ARTICLE
8 February 2024

Are Loan Interest Expenses Deductible?

When businesses secure loans to support their operations and growth, the interest paid on these loans is often considered a necessary cost. Are these interest expenses tax-deductible as business...
Malaysia Tax
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When businesses secure loans to support their operations and growth, the interest paid on these loans is often considered a necessary cost. Are these interest expenses tax-deductible as business expenditures in Malaysia? In this article, we explore the tax implications surrounding interest expenses as business deductions.

Under Section 33(1) of the Income Tax Act (ITA), a business expenditure can be eligible for deduction if it is incurred wholly and exclusively to produce income. This means that expenses incurred to generate more revenue are typically considered tax-deductible. This principle extends to interest expenses too, specifically addressed under Section 33(1)(a) of the ITA. According to this provision, interest can be deducted if the borrowed funds are used to produce gross income and are connected to the regular operations or activities that generate income.

Purpose of the Loan

The purpose of the borrowed funds plays a crucial role in determining the deductibility of interest expenses. If the borrowed money is used to purchase assets that generate income, the interest on the loan amount can be deductible. For example, see:

  • H Holdings (M) Sdn. Bhd. v Director General of Inland Revenue, the Special Commissioners of Income Tax allowed the deduction because the interest expense was for a loan used in purchasing properties that were subsequently rented out, generating rental income.
  • ABTP v Ketua Pengarah Hasil Dalam Negeri – the High Court permitted the deduction of interest expenses paid on loans obtained for the purchase of raw materials needed to manufacture goods sold by the taxpayer. This was directly connected to income generation.

Conversely, interest expenses unrelated to income production, are not allowed as deductions. One example is in the case of Rakyat Berjaya Sdn. Bhd. v Director General of Inland Revenue, where the taxpayer took a loan to settle debts. The interest expense from this loan was not deductible since it was unrelated to income production.

Other Jurisdictions

Similar principles are applied in other jurisdictions. In Singapore, the High Court allowed the deduction of interest expenses in IA v Comptroller of Income Tax, as the loan amount was utilized to purchase raw materials as stock-in-trade for generating income. The decision was subsequently upheld by the Singapore Court of Appeal.

As another example, the South African Court in Commissioner for Inland Revenue v Genn & Co (Pty) Ltd allowed interest expenses as business deductions when the loan was obtained to acquire stock-in-trade in the hardware and timber business.

Conclusion

The deductibility of interest expenses depends on the specific factual background, the purpose of the loan, and the mechanism of interest payment. Ultimately, the Special Commissioners of Income Tax and the courts have the authority to examine and determine the deductibility of interest expenses when a taxpayer raises an appeal on the Notice of Assessment. The key factor in deciding whether interest expenses are deductible is whether the principal amount borrowed is used for income generation.

By understanding the principles and precedents surrounding interest expenses, businesses can navigate the complexities of tax deductions in Malaysia and make informed decisions about their financial operations and expenditures.

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.

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