Withholding tax changes a headache for firms
SM Thanneermalai 
The 2017 Budget widened the scope of the withholding tax regime and reopened the old concerns on the interpretation of this tax regime. The changes have not only added to the cost of doing business but also increased the difficulty for businesses to decide whether or not to deduct withholding tax on payments made to non-residents (foreigners who have no business presence or do not file any tax returns in Malaysia).

The recent law decision case has made it practically mandatory for the payer to deduct the withholding tax despite the double tax agreement providing the recipient protection from such withholding tax (Teraju Sinar case).

Guidelines for exemption from withholding tax

There are on-going discussions between selected parties and the Ministry of Finance to come up with guidelines/criteria to exempt certain taxpayers from having to deduct withholding tax on payments made to non-residents for special classes of income.

These are services rendered by a non-resident in connection with the use of property belonging to him or services rendered in connection with the installation or operation of the equipment purchased from the same person and technical services provided by a non-resident.

If such guidelines are implemented, some taxpayers will benefit from the exemption while other businesses which are contributing significantly to the economy will be left out. The beneficiaries are likely to be big companies and multinationals as they have the money and influence with policymakers and this will mean discrimination.

In the event the exemption route is implemented, it should be confined to cases where there is clear-cut economic benefit to the nation in return for forgoing the tax.

Withholding tax on service payments to non-residents

The Finance Act 2017 widens the withholding tax imposed on non-residents for services rendered to Malaysian businesses regardless of where the services were rendered. Prior to Jan 17, only services rendered within Malaysia were subject to withholding tax.

Impact of double-tax treaty

Non-resident businesses are taxed on income generated from activities in their home country as business income in their home country and under most double tax treaties (DTA), such income can only be taxed in Malaysia if they carry on business through a permanent establishment here.

However, if there is a technical services article in the DTA, Malaysia has the right to impose such payments on non-residents.

Are we extending our scope from territorial to worldwide?

Malaysia confines its scope of taxation to income accruing in or derived from the country. The extension of the scope of the withholding tax to tax income arising overseas from services rendered overseas appears to be in conflict with the territorial scope of taxation. Is this a precursor to the change that may be coming?

Who foots the tax cost?

For on-going contracts, this tax cost will have to be borne by the Malaysian business since the contracts are unlikely to have anticipated such a change in law. Also, in the future, despite the technical services article in many of our DTAs, the foreign service providers are unlikely to back away from the position that such income is business income that ought to be taxed in their country of residence and will expect the payer to bear the cost.

The Malaysian payer will not be able to get a tax deduction since the Inland Revenue Board takes the view that this is not business expense but a tax of the foreigner borne by the Malaysian business.

Changes to definition of royalty

It appears that consultation, albeit confined to certain parties, is only happening post-event, rather than prior to change.

The other big change is the widening of the definition of royalty to include the use of, or the right to use, software and payments to non-residents for the reception of, or the right to receive, images and sounds to be transmitted to the public through certain media and the use of, or right to use, radio frequency spectrum specified in a relevant licence and certain forbearance payments.

Distinguishing software purchases

The widening of the definition of royalty to include use of, and the right to use, software has not simplified matters for businesses which make payments to non-residents.

The current definition does not distinguish between software which is purchased as an off-the-shelf product from a non-resident for a user’s own use or the use of his business and does not have access to the copyrights, and software where the payer has been granted the licence to use and exploit it commercially.

In addition to these difficulties, Malaysian businesses also have no guidance on when a payment for software is regarded as an outright purchase which is not subject to withholding tax. These are intertwined with legal aspects of intellectual property.

Again, the withholding tax cost is likely to be borne by the Malaysian businesses as the sellers/licensees are unlikely to accept any reduction in the transaction prices.

There is an urgent need to amend the legislation to clarify the distinction between the payments made for the purchase of different software: whether they’re off the shelf, for own use, or use within a business.

Clarity is needed here, otherwise it could lead to Malaysian businesses being at a disadvantage, say, when compared to businesses operating out of Singapore where there is greater clarity.

Other intellectual property payments

There is the same level of difficulty on the interpretation of what should come within the confines of the royalty definition.

With the growth of digital businesses and the transformation of “bricks and mortar” businesses into online stores, the uncertainties will lead to increasing business cost since most businesses take the safe route rather than face the wrath of the taxman.

Way forward

It is high time the ministry of finance organise a lab to bring all the relevant stakeholders from the government and private sector together to come up with tax policies to deal with the area of intellectual property and digital commerce.

Without an in-depth study, we are going to face piecemeal amendments to our tax legislation that will not give businesses an edge but instead, add to their burden. Please act before it is too late.

SM Thanneermalai is managing director of Crowe Horwath KL Tax Services Sdn Bhd. Comments:

This article first appeared in Focus Malaysia Issue 245.