The Guidelines on the Tax Treatment of Hybrid Instruments, released by the Inland Revenue Board of Malaysia (IRBM) on 19 June 2024, explain the factors that are taken into consideration by the IRBM in determining whether a hybrid instrument is classified as debt or equity for tax purposes and the tax treatment of a distribution or profit on a hybrid instrument for both the holder and issuer of the instrument.
A hybrid instrument refers to a financial instrument that has features of both debt and equity, such as preference shares, bonds, perpetual loans and profit participating loan notes. According to the IRBM, the general distinguishing features of debt and equity are as follows: Determining whether a hybrid instrument is debt or equity should be based on the substance of the instrument and not solely on its legal form. The factors to be considered include, but are not limited to, the following (arranged according to order of priority by the IRBM):
The above factors are also applicable, with modifications, to determine whether an Islamic hybrid instrument is equity or debt.
According to the IRBM, the tax treatment of hybrid instruments can be summarised as follows: While the guidelines make the IRBM’s views on hybrid instruments clear, their application to taxpayers would require the insertion of provisions in the Malaysian Income Tax Act 1967 that permit the application of the substance-over-form principle to the classification of hybrid instruments for tax purposes.
David Lai
BDO in Malaysia
A hybrid instrument refers to a financial instrument that has features of both debt and equity, such as preference shares, bonds, perpetual loans and profit participating loan notes. According to the IRBM, the general distinguishing features of debt and equity are as follows: Determining whether a hybrid instrument is debt or equity should be based on the substance of the instrument and not solely on its legal form. The factors to be considered include, but are not limited to, the following (arranged according to order of priority by the IRBM):
- The source from which the principal will be repaid and the source of the distribution or profits, as well as the order in which they will be repaid in the case of liquidation or dissolution.
- The right to enforce the payment of distributions or profits and repayment of principal by the instrument holder.
- The rights in the event of default.
- The maturity date of the instrument.
- The ability of the issuer to obtain a loan and make a payment in an arm’s length transaction.
- The right to vote in a general meeting.
- The benefit to the instrument holder.
The above factors are also applicable, with modifications, to determine whether an Islamic hybrid instrument is equity or debt.
According to the IRBM, the tax treatment of hybrid instruments can be summarised as follows: While the guidelines make the IRBM’s views on hybrid instruments clear, their application to taxpayers would require the insertion of provisions in the Malaysian Income Tax Act 1967 that permit the application of the substance-over-form principle to the classification of hybrid instruments for tax purposes.
David Lai
BDO in Malaysia