A brief explanation on Capital Allowance

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The IRB has made a clarification that the provision for treating rental income as a business income only applies to companies (Bhd and Sdn Bhd) and not to individuals.

1. What is Capital Allowance (C/A)?

C/A is a tax term used by the IRB for income tax purposes. Depreciation is an accounting term. Both are paper entries only and both increases the expenses (and therefore reduce the profit figure). For our own accounts (Profit & Loss account), we deduct the depreciation to get the net profit.

However, for the tax calculations, the IRB will add the depreciation back to the net profit and then deduct the C/A to get the Chargeable Income.

2. Why is it given?

As time goes by, assets (such as cars, equipment, furniture and fittings) depreciate in value. In time, businesses will have to spend money to repair or even replace these assets. And here is where the concept of depreciation comes in. The business will make a paper entry in the Profit & Loss account depreciating the value of the asset every year. The rate can be 20% a year, 25% or whatever sensible figure the business decides. In theory, this depreciation figure would be the money used to replace the assets later on.

However, as mentioned above, for the tax calculations, the IRB will add the depreciation back to the net profit and then deduct the C/A. Unlike the " choose a figure as you please " for depreciation, there is a standard C/A rate for each equipment (rates are given in the Income Tax Act 1967).

Example:

P & L Account
Gross Profit
Depreciation
Net Profit
RM100,000
RM 25,000
RM 75,000
For Tax Calculation
Net Profit
Add Depreciation
RM 75,000
RM 25,000
RM100,000
Minus C/A
Chargeable Income
RM 20,000 (figure depends on the rates given in the Tax Act)
RM 80,000
That is for businesses. Now, the same applies for property investment. Investors are given C/A once the Rental Income becomes a Business Income (answer in Q4). The C/A rate is 8% and is only applicable for furniture and fittings (and not the building itself). This makes sense as the furniture and fitting wears out so we will have to replace them in due time.

3. How to calculate C/A?

Let's take the example mentioned in my book How to Become a Property Millionaire (pg 26):

Rental collected RM24,000
Less cash expenses
Less interest payment
Cash flow (before tax)
Less C/A
Net loss
RM 6,000
RM13,000
RM 5,000
RM 6,000
(RM 1,000)

As you can see, the C/A is RM6,000. As mentioned earlier, the C/A rate is 8% of the value of the furniture and fittings, which in this case would be RM75,000.

Of course, as the C/A is dependant upon the value of the furniture and fittings, the figure would rise and fall accordingly. If you spent a higher amount, the C/A would also be higher, and vice versa. (Of course, this also means that if the property is unfurnished, there is no claim for C/A.) It would however remain at a constant 8%. Also, as the years go by, the figure would be 8% of the depreciated value every year.

4. When does Rental Income become a Business Income?

Firstly, let me explain about Rental Income. In Malaysia, Rental Income is under Section 4D of the Income Tax Act 1967. The income is taxable and you have to declare it. Not doing so would be an offence under the Act, and I'm sure you have no deep desire to spend time in a correctional facility (known as a jail cell to the rest of the world) with a roommate named Bubba.

But the IRB is not all thorns. You can deduct most of the expenses incurred to maintain the property. These include repairs made to maintain the property, advertisements made to look for tenants, commission paid to agents, quit rent, assessment tax and also the interest portion of the mortgage (interest only and not the full mortgage). However, you are not allowed to depreciate the building or land.

Now, the story gets more exciting. The IRB has very kindly agreed to treat rental as Business Income when you have a number of rental properties. In other words, the income now falls under Section 4A of the Act and not Section 4D. And because the income is now a Business Income, it means that you can now claim for capital allowance.

Of course, there are some requirements that you must meet before the getting all these fabulous benefits. Nothing worthwhile in this life is free. The following are the minimum requirements you must have before the Rental Income can be considered a Business Income:

3 or more lots in a shopping complex
2 or more shop-houses
4 or more residential properties
A combination of any four of the above

By the way, this only applies to properties that are rented out to external parties (not to directors or staff) and not the property that you are staying in. (If you do not meet the above requirements, then the income is treated as Rental Income and you cannot claim for C/A. You can however claim for all valid expenses mentioned earlier such as interest, commission and taxes paid.)

5. Why is it good?

Although C/A is a paper entry only, it is a valid deduction as far as the IRB is concerned. It is good because it reduces your income (on paper) and therefore reduces your tax due.

6. If you are still hazy about the matter.

Please contact a knowledgeable and reliable tax consultant. He/she will be more than happy to help you with the matter. (If your current tax consultant has never even heard the words C/A, find a new consultant!)

 

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