Budget 2022: Confidence in Resilience: Achieving Fiscal Resilience in a Balanced Way

Budget 2022 is moving on a fine line in balancing the immediate need to revitalize the economy and boost reforms while ensuring fiscal resilience. It strives to ensure that businesses contribute equitably to government revenues while ensuring that they remain competitive and that businesses can continue to thrive, as they are an integral part of rakyat livelihoods.

Paving the way for recovery
Financial aid

Access to finance for survival is certainly at the forefront of the minds of many businesses, small and medium-sized enterprises (SMEs) and large corporations.

With expectations of a return to growth targets of 5% to 6.5% by 2022, the budget commits to ensuring the survival of companies by making funding available in the amount of 40 billion ringgit in as part of the Semarak Niaga Keluarga Malaysia program. In addition to this, the government provides equity capital of at least RM3 billion to viable listed companies. Such support for large institutions would have far-reaching effects on all stakeholders, from employees and suppliers to public investors and financial institutions.

Tax incentives

Various tax incentives have already been introduced via economic stimulus packages to deal with the impact of the pandemic, so it’s no surprise that the new incentives announced in Budget 2022 are much more targeted. The decision to introduce a more comprehensive Digital Ecosystem Acceleration Program (DESAC) – which grants preferential tax rates of 0% to 10%, or an investment tax allowance of up to 100% which can be used against 100% of statutory income – is extremely attractive. for tech companies because it appears to remove location-based restrictions that exist under the Multimedia Super Corridor (MSC) incentive.

For the group as a whole, the government has extended the special reinvestment allowance for existing businesses by two years, bringing the cumulative period to five years. This certainly encourages companies to reinvest or increase capital expenditure, to stimulate domestic direct investment.

Broaden the tax base

Despite the announcement of the largest budget to date, the government is still committed to reducing the budget deficit to 6% of GDP. Instead of announcing new taxes such as a capital gains tax or reintroducing the goods and services tax (GST), the government is banking on potential additional revenues by improving tax administration as well as clever approach to collect additional taxes from taxpayers who continue to enjoy big profits.

Improve tax compliance

The special voluntary disclosure program (SVDP) for indirect taxes is a good initiative to increase collections at a lower cost for the authorities. For taxpayers, this should be seen as a similar opportunity to the SVDP for direct taxes in 2019, which generated additional revenue of RM8 billion. The SVDP has a broad scope covering all indirect taxes, including GST, sales and service tax, and customs duties. The program is extremely attractive, taking into account the 100% discount on penalties in phase 1 and 50% in phase 2, with a potential reduction in taxes in some cases.

As with all voluntary disclosure programs, it is important that the government ensure that taxpayers have the assurance that disclosures made in good faith give them the certainty that all businesses seek. On the other hand, proactive efforts on the part of the authorities should be made to identify high-risk taxpayers and encourage them to come forward for the program to be effective.

Exemption of foreign source income

The concept of territorial taxation is at the heart of the Malaysian income tax system, and Malaysian tax residents have long been accustomed to the principle that only income from Malaysia should be taxed. As such, the proposed general removal of the Foreign Source Income Exemption (FSIE) under Schedule 6 of the Income Tax Act has raised concerns among businesses and individuals receiving income tax. income from outside Malaysia.

The FSIE was introduced to encourage the transfer of income from overseas to Malaysia to be spent or invested here. With today’s increasing globalization, it is not uncommon for Malaysians, both businesses and individuals, to invest abroad. Thus, it remains important that these returns continue to return to Malaysia rather than being stationed abroad. FSIE is also promoting Malaysia as a potential place to set up holding companies with suitable substance, alongside Singapore, which also has an FSIE regime and an extensive treaty network offering treaty rates. advantageous for the payment of dividends, interest and royalties.

Context of the suppression of FSIE

The government’s decision to abolish the FSIE comes in light of Malaysia’s addition to the EU’s “gray list” for having a harmful FSIE regime. In the context, this list of non-cooperative jurisdictions is part of the EU’s efforts to crack down on tax evasion and harmful tax practices. As a country on this list, Malaysia is considered to be a jurisdiction that has made a commitment to comply with EU standards and is subject to monitoring of those commitments. Hong Kong is another notable place that has been graylisted for its FSIE.

What is considered harmful FSIE

The Organization for Economic Co-operation and Development (OECD) and, by extension, the EU recognize that not all FSIE schemes are harmful. In fact, in many cases an FSIE is required to avoid double taxation. Despite the level of global tax cooperation under Double Treaty Agreements (DTAs) and global initiatives such as the Base Erosion and Profit Shift Plan (BEPS), double taxation remains a concern. for many multinational companies. For example, Malaysia’s lack of a full DTA with the United States makes taxpayers dependent on domestic law to seek relief from double taxation.

A detrimental FSIE regime is one that not only prevents double taxation, but also leads to abuse leading to double non-taxation. Foreign source income, which is the subject of scrutiny, would include interest and royalties, in which there might be a lack of “commercial” activity or “substance” to generate such income at home. beneficiary.

What needs to be done

Malaysia should adhere to internationally recognized standards of tax transparency, participate in fair tax competition and meet its commitments under the inclusive framework of the BEPS plan. The question remains, however, whether a comprehensive removal of the FSIE – as suggested in the Budget Speech and Annex – is one step, or many steps, too far to the detriment of all Malaysian taxpayers and ultimately the local economy?

It is absolutely clear that while the abolition of an FSIE regime is a solution that respects Malaysia’s commitments, it is not the only solution. In fact, it is extremely rare for countries to tax all foreign source income. Many EU member states and developed countries (e.g. UK) do not tax dividend income if certain criteria (such as a minimum stake in the foreign entity) are met.

It is entirely possible for Malaysia to maintain an FSIE regime, provided that certain safeguards and mitigating factors are introduced to prevent tax abuse. The focus is on what is particularly harmful for diets that have:

• An overly broad definition of income excluded from tax, in particular passive income from foreign sources without any conditions or guarantees; and or

• A definition of nexus that does not conform to the definition of a permanent establishment in the OECD Model Tax Convention.
If Malaysia wishes to exclude certain passive income from tax, it will need to ensure that it:

• Implements adequate substance requirements;

• Has strong anti-abuse rules; and

• Removes all administrative discretion in determining income to be excluded from tax.

Foreign source royalty income

When key functions related to the derivation of royalty revenues – i.e. development, improvement, protection, maintenance and operation (DEMPE) – are performed in Malaysia, authorities have previously took the position that the royalty is considered to be derived and taxable in the country. To cement the position taken by the authorities, it would be desirable to introduce clear substantive requirements (e.g. minimum staffing or expenditure, certain activities to be carried out) in the income tax law for income from Royalties.

Profits of branches / permanent establishments abroad

This is not considered an area of ​​risk as Malaysia applies a definition of nexus that is consistent with the definition of a permanent establishment under the OECD Model Tax Convention in its national law.

Interest income from foreign sources

Typically, most countries tax foreign-source interest income when it is paid to the lender. When there are withholding taxes paid in the borrower’s place of residence, the lender can claim bilateral credit (or unilateral credit, where local law allows in the absence of a CDI) on taxes paid.

Foreign source dividend income

A proposal that removes the exemption for foreign-source dividend income is completely contrary to the regimes adopted by many developed countries and countries in the region which adopt a territorial tax base. There is also a distinct disadvantage for groups or investment vehicles based in Malaysia that have significant operations overseas and regularly remit dividends to their Malaysian shareholders.

Implications of a general abolition of the FSIE regime

A general abolition of an FSIE scheme would have negative implications such as:

• Discourage the remittance of foreign dividends to Malaysia, thereby reducing liquidity and reinvestment in the Malaysian economy;

• Further reduce Malaysia’s attractiveness as a location for investment vehicles;

• Subject foreign permanent establishments to tax in Malaysia when they remit funds to their Malaysian head office. In the absence of a DTC, the Malaysian taxpayer would not be able to claim full relief from foreign taxes paid; and

• Uncertainty as to the extent of relief available, including funding and other shareholder costs for shareholders receiving dividends.
In these very difficult circumstances, the Minister of Finance certainly has a viable plan that will help meet the most immediate needs of businesses while ensuring fiscal resilience. Various measures to promote economic activity will certainly stimulate economic recovery. While businesses and rakyats are reassured that there are no new taxes, some of the proposed measures can have significant consequences, depending on how they are implemented. We need to make sure that as a country we not only remain competitive in attracting investment, but also in encouraging Malaysian businesses to compete on the world stage.

Jagdev Singh is Tax Manager at PwC Malaysia

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