S33 Deductible Business Expenses

The Act provides general deductibility test and the list prohibited expenses, but this not exhaustive General deduction test is provided under S33. The conditions laid out to enable allowable business expenses are:
a. b. c. d. e. Each business source has to be accounted separately Scope of expense refers to outgoings and expenses Expenses have to be wholly and exclusively Incurred In the production of gross income from that business source

Outgoings and expenses

Expenses refer to disbursements made by the business. Inclusive of business losses due to theft,defalcation of employees, bad debts etc.

Wholly and exclusively

The test for wholly and exclusively are as follows: a. motive must be incidental to the business not just connected to the business b. direct purpose for business expenses must be incurred directly for the business and not for the remote or indirect result which may possibly flow from the expenditure. c. commercial expediency expenses made to remain competitive or for the benefit of the business. Eg: severance package for senior staff, relocation of business premise

Wholly and exclusively

d. Benefit to third party - expenses are deductible if it is incurred to increase the efficiency of the business even though it may benefit a third party. e. Classification of accounts how the expense is classified in the accounts do not dictate if the expense is deductible or not. For example, a company may capitalise expenditure made and amortised it. But as long as it fulfills the conditions under the tax laws, it can be fully deductible in the year it was incurred.

Apportionment of expenses
Sometimes expenses maybe incurred partly not for the benefit of the business. In this case, the expenses relating directly to the business maybe deductible as long as tax payer can show proof. Eg: Company A is renting a three storey building as a business premise whereby the third floor is occupied by one of the owners of the company. In cases like this, IRB would allow the rental portion paid for the 1st and 2nd floor provided the tax payer can show proof that these two floors are in fact used for the generating income for the business.

Incurred
Expenses must have a legal liability before it can be tax deductible. Provisional expenses are not deductible. Eg: Co A expensed off forex losses. This is tax deductible. If Co A only provide for forex losses because the actual loss cannot be determined yet, this provision is not tax deductible.

Accrual
Accrued expenses are tax deductible provided it has fulfilled the other conditions. Tax deductions would still be given even if there are no disbursements made. Eg: Monies set aside to meet retirement sum for staff retirement are accrued liabilities and be allowed tax deduction in the year of accrual and not in the year of payment.

In the production of gross income

For expenses to be tax deductible it must be used in the production of income. Eg: Co A rented a warehouse in January X2. The warehouse was left empty until February X2 because the products to be stored there was only ready in February X2. Rental expense deductible is only for February X2 onwards. Mango Sdn Bhd is a tabloid magazine which frequently publishes articles about Malaysian artists. Recently the court ruled that it has to pay RM250,000 to an artists who won a legal suit against them for printing defamatory article about him. In this case the compensation sum is tax deductible.

Capital expense
Capital expenses is not deductible expense even though it has fulfilled other conditions. Expenses which relate to fixed capital is usually treated as capital expenditure while expenses which relate to circulating capital is usually treated as revenue expenditure. Expenditure incurred to acquire fixed assets whether tangible or not is considered capital expense (eg: patent) Capital expenses are incurred to obtain assets that in turn will produce income. Eg: machineries

Expenses of a capital nature

No specific categories rather depends on the facts in each case The following test can be applied in differentiating capital expenditure and revenue expenditure - asset is enduring in nature - referable to fixed or circulating capital - an initial expenditure - acquisition of goodwill or right to earn profits - improvement to an asset - connected with business structure - once and for all

Expenses of a capital nature

Some examples of capital expenditure:
- cost of acquiring plant and machinery for use in business - cost of acquiring trade marks and patents in order to have the right to produce certain types of goods (however, these expenses are deductible for SMI companies) - money spent to acquire stocks and shares - expenditure on alterations, improvements and additions to business assets or residential premises - consideration paid for acquiring possession of property - costs incurred on the acquisition of a professional practice - premiums paid for leases - monthly payments made to a director whose principal duties were concerned with acquisition of capital assets

Entertainment Expenses
Entertainment is defined as:

(i). The provision of food, drink, recreation or hospitality 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 the above Effective YA 2004 entertainment expenses incurred on suppliers and bankers either by a company or the staff of the company are 50% deductible. This includes entertainment allowance paid to employees.

Entertainment Expenses
Fully deductible entertainment expenses are:
(a). entertainment to employees such as meals, refreshments, annual dinners, gifts to employees - however if lunch or dinner provided for clients and some employees are also invited, expenditure is only 50% deductible (b). entertainment business such as hotels, restaurants that provide entertainment to their patrons will be fully deductible (c). promotional gifts at foreign trade fairs such as souvenirs and bags at trade fairs, trade or industrial exhibitions held outside Malaysia

Entertainment Expenses
(d). Promotional samples however expenditure of gifts given away upon purchase of taxpayers products is not deductible unless affixed or embossed with the companys logo (e). Cultural or sporting event must be open to public. If restricted to members only not deductible (f). Entertainment related wholly to sales provided to customers, dealers and distributors but exclude suppliers. Included are: - food and drinks for the launching of a new product - redemption vouchers given for purchases made - discount vouchers, shopping vouchers, concert or movie tickets, meal or gift vouchers and cash vouchers

Entertainment Expenses
- free gifts for purchases exceeding a certain amount

- redemption of gifts based on a scheme of accumulated points - lucky draw prizes to customers for purchases made - expenditure on trips given as an incentive to dealers for achieving the sales target - light refreshment to trade customers at the business owners premises

Entertainment Expenses
Incurred RM 10,000 5,000 50,000 Allowed RM 5,000 (50%) 2,500 (50%) 50,000(100%)

Employees entertainment allowance Entertainment to suppliers Sponsorship of a cultural show at a sporting event Gifts to customers for purchases above RM100 Launching of new product Meals provided for employees during staff meeting

15,000
20,000 25,000

15,000(100%)
20,000(100%) 25,000(100%)

Bad and doubtful debts

Sect 34(2) state that specific provision for bad debts would be given a deduction if: (a). specific debtors are identified (b). the debts are partly/wholly irrecoverable (c). such debts had been reasonably estimated to be bad Specific provision of bad debts -debts must assessed separately ( outstanding period, credit record of the debtor) - extensiveness of the doubtfulness (history of bad debts, ageanalysis of the debts) - person valuing the debt and date of evaluations - any specific information used in arriving at the evaluation

Bad and doubtful debts

Tax authorities expressly state that general provision of bad debts which is based on certain percentages is non-allowable deductions Before writing bad debts the following action must be taken (one or more): - issuing reminder notices - debt restructuring scheme - rescheduling for debt settlement - negotiation or arbitration of a disputed debt - legal action (filing of civil suit, obtaining judgement from the court etc)

Bad and doubtful debts

A trading debt can be considered as bad debt if one the following occurs: - debtor has died without leaving any assets from which the debt can be recovered - debtor is a bankcrupt or in liquidation without any assets from which the debt can be recovered - debt is statute barred - debtor cannot be traced - attempts for arbitration or negotiation have failed and the cost of litigation prohibitive - any circumstances that render the debt irrecoverable

Bad and doubtful debts

Trade debts taken over Reynolds & Gibson vs Crompton the new business owners acquired the debt at a written down figure the final collection was full amount resulting in gain for the new owners the Court ruled subsequent collection of the debt is not a transaction within the scope of the new business and therefore not deductible or the gain made from the collection is not taxable Advances Reids Brewery Co Ltd vs Male Rental advances given to tenants of public houses when irrecoverable is deductible against business income

Bad and doubtful debts

Advances English Crown Spelter Co Ltd vs Baker This company made advances to an allied (mining) company to supply raw materials The allied company was liquidated The Court ruled the loss as capital loss because the advances were loans made to obtain raw materials and considered as capital investment. Ultimately in deciding whether loss arising from an advance is considered as deductible or not depends on whether the advance is given as a normal course of business Advances made in order to secure contracts or secure raw materials is not considered deductible

Losses through theft, embezzlement or misappropriation

Deductible as long as it is non-capital nature and incidental to the business When an employee is responsible for the loss it is deductible Subsequent recoveries are taxable When the managerial staff is responsible for the loss, it becomes non deductible as it is considered not in the usual course of business

Leave passage
Section 39(1) prohibits deduction of leave passage BUT Exception: Leave passage expenditure incurred by employers for their employees and their immediate family members to attend a yearly event held in Malaysia is deductible if it involves the employer, the employee and the immediate family members Where leave passage expenditure incurred by the employee includes cost of food, accommodation or other incidental expenses, only the amount relating to fares is treated as leave passage cost. Cost of food and accommodation is deductible as entertainment expenses in arriving at the adjusted income of the employers business. Amount deductible is restricted to the amount on his employees only.

Redundancy payments
Redundancy or retrenchment payments made due to cessation of business is not deductible However payments made to employees that resulted in increased or retention of source of income is deductible

Repairs and renewals

General rule for deduction on repairs and renewals: 1). Expenses incurred for repair of premises, plant, machinery or fixtures employed in the production of gross income 2). Expenses incurred for the renewal, repair or alteration of any implement, utensil or article so employed, other than expenses on such items which would qualify for capital allowance under Sch 3. The cost of reconstructing or rebuilding any premises, building, structures or works of a permanent nature, plant or machinery or fixtures are excluded. Capital allowance would be allowed in these cases provided the assets are used for business purposes

Repairs on acquisition
If a new asset is acquired and the asset is in need of repairs, these repairs will not be considered as revenue expenses The four conditions that cause acquisition repairs considered as capital are: a. the purchase price was materially affected by the propertys dilapidated state b. the acquisition cannot be use for the trade until it was repaired c. the acquisition cannot continue to be used in the trade without being repaired shortly after the acquisition d. the terms of the lease (if relevant) require the new tenant reinstate the property to a good state of repair

Differentiating between repair and improvement

No specific definition in the Act. The general test is: - repair involves the replacement of subsidiary part of an entirety - renewal means replacement of substantial part of an entirety which is substantially the whole Important to distinguish between repair and improvement as expenditure on improvement is deemed to capital expenditure and therefore not deductible in calculating adjusted income In practice, improvements to include situations where improved materials or construction techniques are used. It would be repairs if the new assets are essentially the same as previous. For example replace single layer glass windows with double layer glass windows. Repair refer to recurring revenue expenses incurred to maintain the efficient use of an asset in the business and is deductible.

Specific deductions
Interest paid on capital used to acquire income Rent payable in respect of any land or building occupied Repairs to premises, plant, machinery or fixtures used to produce income Bad debts Employers contribution to approved funds or schemes (max 19%) Employers expenditure on equipment to assist disabled employees Expenditure for translating or publishing books in Bahasa Malaysia approved by Dewan Bahasa and Pustaka Contributions to libraries Expenditure in providing services, public amenities and contributions to charity or community projects Expenditure to provide and maintain childcare centres for the benefit of the employees

Specific deductions
Contributions to establishing and managing a musical or cultural group Sponsorship to any approved arts or cultural activity Scholarships Certification and accreditation expenses Practical training in Malaysia to an individual Scientific research expenses Pre-operational expenses incurred by companies undertaking approved overseas investments Certain deduction related to small business incorporated in Malaysia with authorised capital not exceeding RM250,000 International Standardisation Activities Equipment of disabled employees

Interest expense
Interest expense on debt is not governed under S33,therefore deductibility depends on wholly and exclusively test. Should be allowed under two circumstances:
Loan is employed in the production of gross income Loan is laid out on asset used or held in the production of income Interest expenditure incurred on loan made out to purchase capital assets used in the production of income would qualify for deductions. However amount that can be deducted will be restricted if the asset is partly used for non business purposes, If the loan or money were borrowed for the purpose of paying dividends, the interest would not qualify for deduction for tax purposes

Rental expense
Rent would be deductible if: a. payable for occupying land/buildings (immovable) b. used in relation to the period c. incurred for producing gross income Rent is deductible on an accrual basis For rent to qualify as a deduction, there must be a source of income or the asset on which it is paid should be producing income For example: warehouse rented for the storage of goods but which has not been brought into use yet, the rental may not qualify.

Donations
Donations are not revenue expense and therefore not deductible against gross income. Considered as social responsibility expenses. Effective YA 2009, cash donation to approved institution or organisation is restricted to: Company 10% Non-company 7% (Non company includes individuals, trust, club, co-operative society and trade association) However the limitation does not apply to cash donation to the Government, a state government or local authority

Donations
Example: ABC Sdn Bhd incurred the following donations: RM RM Aggregate Income 200,000 Less: donations (a) Cash donation to approved institution 12,000 (b) Approved sport body 11,500 (c) Project of national interest 13,000 (d) Cash donation to school libraries 20,000(restricted to RM20,000) (incurred RM31,000) ______ 56,500 (Restricted to 10% of aggregate income 20,000 or the lower of) Total Income 180,000

Double deductions
Insurance premiums for import/export - insurance premiums paid to insurance companies incorporated in Malaysia on cargo imported into Malaysia - insurance premiums paid by exporters to local insurance companies for cargo exported HALAL certification expenditure deemed to incur in YA where certificate is obtained (effective YA2005, inclusive of ISO certification) Export credit insurance premiums double deductions given for premiums paid to Malaysia Export Credit Insurance Berhad Freight charges manufacturers importing goods from Sabah and Sarawak to Peninsular Malaysia using the ports in Peninsular Malaysia (effective YA 2000) Services sector with regards to promotion of the export of services, R&D and training

Double deductions
Local advertising advertisement of Malaysian branded products both in Malaysia and abroad. Advertising channel include through the internet on local website, magazines/newspapers, licensed TV stations, approved hoardings, trade publications, sponsoring international sporting event, sponsoring international trade conference/exhibition approved by MATRADE Promotion of export advertising, free samples, market research, overseas travel for negotiations and contracts, expenses for giving technical information to buyers, preparation of tenders Research & Development projects must be approved by the Minister Incorporation Expenses for companies incorporated in Malaysia with authorised capital not exceeding RM2.5 million (eff YA 2004) Eg: prepare and print M&A, costs of circulation and advertising the prospectus, company registration, stamp duty, drawing up preliminary contracts, debentures, share certificates, company seal, underwriting commission

Double deductions
Training incentive Manufacturing, non manufacturing and hotel or tour operating companies are allowed double deductions for staff training who are Malaysian citizens provided: a. the training programme is approved b. training done by recognised training institution Double deduction also given for training of handicapped persons Remuneration paid to handicapped employees.

Double deductions
Employment of disabled persons and graduates - wholly and exclusively in the production of income Example: ABC Sdn Bhd paid a blind operator (using special equipment in his work) RM 6,000 wages for the year. The tax computation: RM Profit for the year 20,500 Less: wages to disabled employee * 6,000 Adjusted income 14,500 * this expense has been deducted when deriving profit for the year.
This expense is deducted for the second time in deriving at adjusted income

Capital market graduate training scheme - allowance paid to unemployed graduates endorsed by SC from 1/10/2005 to 31/12/2008 for companies in capital market industry

Prohibited deductions Sect 39

Sect 39(1)(a) domestic or private expenses Sect 39(1)(b) expenses not incurred wholly and exclusively for the purpose of acquiring the income Sect 39(1)(c) capital withdrawn or any sum employed as capital or used in improvements (distinguish improvements/alterations from repair) Sect 39(1)(d) payments to any unapproved scheme Sect 39(1)(e) other qualifying expenditure related to specific industry such as agriculture, forest, mining and qualifying expenditure on plant, machinery, industrial buildings etc. Sect 39(1)(f) - Interest on any debts (debenture, mortgage, royalties etc) having a Malaysian source but paid to non resident persons before deducting the witholding tax or 10% penalty on the gross amount.

Prohibited deductions Sect 39

Sect 39(1)(g) any sums payable otherwise to a state government, statutory body of fund approved by the Minister for the use of license or permit to extract timber from a forest in Malaysia. (includes suma paid to licensees for the informal assignation of their license to extract timber) Sect 39(1)(i) contract payments from which tax under Sect 107A where the witholding tax and 10% penalty on the gross income has not been paid Sect 39(1)(j) special classes of income from which tax under Sect 109B where the witholding tax and 10% penalty on the gross income has not been paid Sect 39(1)(k) sum paid as rental for motor vehicle in excess of RM50,000 or RM100,000. However licensed or permitted motor vehicle by the appropriate authority for commercial transportation (lorry, truck, bus, minibus, van, station wagon or taxicab) is allowable.