How To Save Tax on Your Loan
Tax expert Richard Thornton explains how you could save potentially thousands of ringgit just by knowing when to claim relief from your loan interest
Most property investors whether corporate or individual need to make use of borrowed money to help them finance their purchase. Similarly, individuals purchasing a property as a residence would often be unable to purchase the property of their choice without resort to a bank loan. Luckily, Malaysian banks are often only too willing to provide the funds required at a modest rate of interest. Nevertheless, any interest expense seems like a burden to the borrower and whatever can be done to mitigate the cost, such as tax relief on the interest incurred, is welcome.
Interest incurred on money borrowed to acquire a property does not always qualify for a tax deduction so it pays to know exactly how to take advantage when it does.
Rental income tax reduced by loan interest
Rented property: Regardless of whether the property is owned by an individual, a company or other body or by a non-resident, interest on money borrowed to purchase the property can be deducted from income derived from letting the property thus reducing the income tax bill. There are rules that must be observed if the borrower is not to be disappointed by being denied his tax relief.
One fundamental condition is that when a tax deduction is claimed for interest on a loan, the money borrowed must have been used to purchase the property concerned. In order to qualify, the interest needs to have been incurred in a year in which there is income from the property. Any deficit cannot be carried forward. However, it is not essential that the property be let from the time of purchase.
Refinancing an existing property will not necessarily qualify the interest for a tax deduction against the income from that property but if the loan money has been used to purchase a second property, the interest can qualify as a deduction from the income from the second property.
Interest on money borrowed to extend or improve a property can also qualify for a deduction from income derived from that property. However, care must be taken to distinguish between those expenses which represent real improvements and add value to the property itself and those which are really changes to satisfy the personal tastes of the owner.
In 2008, Simon bought a house and occupied it as his residence until late 2009 when he moved out and added an extension. From April 2010, the property has been let to a tenant. Simon has been paying interest on a housing loan taken out to buy the house and subsequently on a further loan taken out to build the extension. Simon will be able to claim a deduction from his rents for the interest incurred on the original housing loan as well as on the loan to finance the extension but only from April 2010.
Interest on your business property loan is business expense
Business property: Although not itself producing any income, a property used for the purposes of a business is productive and interest incurred on money borrowed to finance the purchase of the property is eligible for deduction as a business expense. This applies to any person whether an individual, a company or other body or a non-resident.
Where a property is used for different purposes, the interest needs to be apportioned appropriately and dealt with according to its uses.
Mr. Sim and his wife jointly own a three-storey shop- house property. The ground floor is used for the purpose of the restaurant business carried on by them in partnership, the first floor is let out to tenants and they occupy the top floor as their residence. During 2009, they incurred interest of RM90,000 on a joint loan taken out to buy the land and construct the property on it.
One third of the interest (RM30,000) will be apportioned to the partnership business where it is a deductible expense, one-sixth (RM15,000) will be allocated to each spouse as a rental income deduction and the remainder (RM30,000) qualifies for no deduction as it is a personal expense.
Owner occupied residential property to get relief for first 3 years
Residential property: Normally no tax relief is available for a housing loan used to buy a property for owner occupation but here is an opportunity not to be missed! Act quickly as it is only available up to the end of 2010.
Under the Supplementary Budget of 2009, there is a useful short-term relief by way of a deduction from total income for the interest on a loan used to purchase a residential property. This applies to an individual who is a citizen and a resident of Malaysia who enters into a Sale and Purchase agreement between March 10, 2009 and December 31, 2010. Not more than one property can qualify. It need not be occupied by the owner but that does not mean that it can be let as no relief is given for any year in which there is income from the property.
Deductions are given for the interest incurred in each of the first three years of assessment commencing from the year in which interest is first payable but with a limit of RM10,000 each year. Joint owners have to split the RM10,000 pro rata to their interest expense. This also applies to a husband and wife if they are separately assessed but, if they are jointly assessed, the whole amount is available. It is a personal relief.
Unlike the tax deductions mentioned above which are only given against specific income sources, it can be deducted from all income of the year concerned. As a deduction from total income, this represents a potential tax saving of RM7,800 (RM10,000 at 26% for 3 years). Any deficit cannot be carried forward so purchasers should make sure that they have enough taxable income to take advantage of it.
In 2009, Bill and his wife Mary jointly bought a residential property for their own use. In that year interest on the housing loan used for the purchase amounted to RM15,000. Bill’s chargeable income (total income less reliefs) for 2009 was more than RM100,000 so his marginal tax rate is 26%. Mary’s total income for that year was RM25,000 and this means that, after allowing for the normal rebate of RM400, she will have no tax to pay.
For Bill, the maximum relief will be RM5,000 (50% of the maximum of RM10,000) to give tax a reduction of RM1,300 (RM5,000 at 26%). Mary is unable to make use of her RM5,000 share.
The situation will be the same for 2010 and 2011 if circumstances remain similar. A little planning would have helped. If Bill had been the sole buyer he would have been able to claim the whole relief of RM10,000. At first glance, an election for joint assessment looks inviting as that would allow for the whole of the RM10,000 to be deducted from the joint income. However, that is not a good plan as it would make nearly all of Mary’s total income liable to tax at the 26% rate.
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 (ISBN 978-967-5040-42-9) published by Sweet & Maxwell Asia. He is a Fellow of the Chartered Tax Institute of Malaysia.
These two works 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 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. The books can be found at www.sweetandmaxwellasia.com.my.