UNIVERSITI TUNKU ABDUL RAHMAN UBAT2113/2013 TAXATION

DEDUCTION OF EXPENSES

Outline
2.1 General deduction of expenses 2.2 Distinction between capital expenditure & revenue expenditure 2.3 Statutorily prohibited expenses 2.4 Specific deductible expenses 2.5 Double deductions 2.6 Exercises 2.7 Examples of deductible & nondeductible expenses
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Learning Outcomes
After studying this topic, you should be able to:

Distinguish between capital & revenue expenditure Ascertain the deductibility of expenses (0, 50% or 100%)

Identify the expenses that qualify for double deductions (200%)

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Deduction of Expenses - General

Generally, an expenditure would qualify for deduction from the gross income of a source (business or non-business) in arriving at the adjusted income if i. it is a revenue expenditure; ii. it satisfies the general deduction test under S 33(1) of the Income Tax Act;

and

2.1

iii. it is not prohibited from deduction under S 39 of the Act.

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Capital Expenditure vs Revenue Expenditure

CKF Pg 249-253

5 tests to distinguish a revenue expenses from a capital expenses

1. Enduring benefit asset 2. Identifiable asset 3. Fixed capital vs circulating capital 4. Business structure vs business process (business entity test)
2.2

5. Initial expenditure
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1. Enduring Benefit Asset

An expenditure which is incurred with a view to bring into existence of an asset or an advantage for the enduring benefit (long term benefit) of a trade is a capital expenditure e.g. initial lump sum contribution to the staff pension fund

2. Identifiable Asset
If an expenditure is incurred to acquire an asset or to enhance the value of the asset, such expense would be capital expenditure e.g. purchase plant & machinery or upgrade/modify

3. Fixed Capital vs Circulating Capital

Fixed Capital

What the owner turns to profit by keeping it in his possession e.g. transporter own lorries What the owner makes profit with by parting with it & letting it change masters e.g. stock in trade e.g. car dealers

Circulating Capital

3. Fixed Capital vs Circulating Capital (Cont'd)

Expenditure to acquire Capital expenditure - fixed capital - circulating capital Revenue expenditure
Expenditure to maintain fixed/circulating capital
Capital expenditure?
Revenue expenditure?
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4. Business Structure vs Business Process (Business Entity Test)

Business Structure Business Process

Profit making apparatus

Income earning activity

Expenditure relating to Capital expenditure - business structure e.g. cinema operator incur expenses to create monopoly Revenue expenditure - business process
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5. Initial Expenditure

Expenditure incurred prior to the commencement of business is capital expenditure because it is not incurred in earning profits but in setting up the business into operation

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General Deduction Test - Sec 33(1)

"Subject to this Act, the adjusted income of a person from a
person from that source for that period all (1)

source for the basis period for a year of assessment shall be an amount ascertained by deducting from the gross income of that

outgoings and expenses (2) wholly and exclusively (3) incurred during that period by that person (4) in the production of gross income from
that source ..."

[S 33(1), ITA 1967]

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General Deduction Test

Outgoings & Expenses

Outgoings
Bad debts, cost of samples given out in promoting a product, business losses due to theft, robbery or defalcation of employees, etc. Expenses Disbursements which involve outlay of cash or money
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General Deduction Test

Wholly & Exclusively

Quantum of expenditure (all)

Wholly

Principle of Remoteness Expenditure which is remotely connected with the achievement of the purported objective is not deductible - expenses incurred must

related to objective

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General Deduction Test

Wholly & Exclusively (Contd)

Motive behind the incurrence of expenditure (sole purpose)

Exclusively

Principle of Duality of Purpose Expenditure incurred for dual purposes is not deductible - should be connected with the income earning operation

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General Deduction Test

Incurred

Money actually laid out or legal liability to pay has arisen

Includes amount paid, payable or becoming payable

Excludes anticipatory loss or contingent liability in the form of provision or reserve

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General Deduction Test

In the Production of Gross Income

Not before nor after the production of income i.e. during that period

Expenditure incurred must be closely linked with the income-earning operation Income may be produced in the current or future period

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Statutorily Prohibited Expenses (Section 39, ITA 1967)

These are business expenses specifically disallowed [S 39(1) ] as tax deductions in arriving at adjusted business income Not deductible even though if it satisfies S 33 wholly & exclusively test (i) Domestic or private expenses

2.3

(ii) Disbursements or expenses which are not wholly and exclusively laid out or expended for the production of gross income

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Statutorily Prohibited Expenses (Contd)

(iii) Capital withdrawn or any sum employed or intended to be employed as capital

(iv) Contribution to unapproved schemes

(v) Capital expenditure (mining/ plant/ building/ agriculture/ forest/ prospecting/ farm expenditure) which are deductible under Schedules 2, 3 or 4
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Statutorily Prohibited Expenses (Contd)

(vi) The following payments to non-residents where withholding tax provisions under Sections 107A, 109 and 109B have not been complied with contract payment (S107A - 10% + 3%) interest (S109 - 15%) royalty (S109 - 10%) installation of equipment (S109B - 10%) technical fee (S109B - 10%) rental of moveable properties (S109B 10%)

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Statutorily Prohibited Expenses (Contd)

(vii) License fees/ permit to extract timber from a forest in Malaysia (not deductible unless it is payable to a State Government, Statutory Authority or a body approved by the Minister) (viii) Lease rental in respect of a motor vehicles which is not licensed for commercial transportation of goods or passengers in excess of RM50,000, in aggregate. The limit for deduction of lease rental is RM100,000 for a new vehicle with cost 21 RM150,000 , S39(1)(k)

Statutorily Prohibited Expenses (Contd)

(ix) 50% of entertainment expenses with certain exceptions S 39 (1)(l) (x) Leave passage (cost of fares for travel) given to employees [other than yearly leave passage provided to employees] S 39(1)(m)

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Specific Deduction of Expenses - Business

The Minister may prescribe other deductions in the form of Rules from time to time through gazette orders Specific deductions for business source are set out in Sections 34, 34A, 34B and 35 of the Income Tax Act 1967

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Examples of Gazette Orders

Income Tax (Deduction for Incorporation Expenses) Rules 2003 [PU (A) 475/2003]
Income Tax (Deductions for the Employment of Disabled Persons) [PU (A) 73/1982] Rules 1982 Income Tax (Deduction for Advertising Expenditure on Malaysian Brand Name Goods) Rules 2002 [PU (A) 62/2002]
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Incorporation Expenses
General: Not deductible (capital) The Income Tax (Deduction for Incorporation Expenses) Rules 2003 allow the deduction of the incorporation expenses of companies incorporated in Malaysia on or after 13.9.2003 with an authorized capital RM2,500,000 .

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Example

Incorporation Expenses

Example:

A company was incorporated on 8.8.2004 with an authorized share capital of RM2,000,000. It incurred incorporation expenses of RM6,000 and commenced business on 1.11.2004.

Answer:

The company is permitted to claim the incorporation expenses upon commencement of business as its authorized capital RM2,500,000.

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S 33 Deductible Expenses
(i) Interest expense on money borrowed and employed in the production of gross income [S 33(1)(a)(i)] laid out on assets used or held in that period for the production of business income [S 33(1)(a)(ii)] (ii) Rental expense on land or building occupied for producing gross income [S 33(1)(b)] (iii) Repairs and renewals
2.4

[S 33(1)(c)]
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Section 34 Deductible Expenses (i) Bad and doubtful debts which are reasonably estimated to be irrecoverable (specific provision) [S 34(2)]
(ii) Employers contribution to an approved scheme, up to 19% of the employees remuneration [S 34(4)] (iii) Initial contribution to an approved scheme [S 34(5)]

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S 34(6) Specific Deductible Expenses

Specifically legislated to allow tax deduction for expenses that may not satisfy S 33 wholly & exclusively test or are capital expenditure

The tax deduction is available to business income

[S 34(6)(c)]

1) Mining allowance

2) Replanting expenditure

[S 34(6)(d)]

3) Equipment or renovation of premises for disabled employees [S 34(6)(e)]

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S 34(6) Specific Deductible Expenses

(Contd)

4) Translation into or publication in the national language of cultural, literary, professional, scientific or technical books approved by the Dewan Bahasa dan Pustaka [S 34(6)(f)] 5) Provision of library facilities (in kind & cash) which are accessible to public or contribution in cash to public libraries, libraries of schools & institutions of higher education (RM100,000 per YA)[S 34(6)(g)]
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S 34(6) Specific Deductible Expenses

(Contd)

6)

Expenditure incurred on provision of services, public amenities and contributions to a charity or community project pertaining to education, health, housing, infrastructure and information and communication technology, approved by the Minister [S 34(6)(h)]

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S 34(6) Specific Deductible Expenses (Contd)

7)

Revenue expenditure incurred on provision and maintenance of a child care centre for the benefit of employees [S 34(6)(i)]

8) Expenditure incurred in establishing and managing a musical or cultural group approved by the Minister [S 34(6)(j)]

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S 34(6) Specific Deductible Expenses

9)

(Contd)

Expenditure incurred up to RM500,000 in sponsoring local or foreign arts or cultural activities approved by the Ministry of Culture, Arts and Tourism of which the deduction for foreign arts or cultural activities is restricted to RM200,000 [S 34(6)(k)]

10) Scholarship expense incurred by a company on student receiving full-time instruction at higher educational institution in Malaysia [S 34(6)(l)]

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S 34(6) Specific Deductible Expenses

11)

(Contd)

Revenue expenditure incurred by a company for obtaining accreditation for a laboratory or as a certification body [S 34(6)(m)]

12)

Revenue expenditure incurred by a company for obtaining certification for recognized quality systems and standards, and halal certification (double deduction) [S 34(6)(ma)]
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S 34(6) Specific Deductible Expenses

(Contd)

13)

Practical training in Malaysia to resident individuals who are not own employees [S 34(6)(n)] Expenditure incurred by a company for participating in international standardization activities approved by the Department of Standards Malaysia [S 34(6)(o)]
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14)

Specific Deductible Expenses

a) Revenue expenditure incurred on scientific research related to the business [S 34(7)] Revenue expenditure incurred on research approved by the Minister [S 34A]

b)

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Specific Deductible Expenses (Contd)

c) Cash contribution to an approved research institute or payment for use of services of an approved research institute or company, a research and development company or a contract research and development company [S 34B]

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Double Deductions

Certain expenses are allowed twice as deductions in arriving at adjusted income Expenses qualified for double deduction are normally gazetted or legislated in the Income Tax Act (ITA) 1967 / Promotion of Investment Act (PIA) 1986

2.5

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Double Deductions - Examples

Expenditure incurred in obtaining certification for recognized quality systems and standards, and halal certification [S 34(6)(ma), ITA 1967]

Revenue expenditure incurred on approved research [S 34A, ITA 1967]

Cash contribution to an approved research institute [S 34B, ITA 1967]
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Double Deductions - Examples (Contd)

Payment for the use of services of an approved research institute or company, a research and development company or a contract research and development company [S 34B, ITA 1967]

Interest payable on loans to small businesses [PU (A) 90/1981]

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Double Deductions - Examples (Contd)

Approved training [PU (A) 61/1992] Remuneration of disabled employees [PU (A) 73/1982] Allowances paid to participants under Unemployed Graduates Training programme [PU (A) 387/2005]
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Double Deductions - Examples (Contd)

Freight charges for shipping goods from Sabah or Sarawak to Peninsular Malaysia [PU (A) 50/2000]
Freight charges for the export of rattan and wood-based products (excluding veneer and sawn timber) [PU (A) 422/1990]
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Double Deductions - Examples (Contd)

Insurance premiums on import or export of cargo paid to an insurance company incorporated in Malaysia [PU (A) 79/1995] Export credit insurance premiums paid to the Malaysia Export Credit Insurance Berhad [PU (A) 526/1985]

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Double Deductions - Examples (Contd)

Advertising expenditure on Malaysian brand name goods [PU (A) 62/2002]

Overseas expenses for promotion of tourism [PU (A) 412/1991]

Approved outgoings and expenses incurred for the promotion of exports (S 41, PIA 1986)

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Exercises
Ascertain the deductibility of the following expenditure: i. Provision for doubtful debts ii. Cost of constructing an improved roof for factory building iii. Premium on insurance policy against fire and loss of profit
2.7
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Guide

Expense Deductible?

Deductible, because
It is revenue expenditure wholly and exclusively incurred in the production of income [S 33(1), Income Tax Act 1967] and it is not prohibited from deduction under S 39 of the Income Tax Act 1967

It is a specific deduction under S 34, S 34A or S 34B of the Income Tax Act 1967
It is allowed for deduction under gazette order

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Guide

Expense Deductible? (Contd)

Not deductible, because

It is a capital expenditure (capital in nature) It is not wholly and exclusively incurred in the production of income [it does not satisfy the general deduction test under S 33(1), Income Tax Act 1967] It is prohibited from deduction under S 39 of the Income Tax Act 1967
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Exercises

i. Provision for doubtful debts

General provision for doubtful debts is NOT DEDUCTIBLE because it is not incurred Specific provision for doubtful debts is DEDUCTIBLE under S 34(2) of the Income Tax Act 1967 provided it has been

included in the gross income of the business reasonably estimated to be irrecoverable based on valid commercial considerations
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ii. Cost of constructing an improved roof for factory building

NOT DEDUCTIBLE because it is capital in nature
It does not represent repair expense which is deductible under S 33(1)(c) of the Income Tax Act 1967 due to the enhancement of value of the roof

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iii. Premium on insurance policy against fire and loss of profit

DEDUCTIBLE because it is revenue expenditure wholly and exclusively incurred in the production of income; and it is not prohibited from deduction under S 39 of the Income Tax Act 1967

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Examples of Deductible & Non-deductible Expenses

1. Entertainment expenses 2. Loss on foreign exchange 3. Legal and professional expenses 4. Lease rental of motor vehicle

2.6

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1. Entertainment
(i) the provision of food, drink, recreation or hospitality of any kind;

or

(ii) the provision of accommodation or travel in connection with or for the purpose of facilitating entertainment of the kind mentioned in (i) above
[S 18, ITA 1967]
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Entertainment Expenses - 100% Deductible

i. ii.

Entertainment provided to employees Entertainment business

iii.
iv.

Promotional gifts at foreign trade fairs

Expenditure incurred for cultural or sporting events opened to the public

v.

Promotional gifts consist of articles incorporating a conspicuous advertisement or logo of the business
Entertainment related wholly to sales entertainment directly related to sales provided to customers, dealers or distributors
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vi.

Entertainment Expenses - 50% Deductible

Expenses incurred on entertaining existing suppliers Entertainment allowances paid to employees for defraying entertainment expenses

Public Ruling No. 3/2004

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2. Loss on Foreign Exchange

Foreign exchange loss arising from capital transaction is not deductible (purchase of fixed assets)

Foreign exchange loss arising from trade transaction is deductible, provided it is a realized loss
Unrealized loss is anticipatory in nature, hence not deductible

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Example

2. Loss on Foreign Exchange

Exchange loss on settlement of foreign trade debts Exchange loss arises from purchase of fixed assets, i.e. capital loss Exchange loss on translation of foreign accounts into local currency at financial year end

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3. Legal and Professional Expenses

Refer to:
Public Ruling No. 6/2006: Tax Treatment

of Legal and Professional Expenses ,e.g. cost of tax appeal is non-deductible expenses. It is expenses to ascertain the amount of tax to be paid & not to earn profit for the business, not trading expenses

issued on 6.7.2006 with effect from Y/A 2006

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4. Lease Rental of Motor Vehicle

The restriction of deduction under S 39 of RM50,000 (car cost > RM150,000) or RM100,000 (car cost RM150,000) does not apply to commercial vehicles which are licensed for commercial transportation of goods or passengers
Lorry Bus Van

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Example

Lease Rental of Motor Vehicle

Type of vehicle Cost Lease rental b/f Lease rental paid during the year (a) Cumulative lease rental Limit for deduction (max) Car 1 (new) Car 2 (new) Car 3 (used)

RM000
110(<150) 50 35 85

RM000
220 60 60 50

RM000
55 30 25 55 50

100
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Non-deductible amount (b)

Deductible amount in current YA(a b)

10
50

5
20
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Self-check on Learning Outcomes

After studying this topic, are you able to: Distinguish between capital & revenue expenditure
Ascertain the deductibility of expenses (0, 50% or 100%) Identify the expenses that qualify for double deductions (200%)
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