Public Ruling No. 5/2004 - Double Deduction Incentive On Research Expenditure

“Time-sheet” means a record of actual time spent on a particular research project by an employee who is not involved in research on a full-time basis.

“In-house research” means research carried out in Malaysia by a person within his business for the purpose of using the results of the research for furthering his own business.

“Research” means any systematic study undertaken in the field of science or technology with the object of using the results of the study for the production or improvement of materials, devices, products, produce or processes.

Only revenue expenditure on research directly incurred by a person resident in Malaysia would be eligible for a claim for double deduction. These expenses must be incurred specifically in undertaking in-house research by that person in relation to his business. The said research must be approved by the Minister of Finance. The Minister has, however, delegated such powers to the Director General of Inland Revenue (DGIR).

In the case of scientific research which does not qualify for approval by DGIR under section 34A, claim for expenses on that scientific research may be given consideration under subsection 34(7) of the Act. 

The conditions that must be complied with to be eligible for the deduction under this subsection are as follows: 
(i) the research expenditure must be of a revenue nature; and 
(ii) the research is related to the business and directly undertaken by the person or on his behalf.

Research Activities in Sectors other than Information Technology (IT) & Software

The following are included as research activities:

1. experimental or other work aimed at the discovery of new knowledge or the advancement of existing knowledge;

2. the search for applications of research findings or other knowledge; 

3. research to devise new methods of testing (excluding routine testing and standardisation);

4. the formulation and design of possible new or improved product or process alternatives;

5. the design, construction and testing of prototypes and models;

Example 1 

A prototype is an original model constructed to have all the technical characteristics of the anticipated new product. The design, construction and testing of prototypes would fall within research. Once modification to the prototype and further testing have been satisfactorily completed, then the research phase would have been completed.

6. the design, construction and operation of a pilot plant that is of a scale not economically feasible for commercial production;

7. the design and construction of a pilot plant prior to commercial production;

Example 2

A pilot plant forms part of the research phase for as long as it is used to evaluate hypothesis, develop new product formulae, establish new product specifications, design special equipment and structures and prepare operating instructions or manuals on the process. Once this experimental phase is over, a pilot plant may begin to operate as a commercial production unit, at which point it no longer represents a research activity;

According to Cambridge Dictionary, pilot plant is defined as a small factory that is built as a model to test systems and processes before building other similar factories.

8. the design of tools, jigs, moulds and dies involving new technology. 

Note: The above research activities should have the objective of using the results of the study for the production or improvement of materials, devices, products, produce or processes.

Research Activities in Information Technology (IT) & Software 

Research in IT and software includes: 
(i) the spectrum of activities of research from the conceptual stage to the “proof-of-concept” stage of the project; 
(ii) software research, which may include software design, methodology, computer systems for example computer language, compiler, operating systems and algorithms; or 
(iii) the development or use of software within a larger research project.

Coverage of software research includes: 

(i) Theoretical Computer Science 

Generally, technological or scientific advances in this area produce new theorems and algorithms. 

(ii) Operating Systems 

Technological advances consist of - 
a. a technological improvement in resource and interface management; 
b. a new operating system; or 
c. the conversion of an operating system to a significantly different hardware environment. 

Some examples of operating systems available in the market are: Linux, Windows, Oracle and Unix.

(iii) Programming Language 

Technological advances include: 
a. new languages; 
b. significant extension of an existing language; and 
c. new or significantly different language translators.

Some examples of programming languages available in the market are: C++, COBOL, PASCAL, Visual Basic and JAVA.

(iv) Applications 

Technological advances may occur when a development represents a significant technological step forward (e.g. new combinations of established computer programme components or known programming principles), provided that this integration requires the resolution of technological uncertainties.

(v) Data Management 

Technological advances include the development of: 
a. algorithms to achieve significantly better basic operations (e.g. data retrieval); 
b. new or enhanced query language for databases that significantly increases the power of search or manipulation capabilities; and 
c. new object representations or data structures. 

Significant increase in paragraph b. above means significant increase in terms of response time, efficiency, flexibility, accuracy of data or enhancement in query command language.

(vi) Software Engineering 

Advances in the methodology required to construct computer programmes with greater flexibility, efficiency, reliability and ease of maintenance.

(vii) Artificial Intelligence (AI) 

Scientific and technological advances which are made in such domains as machine vision, robotics, interference, knowledge representation, expert systems, theorem proving, understanding of natural language, automatic language translation, logic programming and future generation systems. The attempt to resolve a technological uncertainty must be demonstrated as a basis for establishing the eligibility of expenditure. 

Non-Research Activities in Sectors other than Information Technology (IT) & Software 

There are activities that may be closely associated with research but are not research. 

The following are examples of activities that would be non-research activities:

1. activities which involve changes in aesthetic values like features, colour planning or artwork to promote the sale of products; 

2. pre-production work prior to commercial production;

3. routine product, process or service development, not involving a significantly innovative scientific or technological advance; 

Example 3 

Routine analysis and testing by subjecting a product to different conditions to suit the local environment. (The product is available overseas and it is meant to be produced and marketed locally eventually).

4. routine systematic programme of work to update an existing product, process or service by the application or introduction of well established techniques or equipment;

5. engineering follow-through in an early phase of commercial production;

6. quality control during commercial production, including routine testing of products or processes;

7. troubleshooting in connection with breakdowns during commercial production; 

8. routine efforts to refine, enrich or otherwise improve upon the qualities of an existing product or process;

Example 4 

The process of chlorinating water and passing it through a normal distillation system so as to enrich / improve upon the quality of water used in the production of dental toothpaste.

9. adaptation of an existing capability to a particular requirement or customer’s need as part of a continuing commercial activity;

10. seasonal or other periodic design changes to existing products or processes;

11. routine design of tools, jigs, moulds and dies;

Example 5 

Design and drawing work for the preparation, execution and maintenance of production standardisation (i.e. jigs and tools) does not constitute research.

12. testing analysis either of equipment or product; or on the suitability of materials for the purposes of quality or quantity control;

13. activities, including design and construction engineering, related to construction, relocation, rearrangement, or startup of facilities or equipment, other than facilities or equipment used solely for a particular research project;

14. activities which only involve product-testing to ensure conformity of its properties to the required standards for purposes of compulsory registration of the product, as required by any law in Malaysia (such as for agricultural chemicals and pharmaceutical products);

15. legal and administrative work in connection with patent applications, records and litigation and the sale or licensing of patents.

Non-Research Activities in Information Technology and Software 

Non-research activities in IT and software includes:

1. product development using IT and its components and commercialisation of the output;

2. routine computer programming, systems maintenance, application of software or enhancement of existing application system;

3. software related activities such as: 
(i) supporting existing system; 
(ii) converting and / or translating computer languages; 
(iii) adding user functionality to application programmes; 
(iv) debugging of systems; 
(v) adaptation of existing software; and 
(vi) preparation of user documentation.

Example 6 

Adaptation or application of existing software such as Lotus Smartsuite or Microsoft Office in developing a stock-inventory system or management support system. 

Example 7 

Development of a software system such as banking or management system based on the requirement of the customer by using known application software and without any new technological findings.

General Non-Research Activities 

Research must be distinguished from a wide range of related activities. 

The following are examples of activities that are not research in nature:
1. general education and training;
2. scientific and technical information services;
3. general purpose data collection or efficiency surveys;
4. market research and evaluation;
5. calibration of standards and routine testing and analysis of materials, components, products and processes;
6. routine computer maintenance or software development;
7. setting-up of manufacturing line or equipment;
8. routine soil / fertiliser analysis or testing;
9. fabrication or modification of machinery / equipment;
10. general commercial activities will not be considered as research. 

These include: 

(i) the range of commercial and financial steps necessary for innovation and development and marketing of a new product, process or service such as a business plan, cost benefit analysis, management or policy studies; 

(ii) the production and distribution of goods and services; 

(iii) administrative and other supporting services (such as secretarial, clerical, book-keeping or security); and 

(iv) general support services (such as transportation, storage, up-keeping, cleaning, repair and maintenance).

Criteria for Eligibility of Research Project / Activity 

In order to obtain approval for a research project / activity the following criteria should be fulfilled:

1. The research project / activity undertaken by a person must satisfy the definition of research.

2. The research activity must be geared towards the production of new or substantially improved materials, devices, products, processes, systems or services prior to the commencement of commercial production or use.

3. Research activity is distinguished by its non-routine nature and the novelty of what is being created. If successful, it will result in the extension of scientific or technical advancement / knowledge (although it is recognised that research will not always be successful).

4. In the case of a software development project, its completion must be dependent on the development of a scientific and / or technological advancement. The aim of the project must be the resolution of a scientific or technological uncertainty on a systematic basis.

5. The research undertaken must be in accordance with the needs of the country and must be beneficial to the Malaysian economy such as training of Malaysians for technology transfer and undertaking research activities in Malaysia.

Research Expenditure Which Qualifies for Double Deduction 

To qualify for double deduction, the research expenditure must be for an approved project(s) and must be incurred in the basis period. The accounts for the expenditure incurred for each project must be kept separately. The following expenditure qualifies for a double deduction:

1 Raw materials used in research 

(i) Raw materials used directly in a research project excluding the purchase of fixed assets used in the research. For each project, the name, amount used and cost of each raw material used must be kept, along with information about its relevance to the projects. If raw materials are taken from the stock, the cost attributable can be separately identified and measured reliably. 

(ii) Cost of moulds, dies and soft tools (life span not exceeding one year) which cannot be reused. These moulds, dies and soft tools should not be eligible for capital allowance claim. In the case where tools are reused for production the cost in respect of the research project should be apportioned by comparing the period of utilisation to develop prototype units with the period of utilisation to manufacture production units. 

Cost of materials used for production or used for administrative purposes do not qualify for double deduction.

In cases where the moulds, dies, and soft tools used to develop the prototype were incurred in one basis period and the said tools were reused for the manufacture of production units in the next basis period(s), then the claim for double deduction made in the first mentioned basis period need to be revised accordingly. 

If such revision results in additional tax payable for the first-mentioned year of assessment, penalty would not be imposed for cases where the claim has been made in good faith. 

2. Manpower in a research project 

(i) Only expenditure on the basic salary of an employee directly involved in the research project (research employee) is eligible for double deduction. Expenditure such as EPF, SOCSO, bonus, medical fees and benefits-in kind will not qualify for double deduction. If an employee is not involved in a research project on a full time basis, expenditure claimed should be apportioned according to the actual time spent by that employee on that research project. The basis of apportionment must be substantiated by keeping a time-sheet. 

(ii) Salaries of employees involved in the research attending courses / seminars directly relevant to the research project may be considered for the claim. 

(iii) Employees involved in the research are those providing technical input, feedback, guidance or direction on the research project.

3. Technical services

The following technical services payments are included:

(i) Consultancy fees paid to a particular research organisation or individual for obtaining information / advice pertaining to the research being undertaken. 

(ii) Payment to particular organisations for the use of testing equipment such as those available in SIRIM, FRIM and the universities. 

(iii) Payment to a particular organisation or individual for analytical services and data evaluation processing.

If the payment for technical services undertaken outside Malaysia is more than 70% of the total allowable expenditure, the payment will not qualify for double deduction. However, the balance of the allowable expenditure (if it is an ordinary allowable expenditure incurred locally such as the purchase of raw materials, manpower and transportation) will qualify for double deduction.

The expenditure for the technical services which are obtained from overseas and undertaken in Malaysia will qualify for double deduction. 

If payment is made to a non-resident as in the case of employing a foreign researcher / consultant, deduction and payment of withholding tax, where applicable, must be made.

Information should be kept in respect of:
(i) the name and address of the researcher / consultant /organisation whose technical services are obtained; 
(ii) purpose or relevance of the technical services in the said research project; and 
(iii) the amount paid.

4. Travelling cost 

(i) Visiting research stations Travelling cost incurred by research employees related to visiting research stations solely for the purpose of conducting research work. Allowable expenditure includes travelling costs and daily allowances (includes the cost of food and lodging). The daily allowance is restricted to RM 400.00 per person or the actual cost incurred, whichever is lower.

(ii) Attending courses / seminars Cost of travelling locally or overseas by research employees related to attending courses / seminars relevant to research projects. These courses / seminars must be solely for the purpose of obtaining the latest or up-todate scientific information which is directly relevant to the project. Allowable expenditure includes travelling costs and daily allowances (including the cost of food and lodging) and course/seminar fee. The daily allowance is restricted to RM 400.00 per person or the actual cost incurred, whichever is lower. 

Expenditure such as travelling costs to visit vendors, meetings with suppliers /clients, attending exhibitions / shows, market surveys and other such expenditure not related to research do not qualify for double deduction.

5. Transportation cost 

Cost of transporting raw materials used directly in the research. However, expenditure such as cost of transporting fixed asset, end-products, postage for administrative purposes or others not related to research do not qualify for the double deduction. 

In the case where the research uses the same type of raw materials as that used in manufacturing an existing product and the raw materials are purchased in bulk and have been delivered at different times with different transport cost, then the cost of transportation for a basis period would be apportioned according to the total quantity of raw materials used for research over total quantity of raw materials purchased during the same basis period.

6. Maintenance cost 

Maintenance costs for motor vehicles, buildings, equipment and machinery used directly in a research project qualify for double deduction. However, expenditure not related directly to research do not qualify for double deduction. 

Maintenance costs on motorcars used by research employees / consultants, capital expenditure incurred on plant and machinery (including installation costs), fixtures, land, premises, buildings, structure or works of a permanent nature and alterations, additions or extensions to the said items are some examples of expenditure which are not related directly to research. Therefore, such expenses do not qualify for double deduction.

7. Rental 

(i) Rental of motor vehicles, buildings, equipment and machinery used directly in a research project qualify for double deduction. However, expenditure not related directly to research do not qualify for double deduction.

Expenditure such as rental of premises for administrative purposes, rental of motorcars for research employees / consultants (including petrol, insurance and road tax) and rental of machinery for production are not expenditure related directly to research and as such do not qualify for double deduction.

(ii) In cases where the buildings or machinery are also being used for other purposes apart from research, apportionment of the expenditure must be made based on usage related to research for example floor space used for the research or by taking the period of utilisation of machinery to develop prototype units compared with the period of utilisation for other non-research activities.

Other expenditure

Claims for double deduction can also be made on other revenue expenditure incurred directly for research such as water and electricity, telephone, fax, courier, stationery, photostating of research reports or schematic design, ink / toner used to print reports, lab coats and slides or photographs. Other expenditure such as books or magazines, insurance and all taxes such as service or road tax do not qualify for double deduction.

Detailed information should be kept on the types of expenditure and their relevance to the research project. In cases where no separate meters for water and electricity are set up for research, apportionment of the said expenditure must be made based on percentage used for research.

Capital expenditure incurred on plant and machinery, fixtures, land, premises, buildings, structures or works of a permanent nature (including installations) or alterations, additions or extensions thereof or in the acquisition of any rights in or over any property (including royalty) do not qualify for double deduction.

Application for Approval for Research Projects / Activities

1. Granting of approval 

The DGIR will only give approval for a research project. This approval does not include approval for research expenditure incurred. 

2. Application form 

The application by a person to obtain approval for a research project must be made for each year of assessment on the application form Borang 1 and submitted with relevant supporting documents to the Technical Division, Inland Revenue Board, six (6) months before the financial year-end of the business. Applicants are required to adhere to all conditions imposed and furnish correct information as required in the said form. Late applications will be considered on a case by case basis. The DGIR will then issue a letter of approval or rejection to the applicant. Approvals given will be subjected to the terms stated in the letter.

3. New research projects 

Application for approval of any new research project must be submitted together with the proposal reports in the application form. In cases where an application has been submitted and a new research project commenced after the application, the applicant has to submit an additional application for the relevant project using the application form within one (1) month after the close of the financial year-end of the applicant. 

Where a proposed project submitted for approval was delayed or did not take off, the person should notify IRB.

4. Multiple research projects 

Detailed information must be provided for each research project. In cases where numerous research projects are undertaken concurrently under a specific research programme, the programme and the overall objective must be specified.

5. Research projects for related companies 

As a concession, a holding company which undertakes research project / activity at its research centre on behalf of companies within its group may submit an application for approval of research project / activity on behalf of its subsidiary or associate companies. However, the details for each subsidiary or associate company should be separately and clearly stated.

Claim for Double Deduction on Research Expenditure

Upon receiving the approval of the research project, the applicant will claim the double deduction for expenditure incurred in the relevant income tax return form.

1. Supplementary worksheet 

The applicant is also required to prepare two copies of the supplementary worksheet Borang 2. The original copy (with supporting documents) must be kept by the applicant for audit purposes. The second copy is to be sent simultaneously to the Technical Division, IRB for record upon submission of the relevant income tax return form.

2. Research expenditure for related companies 

In cases where research is undertaken by a research centre for subsidiary or associate companies, allowable expenditure incurred in relation to a project undertaken on behalf of subsidiary or associate companies shall be allocated to each company. The subsidiary or associate companies may claim double deduction based on the allocation of expenditure made by the research centre. 

Research fees paid to related research centre / company will not be allowed a double deduction. No double deduction can be claimed by the research centre.

Period of Research Project 

An applicant can claim only those expenditure incurred during the period from the commencement to the completion of the approved project. Commencement of a project means the date the specific research activity commences. Completion of a research project means the date whereby testing of a prototype product has been completed or the principles of a new production process have been established. In the case where the duration of the project spreads over two or more basis periods, the expenditure incurred can only be claimed in respect of the amount incurred in each respective basis periods.

Example 8 

Company A Sdn. Bhd. undertakes a research project in the year of assessment 2005. The financial year-end of the company is 31.12.2005. The project is to develop a new product. The research activity commences on 01.01.2005 and immediately carries out experiment and testing which is intensive and systematic in the field of science. The final testing of prototype finishes on 30.06.2005. Production starts on 01.07.2005. 

The project meets the definition of research and hence is eligible to claim double deduction for expenditure incurred during the period 01.01.2005 to 30.06.2005.

Example 9 

Company B Sdn. Bhd. commences a research project on 01.06.2005 under the title of ‘Executive desktop’. The project is completed on 31.05.2006. The financial year end of the company is 31.12.2005. The research activities involve the development of a new software for the export market. The company provides a detailed development schedule plan, the research methodology employed including the raw materials utilised and the resource persons involved. 

The project meets the definition of research in Software & IT and, hence, is eligible for double deduction claim on the expenditure incurred during the period 01.06.2005 to 31.12.2005 (for the year of assessment 2005) and the period 01.01.2006 to 31.05.2006 (for the year of assessment 2006)

Period of Approval for Ongoing Project 

For a research project which requires 5 or more years to be completed, the DGIR can approve the research period for up to three (3) years. Where a research project / activity has been approved by the DGIR for three (3) years and that period has not expired, the applicant can directly claim the double deduction in the income tax return form for each relevant year of assessment without reapplying for the particular approved research project / activity. Applicants are then required to state in the supplementary worksheet the period and reference of the approval. After the expiry of the period of approval, new application should be made to obtain further approval for the project.

Abandonment of Project 

Where an approved project is delayed, abandoned or ceased within the period of approval, the person should notify the DGIR. In the case of cessation or abandonment of the project, the approval is deemed withdrawn with effect from the date of cessation or abandonment.

Amount Claimed in the Tax Computation 

The amount of deduction shall be twice the amount of expenditure, not being capital expenditure incurred in the basis period. If the research expenditure has been charged in the profit and loss account, a further deduction of the expenditure will be allowed. However, if the research expenditure incurred is capitalised in the balance sheet, a deduction of twice the amount of the expenditure will be allowed.

Keeping of Sufficient Records

A person must maintain sufficient records of all activities pertaining to any research project including records of the research activity, records of the time spent (man-hours) by each research employee on each project and relevant documents supporting the expenditure claimed. Separate sets of records must be maintained for different projects. In addition, research expenditure records must be maintained independently from the overall production costing. For this purpose, a research unit should be set up to undertake such activities.

Documentation of step-by-step methodology, testing, investigation and results for each phase of the research project must be maintained. Preferred documentation would include logbooks or diaries maintained by each research employee which record the day-to-day research activities performed, raw materials used and man-hours spent for each research project.

Appeals 

Written appeals in respect of rejected applications must be made to the DGIR within 30 days from the date of the rejection letter.

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Edited by: 浪子

Source: http://lampiran1.hasil.gov.my/pdf/pdfam/PR5_2004.pdf