Richard Thornton lifts the veil on capital allowances

Capital allowances, which are provided by law, are intended to give a measure of relief for wear and tear of fixed assets for business operators. They are not available to all property investors, only those who qualify to have their rents treated as business income. See RENTS AS BUSINESS INCOME: BENEFITS AND SNAGS in the September 2010 issue.

Capital allowances are based on qualifying capital expenditure incurred for the purposes of  “the business” at rates which are specified by law. Property investors not eligible for capital allowances must rely upon the “renewals basis” under which no allowance is given for the initial capital expenditure but a deduction from rents is given for the cost of replacing items of furniture and equipment which have become unusable and have to be replaced.

In order to qualify, expenditure must be capital in nature, resulting in the provision of an asset of an enduring nature. The asset must be machinery or plant or a qualifying building and it must be in use for the purposes of the business at the end of the basis period. The defining of the word plant has had a long and chequered career through the courts from the time when it was described as applying to whatever apparatus is used by a businessman for carrying on his business (including a horse) but not to his stock in trade. Bearing mind that the business in the present context is the exploitation of property held to produce income we can deduce that plant will include furniture and fittings in and about the rented property and also equipment such as tools and equipment for the use of the owner and his staff in maintaining the property and the environment. Some items particularly cookers, refrigerators and vacuum cleaners are machinery. Larger items such as air conditioning equipment and water pumps will not always qualify. It would depend upon the circumstances of the property and the letting.

Normally, capital allowances consist of an initial allowance which is given once only at the rate of 20% at the time when the capital expenditure is incurred and a flat rate annual allowance given every year based on the original cost of the asset. Annual allowance rates vary according to the nature of the assets and the principal rates are:

 
The annual allowance is given for each year until the capital expenditure has been fully written off, unless the asset is sold or scrapped, in which case a balancing allowance or balancing charge will be calculated.

However, accelerated allowances were made available under the government’s 2009 stimulus measures. Time is short to take advantage of these because both apply to capital expenditure incurred only up to 31 December 2010. For eligible small companies, there is a one-year write off for capital expenditure incurred in 2009 and 2010. The other accelerated allowance, available generally, is for expenditure incurred between 10th March 2009 and 31st December 2010 and consists of an initial allowance at 20% and an annual allowance at 40% to give a two-year write off. 

Example:

Pleasant Investments Sdn Bhd owned and rented out several (at least four) residential properties and its renting was treated as a business activity. Pleasant Investments Sdn Bhd is not eligible for the small company incentive. For the year ended 31 December 2009, the following applied:

Chargeable income for the year of assessment 2009:

When an asset is acquired on hire purchase, capital allowances are given as the expenditure is incurred. The next example illustrates this as well as a balancing adjustment on sale:

  For the year ended 31 December 2010, the following applied to Pleasant Investments Sdn Bhd:

Chargeable income for the year of assessment 2010:

The balancing charge is calculated by deducting the residual value of the motor van (Nil) from its sale proceeds. As the motor van was bought in 2004, its cost is fully written off (initial allowance 20% plus 4 years’ annual allowance at 20%). The capital allowances on the new van are based on the expenditure incurred during 2010, RM16,000 for the deposit and RM18,000 for the instalment payments. Annual allowance for 2010 and 2011 is calculated at the accelerated rate of 40%. The remaining instalment payments will qualify as they are incurred in later years but as they will fall after 31st December 2010, the annual allowance rate will be the normal 20%.

Industrial buildings allowances are given for capital expenditure incurred on the construction or purchase of buildings used for industrial purposes. They do not apply to all commercial buildings. Except for certain special kinds of building, the rates are 10% initial and 2% annual.  A company may become eligible for industrial building allowances by incurring capital expenditure on a factory or warehouse for renting.

Property investors should be aware that capital allowances are only available in restricted circumstances. The property income must be treated as business income. Such treatment on the quantitative basis (minimum number of properties of the same kind) is only available to a company and, even then, only to one which is not treated as an investment holding company.

Richard Thornton is author of 100 Ways to Save Tax in Malaysia for Property Investors (ISBN978-983-2631-83-5) and 100 Ways to Save Tax for Malaysian Investors (ISBN978-967-5040-42-9) published by Sweet & Maxwell Asia. See http://malaysiaauthorindex.com/wiki/Richard Thornton. He is also a Fellow of the Chartered Tax Institute of Malaysia.

The two works referred to immediately above contain some valuable insights on how to achieve legitimate tax savings for investors in property and other assets as well as dealing with complex issues such as “When can an investor be taxed as a dealer?” and “Is it a good idea to use a company?” Written in clear simple language, the books contain helpful examples to explain how the tax planning ideas can be put into action. They can be obtained from most book stores, or from the author at ricton100@gmail.com