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Tax Deduction on Professional Fees and Consultancy Services in Malaysia
In the contemporary business environment, companies frequently engage professional services and consultancy firms to enhance operational efficiency, ensure compliance, and drive strategic initiatives. In Malaysia, the Income Tax Act 1967 (ITA) provides provisions for the deductibility of professional fees and consultancy services, recognizing their importance in the production of income. However, the deductibility of these expenses is subject to specific conditions and limitations, necessitating careful consideration by businesses.
Scope of Professional Fees and Consultancy Services
1. Definition and Categories:
Professional fees and consultancy services encompass a wide range of activities provided by specialists such as accountants, auditors, tax consultants, legal advisors, management consultants, and other professionals. These services are often categorized into two main types:
- Technical Services: These include services related to specialized areas such as engineering, IT, and legal compliance.
- Management Consultancy: This covers strategic advice provided to improve business operations, including financial planning, market analysis, and organizational restructuring.
2. General Deductibility:
Under Section 33(1) of the ITA, expenses incurred on professional fees and consultancy services are deductible if they are “wholly and exclusively” incurred in the production of gross income unless such expenses are capital expenses or expenses specifically prohibited under the ITA.
3. Types of Deductible Expenses:
Pursuant to the Inland Revenue Board of Malaysia (IRBM)’s Public Ruling 6/2006 Tax Treatment of Legal and Professional Expenses, legal or professional expenses are deductible when incurred for the maintenance of trade rights or trade facilities, existing or alleged to exist. For example:
- Debt Collection
Legal and other expenses incurred by a person in the course of collecting trade debts from customers.
- Renewal of Loans
Legal expense incurred by a finance company in renewing existing loans.
- Preparation of Accounts
Ordinary expenses of keeping books and preparing financial records and accounts including charges for accountancy work and statutory audit fees expenditure.
- Defending Title to Property
Legal expenses incurred in connection with defending a person’s title to the ownership of an asset that is used in the business.
- Legal Expenses Incurred By a Landlord
Legal expenses including litigation costs incurred on renewal of a lease.
- Defending an Action Connected With a Trade or Breach of Trading Contracts
- Expenditure incurred by a person in resisting a claim that he has broken a trading contract is allowable unless the breach was deliberate and dishonest.
- Averting a threat to the goodwill of a business.
- Preservation and/or protection of a capital asset that does not result in the creation of a new asset.
- Where litigation ensues after a customer withholds payments wholly or in part on the grounds of inferior workmanship, sub-standard material, non-fulfilment of contract requirements or for other reasons, the legal action is regarded as an ordinary incident of trade.
- Litigation against claims for libel arising from published documents in respect of a newspaper or publishing business.
- Defending legal action taken against a professional in respect of negligence in undertaking work for a client.
- Legal Cost Incurred in Disputes Over Trading Contracts When Incurred for
- Enforcement of a contract for the supply to a litigant of goods which would be resold for profit.
- The establishment of an agreement between the litigant and another under which the litigant is entitled to render services for specific remuneration.
- Determination of fares fixed by a transport company for carrying passengers.
- Attempting to recover sums which would have been taxable if received.
- Claims for compensation for trading goods lost in transit.
- Other Legal Expenses
- Renewal of leases and licenses.
- Claim for compensation for trading goods destroyed, defective or lost in transit.
- Legal fees and agency fees incurred in connection with employment agreements as well as in connection with preparation of trading contracts or agreements.
4. Non-Deductible Expenses:
The following are examples of legal and professional expenses which will not qualify for deduction:
- Debt collection
Legal and other expenses incurred by a person in the collection of non-trade debts and loans of a capital nature.
- Renewal of loan
- Legal expenses incurred by a trading or commercial company.
- Legal expenses on renewal of a mortgage on premises.
- Cost of raising additional capital whether by means of a loan or otherwise (this will also apply to a person carrying on a business of banking or money-lending).
- Legal Expense Incurred By a Landlord
When a property is let for the first time by the owner or lessor.
- Cost of Defence in a Fraud Case
The cost of defending criminal prosecution or in connection with unlawful acts in the operation of a business.
- Legal Expenses Incurred in Connection With:
- The transfer of a mortgage on business premises.
- The grant of a lease of business premises unless in connection with the renewal of a lease.
- The acquisition of capital assets or the sale or transfer of capital assets.
- Securing an enduring advantage for a trade or business.
- Obtaining a trading licence.
- Increasing or reducing share capital or altering the Memorandum and Articles of Association of a company.
- Floatation, registration, winding up or liquidation of a company.
- Obtaining new leases, mortgages, loan or credit facilities.
- Valuation charges relating to probate, company reconstruction and change of ownership.
- Legal fees relating to income already earned e.g. income tax appeals.
- Costs of legal proceedings incurred in pursuing a claim for unlawful or unjust dismissal by an employee.
Conditions for Deductibility
1. Direct Connection to Income Production:
The primary condition for the deductibility of professional fees and consultancy services is that the expense must be directly connected to the production of income.
2. Reasonableness and Necessity:
The fees must be reasonable in relation to the services provided. Excessive fees or those not commensurate with the market rates may be subject to scrutiny by the IRBM and could potentially be disallowed.
3. Documentation and Justification:
Companies must maintain detailed records and documentation to substantiate their claims for tax deduction. This includes:
- Invoices and Receipts: Clear and accurate records of payments made to service providers.
- Contracts and Agreements: Formal agreements that outline the scope of services provided, ensuring they are directly related to income-generating activities.
- Reports and Outcomes: Documentation of the work completed by the consultants or professionals, demonstrating the benefit to the business.
Compliance and Audit Considerations
1. Importance of Accurate Record-Keeping:
To ensure compliance and to substantiate claims for tax deductions, businesses must keep comprehensive records. This includes maintaining all relevant contracts, invoices, and evidence of payment for professional and consultancy services.
2. IRBM Audits and Verification:
The IRBM may conduct audits to verify the legitimacy of claimed deductions. During such audits, businesses must be able to demonstrate that the professional fees and consultancy services were necessary for income production and that the expenses were reasonable and properly documented.
3. Potential Penalties:
Incorrectly claiming deductions for non-deductible expenses can lead to penalties, including the disallowance of the deduction and the imposition of additional tax liabilities, interest, or fines. Therefore, businesses must exercise caution in categorizing and reporting these expenses.
Conclusion
In Malaysia, professional fees and consultancy services play a critical role in enabling businesses to operate efficiently, remain compliant with regulations, and achieve strategic objectives. The ITA provides for the deductibility of these expenses, provided they meet the necessary criteria and are directly related to the production of income. By maintaining accurate records and ensuring compliance with the ITA’s provisions, businesses can effectively manage their tax liabilities while leveraging the expertise of professionals and consultants to drive their growth and success.