Section 39: The Expenses You Can Never Deduct

Most add-back schedules are built from habit. Depreciation, entertainment, fines, donations — the same six lines every year, copied forward. Section 39(1) actually contains eighteen live prohibitions, and the ones that cost the most money are not on anybody’s habitual list.

Here is the whole of it, in statutory order, as it stands in the reprint of the Income Tax Act 1967 dated 21 May 2024.

How section 39 beats section 33

Section 39(1) opens with the words subject to any express provision of this Act. On its own that would let the general deduction in s.33 override the prohibitions.

Subsection 39(2) closes that door. It declares that section 33, except in so far as it relates to expenses of the kind specified in paragraphs 33(1)(a) to (d), is not an express provision of the Act within the meaning of section 39. Interest, rent, repairs and prescribed deductions sit outside; everything else is subject to the s.39 list.

Run the tests in that order. An expense must be wholly and exclusively incurred in the production of gross income from the source and escape section 39.

The full list

Para	What it disallows	Note
(a)	Domestic or private expenses	The dual-purpose problem in one word
(b)	Disbursements or expenses not wholly and exclusively laid out for the purpose of producing the gross income	Mirrors s.33 as a prohibition, in slightly different words
(c)	Capital withdrawn, or any sum employed or intended to be employed as capital	The capital-versus-revenue line
(d)	Payments to a pension, provident, savings or similar fund that is not an approved scheme	Check approval before contributing
(e)	Expenditure that is qualifying mining, plant, building, agriculture, forest or prospecting expenditure under Schedules 2, 3 or 4	This is what disallows depreciation; relief comes through capital allowances instead
(f)	Interest or royalty derived from Malaysia on which s.109 tax was deductible and not deducted and paid	Two provisos, below
(g)	Sums payable for the use of a licence or permit to extract timber from a forest in Malaysia, other than to a State Government or an approved statutory body	Litigated in Embunan Harian Sdn Bhd v DGIR
(h)	Deleted by Act 619
(i)	Contract payments on which s.107A tax was deductible and not deducted and paid	Non-resident contractors
(j)	Payments on which s.109B or s.109F tax was deductible and not deducted and paid	Special classes of income, and income under s.4(f)
(k)	Motor vehicle rentals above RM50,000, or above RM100,000 where the vehicle was unused before rental and cost no more than RM150,000	Commercial goods and passenger vehicles are outside the cap
(l)	Fifty per cent of entertainment expenditure, subject to eight provisos
(m)	Leave passage benefits provided to an employee, within or outside Malaysia	Subject to proviso (l)(viii)
(n)	Remuneration to a partner of an LLP not specified in the LLP agreement	Limited Liability Partnerships Act 2012, s.9
(o)	Input tax under the Goods and Services Tax Act 2014 where the person was liable to register and did not, or is entitled to credit it
(p)	Output tax under the Goods and Services Tax Act 2014 borne by a registered or liable person
(q)	Public entertainer income on which s.109A tax was deductible and not deducted and paid	Same proviso structure
(r)	Payments by a resident to a Labuan entity referred to in s.2B(1)(a) of the LBATA 1990, subject to Ministerial rules
(s)	Payments on which s.107D tax was deductible and not deducted and paid	Agent, dealer and distributor payments

Two further provisions sit outside the alphabet and are easy to miss:

• Subsection 39(1A) — where information is required under s.81 within the time specified in a notice and concerns a deduction claimed, the deduction is denied outright if the information is not supplied in time. This is a documentary trap, not a substantive one.
• Subsection 39(3) — paragraphs (f), (i) and (j) do not apply for a year of assessment in which the person is exempt under paragraph 127(3)(b), subsection 127(3A) or the Promotion of Investments Act 1986 on all income from all sources, other than exemption equal to capital expenditure.

Withholding tax: three limbs, not one

This is where most published guidance goes wrong, and it goes wrong in the most expensive place.

There is no single withholding-tax disallowance paragraph. There are three parallel ones, and they attach to different charging sections:

Charging section	Payment	Disallowance
s.109	Interest and royalty derived from Malaysia	s.39(1)(f)
s.107A	Contract payments to non-resident contractors	s.39(1)(i)
s.109B, s.109F	Special classes of income under s.4A, and s.4(f) income	s.39(1)(j)
s.109A	Public entertainers	s.39(1)(q)
s.107D	Agents, dealers and distributors	s.39(1)(s)

The distinction bites hardest on software and cloud services. Royalty is defined in s.2 to include software expressly, so a payment for software licensed from a non-resident is a s.109 royalty and its disallowance runs through paragraph (f), not paragraph (j). A tax computation that cites (j) for every non-resident payment has mislabelled the single most common cross-border expense in a modern business.

The Court of Appeal decision in KPHDN v Teraju Sinar Sdn Bhd (21 April 2014) shows the mechanism in operation on the (j) limb: handling and repacking charges paid to a non-resident were disallowed because s.4A(ii) and s.109B applied to services performed in Malaysia, and the failure to withhold therefore attracted s.39(1)(j).

The two provisos, and why paying late is not a cure

Each of paragraphs (f), (i) and (j) carries the same pair of provisos:

• Proviso (i) — the paragraph does not apply if the payer has paid the amount referred to in subsection (2) of the relevant charging section. That amount is the tax plus the increase imposed by the charging section itself — s.109(2), s.109B(2), s.107A(2), s.109F(2), s.107D(3). The increase is a feature of the withholding provisions, not of s.113.
• Proviso (ii) — where the tax is paid after the due date for furnishing the return for the year of assessment concerned, that payment shall not prejudice the imposition of penalty under subsection 113(2) if the deduction was claimed in that return.

So the two consequences stack, and they behave differently. Paying the withholding tax and the increase restores the deduction. It does not undo the incorrect-return penalty. LHDN Public Ruling No. 10/2019 works the arithmetic through at Examples 18 and 19 and states plainly that where the payer subsequently pays and the assessment is reduced under proviso (ii), the s.113(2) penalty is maintained.

The full computation, including how the increase and the penalty interact on a real invoice, belongs with the withholding-tax non-compliance article rather than here.

Paragraph (r): the Labuan restriction that hits the Malaysian payer

Paragraph 39(1)(r) is short and unusually open-ended. It disallows, subject to any rules as may be prescribed by the Minister, any amount in respect of a payment made by a resident to a Labuan entity referred to in paragraph 2B(1)(a) of the Labuan Business Activity Tax Act 1990.

Three things follow that are worth stating explicitly, because the market rarely does.

The cost lands onshore. The Labuan recipient’s 3 per cent rate is untouched. The restriction reduces the deduction of the Malaysian company paying the fee, interest or rent — so the tax cost of a poorly structured Labuan arrangement appears in the Malaysian group company’s computation, not the Labuan one.

The percentages are set by rules, not by the Act. Paragraph (r) itself specifies no proportion. The proportions live in Ministerial rules made under the paragraph. Those rules could not be retrieved from any official source, so no figure appears here. The 25 per cent and 97 per cent figures circulating across advisory sites are not verified against a gazette and should not be relied on.

The exemption may have lapsed. An exemption order was published covering years of assessment 2019 to 2025. No extension beyond YA2025 could be located. Anyone paying a Labuan entity from a Malaysian company should confirm the current position with LHDN before assuming any relief exists at all — this is the single largest open question in the Labuan cluster.

Common mistakes

Citing paragraph (j) for every withholding failure. Royalty and interest run through (f); non-resident contract payments run through (i). Getting this wrong misstates which section’s increase applies and which return is incorrect.

Treating the 10 per cent increase as a s.113 penalty. The increase lives in the charging sections themselves. Section 113(2) is a separate penalty equal to the tax undercharged, reached through proviso (ii).

Assuming late payment cleans the slate. It restores the deduction only. Public Ruling No. 10/2019 confirms the s.113(2) penalty survives.

Adding back only 50 per cent of every entertainment line. Eight statutory provisos take whole categories out of paragraph (l) entirely. Classifying before halving is worth real money.

Forgetting paragraph (d). Contributions to an unapproved retirement or savings scheme are disallowed in full, regardless of commercial rationale.

Missing paragraph (k) in aggregate. The second proviso caps the cumulative rental deduction across the year of assessment and all subsequent years at RM50,000 or RM100,000 for that vehicle, not the annual figure.

Ignoring a s.81 notice. Subsection 39(1A) turns an administrative delay into a permanent disallowance.

What’s next

Take the add-back schedule paragraph by paragraph against the list above rather than against last year’s working paper. Where the disallowance is a withholding failure, fix the withholding first — the deduction can be recovered, the penalty usually cannot. Where the payment goes to a Labuan entity, treat paragraph (r) as an unresolved risk and get the current rules confirmed in writing. And where the line is entertainment, classify each item against the eight provisos before halving anything.