Pioneer status, investment tax allowance, and reinvestment allowance

This article is relevant to candidates preparing for the Advanced Taxation (ATX‑MYS) exam. The article is based on the prevailing laws as at 31 March 2018.

This article collates and discusses the provisions in the Income Tax Act 1967 (the Act), and the Promotion of Investments Act 1986 (PIA). While reading this article, candidates are expected to refer to the relevant provisions of the Act and PIA, as amended.

This article is relevant to section A2(c) of the syllabus and study guide.

Section A2(c)(iii), (iv), and (v) require candidates to be able to determine tax liabilities of companies, involving application of the following exemptions and reliefs:

(iii) Pioneer status,
(iv) Investment tax allowance, and
(v) Reinvestment allowance.

Candidates must first study closely the source authority for these incentives – ie the relevant laws, and the respective IRB public rulings or guidelines, where available, to obtain a good general understanding. This article aims to augment that understanding through comparison, contrasting, and analysis.

The incentive measures discussed in this article are:

Mode of incentive

Incentive measure

Full or partial exemption of statutory income Pioneer status
Additional relief for qualifying capital expenditure

Investment tax allowance


Reinvestment allowance


Terms used

The following abbreviated terms are used in this article: 

  • AI: Adjusted income
  • CA: Capital allowance
  • DGIR: Director General of Inland Revenue
  • IRB: Inland Revenue Board
  • ITA: Investment Tax Allowance
  • MIDA: Malaysian Investment Development Authority
  • PIA: Promotion of Investments Act 1986
  • PR: Public Ruling
  • PS: Pioneer Status
  • RE: Residual Expenditure
  • QCE: Qualifying capital expenditure
  • QP: Qualifying Project
  • RA: Reinvestment Allowance
  • SI: Statutory income
  • The Act: Income Tax Act 1967
  • TRP: Tax Relief Period
  • YA: Year of assessment

Pioneer status

General
It is possible for a company to be granted PS by MIDA for multiple promoted products or promoted activities with their respective TRPs commencing and ending on different dates. The production day is significant as it marks the commencement of the PS – ie the TRP subsists for exactly five years from the production day. Separate accounts must be kept for each pioneer business, distinct from the rest of the business activities.

A pioneer company is deemed to have three periods in its lifecycle: pre-pioneer, pioneer and post-pioneer periods. The pioneer business is deemed to have permanently ceased at the end of the TRP. A new business (post-pioneer business) is deemed to have commenced on the day following the end of the TRP. This has implications for CA.

During the TRP of a company which has been granted the standard (or normal) PS, 70% of the SI of pioneer income after deduction of various losses (see Appendix B) is exempted. The balance of 30% is "leap-frogged" to the total income stage to form part or whole of the total income of the pioneer company. This means that the 30% is quarantined for tax: approved donations and other deductions from aggregate income are by-passed (see Illustration 2).

Treatment of CA – pre-pioneer, pioneer, post pioneer
CAs are compulsorily deducted from the AI of a pioneer business – ie the income of pioneer company is reduced by CAs notwithstanding that no claim for such allowances is made.  

Appendix A contains the CA rules for pioneer companies. As they are highly technical, illustration 1 below is provided to explain them:

Illustration 1

Facts
ABC Sdn Bhd (ABC) was granted PS in respect of its promoted product on 1 May 2013. The manufacturing business commenced on 1 November 2013. The 'production day' for PS purposes was ascertained to be 1 September 2014. ABC closes accounts annually to 31 December.

QCE was incurred as follows:

Date RM'000
10 July 2013360
15 December 2013400
4 April 2014120
7 July 2019680

Based on the above, the three periods are:

  1. Pre-pioneer period: 1 November 2013 to 31 August 2014
  2. Pioneer period: 1 September 2014 to 31 August 2019
  3. Post-pioneer period: 1 September 2019 et seq


The basis periods are as follows:

YA Basis period  QCE incurred (RM'000)
YA 2013  1 November 2013 to 31 December 2013  Pre-pioneer760 (360 + 400)
YA 2014 1 January 2014 to 31 August 2014 Pre-pioneer120
YA 2014 1 September 2014 to 31 December 2014 Pioneer 
YA 2015 1 January 2015 to 31 December 2015 Pioneer 
YA 2016 1 January 2016 to 31 December 2016 Pioneer 
YA 2017 1 January 2017 to 31 December 2017 Pioneer 
YA 2018 1 January 2018 to 31 December 2018 Pioneer 
YA 2019 1 January 2019 to 31 August 2019 Pioneer 
YA 2019 1 September 2019 to 31 December 2019 Post-pioneer680

Computation and deduction of CAs –
click here


Treatment of losses   
The rules relating to the treatment of losses for a pioneer company are contained in Appendix B.

Illustration 2 below serves to illustrate the mechanism of exemption of pioneer income. In particular, note the following:

  1. 70% of the SI of pioneer business(es) – ie after deducting CAs, is used to set-off losses from non-pioneer business, and then pioneer business (in that order)
  2. The balance, if any, after setting off the losses, is the amount exempted, and this amount is credited to the exempt account
  3. The remaining 30% is leap-frogged to total income, which means this 30% pioneer income cannot be used to absorb current year losses [under s44(2)], and approved donations.
     

Illustration 2
Sample computations for a pioneer company
 

Facts
DEF Sdn. Bhd. has the following sources of income:


YA 2018

   RM'000
Business 1 (non-pioneer)SI 142
Business 2 (non-pioneer)Adjusted loss (389)
Business 3 
- pre-pioneer
- pioneer

Adjusted loss
Adjusted loss
           
(40)
(99)
Business 4 (pioneer)SI 300
Interest income  80
Unabsorbed non-pioneer business loss b/f  (25)
Donation (approved)  10

YA 2019

    RM'000
Business 1 (non-pioneer) SI 120
Business 2 (non-pioneer)  SI           
50
Business 3 (pioneer)
 SI           70
Business 4 (pioneer) SI 500
Interest income   132
Donation (approved)   50

Computation of tax charged –
click here

Investment tax allowance

General
Like PS, ITA is an incentive measure available only for promoted products or promoted activities. It is an alternative to PS, but comes in the form of additional relief of 60% of the qualifying capital expenditure (QCE) incurred to be set-off against 70% of SI. QCE for ITA is defined in s29 of the PIA. [Note: Candidates are expected to be conversant with this definition.]

ITA and PS are mutually exclusive. Also, once a promoted product has been granted ITA, the said promoted product cannot qualify for another round of ITA later on after the five year TRP from the date on which the approval is agreed to take effect. Separate accounts must be kept in respect of the promoted product or activity which has been granted ITA [s43A of PIA].

Sample computations
The worked example below illustrates the mechanism of computing ITA and the set-off against SI.


Illustration 3

Facts
OPQ Sdn Bhd (year-end 31 December) was granted ITA in respect of its manufacturing of a promoted product with effect from 1April 2018. QCE and forecast income for the promoted product is expected to be as follows:

YAAI
(RM'000)
CA
(RM'000)
Date QCE
incurred
QCE incurred 
(RM'000)
20183,0003,00010 August 201860,000
201922,5002,5002 February 201912,000
202037,0007,000 Nil

Computation and set-off of ITA –
click here

It should be noted that in the above illustration, the TRP runs from 1 April 2018 to 31 March 2023. Any QCE incurred after 31 March 2023 will not be eligible for ITA.

Reinvestment allowance (RA)

General
RA is an incentive provided under the Act [Schedule 7A] to encourage reinvestment or continued investment by foreign and domestic investors, hence the rather long 15-year TRP.

RA shares similarities with ITA in its features and the incentive mechanism. The additional relief on QCE incurred is 60% to be set off against 70% of the SI from the business in respect of the QP. [See Illustration 3]

If a company is of the view that it fulfils the stipulated requisites, it may claim RA in the relevant tax return. There is no requirement to apply for prior approval from any authority. In the past, there has been a high incidence of DGIR's differing interpretation regarding:

  • What constituted qualifying capital expenditure
  • What part of the 'factory' qualified, and
  • What activities constituted 'manufacturing'.


Many cases went to the courts for judicial determination. These cases were followed by laws being amended and public rulings issued to better reflect DGIR's interpretation. The situation has now stabilised somewhat and the following features are now applicable:

  • The part of a factory that qualifies for RA is restricted to the portion of the floor areas used to place or install plant and machinery for a QP, or to store raw materials or finished goods provided the storage space is not more than 10% of the total floor area.
  • Plant and machinery only includes those used directly in the manufacturing activity. The assets used after the manufacturing process do not qualify for RA.
  • 'Manufacturing' is defined in the law [paragraph 9, Schedule 7A and gazette order]: it states specifically both the activities included and excluded.
     

Comparison and analysis
Below is an analysis of the three incentive measures to help candidates in the selection of the appropriate incentive to optimise tax benefits. 

 

 

PS

 

ITA

 

RA

Eligible product or activity Must be promoted product or promoted activity Must be promoted product or promoted activity Need not be promoted product. Must have 'qualifying project', as defined, for manufacturing or farming business
TRP Five years from the production day Five years from the agreed effective date of approval 15 consecutive years from the first claim of RA
Capital intensive? Not relevant Must have substantial capital expenditure, and must be incurred during the five year TRP Must have substantial capital expenditure
Approval needed

Approval by MIDA

 

Approval by MIDA No prior approval from any authority is needed. But the claim is subject to DGIR's scrutiny and interpretation
Restriction on QCE? No, as the exemption is based on income, not on capital expenditure incurred

• Generally, no restriction on QCE as defined in PIA [s29]

• No restriction on factory space, factory storage space not restricted to 10%

• However, ITA cannot be given for replacement of existing plant and machinery, or for automation per se

Considerable restriction on QCE:

• Only plant and machinery directly used in manufacturing qualify

• Plant and machinery used in post-production do not qualify

• Factory space is restricted to where plant and machinery is installed, and only 10% storage space

Set-off of
CA

 

CAs are compulsorily deducted. Special rules apply on eligibility and set-off of CAs Normal CA rules under Schedule 3 of the Act apply Normal CA rules under Schedule 3 of the Act apply
Set-off of losses Special rules apply on set-off of non-pioneer and pioneer loss Normal loss rules per the Act [s43(2) and s44(2)] apply Normal loss rules per the Act [s43(2) and s44(2)] apply
Carry forward of unabsorbed allowance Not applicable as no unabsorbed allowance is carried forward Unabsorbed ITA may be carried forward to be set-off against SI of same promoted product/activity until fully absorbed Unabsorbed RA may
be carried forward to be set-off against SI of same business until fully absorbed
Any income compulsorily subject to tax? Yes. 30% of SI of pioneer business will be taxed, regardless of loss or donation No. Absorption is at SI, no balance goes to form part of total income No. Absorption is at SI, no balance goes to form part of total income

Exempt income, exempt dividend

 

Pioneer income after CAs and losses is exempt and credited to exempt account for distribution of exempt dividend Amount of ITA absorbed against SI  is credited to exempt account
for distribution of exempt dividend
Amount of RA absorbed against SI is credited to exempt account for
distribution of exempt dividend
General PS is beneficial
if substantial pioneer profits are generated early in the TRP
ITA is beneficial for capital intensive projects. After approval by MIDA, room for DGIR's interpretation is minimal RA's scope is widest (QP on expansion, modernisation, automation and diversification), and TRP is longest, but is subject to DGIR's scrutiny and interpretation

 

Appendix A

CA rules for a pioneer company

1. Where a pre-pioneer asset is used in a pioneer business:

  • the RE at the end of the basis period for the YA immediately prior to the YA in the basis period during which the TRP commences, is deemed to be the RE on the commencement of the pioneer business
  • QCE incurred in the period in which the date of cessation of the pre-pioneer business falls, is deemed to be incurred on the day of commencement of the pioneer business.


2. Where the asset is used for the pioneer business and continues to be used for the post-pioneer business:

  • the RE at the end of the basis period from the YA immediately prior to the YA in the basis period in which the day of commencement of the post-pioneer business falls, is deemed to be the RE on the day of commencement of the post-pioneer business
  • any QCE incurred during the basis period in which the date of cessation of pioneer business falls shall be deemed to be incurred on the day of commencement of the post-pioneer business.


3. Where pre-pioneer CAs cannot be utilised or cannot be utilised in full, such unabsorbed CAs are set off against the income from the pioneer business.

4. Any unabsorbed pioneer CAs are carried forward to the following YA during the pioneer period.

5. Where CAs cannot be fully utilised by the pioneer business for the YA in the basis period immediately prior to the YA in the basis period in which the day of commencement of the post-pioneer business falls, such unabsorbed CAs shall be carried forward to be set off against the income of the post-pioneer business. 


Appendix B

Rules on absorption of losses for a pioneer company
The following rules are deduced by reading together s21A of PIA and sections 43 and 44 of the Act. 

Provision

Comments

The pioneer income of a pioneer company is reduced to the extent of any adjusted loss for the basis period for a YA in respect of a business relating to:

 

Losses referred to here are current year losses

(a) a non-promoted activity or product

 

This refers to a non-pioneer business current year loss


This means that current year non-pioneer loss should be utilised against current year pioneer income

(b) a promoted activity or promoted product for which no PS or ITA was granted

 

This refers to a non-pioneer business, but more significantly, it excludes the current year pre-pioneer loss – ie in the first YA in which TRP commences


This means that the pre-pioneer loss for the YA in which TRP commences cannot be set-off against pioneer income. This loss is therefore treated under the loss provisions in the Act, under s44(2) against aggregate income from non-pioneer sources, failing which it is to be carried forward and set off against non-pioneer business income under s43(2)

(c) a promoted activity or promoted product granted pioneer status or ITA but whose TRP has expired This refers to the unabsorbed pioneer loss b/f from a pioneer business whose TRP has expired


Other observations

  1. The non-pioneer loss thus utilised against the SI of the pioneer company in respect of the pioneer business for a YA shall be disregarded for the purposes of sections 43(2) and 44(2) of the Act
  2. This means that any non-pioneer loss should first be set off against current year pioneer income and the amount of such loss thus utilised is no longer available for set off against current year non-pioneer income.  [s21A (3) of PIA]
  3. Non-pioneer losses are deducted first [in s21A of PIA] before deducting pioneer losses in a YA from the 70% pioneer income
  4. A loss incurred in respect of a pioneer business during the TRP will be set off against any income from the pioneer business(es) of the company. [s25(1) of PIA]
  5. Any unabsorbed pioneer losses at the end of the TRP shall be carried forward to the post-pioneer period to be set off against the SI of all businesses [under s43(2) of the Act]

Written by a member of the ATX-MYS examining team