What is Capital Allowance in Malaysia? Rate, Types, and Calculations

In Malaysia, capital allowance is a tax deduction that allows businesses to recover the cost of fixed assets over time, similar to depreciation but specifically for tax purposes. Under Section 42(1) of the Income Tax Act (ITA), businesses can claim capital allowances on the cost of qualifying fixed assets.

The Inland Revenue Board of Malaysia (IRBM) has established specific eligibility criteria, rates, and calculation methods that businesses must adhere to when claiming capital allowances. This guide provides a detailed overview of capital allowances, including their types, applicable rates, and the process for claiming them in Malaysia.

What are Capital Allowances? 

Capital allowances are deductions allowed to businesses in respect of qualifying fixed assets, such as machinery, equipment, and vehicles, to reduce taxable income. Since depreciation is not tax-deductible in Malaysia, capital allowances act as tax relief on the wear and tear of business assets. 

Businesses can claim capital allowances under the following conditions:

• Capital allowances are available only to businesses. This is not available to individuals.
• The asset must be of a capital nature and used in business operations.

What Assets Qualify for Capital Allowances?

The capital allowance rules and regulations are outlined in Schedule 3 of the ITA. However, not all capital assets recorded in the accounting books qualify for CA. As per Paragraph 70A of Schedule 3 of the ITA, there is a requirement that an asset must satisfy the definition of "plant": 

"An apparatus used for carrying on a business, excluding buildings, intangible assets, or any asset that serves as a place where the business operates."

This means that structures like buildings and office spaces do not qualify for capital allowances. Therefore, the following are common business assets that qualify for capital allowances:

• Motor vehicles
• Machinery
• Office equipment
• Furniture & fixtures

Depreciation Vs. Capital Allowance

While depreciation and capital allowances are closely related and may seem similar, they serve different purposes, follow different rules, and impact financial reporting and taxation in distinct ways. 

Capital Allowance Rates for Different Asset Types in Malaysia

Capital allowances in Malaysia are categorized into two types: Initial Allowance (IA) and Annual Allowance (AA). These allowances help businesses recover the cost of capital assets used for generating income. 

• Initial Allowance (IA): A one-time deduction of 20% of the asset's cost, granted in the year the capital expenditure is incurred.
• Annual Allowance (AA): A percentage fixed and deducted annually from the original cost of the asset, continuing till the asset is completely written off from the books.

This table summarizes the LHDN capital allowances rates in Malaysia

Further, for vehicles used for non-commercial purposes, the qualifying expenditure (QE) is capped at the following amount:

How To Calculate Capital Allowances?

Capital allowances are based on the qualifying expenditure (QE) of a business asset. The deductions include an initial allowance (IA) and an annual allowance (AA), which reduce the taxable income. Any unabsorbed capital allowance can be carried forward to future years but can only be offset against income from the same business source.

Here’s a general formula for the calculation of capital allowance: 

Let’s take a few examples to understand this calculation better: 

Example 1: XYZ Sdn Bhd purchased heavy machinery worth RM200,000 in 2020.

Q1: What is the maximum capital allowance claimable?
Answer: RM200,000

Q2: What is the Residual Expenditure (RE) after three years (2023)?
Answer: RM40,000 

Capital Allowance Calculation at the end of year 3

Q3: If the machinery is sold for RM150,000 at the end of 2023, is there a balancing charge or allowance?

Answer: Balancing Charge = Disposal Value - Residual Expenditure = RM150,000 - RM40,000 = RM110,000. So basically, the balance charge is the profit on the sale of such assets. 

So, a balancing charge of RM110,000 will be added to taxable income.

Example 2: Motor Vehicle with Limited Qualifying Expenditure: XYZ Sdn Bhd purchased a car worth RM198,000 in 2018.

Q1: What is the maximum capital allowance claimable?
Answer: RM50,000 (since the claim is capped). 

Q2: What is the Residual Expenditure (RE) after two years (2020)?
Answer: RM10,000. 

Capital Allowance Calculation at the end of Year 3

Q3: If the car is sold for RM98,000 in 2020, is there a balancing charge or allowance?

Answer: Calculation:

Deemed Disposal Value = (Selling Price / Purchase Price) x Qualifying Expenditure  

                      = (RM98,000 / RM198,000) x RM50,000  

                      = RM24,747  

Balancing Charge = Deemed Disposal Value - Residual Expenditure  

                 = RM24,747 - RM10,000  

                 = RM14,747 

So, a balancing charge of RM14,747 will be added to taxable income.

Common Mistakes to Avoid When Claiming Capital Allowances

Claiming capital allowances (CA) incorrectly can lead to over- or under-claimed amounts, resulting in tax issues. Here are key mistakes businesses should avoid:

• Misidentifying Qualifying Expenditure – Not all capital expenses qualify for CA. Some assets may be claimable in one industry but not another (e.g., decorative items in hotels vs. software firms). Structural elements of a building are generally not eligible.
• Claiming Before Asset is in Use – CA can only be claimed once the asset is actively used for business. Simply purchasing or installing the asset does not qualify.
• Incorrect Asset Transfers Between Related Companies – When transferring assets between related entities, they must be recorded at their tax written-down value (TWDV), not the selling price, to avoid tax miscalculations.
• Claiming for Assets Used by Another Company – If an asset is purchased by one company but used by a related business, neither company can claim CA since the purchasing company is not using it, and the other did not incur the cost.
• Poor Documentation – Lack of proper records (invoices, payment proof, asset details) can result in CA claims being denied during tax audits. Businesses must retain documentation for at least seven years for compliance.

Importance of Capital Allowances for Malaysian Businesses

Capital allowances relieve businesses on capital expenditure, enabling them to manage cash flow and reduce tax liabilities. This will allow the company to reinvest in necessary assets to grow sustainably. Here is why capital allowance is essential for Malaysian businesses: 

• Capital allowances reduce taxable income, reducing a business's overall tax liability.
• The capital allowance claims give an immediate cash benefit to improve business cash flow.
• It allows businesses to retain more funds for reinvestment and possible future expansion.
• No limits for high tax-paying businesses, making capital allowances accessible to all businesses.
• This tax relief encourages businesses to invest in new equipment and machinery and acquire new technology, thereby increasing capital investment in the country. 

Conclusion 

In Malaysia, capital allowance is a tax relief that helps businesses recover the cost of qualifying fixed assets such as machinery, vehicles, and equipment, reducing taxable income. Unlike depreciation, which is used for accounting purposes, capital allowances are designed specifically for tax benefits under the Income Tax Act (ITA). 

Businesses can claim Initial Allowance (IA) (one-time deduction) and Annual Allowance (AA) (recurring deduction) based on asset type, with rates varying for different assets. For example, heavy machinery qualifies for 20% IA and 20% AA, while office equipment gets 20% IA and 10% AA. Capital allowances cannot be claimed on buildings or intangible assets, and claims must be backed by proper documentation.