It has been several months since the legislation of thin capitalisation law in
Although the government did not initiate any public discourse on this matter, the announcement did not come as a surprise. The local tax industry was abuzz with the government’s intention to introduce thin capitalisation law. Unfortunately, there was no explanation from the authorities as to the need for such law in
Further, it is also very disappointing that the government did not openly engage the public or local tax industry in a dialogue prior to the introduction of that law. Shortly after the announcement, some respectable quarters within the industry questioned the government’s wisdom of introducing thin capitalisation.
This article is not devoted to questioning whether
Firstly, the thin capitalisation provision came into effect on 1 January 2009. That means, legally speaking, the Director General of the Inland Revenue (“DGIR”) may disallow the deduction of “excessive” interest payment as revenue expenditure from 1 January 2009 onwards. That said, the rules or regulations pertaining to the implementation of thin capitalisation law have yet to be issued by the government until today.
The first and foremost question is, “What is the acceptable debt and equity ratio?” The ratio adopted by other jurisdictions is 3:1. Will
It is likely that details such as this will be contained in the regulations. Eventually, when the thin capitalisation rules are issued, when will it take effect? Will it take effect retrospectively from 1 January 2009?
Since s.140A(4) of the Income Tax Act 1967 [Act 53] (“the ITA”) is already in force, taxpayers are anxious and seeking advice from tax practitioners, despite the fact that thin capitalisation rules have yet to be issued. This puts tax practitioners in a dilemma as the advice or proposal that they suggest may be contrary to the thin capitalisation rules.
This is all the more evident in instances where the taxpayer is subject to higher taxes if the thin capitalisation rules are followed. In such a case, the taxpayer may be subjected to additional taxes and penalty if the IRB decides to apply the thin capitalisation rules retrospectively.
Furthermore, the tax practitioners are also exposing themselves to a possible action under s.114(1A) of the ITA as their advice can be construed by the IRB to have resulted in the understatement of the taxpayer’s tax liability. In light of these potential problems, it would be welcomed if the government does not implement the thin capitalisation rules retrospectively from 1 January 2009.
The IRB has also yet to issue any guidelines or public ruling to guide taxpayers on how it intends to implement the thin capitalisation law. Such guidelines or public rulings are necessary as it provides an insight to the taxpayer on the approach taken by the IRB in enforcing the law.
The self-assessment system, which was introduced in
The key words in the thin capitalisation law, namely, “interest”, “Financial assistance” and “fixed capital”, are not defined. These words are not interpreted in s.2 of the ITA. Recently, at a tax seminar organised by the IRB, the participants were advised that the term “interest” for thin capitalisation law includes guarantee fees, commitment fees, representation fees, commission and borrowing bond fees. However, this definition of IRB contradicts its policy as these types of payments are not recognised as interest for the purposes of business deduction.
Businesses are only allowed deduction for actual interest payment and not other expenditure that are akin or incidental to interest. It is certainly unfair to taxpayers as the IRB seems to be blowing hot and cold on the definition of interest. When it suits the IRB, a wide interpretation is given to the word “interest”. Such an approach is certainly not professional and the IRB must be professional by being consistent with its views. If interest is treated to include guarantee fees for thin capitalisation rules, then it is only appropriate that the IRB allows the taxpayers to deduct guarantee fees paid in the course of business as business expenditure.
Interest paid by a Malaysian taxpayer to a non-resident is subject to withholding tax in
Otherwise, the IRB will be “benefiting” twice in the sense that the Malaysian taxpayer is not allowed to deduct the “excessive” interest paid to the non-resident but nevertheless, the IRB gets to tax the excessive interest by imposing withholding tax on it. It is only appropriate in circumstances where the excessive interest is disallowed that the IRB refunds the withholding tax on that portion back to the non-resident.
Further, since s.140A reads “in the basis period for a YA the value or aggregate of all financial assistance granted by a person to an associated person who is a resident”, the question arises as to whether s.140A(4) applies to financial assistance that was rendered before 1 January 2009.
The author’s view is that if a loan was made in 2008, it will mean the financial assistance was granted in YA 2008 and not in YA 2009. In that regard, the IRB should not disallow the excessive interest (if any) that is payable in YA 2009 and subsequent years of assessment as the financial assistance was granted before s.140A(4) took effect. Any attempt by the IRB to invoke s.140A(4) on financial assistance that was granted before 1 January 2009 would be ultra vires and against the principles of natural justice. In such circumstances, the taxpayer should consider challenging the IRB’s decision by way of judicial review.
Interestingly, s.140A(4) states that the DGIR may disallow the deduction in cases where he is of the opinion that the financial assistance rendered is excessive. The language used is different from the one used for s.140A(3), which is the transfer pricing provision. Section 140A(3) states that the DGIR may adjust a transaction between associated persons where he has the reason to believe that the transaction is not at arm’s length.
Notwithstanding the difference in the phraseology used for sections 140A(3) and 140A(4), the author opines that the DGIR must state the grounds that influenced him to invoke s.140A(4) against the taxpayer. This will surely enable the taxpayer to understand better why s.140A(4) was invoked and assist the taxpayer in preparing his defence.
Conclusion
The foundation for thin capitalisation rules in
* This article was first published in the inaugural issue of TaxViews Asia (July 2009), a tax magazine published by CCH Singapore.
[1] The thin capitalisation provision was inserted via the Finance Act 2009. The newly inserted s.140A(4) to the Income Tax Act 1967 reads:
“Where the Director General, having regard to the circumstances of the case, is of the opinion that in the basis period for a year of assessment the value or aggregate of all financial assistance granted by a person to an associated person who is a resident, is excessive in relation to the fixed capital of such person, any interest, finance charge, other consideration payable for or losses suffered in respect of the financial assistance shall, to the extent to which it relates to the amount which is excessive, be disallowed as a deduction for the purposes of this Act.”