ALAS, the day that the Government announces its intention to tax residents, including companies and individuals, on foreign-sourced income (FSI) received in Malaysia has come! The taxation on FSI is certainly the talk of the town.
Was it a surprise?
This is certainly not a complete surprise for several reasons. Like many other countries, there is a need to expand Malaysia’s tax base given the impact of the pandemic.
This is also expected from the Government in response to Malaysia’s recent inclusion into the European Union’s (EU) grey list where the EU has regarded the FSI exemption (FSIE) regime of several countries, including that of Malaysia and Hong Kong, as harmful tax regimes.
The EU acknowledges that FSIE regimes operating on a territorial basis are not inherently detrimental. However, concerns arise where they create instances of double non-taxation – particularly around the non-taxation of passive income such as interest or royalties where the recipient has no substantial economic activity.
Countries in the grey list, including Malaysia, have committed to amend or abolish their purportedly harmful FSIE regimes by Dec 31, 2022.
By taxing certain income such as interest and royalty received from non-residents, Malaysia would be able to exercise its taxing right and prevent the countries of non-residents from imposing additional taxes under the Subject to Tax Rule which is part of the OECD Global Minimum Tax Proposal.
What constitutes an FSI?
Currently, if a taxpayer earns or receives income with foreign elements, the crux of the matter is straightforward – is it from a local source or otherwise? Despite the location of the source of income being a fundamental question, the Income Tax Act does not contain a detailed definition except that “source” means “a source of income”.
The tax authorities here have not provided much publicly available guidance on this topic. Taking cue from Hong Kong’s view – whether an income should be regarded as local sourced or otherwise – is a fact based on the individual circumstances of the case.
Guidance can also be drawn from judicial principles enunciated in past tax cases deliberated in court. The broad guiding principle, attested by many authorities, is that one looks to see where and what the taxpayer has done to earn the income.
Impact on man-on-the-street
One common situation would be the rental income earned by a Malaysian tax resident from a real property located outside of Malaysia – in this scenario, let’s say Singapore. This income is an FSI and would not be taxed in Malaysia presently.
From Jan 1 next year, income remitted to Malaysia would be taxed. It is not unusual for the income to be sent home to meet the landlord’s commitment in Malaysia.
In this case, both countries have the right to tax. To avoid double taxation on the same rental, Malaysia, being the country of residence would grant a foreign tax credit based on a prescribed formula that takes into account the taxes paid in Singapore, against the Malaysian tax payable.
However, the Malaysian resident landlord would still need to pay the net tax to the Malaysian Government.
A Malaysian who lives in Johor Bahru commutes daily to Singapore for work. He draws a salary from his Singaporean employer. Under the tie-breaker rule, he would be a Malaysian tax resident given that his permanent home is in Johor Bahru.
Before Jan 1 next year, he can remit his salary into Malaysia without Malaysian tax. Under the new rule, his remittance would be subject to Malaysian tax. The Singapore tax paid can be used as a set off. However, he would need to top up the net additional tax and pay the Malaysian tax authorities. In short, there would be an incremental tax.
Impact on companies
Dividends received by Malaysian resident companies from foreign subsidiaries would be taxed in Malaysia with effect from Jan 1, 2022. Foreign dividend withholding tax suffered would be creditable against Malaysian tax payable.
Certain tax treaties allow foreign tax paid by the subsidiary companies in respect of their income out of which the dividends are paid to be part of the credit.
Interest from money lent to borrowers outside Malaysia, including intra-group lending, would also be taxed upon remittance moving forward. Remittance of profits of operations outside Malaysia, notably branch profits, would also be subject to Malaysian tax after taking into account the foreign tax paid.
All-in-all, additional top-up tax would occur where Malaysian tax is higher than the foreign taxes. Certain large Malaysia-based groups would also be subject to the OECD’s Global Minimum Tax Proposal and are likely to top up taxes in Malaysia if their foreign subsidiaries are having an effective tax rate of less than 15%.
Targeted exemption
While the knee-jerk reaction by man-on-the-street is to lament on the Budget 2022 proposal that there would be a double taxation on the same income, this would not necessarily be the case given the availability of foreign tax credit explained earlier.
In any case, it would be useful if the Government could provide an estimate of the incremental taxes it expects to collect from this measure, bearing in mind that it is also likely to create additional work for our tax authorities as they will now have to verify the amount of FSI received and tax credit claims during future tax audits.
It remains to be seen if the Government would still provide a targeted exemption on foreign-sourced dividends, branch profits and service income received in Malaysia provided that certain conditions are met.
We hope to see the Government introducing something similar to build Malaysia’s attractiveness as a regional investment holding hub.
Plan ahead
What should businesses do while waiting for details to be announced? An immediate course of action would be to identify if they derive any FSI (which may not have been given much attention before this), timing of their receipt and the quantum of any incremental tax liability after factoring in the availability of any tax credits.
This is especially important for companies with a Dec 31 financial year end since the deadline for submitting their estimate of tax payable for Year of Assessment 2022 is round the corner.
Moving forward, businesses would also have to consider the potential tax impact when planning the timing of repatriation of their FSI to meet their commercial requirements locally. – Nov 9, 2021
Tan Hooi Beng and Lee Boon Siew are Deputy Tax Leader and Tax Associate Director respectively at Deloitte Malaysia.
The views expressed are solely of the author and do not necessarily reflect those of Focus Malaysia.
