Did you know that deductibility restriction applies whether or not the substance test is met?

On this episode of Take 5 with Thannees’, our Manager, Lee Chak Wei explains how this impacts companies that transact with Labuan entities.

Video Transcription

Welcome to another episode of Take 5 with Thannees Tax Consulting Services. Today we are going to highlight to you that the restriction of the deductibility of the payment made to a Labuan company will still apply or notwithstanding whether the substance requirements of the Labuan company has been met.

Currently under Section 39(1)(r) of Income Tax Act there is a restriction on the deductibility of any payments. There is a 25% on lease payments and interest payments and a 97% restriction on all other type of payment made to a Labuan company.

But if the Labuan company has not complied with the substance requirements prescribed by the Ministry of Finance, this restriction under Section 39(1)(r) will not be applicable to them. But moving forward from 1^st January 2021 onwards, regardless of whether the Labuan company has complied with the substance requirement, this same restriction on the deductibility of payment will apply.

So what does this means? It means that from 2021 onwards if the Labuan company do not meet the substance requirements, it will be taxed at 24% under LBATA instead of the usual 3% or 0% but this does not mean that the payment made by the Malaysian resident company to the Labuan company will be allowed at 100% deduction. The Finance Bill 2021 clearly states that this restriction will still apply even though the Labuan company is being taxed at 24%.

However, the Labuan Investment Committee has already clarified that there are certain payments that will not be affected in the change in law. So these are:

1. Payments made to a Labuan international commodity trading company.
2. Payments made by a resident general insurer to a Labuan (re)insurer.
3. Payments made to a Labuan entity which has elected to be taxed under Income Tax Act.
4. Payments by a Labuan entity taxed under Income Tax Act to another Labuan entity taxed under Labuan Business Activity Tax Act.

So if your Labuan company cannot meet the substance requirements, maybe you can consider to elect it for it to be taxed under Income Tax Act instead of Labuan Business Activity Tax Act so that any Malaysian resident that are making payments to this company will not be subject to the restrictions under Income Tax Act. But please be aware that once you have already decided to make the change to be taxed under Income Tax Act, you can no longer be taxed under the Labuan Business Activity Tax Act in the future anymore.

 So that is all the time we have for today. We hope that you enjoyed this episode of Take 5 with Thannees and please tune in next time for more tax updates with us.

Thank you. See you soon.