(Tax Update) Tax Implication on Loan or Advance to Directors by a Company

On November 30, 2015, the Inland Revenue Board (IRB) of Malaysia released Public Ruling (PR) No. 8/2015, which addresses the tax implications of loans or advances provided to directors by a company.

This ruling specifically outlines the tax treatment for:

Loans or advances provided to directors by a company either without interest or at an interest rate lower than the arm's length rate.
Situations where a company is deemed to have received interest income from such loans or advances.

Key Insights from the Public Ruling

This blog will help you understand:

The tax treatment of loans or advances to directors.
The sources of funding that impact tax treatment.
How other circumstances are treated.
The method for determining deemed interest income.
The tax implications for dormant companies making loans or advances to directors.

Detailed Overview

1. Tax Treatment of Loans or Advances to Directors

When a loan or advance is made to directors using a company's internal funds, the company is deemed to receive interest income. This interest income is taxable under Section 140B of the Income Tax Act (ITA).

However, if the loan or advance is funded from external sources, such as bank loans, no tax will be imposed on the company for the interest.

2. Understanding the Sources of Funding

The funding for loans or advances can be categorized into three types:

Internal Funding : This includes funds generated from the injection of capital, retained earnings, and reserves.
External Funding : These are loans obtained from banks or third parties.
Mixed Funding : A combination of both internal and external funds. Notably, only the interest income generated from internal funds is subject to tax. For external funds, it is essential to maintain proper documentation and proof of funding.

If any part of the loan from external funds is used for investment purposes, interest restrictions may apply under Subsection 33(2) of the ITA.

3. Tax Treatment for Various Circumstances

Loans or Advances from External Funds to Directors Who Are Also Employees

In this case, any interest expense incurred from the loan facility needs to be reported as a perquisite and included as part of the employee's gross income under Paragraph 13(1)(a) of the ITA.

Loans or Advances in a Partnership

If the director is also a partner in the company, the loans or advances are subject to Section 140B of the ITA, as partnerships are not considered separate legal entities from their owners.

4. Determining Deemed Interest Income

Interest-Free Loans

For loans provided without interest, the deemed interest income is calculated using a formula prescribed in Subsection 140B(2) of the ITA, based on the Average Lending Rate (ALR) published by Bank Negara Malaysia (BNM).

Loans with Interest

The interest income is determined by comparing the interest rate charged by the company to the rate computed using the prescribed formula. The higher amount is reported as the company's interest income, while the lower amount is disregarded.

5. Implications for Dormant Companies Making Loans or Advances

If a dormant company provides loans or advances to directors, it will be considered an active company, implying that its business is deemed to have commenced operations under Subsection 21A(8) of the ITA.

Consequently, any loans or advances given will still fall under the provisions of Section 140B of the ITA.

Conclusion

Understanding the tax implications of loans or advances provided to directors is crucial for company compliance. Adhering to the guidelines set out in PR No. 8/2015 can help companies avoid potential tax pitfalls and ensure proper reporting and tax compliance.

For more detailed advice tailored to your company's specific circumstances, consider consulting with our experts at KTP.

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