Amendments to Earnings Stripping Rules (ESR)

Amendments to Earnings Stripping Rules (ESR)

As highlighted in earlier Special Tax Alerts, the Income Tax (Restriction on Deductibility of Interest) Rules 2019 (“Rules”) were gazetted on 28 June 2019 with respect to Section 140C of the ITA, which was introduced into the ITA to implement the ESR. Thereafter, the Restriction on Deductibility of Interest Guidelines [Section 140C, ITA] dated 5 July 2019 were issued by the IRB to provide clarification on the Rules (see Special Tax Alerts No. 4/2019 and 5/2019).

Following the above, the Income Tax (Restriction on Deductibility of Interest) (Amendment) Rules 2022 [P.U.(A) 27] were gazetted on 31 January 2022. The amendments are as outlined below:

• Section 140 stipulates that in ascertaining the adjusted income of a person from his business sources, no deduction shall be allowed: 

(a)   for any interest expense in a controlled transaction granted directly or indirectly to that person,

(b)  which is in excess of the maximum amount of interest as determined under the Rules

The Rules prescribe that the maximum amount of interest is 20% of the amount of “tax-EBITDA” of that person from each of his business sources for the basis period for a year of assessment (YA).

Tax-EBITDA is the sum of A + B + C, where:

A    is the amount of the adjusted income of the person from his business sources for the basis period for a YA before any restriction on deductibility of interest under Section 140C of the ITA is made

B    is the total amount of qualifying deductions allowed in ascertaining the amount of the adjusted income in A

C    is the total amount of interest expense incurred in relation to the gross income of the person for any financial assistance in a controlled transaction from his business sources for the basis period for a YA

The Amendment Rules provide that a “qualifying deduction” means: 

(a)   where there is business expenditure incurred in the profit and loss (P&L) account allowed as a deduction under the ITA and the amount of deduction allowed exceeds the amount of business expenditure incurred, an amount equal to the difference between the amount of deduction allowed and amount of the business expenditure, or

(b)  where there is no business expenditure incurred in the P&L account, the amount of deduction allowable under the ITA 

Previously, a “qualifying deduction” means:

(a)   An amount equal to the expenditure incurred by the person which qualifies for double deductions,

(b)  Any claim for deduction under any rules made under Paragraph 154(1)(b) of the ITA where the deduction is allowed for purposes of ascertaining the adjusted income of the person.

• The earlier Rules stipulated that where a company has interest expense which is in excess of 20% of tax-EBITDA, the excess can be carried forward and deducted against the adjusted income of the company for subsequent YAs. In any given YA, the total interest which can be claimed is limited to 20% of tax-EBITDA. A company can utilize such brought-forward interest expense even if the company has no interest expense in the subsequent YA, until the excess has been fully utilized.

The Amendment Rules now provide that the above would apply to a “person” (instead of being restricted to only a company).

• The Amendment Rules reaffirms that in the case of a company, the carry-forward of interest from the preceding year is subject to the condition that the Director General is satisfied that the shareholders of the company are “substantially the same” in the following YA. The Rules also provide clarification as to how shareholders would be ascertained to be “substantially the same”.

The Amendment Rules came into operation on 1 February 2022.