Introduction - Tax Computation for Companies

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Introduction - Tax Computation for Companies

Tax Computation for Companies

1.0     Introduction

Malaysian taxation system has moved into self assessment regime for companies with effect from year of assessment 2001, which will be followed by sole proprietors, partnerships, trusts, co-operatives and employees with effect from year of assessment 2004 with the recent legislation of Income Tax (Amendment) Act 2002[2]. Under the self assessment regime, taxpayers must be familiar with the operation of the Income Tax Act 1967[3] and its interpretation, Inland Revenue Public Rulings and guidelines as they are now placed with the onerous responsibilities to estimate the income tax payable for each year of assessment, voluntary payment of income tax to the collection branches or via banks and to submit the income tax return on time. Tax audits couple with monetary penalties and imprisonment will serve as deterrence to taxpayers from the non- compliance to the Malaysian Act.

Companies directors must ensure the tax computation of companies are prepared in accordance to the current law and practices. This will certainly facilitate the tax audit later on as well as minimize any possible tax penalties. The tax computation ranges from trading, manufacturing to service companies and this article aims to provide the step by step guidance that are essential in preparing a tax computation for company and hopefully to assist the company to comply with the self assessment requirements.

2.0    The beginning

Tax computation begins with the profit and loss account of the company, add in the tax adjustments required by the Income Tax Act 1967 (the Act) to arrive at chargeable income for the computation of income tax payable at the rate of 28%.

The first step is to compute business income under section 4(a) of the Act, which begins with the ‘net profit’ or ‘net loss’ as shown in the audited profit and loss account (P/L) of the company. The P/L is categorized into income section and expenses section, and has to be dealt with it separately. Insurance compensation on trading stock, compensation received from trade creditors, interest income from trade debtor is assessed as business income, thus no adjustment is required.

The Act requires each source of income such as business income, investment income to be computed separately. Therefore investment income and its related expenses is excluded first when computing business income. This normally refers to interest expense in acquiring the investment source and it will be added back, shown in the positive column.

The Act imposes tax on transactions that are income in nature. Capital gain from realization of long term investment or capital assets is not within the ambit of income tax as it is tax free. In the same vain, capital loss is not tax deductible.

The initial tax adjustment will be as follows:

Sweet Ting Sdn Bhd
Computation of Chargeable Income for the year of assessment 2002

							-	+
				Profit before taxation				xx
				Investment income (as per P/L)
					: Rental income		xx
					: Interest income		xx
					: Dividend income		xx
				Investment expenses
					: Interest expense			xx
				Capital gain
					: gain on disposal of shares, motor vehicle, plant and machinery		xx
				Insurance compensation on damages to fixed assets			xx
					: trading stock			nil
				Capital loss
					: loss on disposal of shares, motor   vehicle, plant and machinery			xx

3.0     Expenses in the P/L

Expenses in the P/L broadly can be divided into deductible and non deductible expenses. Allowable expenses are expenses wholly and exclusively incurred in the production of income or alternatively allowed under section 34 of the Act.

Non deductible expenses refers to the expenses that are specifically prohibited under section 39 of the Act or capital expenses such as improvement on capital asset or capital asset expensed off to P/L. These non allowable expenses have to be shown in the positive (+) column (not allowed).

The list of prohibited expenses as provided in section 39(1) is as follows:

1. domestic or private expenses;
2. disbursement or expenses that are of ‘dual’ purposes (both private and business);
3. capital withdrawn or sum employed as capital;
4. contribution to an unapproved pension and provident scheme;
5. qualifying mining, agriculture, forest, prospecting, and farm expenditure;
6. interest and royalty expenses where applicable withholding tax are not deducted and paid;
7. payment for the use of licence or permit to extract timber from a forest in Malaysia other than to Government or statutory bodies;
8. (deleted);
9. contract payment to non-resident where applicable withholding tax are not deducted and paid;
10. special classes of income paid to non-resident where withholding tax are not deducted and paid;
11. lease rental for motor vehicles in excess of RM50,000 or RM100,000 (in certain cases) per vehicle, computed on aggregate basis;
12. entertainment expenses;
13. leave passage for employees within and outside Malaysia.

Capital expenses are not tax deductible and it include:

1. cost of printing and distribution of annual reports;
2. stamp duty and secretarial fees for increased share capital;
3. stock listing expenses;
4. pre-commencement business expenses;
5. entrance fees to club;
6. legal and professional fees relating to violation of laws, capital structure of company, acquisition of loan or assets;
7. donations (irrespective of whether approved or unapproved donations);
8. lump sum payment for early termination of lease;
9. loan written off in relation to that of employees’ or suppliers’;
10. fine imposed for violation of law;
11. penalty on withholding tax;
12. foreign exchange gain / loss on acquisition of plant and machinery, repayment of foreign loan;
13. registration of trademark;
14. fees for designing company logo;
15. compensation to competitor to restrict competition (restrictive covenant).

Expenses that are not incurred in the production of income such as provision of expenses or capital asset expensed off to P/L is not tax deductible and will be added back, shown in the positive column. These are:

Expenses that are not incurred:

1. general provision for bad and doubtful debts;
2. provision for gratuity / retirement benefits;
3. provision for warranty cost, stock obsolescence;
4. depreciation;
5. amortisation for renovation of premises, lease amortisation;
6. unrealised exchange loss in relation to acquisition of raw materials;
7. provision for repair and maintenance;
8. preliminary expenses written off.

Capital asset expensed off to P/L:

1. renovation of factory, office premises;
2. improvement for repairs;
3. small value capital items e.g. chairs, calculators etc;
4. installation cost of machines charged in repair and maintenance account;
5. cost of stand used in advertising;
6. deposits paid for telephone or utilities;
7. replacement of electrical alarm system.

4.0     Double deduction

The Act provides incentives such as double deduction of revenue expenses in arriving at adjusted income of a business. These revenue expenses would be allowed under the Act but an additional tax deduction is given to encourage or to relieve the tax burden of business enterprises.

Expenses qualified for double deduction are normally gazetted as PU orders, legislated in the Income Tax Act 1967 or in Promotion of Investments Act 1986 (PIA 1986). These include:

1. revenue expenses for promotional of export [section 41(3), PIA 86] ;
2. revenue expenses for approved training [P.U.(A) 61/92] ;
3. overseas expenses incurred by resident company carrying on a hotel or tour operating business for promotion of tourism [P.U.(A) 412/91]
4. research expenditure
   Double deduction of expenses would be granted in respect of any allowable research expenditure:
   1. approved research projects undertaken by a company either in-house or contracted to external research companies or institutions;
   2. the company is participating in industrial adjustment approved under section 31A of the Promotion of Investments Act 1986 and such expenses were incurred within 10 years (section 34A);
   3. expenses incurred by companies for the use of facilities and services provided by approved research companies or institutions; or research and development companies or a contract research and development companies (section 34B);
   4. contributions in cash to approved research companies / institutions (section 34B);
   5. approved research expenditure by the Minister (section 34A).
5. remuneration of handicapped employees [P.U.(A) 73/82]
   • remuneration paid to an employee who is physically or mentally disabled and is not able to perform the work of a normal person. Such remuneration must be allowable under section 33.
6. insurance premium paid for the import of cargos [P.U.(A) 72/82]
   • provided the risks are insured with an insurance company incorporated in Malaysia.
7. export credit insurance premium [P.U.(A) 526/85]
   • provided it is paid to the Malaysian Export Credit Insurance Bhd (MECIB).
8. insurance premium paid for export of cargo insured with a local insurance company [P.U.(A) 79/95]
   • provided the insurance premium must be allowable deduction under section 33 of the Act and the risks are insured with an insurance company incorporated in Malaysia.
9. approved international trade fair [P.U.(A) 361/91]
   • expenses incurred for participation in an approved international trade fair held in Malaysia for the promotion of exports. The trade fair must be approved by the Minister of International Trade and Industry. The expenses must be allowable under section 33 of the Act but excludes the cost of exhibits.
10. interest payable on loans to small scale business [P.U.(A) 90/82]
    • employer needs to produce certificate of approval from authority and interest must first be deductible by virtue of section 33.
11. promotion of export of services by service sector such as transportation, communication and utility sector [P.U.(A) 193/99]
    • eligible expenses incurred pertaining to the promotion of export of services.
12. advertising on Malaysian brand name goods [P.U.(A) 62/2002]
    • expenditure incurred on advertising Malaysian brand name goods locally provided:
      1. company is at least 70% Malaysian owned;
      2. brand name is owned by the company and is registered in Malaysia or outside Malaysia; and
      3. company’s product must achieve export quality standard.
13. freight charges incurred for the export of rattan and wood based products [P.U.(A) 422/91]
    • the person claiming the deduction must be engaged in the manufacture of rattan and wood based products. (Excluding veneer and sawn timber).
14. ship freight charges for shipping goods from Sabah and Sarawak to Peninsular Malaysia [P.U.(A) 50/2001]
    • provided it was incurred by manufacturer and used ports in Peninsular Malaysia.

5.0     Bad and doubtful debts

Bad debts written off relating to business income is allowed as tax deduction. However, general provision for bad debts is not allowed as these expenses are mere contingency expenses, which are not incurred in the production of income.

Section 34(4) of the Act permits specific provision for trade debts to be tax deductible. To qualify as trade debts, the individual debtor and the specific reasons for such provision must be specifically defined as provided by Public Ruling 1/2002 to include one of the following circumstances:

1. the debtor has died without leaving any assets from which the debt can be recovered;
2. the debtor is a bankrupt or in liquidation and there are no assets from which the debt can be recovered;
3. the debt is statute-barred;
4. the debtor cannot be traced despite various attempts and there are no known assets from which the debt can be recovered;
5. attempts at negotiation or arbitration of a disputed debt have failed and the anticipated cost of litigation is prohibitive; or
6. any other circumstances where there is no likelihood of cost effective recovery.

Non trade debts such as loan given to employees, advance given to related company or suppliers is not tax deductible even though the debts are written off. These debts are not incurred in the ordinary course of business and are relating to the business structure of the business source, which are capital in nature.

Recovery from the specific provision is assessable as income as provided in Section 30(3) of the Act. No tax adjustment is required as the amount already shown as income in the P/L account.

Recovery from non trade debts would be a capital receipts and not be taxed. Therefore, the recovery has to be excluded from the tax computation. (shown in negative column)

6.0     Section 34(6) specific expenses

These expenses although not related to the income production activity, nonetheless they are deductible as it is specifically allowed under Section 34(6). The Malaysian Government encourages the incurring of these as expenses as to fulfill the social responsibility of the taxpayer. Some of the specific expenses has a threshold for deduction, therefore any excess of the limit will be disallowed (added in the positive column). The full list of Section 34(6) is as follows:

1. Mining expenses by the mining operator as computer in sch 2 of the Act;
2. Replanting expenditures
3. Provision of equipment for disable person necessary to assist the disabled employees in carrying out their duties;
4. Translation or publication in Bahasa Malaysia of cultural, literary, professional, scientific or technical books approved by Dewan Bahasa dan Pustaka;
5. provision of library facilities, which are accessible to the public; or contributions to public libraries, libraries of schools and institution of higher education provided the amount shall not exceed RM100,000;
6. provision of services, public amenities and contributions to a charity or community project pertaining to education, health, housing, infrastructure and information and communication technology as approved by the Minister;
7. provision and maintenance of a childcare centre for the benefit of employees (restricted to revenue expenses);
8. Expenditure incurred in establishing and managing a musical or cultural group approved by the Minister;
9. Expenditure incurred for sponsoring any arts or cultural activity approved by the Minister of Culture, Arts and Tourism is deductible subject to a limit of RM200,000 for a year of assessment.
10. Companies providing scholarship to a student for any course of study leading to an award of a diploma, degree (including master and doctorate) would be given a tax deduction provided:
    1. the student is receiving full time instruction;
    2. the student has no means of his own; and
    3. the total monthly income of whose parents or guardian does not exceed RM5,000.
       
       The scholarship expense refers to the course fees and reasonable living expenses of such student. The educational institution must be established or registered in Malaysia.
11. Companies incurring expenditure (restricted to revenue expense) for the purpose of obtaining certification for recognised quality systems and standards, and halal certification, as evidenced by certificate issued by a certification body determined by the Minister;
12. Expenditure incurred by a business person on the provision of practical training in Malaysia to a resident individual who is not his employee.

7.0     Adjusted income and statutory income from business

Adjusted income is the first tax concept in the tax computation of a company. The Act provides business income to claim capital allowances on any qualifying capital expenditure used in the business. Balancing adjustment would need to compute when there is a disposal of qualifying asset. Balancing charge is added to adjusted income while balancing allowance is deducted from adjusted income. The adjusted income less out all capital allowances would be statutory income.

The computation format is as follow:

		-	+
Net profit before tax			xx
Investment income		xx
Investment expense			xx
Capital gain		xx
Capital loss			xx
Section 39 prohibited expenses			xx
Capital expenditure			xx
Double deduction : Additional deduction		xx
Bad and doubtful debts : general provision
	: opening balance (b/f)	xx
	: closing balance (c/f)		xx
Non trade debts written off			xx
Recovery of
: trade debts		NIL
: non trade debts		xx
Section 34(6) expenses			NIL
Amount in excess the threshold as provided in sec 34(6)			xx
		xxx	xxx
			(xx)
Adjusted income			xx
Add:	Balancing charge		x
			xx
Less:	Capital allowances
Unabsorbed		x
Current year		x
Balancing allowances		x	(x)
Statutory income			xx

8.0     Investment income

Investment income such as dividend, interest, rental has to be computed individually to arrive at adjusted income of each investment source. No capital allowance is available to investment income.

Malaysian dividend income is assessed at gross amount despite it is received at net amount of 72% of the gross dividend. The tax credit on dividend (28%) is available as a set off against income tax payable of the company.

All foreign source income such as overseas dividend, interest income, rental income is exempted when received in Malaysia by virtue of the Income Tax Exemption Order No 48. [ITEO NO 48/1997] It is therefore excluded form the tax computation.

9.0     Aggregate income

Aggregate income is arrived by combining the statutory income from the business and the investment income computed.

Statutory income - 4(a)		xx
Investment income
Sec 4(c) Dividend income (gross)	xx
- Interest expense	(x)
Adjusted income		x
Interest income (gross)	xx
- Interest expense	(x)	x
Sec 4(d) Rental income (gross)	xx
- Rental expense	(x)	x
Aggregate income		xx

10.0   Donation

Cash Donation to Government, State Government or local authority is fully deductible against aggregate income. In relation to cash donation to approved institution or organisation (charitable institution), the amount deductible is restricted to 5% of aggregate income.

Donation in kind is not tax deductible except for the following:

1. gift of artifact, manuscript or painting to Government or State Government;
2. cash donation restricted to RM20,000 for the provision of public library facilities, school or higher institutions;
3. gift of painting to National or State Gallery.

11.0   Current year business loss and unabsorbed business loss

Business income is given preferential tax treatment as adjusted loss is discreetly available to it is not available to investment income. In the event the total in negative column (-) exceeds the total in positive (+) column, adjusted loss is said to exist. adjusted income will then be nil.

Current year business loss is available as a set off at the aggregate income before the deduction of approved donation. Should this amount exceeded the amount of aggregate income, the excess is known as ‘unabsorbed business loss’, only deductible against statutory income from the business source in the following year of assessment until the amount being fully set off.

12.0   Final

Chargeable income is computed by taking the aggregate income less the current year business loss; less out approved donations. Any excess donation over the aggregate income is permanent lost and not available to be carried forward to the following year of assessment.

Income tax payable at 28% will be levied at the chargeable income.

Aggregate income	xx
Less: donation	(x)
Chargeable income	xx
Income tax payable at 28%	x
Less: tax credit on dividend
(section 110 set off)	(x)
Net income tax payable	xx

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