replace the thin capitalisation legislation which has been in abeyance since 2009.  It brings significant impact on tax treatment of interest expense and potentially affects many corporations especially multinational groups.

Outline of the Rules

Pursuant to the Rules, ESR is applicable to a specified person who has been granted any financial assistance in a controlled transaction in the basis period for a YA.

"Controlled transaction" shall be construed as a financial assistance —

(a)    between persons one of whom has control over the other; or

(b)    between persons both of whom are controlled by some other person.

De Minimis Threshold

ESR is applicable where:

Total interest expense on any financial assistance in a controlled transaction in the basis period for a YA

> RM500,000

“Interest expense” and “financial assistance” are defined under Section 140C of the ITA.

Maximum Amount of Interest Deduction

ESR works by restricting tax deduction on interest expense to a percentage of a Company’s Earnings before Interest, Taxes, Depreciation and Amortisation (“EBITDA”). 

The maximum amount of interest expense deductible from each business source for the basis period for a YA is 20% of tax-EBITDA. 

The tax-EBITDA shall be ascertained in accordance with the following formula:

Tax-EBITDA

 

 = Adjusted income from business before restriction under ESR

 

 + Qualifying deductions

  1. Amount of expenditure incurred where double deduction has been claimed
  2. Deduction made under Income Tax Rules issued under Section 154(1)(b) of the ITA

 

 + Interest expense subject to ESR

Carry Forward of Interest Expense Restricted

Interest expense in excess of 20% is allowed to be carried forward to deduct against the adjusted income of the Company for future years until it is fully utilised, subject to the substantial shareholding test as provided in the Rules.

Persons Excluded from ESR

ESR is not applicable to:

  1. An individual;
  2. The following financial institutions licensed under the Acts specified in the Rules:

·        Bank, investment bank, insurer and professional reinsurer

·        Islamic bank, takaful operator and professional retakaful operator

·        Labuan bank and investment bank

·        Labuan Islamic bank and Labuan Islamic investment bank

·        Labuan insurer and reinsurer including a Labuan captive insurance business

·        Labuan takaful operator and retakaful operator including a Labuan captive takaful business

·        Development financial institution

  1. A construction contractor as defined under the Income Tax (Construction Contracts) Regulations 2007;
  2. A property developer as defined under the Income Tax (Property Developer) Regulations 2007;
  3. A person who has been granted an exemption under subsection 127(3)(b) or 127(3A) of the ITA.

Issues to Ponder

The Malaysian Inland Revenue Board has clarified in the Minutes of the Dialogues and Responses to the Joint Memorandum on Issues Arising from 2019 Budget Speech & Finance Bill 2018 that ESR is applicable to cross-border related party financial assistance only.  However, the Rules do not seem to exclude domestic related party financial assistance arrangement from the application of ESR.

Further clarification is also required on what constitute “payments economically equivalent to interest” which is included in the definition of interest expense.

It remains to be seen whether the above issues will be addressed in the guidelines on ESR that are expected to be issued by the authorities following the gazette of the Rules.

Steps to be Taken

In view of the implementation of ESR for companies in respect of the basis period beginning on or after 1 July 2019, companies will need to commence assessing whether 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

If you wish to discuss the impact of ESR on your company, 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)