7 Business Exp

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UNIVERSITI TUNKU ABDUL RAHMAN

UBAT2113/2013 TAXATION

DEDUCTION OF DEDUCTION OF EXPENSESEXPENSES

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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 deductions2.6 Exercises2.7 Examples of deductible & non-

deductible expenses

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Learning Outcomes

Distinguish between capital & revenue expenditure

Ascertain the deductibility of expenses (0, 50% or 100%)

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

After studying this topic, you should be able to:

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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 –

Deduction of Expenses - General

i. it is a revenue expenditure;

ii. it satisfies the general deduction test under S 33(1) of the Income Tax Act; and

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

2.1

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Capital Expenditure vs Revenue Expenditure

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)

5. Initial expenditure2.2

CKF Pg 249-253

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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

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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

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3. Fixed Capital vs Circulating Capital

FixedCapital

Circulating 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

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

Expenditure to acquire- fixed capital - circulating capital

Expenditure to maintain fixed/circulating capital

Capital expenditure

Revenue expenditure

Capital expenditure?

Revenue expenditure?

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4. Business Structure vs Business Process (Business Entity Test)BusinessStructure

BusinessProcess

Profit making apparatus

Income earning activity

Expenditure relating to- business structure e.g. cinema operator incur expenses to create monopoly - business process

Capital expenditure

Revenue expenditure

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

that source for that period all (1) 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

Bad debts, cost of samples given out in promoting a product, business losses due to theft, robbery or defalcation of employees, etc.

Outgoings

Expenses

Outgoings & Expenses

Disbursements which involve outlayof cash or money

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General Deduction Test

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

Wholly & Exclusively

Wholly Quantum of expenditure (all)

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General Deduction TestWholly & Exclusively (Cont’d)

ExclusivelyMotive behind the incurrence of expenditure (sole purpose)

Principle of Duality of PurposeExpenditure 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 TestIn 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

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

2.3

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Statutorily Prohibited Expenses (Cont’d)

(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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(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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(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 ≤ RM150,000 , S39(1)(k)

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(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 Advertising Expenditure on Malaysian Brand Name Goods) Rules 2002

[PU (A) 62/2002]

• Income Tax (Deductions for the Employment of Disabled Persons) Rules 1982 [PU (A)

73/1982]

• Income Tax (Deduction for Incorporation Expenses) Rules 2003

[PU (A) 475/2003]

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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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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.

Example

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S 33 Deductible Expenses

(i) Interest expense on money borrowed and –

(ii) Rental expense on land or building occupied for producing gross income [S 33(1)(b)]

(iii) Repairs and renewals [S 33(1)(c)]

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)]

2.4

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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) Employer’s contribution to an approved scheme, up to 19% of the employee’s 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

1) Mining allowance [S 34(6)(c)]

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 (Cont’d)

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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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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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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9) 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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11) 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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13) Practical training in Malaysia to resident individuals who are not own employees

[S 34(6)(n)]

14) 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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Specific Deductible Expenses

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

b) Revenue expenditure incurred on research approved by the Minister [S 34A]

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Specific Deductible Expenses (Cont’d)

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 (Cont’d)

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

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

[S 34B, ITA 1967]

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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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Freight charges for the export of rattan and wood-based products (excluding veneer and sawn timber) [PU (A) 422/1990]

Freight charges for shipping goods from Sabah or Sarawak to Peninsular Malaysia

[PU (A) 50/2000]

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Insurance premiums on import or export of cargo paid to an insurance company incorporated in Malaysia

Export credit insurance premiums paid to the Malaysia Export Credit Insurance Berhad [PU (A) 526/1985]

[PU (A) 79/1995]

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Advertising expenditure on Malaysian brand name goods

Overseas expenses for promotion of tourism

Approved outgoings and expenses incurred for the promotion of exports

[PU (A) 62/2002]

[PU (A) 412/1991]

(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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Expense – Deductible?Guide

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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Expense – Deductible? (Cont’d)

Guide

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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i. Provision for doubtful debts

Exercises

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. Entertainment provided to employees

ii. Entertainment business

iii. Promotional gifts at foreign trade fairs

iv. 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

vi. Entertainment related wholly to sales - entertainment directly related to sales provided to customers, dealers or distributors

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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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Exchange loss arisesfrom purchase of fixed assets, i.e. capital loss

2. Loss on Foreign Exchange

Exchange loss on settlement of foreign trade debts

Exchange loss on translation of foreign accounts into local currency at financial year end

Not deductible

Deductible

Not deductible

Example

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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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Lease Rental of Motor VehicleExample

Type of vehicle Car 1 (new)

Car 2 (new)

Car 3 (used)

RM’000 RM’000 RM’000

Cost 110(<150) 220 55

Lease rental b/f 50 - 30

Lease rental paid during the year (a)

35 60 25

Cumulative lease rental

85 60 55

Limit for deduction (max)

100 50 50

Non-deductible amount (b)

- 10 5

Deductible amount in current YA(a – b)

35 50 20

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Self-check on Learning Outcomes

Distinguish between capital & revenue expenditure

Ascertain the deductibility of expenses (0, 50% or 100%)

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

After studying this topic, are you able to:

Documents

7 Business Exp