A Complete Guide to Credit Notes in Malaysia for Businesses

A Complete Guide to Credit Notes in Malaysia for Businesses

In the dynamic world of business transactions, things change. Goods are returned, services are cancelled, retroactive discounts are allowed, and billing errors are discovered. In Malaysia's controlled tax environment, these kinds of adjustments cannot be handled informally. The instrument designed to manage these changes legally and transparently is the Credit Note. Regulated under the strict oversight of the Inland Revenue Board of Malaysia (LHDN), a credit note is not just a courtesy of accounting--it is a critical compliance document that supports the accuracy of a business's tax reporting. Issuing a credit note appropriately will correctly reduce your sales and income tax liability, whilst also allowing your customer to correctly adjust their expense claims, which ultimately protects the integrity of the entire tax chain. This guide informs you of the what, when, why, and how of credit notes under Malaysian law so your business can remain fully compliant.

Recent Amendments

Malaysia's tax laws are periodically updated. While the fundamental principles of credit notes remain the same, companies must take heed of the broader legislative environment:

1. E-Invoicing Timeline: The LHDN is introducing e-invoicing mandatorily in phases, starting with large taxpayers from August 2024. This digitalization will drastically change how invoices and credit notes are issued, reported, and validated. While the conceptual rules for credit notes remain, their technical issuance and integration with LHDN's systems will evolve. Under LHDN e-invoicing rules, a validated e-Invoice receives a Unique Identifier (UUID), and adjustments after a 72-hour grace window must be made by issuing a debit/credit/refund e-Invoice that references the original invoice's UUID
2. Sales and Service Tax (SST) is still in the process of amending the Service Tax Act 2018 and the Sales Tax Act 2018, including updates to taxable services and rates. The SST rules on credit notes follow the fundamental principles of the Income Tax Act, but these principles must be applied within the SST framework.

Businesses must always check the latest guidelines published on the official LHDN and JKDM (Royal Malaysian Customs Department) websites for the most current procedure to be compliant.

What is a Credit Note?

A credit note is a document exchanged between a supplier and a buyer, a trading document exchange that is legal evidence of a reduction in the amount initially supplied of a good or service in an original tax invoice form. It is a technical "anti-invoice" that offsets part or all of the value of the initial supply.

Crucially, for tax purposes,a credit note serves as the legal basis for a supplier to reduce their sales and income tax liability with LHDN and to adjust any SST reporting with JKDM. It rectifies the books of both parties to reflect the true nature of the transaction after an adjustment.

Purpose and Legal Implication

The primary purpose of a credit note is to correct the historical record of a transaction for both accounting and tax compliance reasons.

For the Seller/Supplier:  

• Reduces Tax Liability: The value of the credit note reduces your total taxable sales in a given period, thereby reducing your income tax liability with LHDN and any output SST with JKDM.  
• Accurate Financial Reporting: It ensures your accounting records accurately reflect your actual revenue, not just gross billing.  
• Audit Trail: It creates a clear and defensible audit trail for LHDN officers, explaining why the tax declared in one period was later adjusted.

For the Buyer/Customer:  

• Adjusts Expense Claims: If you had already claimed an expense deduction on the original invoice, you are legally required to adjust that claim proportionally based on the credit note.  
• Accurate Expense Recording: It allows you to accurately record your final expense and liability to the supplier.

When Must a Credit Note Be Issued?

A credit note must be issued whenever there is a change that reduces the value of a supply that was already tax-invoiced. Common scenarios include:  

• Goods Returned by Customer: Goods received by a customer are damaged or defective, or the wrong goods have been sent.  
• Price Reduction or Discount: You agree to give a retrospective discount or rebate to the customer when the invoice is raised.  
• Services Not Rendered/Cancelled: You have invoiced services in advance, but you have cancelled or not delivered the agreed services.   
• Errors in Original Invoice: There was an error on the original invoice, for example, overcharge, duplicate invoice, or incorrect quantity.  
• Written off Bad Debts: A specific situation where a debt is considered to be an irrecoverable loss and will be written off in accordance with strict LHDN rules, requiring supporting documentation.

Key Contents of a Valid Credit Note

There is no prescribed statutory format, but according to LHDN's guidelines, a valid credit note must contain specific information to be accepted for tax adjustments. It must include:  

• The words “CREDIT NOTE” are displayed prominently.  
• A unique serial number for the credit note.  
• Date of issue of the credit note.  
• Name, address, and Tax Identification Number (TIN) of the supplier.  
• Name and address of the customer.  
• The date and number of the original tax invoice that is being adjusted.  
• A clear description of the goods or services being credited.  
• The quantity and amount of the credit.  
• The rate and amount of tax being credited (e.g., the SST or previously applicable GST amount).  
• A clear statement of the reason for issuing the credit note (e.g., "return of damaged goods," "price adjustment").  
• The total amount of the credit note, including a clear tax breakdown.

Compliance Process and Timing

The process of raising a credit note is formal and must be included in your accounting cycle.

Step 1: Identify the Need for Adjustment

Specify a legitimate trigger event (e.g., goods returned, mistake found).

Step 2: Issue and Prepare the Credit Note

Draft the credit note containing all mandatory information listed above. Issue it to your customer promptly. For e-invoicing, generate a credit e-Invoice that references the original invoice's UUID.

Step 3: Adjust Your Tax Return (Supplier)

In your income tax return (Form C) for the period in which the credit note is issued, you must reduce your total taxable sales. For SST, adjust your SST return filed with JKDM. This is a declaration to LHDN that you are correcting a previous declaration.  

Step 4: Customer Adjusts Their Tax Return (Buyer)

Upon receiving the credit note, the customer must reduce their expense deduction in their own income tax return for the period they receive it, if they had already claimed the input tax on the original invoice.

Timing:

There is no explicit "deadline" in the law for issuing a credit note. However, it must be issued within the same taxable period in which it is discovered or within a reasonable time thereafter. Best practice is to issue it immediately upon agreeing to the adjustment with the customer. The tax adjustment must be made in the return for the period it is issued. For e-invoicing, ensure the credit note is generated and reported as per MyInvois rules.

Difference Between a Credit Note and a Debit Note

It is critical to understand the distinction:

Credit Note	Debit Note
Issued by the seller.	Distributed by the buyer to the seller to ask for a credit note.
It reduces the amount the buyer owes. It represents a decrease in the seller's accounts receivable and a decrease in their output tax.	It can also be distributed by the seller to show an increase in the amount of an existing invoice (e.g., for additional fees found later).

In common practice in Malaysia, the seller-initiated credit note is the standard document for downward adjustments.

Penalties for Non-Compliance

Failing to properly issue and account for credit notes can lead to severe penalties:

• Incorrect Tax Reporting: If you reduce your output tax without a valid, documented credit note, LHDN can disallow the adjustment. This results in an underpayment of tax.  
• Penalties under the ITA: Penalties can be severe — monetary fines and penalties linked to the tax undercharged and criminal sanctions are possible under relevant ITA provisions (such as Sections 113 and 114). See LHDN guidance for specifics.  
• Disallowance of Deduction (Buyer): If a buyer makes an input tax credit claim but doesn't claim a deduction where a credit note is drawn, the excess claim can be disallowed and the buyer penalized.  
• Audit Triggers: Inability to keep proper documentation on adjustments is a strong trigger for LHDN audits. Retain credit notes and supporting documents for at least seven (7) years.

FAQs

1. Is there a time limit for issuing a credit note?

While the Income Tax Act does not specify a strict deadline, it must be issued within a "reasonable time" and within the same taxable period where the adjustment is identified. For practical compliance and clean accounting, it should be issued immediately.  

2. Can a credit note be raised against a cancelled invoice?

Yes. If a transaction is completely cancelled and no payment is made, you can give a credit note for the full value of the original invoice, essentially wiping it out for accounting and taxation purposes.  

3. What should a buyer do upon receiving a credit note?

The buyer should first verify its accuracy against the original invoice and their records. If they had already claimed an expense deduction on the original invoice, they must reduce their expense claim in their next tax return by the amount specified on the credit note. The accounting entry typically involves reducing accounts payable and the input tax credit account.  

4. Do I need to raise a credit note for a cash discount?

If the discount was known and agreed upon when you sent the original invoice, you can simply show the discount on the original invoice. You only require a credit note for retrospective discounts or rebates that were not known at the time you made the original sale.  

5. How does e-invoicing change the credit note process?

With the upcoming mandatory e-invoicing regime, credit notes will need to be issued in a specific digital format and reported to LHDN's central platform. They will be digitally linked to the original invoice, making the adjustment process fully transparent and automated for tax purposes.

Conclusion

The issuance and management of credit notes are not merely an administrative task but a fundamental component of tax compliance and accurate financial reporting in Malaysia. A credit note issued lawfully enables the adjusting of previously reported tax debts, protecting the buyer and supplier in the case of audit by LHDN. The primary purpose of such action is to ensure the integrity of the tax system by allowing the government to be charged with the correct amount of tax based on the final value of transactions. The benefit to firms is the capacity to correct and address commercial readjustments in an organized, justifiable manner that does not invoke huge penalties and interest payments. Mastering the correct procedure for credit notes is a non-negotiable aspect of sound corporate governance and financial stewardship for any business operating in Malaysia.

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