Restriction on Deductibility of Interest Guidelines (Earning Stripping Rules)


Income Tax (Restriction on Deductibility of Interest) Rules 2019 which is also known as earning stripping rules (ESR) has been gazetted on 28 June 2019.

*Similar restrictions are called “Thin Capitalisation Rules” in some countries.

Purpose of these rules

As the name suggests, these rules are to address the tax planning trick by which profit is being shifted between related parties within the country, or from Malaysia to another country, through the charging of interest on inter-company borrowings.

Who would be affected?

The rules will apply to any company where the total interest expense payable to related parties exceeds RM500,000 in a basis period for a year of assessment.

When does it start?

The Earning Stripping Rules (ESR) will take effect from 1 July 2019.

Salient features of the restrictions

  • The maximum amount of interest concerned shall be restricted to 20% of the amount of tax-EBITDA. The rules provide the formula to determine the amount of tax-EBITDA which is:

A + B + C

* A” refers to the amount of the adjusted income of the person from business sources for the basis period for 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. Qualifying deductions refers to the amount of expenditure incurred by the person which is twice the amount incurred and any deductions claimed under any rules made under S.154(1)(b).

*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 business sources.

  • The interest expense that has been restricted (not allowed in a particular year), can be carried forward to be utilised in the subsequent year. There is no time limit for the carrying-forward of restricted interest expense if there the company meets the substantial shareholders continuity test (i.e. no major changes in shareholding).

  • The rules seem to apply to all borrowings by a local company from its local and foreign related companies. IRBM has previously indicated that ESR would apply to cross border transactions only, as such, it is hoped that IRBM would clarify this matter soon.

  • ESR do not apply to individual, banks and selected financial institutions, special purpose vehicles, property developers, construction contractors who is subject to Income Tax (Construction Contracts) Regulations 2007.

Commentary:

Earning stripping rules or thin capitalisation rules are not new in the tax fraternity as many countries have implemented similar restriction. The Malaysian version was introduced in Budget 2018. And for this purpose, S.140C was enacted and subsequently the corresponding rules and guidelines were announced.

Companies with inter-company loans from related parties (local and foreign) should assess their inter-company financing arrangements and interest expense vis-à-vis these new interest restriction rules.

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Every effort has been made to provide accurate information. However, the information

and regulations contained in this article are subject to changes and amendments by the

relevant authority at any time. As such, the information in this article may not be current.

And the information provided in this article is general commentary only and shall not be considered as advice or recommendation. As all tax situations are specific to their facts and will differ from the situations in this article - if you have specific tax questions you should consult a licensed tax agent.

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