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Profits Tax - Interest expenditure 

In general, interest is deductible if the money was borrowed for the purpose of producing assessable profits. The question of deductibility hinges on the use of the money borrowed. If it is used as circulating capital, it is generally allowable. If it is used for private investment or personal use, it is not deductible.  

If the money is to purchase fixed assets, it is allowable providing the asset is being used for producing the assessable profits. If the fixed asset is not completed (that is not being used for producing profits yet), the related interest will be capitalized and therefore not deductible.  If the fixed asset has been completed and is ready for use, then the interest is revenue nature and deductible.

A lot of tax disputes arise where the money is used for a combination of purposes. In such case, the amount attributable to each purpose should be ascertained and apportioned accordingly. 

Section 16(1)(a) of Inland Revenue Ordinance states the basic test of deductibility for interest expenditure. In short, the interest will be deductible if it satisfies Section 16(1) and at least one of the conditions laid down in Section 16(2).

When considering the purpose of the loan, regard must only be made to the direct and immediate purpose of the loan. In the case Zeta Estates Ltd. v CIR, the Board of Review found that the direct and immediate purpose of obtaining the loan was for distribution of dividends to the shareholders. The taxpayer, however, claimed that the loan was to replenish the company's working capital after the distribution of dividend. The Board did not accept the claim as fulfilling the section 16(1) requirement of “in the production of assessable profits”. As section 16(1) fails, there is no need to consider the conditions under section 16(2). The taxpayer appealed to the court against the Board’s decision. The courts at last allowed the taxpayer's appeal.

Press here for Section 16(2) conditions

Read IRD's query: Where the taxpayer claims deduction of interest

Tax analysis programs for taxpayers

 

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