Recently, the Inland Revenue Board of Malaysia (IRBM) issued the Restriction on Deductibility of Interest Rules (ESR) which are intended to prevent base erosion through the use of excessive interest expense or any payments which are economically equivalent to interest via controlled financial assistance.
The ESR addresses the following main points:
- The ESR came into effect on July 1, 2019 under Section 140C of the Income Tax Act. As such, companies with a financial year beginning July 1, 2019 are the first to be impacted by the ESR.
Who is Affected
- The ESR applies to a party having annual expenses from any cross-border financial assistance granted in a controlled transaction in excess of MYR 500,000.
- The ESR does not apply to individuals, financial institutions, insurance companies, reinsurance companies, development financial institutions, special purpose vehicles, construction contractors or property developers.
- Financial assistance in a controlled transaction includes "loans, interest-bearing trade credit, debt, advances or the provision of any security or guarantee."
How it Works
- The ESR restricts the tax deductibility of these expenses to a maximum of 20 percent of tax-adjusted earnings before interest, taxes, depreciation and amortization (Tax-EBITDA). Excess can be carried forward to future years, subject to the continuity of ownership test.
- It is important to note that the ESR is not restricted to cross-border related party financial assistance, but also extends to loans provided by foreign third parties if the loan is guaranteed by a related party of the borrower.
- The ESR does not apply to financial assistance provided by domestic related parties inside Malaysia.
Given that the ESR has been effective from July 1, 2019, Malaysian taxpayers should undertake a comprehensive review of their existing loans/financial assistance arrangements to determine if they fall within the scope of the ESR and undertake an appropriate transfer pricing analysis to support the arm's length nature of the interest rates or other payments.
The ESR announcement by IRBM is available here.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.