Network

Tax on Foreign Income – A Corporate Investor’s View

Dr. Voon Yuen Hoong, Executive Director, Tax Compliance & Michael Cheah Liat Sheng, Senior Manager, Tax Advisory
12/09/2022
Network
Introduction

Introduction

Over the past three decades, Malaysian corporates have grown and expanded their business footprint not only to neighbouring countries but also to other continents in many parts of the world. To this end, it is not uncommon to see many Malaysian companies receiving income from their business and investment ventures in foreign countries. Examples of such income include sales from exports of goods and services, dividends from investments in foreign subsidiaries or associates, interest from placement of funds in foreign banks or advances to related companies, royalty fees from licensing of intangible assets, rental from properties located overseas, commission from acting as agents, etc.

Tax Positions on Income Received from Overseas up to 31 December 2021

From the tax angle, Malaysia adopts a territorial principle of taxation in that only income accruing in or derived from or received in Malaysia from outside Malaysia is subject to income tax in Malaysia pursuant to Section 3 of the Income Tax Act, 1967 (“ITA”). Nevertheless, Malaysian tax residents (excluding those engaged in banking, insurance or sea or air transport businesses) enjoy tax exemption on the “income received in Malaysia from outside Malaysia” i.e. foreign sourced income (“FSI”) under Paragraph 28, Schedule 6 (“Para 28”) of the Income Tax Act, 1967 (“ITA”). In not many words, FSI received by Malaysian tax residents are taxable under the ITA, but tax exemption is provided under Para 28. 

Nevertheless, not all income received from foreign payers are exempted as one needs to examine and ensure that the foreign income is truly “sourced from outside Malaysia” before exemption is given. Generally, whether the income is sourced within or outside Malaysia would depend on the location where the related income-generating activities had taken place. For example, export sales of goods by a trader are not exempted because the personnel who carried out the various business functions are located in Malaysia. In contrast, one may argue that interest income from investment funds placed and managed outside the country is foreign sourced and exempt under Para 28.

Change in tax treatment on FSI effective 1 January 2022

The tax exemption position on FSI received by Malaysian residents took a turn, when the tax exemption provided for under Para 28 was removed with effect from 1 January 2022, following the proposal made in the Malaysian Government’s Budget 2022 on 29 October 2021. The rationale for the removal, other than a measure by the Government to raise revenue collection, is a step taken by Malaysia to comply with the global tax standards on harmful tax practices.

 

Income derived from

(Source of Income)

Income received in

Prior to 1.1.2022

Effective from 1.1.2022

Malaysia

Malaysia

Taxable

Taxable

Overseas

Malaysia from outside Malaysia

Tax exempted

Taxable

The implementation of the above legislation is staggered into 2 timelines, depending on the timing of remittance of FSI into Malaysia. Taxpayers are given a 6-months transitional period from 1.1.2022 to 30.6.2022 to remit their foreign sourced income in order to enjoy the lower tax rate of 3% calculated on the gross income remitted (Part XX, Schedule 1 of the ITA). Remittances subsequent to 30.6.2022 will be subject to the normal tax rates.

Special Income Remittance Program – Terminated on 11 March 2022

The Special Income Remittance Programme (Program Khas Peremitan Pendapatan or PKPP) had been introduced by the Inland Revenue Board (“IRB”) on 16 November 2021 to help taxpayers in the transition to the new FSI regime. The FSI remitted during the PKPP period i.e. between 1 January 2022 and 30 June 2022 would be accepted in good faith by the IRB without any audit nor investigation be conducted on the taxpayer and no penalties will be imposed on FSI remitted during the PKPP period. However, this program is short-lived when the IRB made a subsequent announcement to revoke the PKPP on 11 March 2022, as it is deemed not relevant after the MoF agrees to provide a concession to exempt certain categories of FSI for a period of 5 years from 2022 to 2026.

Concession From 1 January 2022 to 31 December 2026

Since the announcement was made on 29 October 2021, the removal of exemption under Para 28 has been highly debated and criticised with regard to, among others, its timeliness of implementation, vagueness on the scope of FSI, and lack of clarity on claiming of double tax relief if the income had suffered foreign tax. In addition, the new measure is seen as a stumbling block to attract foreign direct investment (“FDI”) in Malaysia, thus affecting Malaysia’s competitive position in the global trade map. 

After weighing the pros and cons, on 30 December 2021, the Ministry of Finance (“MoF”) had made an announcement to defer the full implementation of the new Para 28 to 1 January 2027. The official rules were issued by the Government by way of exemption orders dated 19 July 2022, in the Income Tax (Exemption) (No.5) Order 2022 and Income Tax (Exemption) (No.6) Order 2022 (“Exemption Orders”), applicable for individuals, partners in conventional partnerships, limited liability partnerships (“LLP”) and companies. The exemption period is from 1 January 2022 to 31 December 2026. Individuals are exempted on all categories of income including income from employment, dividend, rental and interest. On the other hand, companies and LLPs are exempted on foreign dividend income only. What stand out in the Exemption Orders are the pre-conditions set to qualify for the exemption during the 5 years concession period, whereby:

  • FSIs received by individuals, LLPs and companies “shall have been subjected to tax of a similar character to income tax under the law of the territory which the income arises”. 
  • In the case of foreign dividends received by individuals from conventional partnerships, LLPs and companies, the added condition is that “the highest rate of tax of a similar character to income tax charged under the law of the territory which the income arises at that time is not less than 15%”.

The Exemption Orders further confer the power on the IRB to issue the relevant guidelines on the applicable tax treatments, which are yet to be available at the time of writing.

The rules in the Exemption Orders remind us of the tax regime for tax exemption on foreign sourced income currently adopted by our neighbour, Singapore, implemented since 1 June 2003. According to the Inland Revenue Authority of Singapore’s (“IRAS”) e-Tax Guide, Tax Exemption For Foreign-Sourced Income, taxpayers need to meet 3 conditions for the FSIs to be exempted in Singapore, i.e. “subject to tax” condition, “foreign headline tax rate of at least 15%” condition, and “beneficial tax exemption” condition. In comparison, it appears that Malaysia requires the “subject to tax” condition to be complied with for all categories of taxpayers, and “foreign headline tax rate of at least 15%” condition for dividend income received by conventional partnerships, LLPs and companies. There is no requirement for the “beneficial tax exemption” condition in Malaysia.

Table: Tax exemption of FSI from 1 January 2022 to 31 December 2026

 

No.

Category of taxpayer

Category of FSI exempted

Condition for exemption

Resident individuals

All categories of foreign sourcedincome

  • Subject to tax in the source country

2.

Resident individuals who are partners of conventional partnership

Foreign dividends in relation to partnership business in Malaysia

  • Subject to tax in the source country
  • Foreign headline tax rate of at least 15%

3.

Resident companies and Limited Liability Partnerships

Foreign dividends

  • Subject to tax in the source country
  • Foreign headline tax rate of at least 15%

 

What is clear from the Exemption Orders is that taxpayers need to meet certain conditions to enjoy the tax exemption. As it may not be as straight forward to qualify for the tax exemption, the limelight is now on the IRB to expedite the issuance of the relevant guidelines, which are expected to provide the much-needed administrative details surrounding the reporting of FSI, including documents required to provide evidence for exemption of FSI, tax calculations of non-exempt FSI, the claiming of double taxation relief on FSI especially foreign dividends, etc.

Taxable FSI Received by Corporate Investors

For now, FSI other than dividend income received by Malaysian corporate tax residents will still be subject to tax in Malaysia. Notably, where the foreign dividends are received by a legal structure other than a company incorporated under the Companies Act 2016, there is no exemption provided during the 5 years period on the income. 

A list of the more common situations of taxable FSI is set out below:

No.

Legal Structure

Type of Foreign Assets Owned

Type of Income Received

Is the income exempted?

1.

Companies

Immovable properties

Rental

No

2.

Companies

Interest-bearing loans

Interest

No

3.

Unit Trust Fund

Foreign investments

Interest

No

4.

Companies

Intellectual Proprietary Rights

Royalty

No

5.

Family trust

Foreign investments

Interest

No

 
Double Tax Relief on Foreign Tax Suffered

The tax on FSI received in Malaysia may be reduced by the foreign tax credit paid subject to certain limitations. Where a Malaysia tax resident has suffered foreign tax on the FSI, the taxpayer is given bilateral or unilateral tax credit relief against the Malaysian tax payable on the same FSI. Bilateral relief is given under Section 132 of the ITA when the foreign country has a double tax agreement with Malaysia e.g. Singapore, Indonesia, Japan, China, Australia, South Africa, United Kingdom, France, etc. On the other hand, unilateral relief is given under Section 133 of the ITA when there is no or limited double tax agreement by Malaysia with the foreign country e.g. British Virgin Islands, Taiwan, United States of America, etc. While full relief may be possible under a double tax agreement, the final amount is calculated based on a prescribed formula and relief is only given up to the maximum of the Malaysian tax suffered. As for unilateral tax relief, the foreign tax recognized is automatically halved. 

In addition, the Malaysian tax resident is required to substantiate the amount of tax paid in overseas with the relevant supporting documents from the tax authorities in the foreign countries in order to claim the said tax relief in his tax return.

Capital Receipts are Non-Taxable

The tax on FSI will only affect gains that are “income” in nature. Receipts that are “capital” in nature (also known as capital gains) will not be subject to Malaysian tax. Capital gains include proceeds from the disposal of foreign stocks, foreign properties, foreign assets, foreign currencies, foreign investment papers, etc, provided these assets have been held as long-term investments. As to whether the gains are “income” or “capital” in nature, the onus of proof lies with the Malaysian tax resident based on the facts and circumstances giving rise to the gains. If the remittances are found to be income in nature instead of capital as claimed by the taxpayers, the same shall be subject to income tax.

Actions required from tax resident corporate investors

The year 2022 marks a new beginning for investors with foreign asset holdings, in navigating a new tax landscape going forward. The removal of tax exemption under Para 28 in Malaysia shall have a long lasting impact on these corporate investors. The imminent measures include evaluation of the financial returns on their existing overseas investments, net of all tax costs. It goes without saying that in sourcing new investment opportunities overseas, investors shall need to factor in the additional tax costs in Malaysia which is effective 2022. 

Before concluding, here are a few suggestions on the action plans for investors:

  1. Review the Malaysian tax impacts on all taxable FSI from investments outside Malaysia. Tax simulations may be useful for the investment selection process.
  2. Maintain proper records of the foreign assets, including tracking of the funds retained in foreign bank accounts vis-à-vis those repatriated to Malaysia. On the amount remitted into Malaysia, ascertain the nature as to whether they belong to “income” or “capital” which shall have different tax implications in Malaysia. 
  3. Where the funds are mixed, distinguish between foreign source income and domestic source income for proper reporting of taxable income for Malaysian tax purposes. 
  4. Conduct a comprehensive review of the current investment structure and strategise the most optimal approach to undertake future investments. This review may involve international tax planning to mitigate tax exposure involving multiple countries.
  5. Examine the existing intercompany loans and undertake possible steps including debt restructuring exercises, or rescheduling repayments to reduce the tax impact on remittance of interest income into Malaysia. On this note, any proposed changes shall need to include transfer pricing considerations to avoid tax pitfalls in the future. 

If guidance is required, consider seeking professional advice from a tax consultant. This could help to avoid stepping into other possible tax landmines that could only be uncovered in the future when the company is audited by the IRB. 

This article was first published in the Smart Investor (Sept/Oct 2022) issue.

 

Read more

Our Expert

Dr. Voon Yuen Hoong is a Tax Executive Director at Crowe Malaysia. She specialises in tax compliance, tax audits & investigations, as well as tax incentives application & planning.
Crowe Malaysia Tax Compliance, Crowe Malaysia, Tax
Dr. Voon Yuen Hoong
Partner
Location: Kuala Lumpur

Stay Up-to-date with Our Newsletter

The important updates, articles and other exciting news that you don't want to miss.