Updated Guidelines on Earnings Stripping Rules (ESR)

Updated Guidelines on Earnings Stripping Rules (ESR)

As highlighted in earlier 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 Income Tax Act 1967 (ITA), which was introduced into the ITA to implement the ESR. The Restriction on Deductibility of Interest Guidelines [Section 140C, ITA] (Guidelines) dated 5 July 2019 were issued to provide clarification on the Rules (see Special Tax Alerts No. 4/2019 and 5/2019).

Thereafter, the Income Tax (Restriction on Deductibility of Interest (Amendment) Rules 2022 (Amendment Rules) were gazetted on 31 January 2022, mainly to amend the definition of “qualifying deduction” for the purpose of computing the “Tax-EBITDA” under the ESR (see Tax Alert No. 3/2022).

Following the above, the Inland Revenue Board (IRB) has recently published on its website the updated Restriction on Deductibility of Interest Guidelines [Section 140C, ITA] (updated Guidelines). Some of the key changes are outlined below.

• The updated Guidelines reflect and provide examples (see Annexes to the updated Guidelines) to demonstrate the application of the amended definition of “qualifying deduction” for the purpose of computing the “Tax-EBITDA[1]”.

To recap, 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” meant:

(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 updated Guidelines reiterate that the restriction on the deductibility of interest under Section 140C of the ITA and Rules apply in respect of a basis period beginning on or after 1 July 2019. However, the updated Guidelines also clarify that the Amendment Rules will only take effect for basis periods beginning on or after 1 February 2022 (see Example 7 of the updated Guidelines).

• Pursuant to Sections 33(4) and 33(5) of the ITA, a taxpayer is only eligible to claim a deduction in respect of interest on borrowings when such interest is “due to be paid”. However, the deduction would be related back to the year the interest is payable. Taxpayers may only claim the deduction if they notify the Director General of the deduction, in writing, not later than 12 months from the end of the YA in which the interest expense becomes “due to be paid”.

For the purpose of the ESR, the updated Guidelines clarify that in a situation where the interest payable for a particular YA is only due to be paid in a later YA, the said interest is to be excluded from amount “C” 1, as the interest would have been excluded in deriving amount “A” 1. Thereafter, when the said interest is due to be paid, the Tax-EBITDA will need to be recomputed to take into account the said interest (i.e., factor into amounts “A” and “C”).

• The Guidelines have been updated to reflect the same categories of taxpayers which are not subject to ESR as indicated in the Rules, as follows:

-        Included in the updated Guidelines: A person who has been granted an exemption under Paragraph 127(3)(b) or 127(3A) of the ITA in respect of adjusted income of the person

-        Excluded in the updated Guidelines: Special Purpose Vehicle (SPV) as defined under Section 60I(1) of the ITA

The updated Guidelines are available at the following link: Restriction on Deductibility of Interest Guidelines [Section 140C, Income Tax Act 1967]