It is not uncommon for directors of companies to engage in the transfer of funds between the company and themselves, either for business purposes or personal use. However, it should be noted that while the borrowing of funds to a company may have no immediate tax implications, the lending of funds to directors by a company is subject to specific tax treatments and implications. This article explains the implications and tax treatments for these situations.

Background

The lending of funds to directors by a company is governed by Section 140B of the Income Tax Act 1967 (“ITA”). The Inland Revenue Board further issued a Public Ruling No. 8/2015 titled Loan or Advances to Director by a Company to specifically address these practices.

What and why deemed interest?

Loan and advances to directors are usually interest free and have no term no repayment. It is then that deemed interest is an interest charge that is assumed or deemed to have been paid by a borrower to a lender, even if no actual interest was paid or received. This means that even if there was no agreement or intention to charge or pay interest on a loan, the tax authorities may still deem that interest was charged or paid and tax it accordingly.

The purpose of deeming interest is to prevent the avoidance of tax by charging low or no interest on loans made between related parties such as companies and their directors. It ensures that the parties are taxed on the actual economic value of the transaction and discourages the use of such loans as a means of avoiding tax liabilities. 

Scope and tax implication

Per Section 140B of the ITA, “…a company makes any loan or advances of any money from the internal funds of the company to a person who is a director of that company, the company shall be deemed to have a gross income consisting of interest from such loan or advances for that basis period.”  

This simply means that the deemed interest calculated are to be added as income to the company which are subjected to tax, if the funds advances to the director are from internal funds. If the loans or advances to directors are financed from external funds or third party (i.e. bank loan / financing), then the provision of section 140B of the ITA is not applicable.

Loan or advances to employees who are NOT a director however are not subject to deemed interest provision under the ITA. However, if the loan is made on non-commercial terms, such as an interest-free loan or a loan with a lower interest rate than the market rate, the difference between the actual interest charged (if any) and the market interest rate may be considered as a taxable benefit in kind for the employee and subject to tax as part of the employee’s income.

Summary

Deemed interest is a term used to describe interest charges that are assumed to have been paid on a loan, even if no actual interest was paid. Loans or advances made by a company to its directors are subject to deemed interest provisions in Malaysia, which means that non-commercial loans, such as interest-free loans or loans with lower interest rates than the market rate, may be considered as deemed interest income in the perspective of company tax position and is subjected to tax.