Legal cost is a mythical concept which has posed as one of the fear factors in legal proceedings as it has often been stigmatised to come with a premium price tag. However, the incurring of legal costs to claim / defend trade disputes can help to save taxes under the Income Tax Act 1967 (“ITA”).

There are primarily two ways which are respectively direct and indirect in nature:

  1. Direct – Legal costs in connection with trade dispute as deductible expenses

Under Public Ruling No. 6/2006 on Tax Treatment of Legal and Professional Expenses issued under ITA, it has been prescribed that legal expenses incurred in certain scenarios are deductible expenses such as, inter alia:

  1. recovering trade debts from customers (normally contractual in nature);
  2. a finance company renewing existing loans;
  3. defending a person’s title to the ownership of an asset that is used in the business;
  4. litigation costs incurred on renewal of a lease by a landlord;
  5. defending a claim in relation / arising from your trade / business / profession, unless the breach is deliberate and / or dishonest;
  6. Legal cost incurred in disputes over trading contracts;
  7. Legal costs incurred by developer for transfer / sub division / conversion of land.

However, those that are not deductible are as such:

  1. Legal expenses incurred for recoveries of non-trade debts (such as loans given out to employees);
  2. Renewal of loans by non-financial companies;
  3. Legal expense incurred by a landlord in relation to new leases;
  4. Cost in defending criminal prosecution and / or fraudulent acts in the operation of a business.

The above gleans that allowable deductible legal expenses are those incurred in close connection with businesses’ main trade / activities and are normally confined to causes of actions that are contractual in nature. It is also worth to highlight that the allowability of deductions is not contingent on the outcome of legal proceedings and that it shall suffice when legal expenses are incurred in relation to legal proceedings in connection with a trade dispute.

  1. Indirect – Writing off bad debts as deductible expenses

The second method is commonly known as writing off bad debts. These are trade debts which have long not been paid and have been identified as wholly irrecoverable. There are no hard and fast rules on what amounts to bad debts as each circumstance is different.

Under Public Ruling No. 4/ 2019 entitled Tax Treatment Of Wholly & Partly Irrecoverable Debts And Debt Recoveries, there are several preconditions to be satisfied before one can write off a trade debt as bad debts.

Under Section 5.3 of the said Public Ruling, it is stated that:

Sound considerations should be taken by the person carrying the business before a trade debt can be written off. All circumstances of the debt such as the likelihood and cost of its recovery should be considered before a decision is made to write off the debt.

All reasonable steps based on sound commercial considerations should be taken to recover the debt.

To support a claim for deduction of a bad debt written off for tax purposes, there should be sufficient evidence of such steps taken, including one or more of the following:

  1. a) issuing reminder notices;
  2. b) debt restructuring scheme;
  3. c) rescheduling of debt settlement;
  4. d) negotiation or arbitration of a disputed debt; or
  5. e) legal action (filing of civil suit, obtaining of judgement from the court and execution of the judgement).

The steps that should be taken depends on the amount of the irrecoverable debt and to be written off and/or the anticipated cost effectiveness of each action. If the amount of the debt and the anticipated cost hinders any action to pursue the debt, the reasons should be documented. To support a claim for deduction for tax purposes, the decision made should be based upon valid commercial considerations and not for personal, private or other reasons. It should be considered a reasonable basis if it can be shown that the anticipated cost of any legal action is prohibitive in relation to the amount of debt.”

Debts which are irrecoverable become bad (either wholly or partly) when all reasonable steps have been taken to recover such debt.

As long as there are any other reasonable steps for recovery, such debt cannot be written off as bad.

After reasonable steps for recovery as in paragraph 5.3.1 have been taken, a debt can be considered as wholly irrecoverable or bad on the occurrence of any one of the followings:

  1. a) the debtor has died without leaving any assets from which the debt can be recovered;
  2. b) the debtor is a bankrupt or under liquidation and there are no assets from which the debt can be recovered;
  3. c) the debt is statute-barred;
  4. d) the debtor cannot be traced despite various attempts and there are no known assets from which the debt can be recovered;
  5. e) attempts at negotiation or arbitration of a disputed debt have failed and the anticipated cost of litigation is prohibitive; or
  6. f) any other circumstances where there is no likelihood of cost effective recovery”

As seen above, it imposes burdens on business owners to undertake reasonable steps to recover those debts before the same can be written off as bad debts.

In many circumstances, it is warranted that the minimum legal actions that must be taken is to engage a lawyer to issue letter of demand to debtors.

The purpose of letter of demand is to put on a legal notice and demand for payments to be made before legal proceedings in court is taken out. However, in circumstances where debt quantum is small, to carry out and maintain court actions may not make business sense.

Nevertheless, it is still important to issue a letter of demand as an exhibition of intent to formally demand the recoveries of debts and hence, satisfying the preconditions as laid down under section 5.3 of the said public ruling as abovementioned.

In contrast, in cases where the debt quantum is substantial, legal actions such as initiating a court action and / or other pre-agreed dispute resolution methods (arbitration) may be required which may require one to even go as far undertaking execution proceedings before one can write off a bad trade debt.


The above two methods appears to make more business sense to those businesses pondering whether to recover their underperforming trade debts / defending trade claims especially during this appearing gloomy economy.

While the same appears to be the saving grace to many of those who are embroiled in legal disputes, one must keep at the forefront of their mind that it is of paramount importance to uphold and protect your own legal rights and in doing so, by engaging a skilled lawyer to advise and represent you in upholding your legal rights and protecting your business interests.

A skilled lawyer can concurrently and intelligently consider and analyse legal and commercial factors and provide you the appropriate legal solutions.


Voon & Co Advocates


Voon & Co Advocates is a multi-practice legal firm with a specialty in criminal / civil disputes. For any inquiries, please visit us at our office at 27 Level 3, Block A2 Saradise Kuching, Off Jalan Stutong 93350 Kuching Sarawak and / or contact us at 082 528661 / email us at