At a glance
- Section 224 of the Companies Act 2016 prohibits a company lending to its directors, but section 224(2)(a) puts an exempt private company outside the prohibition entirely — which covers a large share of owner-managed Sdn Bhds.
- Section 140B of ITA 1967 deems interest income only where the loan is funded from the company's internal funds; a loan genuinely financed from external borrowing is not caught, though it can create a perquisite for a director who is also an employee.
- The deemed interest computation runs on the balance at the end of each calendar month, so a nil balance at the financial year end does not remove the adjustment for the months the balance existed.
A director's loan account is one of the most common items on an owner-managed Malaysian company's balance sheet, and one of the most commonly mishandled. The difficulty is that two authorities look at the same balance and ask different questions. The Companies Act 2016, administered by the Companies Commission of Malaysia (SSM), asks whether the company was permitted to lend at all. The Income Tax Act 1967 (ITA 1967), administered by Lembaga Hasil Dalam Negeri Malaysia (HASiL), asks whether the company should be taxed on interest it never charged. A company can settle one question and leave the other open without noticing.
Section 224 asks whether the company could lend at all
Section 224(1) of the Companies Act 2016 prohibits a company from making a loan to a director of the company, or to a director of a company deemed related to it under section 7. The same subsection reaches indirect support: the company must not stand as surety, or provide security, in connection with a loan made to such a director by another person.
What the ledger calls the balance is not decisive. Where a company settles a director's personal spending and carries the amount as a receivable, or where drawings accumulate over several years in a current account, the substance is a loan for the purposes of section 224. The provision is drafted around the transaction, not the bookkeeping label.
The exempt private company carve-out is the first thing to check
Section 224(2)(a) provides that nothing in section 224 applies to an exempt private company. That exclusion matters far more in practice than the breadth of the prohibition suggests, because a large share of Malaysian owner-managed companies fall within the definition: broadly, a private company in whose shares no corporation holds a beneficial interest, directly or indirectly, and which has not more than twenty members, none of whom is a corporation.
The status should be confirmed against the definition in section 2 and the company's own register of members rather than assumed. A single corporate shareholder anywhere in the ownership chain takes the company outside the definition, and the position can change without any decision by the company itself.
Section 225, which deals with loans to persons connected with a director — a spouse, child, parent, sibling and the other relationships identified in section 197 — is drafted differently. It applies to a company other than an exempt private company. Both sections leave the exempt private company outside the prohibition, but they reach different borrowers, so identify the borrower before selecting the section.
Where the prohibition applies, the exceptions are narrow and timed
Section 224(2) also excludes funds provided to a director to meet expenditure incurred for the purposes of the company or to enable him properly to perform his duties as an officer; funds provided to a director in the full-time employment of the company or its holding company to purchase or otherwise acquire a home; and a loan to such a director under a scheme for loans to employees that the company has approved by resolution.
Two of those exceptions carry a procedural condition. Section 224(3) requires the prior approval of the company by a resolution in which the purpose of the expenditure and the amount of the loan, or the extent of the surety arrangement or security, are disclosed. Where prior approval was not obtained, section 224(4) allows a private company to authorise the arrangement within six months of the loan being made, and a public company to do so at or before its next annual general meeting. If no authorisation follows, section 224(5) requires the loan to be repaid — for a private company, after twelve months from the making of the loan.
The consequences of missing that sequence sit with the directors rather than with the recipient alone. Under section 224(6) the directors who authorised the arrangement are jointly and severally liable to indemnify the company against any loss incurred, and section 224(7) preserves the company's ability to recover the amount notwithstanding the contravention. Contravention is also an offence, carrying on conviction imprisonment for a term not exceeding five years or a fine not exceeding three million ringgit, or both. A separate carve-out in section 224(8) covers a financial institution lending to a director in the ordinary course of its business.
Section 140B asks something different
Section 140B of ITA 1967 applies from year of assessment 2014. Where a company provides a loan or advance to a director without interest, or at a rate below the arm's length rate, the company is deemed to have gross income consisting of interest from that loan, assessed under paragraph 4(c). HASiL's Public Ruling No. 8/2015, published on 30 November 2015, sets out how the provision is applied.
Nothing in section 140B turns on the company's status under the Companies Act 2016. An exempt private company that lends to its director entirely lawfully is still within section 140B. This is where the two tests separate, and it is where a company that has satisfied itself on the company-law question most often assumes the tax question has been settled as well.
The internal funds condition is the real boundary
Public Ruling No. 8/2015 confines section 140B to loans funded from the company's internal funds, which it describes as surplus funds arising from an injection of capital, retained earnings and company reserves. Where the loan is financed from external funds — a bank or third-party borrowing obtained for that purpose — the ruling states that section 140B does not apply. Where funding is mixed, deemed interest is computed only on the portion attributable to internal funds, and the company carries the burden of proving which part came from outside.
The external-funding route is not free of consequence, and the ruling says so. Where a company borrows from a third party to lend to a director who is also an employee, the interest cost the employer incurs on that borrowing is a perquisite to the director, forming part of the employee's gross income under paragraph 13(1)(a). The exposure moves from the company to the individual rather than disappearing.
Not every director is a director for this purpose
Section 140B uses the meaning of “director” in subsection 75A(2), which turns on shareholding as well as office. Public Ruling No. 8/2015 works this through: in one of its worked examples a director holding less than twenty per cent of the ordinary shares is not a director for the purpose of the provision, and the portion of the advance attributable to him is excluded from the computation. The ruling also looks through a loan made to a partnership whose partners are directors of the lending company, apportioning the amount by capital contribution.
The computation is monthly, which is why a nil year-end balance does not help
Deemed interest is computed month by month under the formula in subsection 140B(2): one-twelfth of the amount outstanding at the end of each calendar month, applied to the average lending rate of commercial banks published by Bank Negara Malaysia at that month end. The outstanding amount is the balance after deducting repayments and adding advances made during that month.
It follows directly that a balance repaid before the financial year end still produces deemed interest for every month it was outstanding. A clean closing balance is not evidence that no adjustment is due, and preparing the schedule only at year end will not produce the right figure. Where the company does charge interest, subsection 140B(3) takes the higher of the interest charged and the formula amount and disregards the lower. A dormant company is not outside this: the ruling treats a dormant company that lends to a director as having commenced operations under subsection 21A(8).
The alternatives, and what each of them costs
- Salary or bonus, where the director is genuinely employed. Deductible to the company on ordinary principles, but it brings monthly tax deduction, statutory contributions and reporting on the employee's annual statement.
- Directors' fees. For a private company the board may approve the fees and benefits payable to directors, subject to the constitution; the approval is recorded in the minutes and shareholders are notified within fourteen days. Members holding at least ten per cent of the total voting rights who consider the payment not fair to the company may require it to be put to a resolution.
- Dividend. Available only out of profits available for distribution and only where the company meets the statutory solvency requirement, and not deductible to the company.
- Reimbursement of expenditure actually incurred for the company, supported by records showing the business purpose.
- A loan taken deliberately, documented, approved on the section 224 route where that section applies, and carrying interest at not less than the formula amount so that no deemed adjustment arises.
Where this is routine, and where it is not
For an exempt private company with a single director-shareholder, a modest balance cleared during the year and a monthly schedule already in place, this is internal work and there is no reason for it to become anything larger. The judgement calls are narrower: a corporate shareholder that has entered the register and removed exempt private company status; a balance that has persisted across several years; companies in one group lending to each other's directors, where section 7 brings the arrangement within section 224; funding that is partly internal and partly external and has never been evidenced; a shareholding that sits close to the twenty per cent line; and a dormant company that has made an advance without appreciating the effect on its own filing position.
General-information limitation
This article is general information about section 224 of the Companies Act 2016 and section 140B of the Income Tax Act 1967. It is not legal or tax advice for a particular company, and it does not determine whether any arrangement is permitted, whether any entity is an exempt private company, or what adjustment any company should make. Requirements and published guidance can change. Confirm the current position against SSM and HASiL material, and obtain advice on your own facts where the matter is material.
To discuss a director's loan balance in your own company, see Saifudin & Co's tax advisory and compliance and accounting and financial reporting services.