What is interest?

“Interest” is the return or compensation for the use or retention by a person of a sum of money belonging to or owed to another.

Tax treatment of interest expense

Deductibility of interest expense under paragraph 33(1)(a)

In ascertaining the adjusted income of a person from a source for the basis period for a year of assessment, interest incurred and payable on money borrowed by that person and –

  • (i) employed in that period in the production of gross income from that source ; or

(ii) laid out on assets used or held in that period for the production of gross income from that source

is an allowable expense.

Deductibility of interest expense under paragraph 33(1)(a)

A person would not be given any deduction on the interest expense which he has incurred on borrowed money to construct a building or plant prior to commencement of his business.

The person would not be able to claim industrial building or capital allowance (if applicable) as well on the amount of interest incurred even though such interest expense may have been capitalized as part of the cost of the building or plant. This is so because the interest expense is not part of the cost of construction of building or provision of plant.

Deductibility of interest expense under paragraph 33(1)(a)

Borrowed money not wholly and exclusively used in business

  • Subsection 33(2) of the ITA provides that if a person has borrowed money for purposes of business as well as for non-business purposes, the interest expense charged to the profit and loss account may not be allowed a full deduction.

Deductibility of interest expense under paragraph 33(1)(a)

Money used for non-business purposes includes

  • (i) investments in landed properties, shares, securities and Islamic securities, placement in fixed deposits ; and

(ii) loans (including interest-free loans) given to some other persons

 

Interest restriction under subsection 33(2) of the ITA 

  • The deduction of interest expense payable on borrowed money used for purposes of business, investments and loans is determined as follows:

(i) if the total amount of investments and loans is the same with or exceeds the amount of borrowed money, the whole amount of interest expense is disallowed; or

(ii) if the total amount of investments and loans is less than the amount of borrowed money, then only a portion of the interest expense is disallowed.

Interest restriction under subsection 33(2) of the ITA ITA

  • The portion of interest expense to be restricted against the gross business income is computed by using the following formula

Application of the formula

subsection 33(2) interest restriction will be computed based on the end-of-year balance:

  • the total cost of investments and loans which are financed directly or indirectly from the borrowed money does not exceed RM500,000,

subsection 33(2) interest restriction will be applied strictly based on monthly balances

  • the total cost of investments and loans which are financed directly or indirectly from the borrowed money exceeds RM500,000 ;or
  • there are no investments and loans at the end of the financial year because the investments and loans which are financed directly or indirectly by the borrowed money have been sold, transferred or repaid during the year.

Example 1:

Abadi Sdn Bhd borrowed RM1 million from CIMB Bank in January 2009 for use as working capital in its manufacturing business. The company incurred interest of RM100,000 in the year 2009. It has no other investments (as reflected in the company’s balance sheet).

The interest expense of RM100,000 is allowed as a deduction from the gross business income of the company as it was incurred in the production of that income.