As of January 1, 2022, the current exemption from income tax on foreign source income (FSI) received in Malaysia by Malaysian residents will be removed.
This article highlights the impact and practical considerations that businesses and individuals should consider when preparing for the impending tax on the ISP. The content of this article reflects the legislation and FAQs available to the public as of December 20, 2021.
Overview of the existing ISP exemption
Currently, the FSI of anyone received in Malaysia is exempt from income tax, with the exception of Malaysian resident companies engaged in banking, insurance, or air or sea transport. This has not always been the case: the FSI tax exemption was first introduced in 1998 for resident companies to encourage taxpayers with income from abroad to repatriate their income to Malaysia ( except for the few industries mentioned above). In 2004, this FSI exemption was extended to all taxpayers, including individuals.
Imminent taxation of ISPs in Malaysia
When announcing the 2022 budget, the government proposed to remove the tax exemption on ISPs enjoyed by residents of Malaysia with effect from January 1, 2022. This proposal is reflected in the 2021 budget bill, which has was adopted by the House of Representatives but is still being read in the Senate and has not yet been published as law at the time of writing (finance bill).
Under the Finance Bill, ISPs received in Malaysia between January 1, 2022 and June 30, 2022 by all tax residents, including individuals and businesses, will be taxed at 3% on a gross basis. The FSI tax rate received after this period will be the applicable tax rate for individuals and resident companies. The proposal as is covers all forms of income (eg business or employment income, dividends, interest, royalties) and will affect all Malaysian resident taxpayers, regardless of their size or industry.
On November 16, 2021, the Inland Revenue Board of Malaysia announced in a press release that it will be offering a special income disbursement program (Program Khas Peremitan Pendapatan, also known as PKPP) for the period from January 1, 2022 to June 30. 2022, during which ISPs received in Malaysia by taxpayers who declared their participation in the PKPP before July 30, 2022 will not be subject to audits, investigations or sanctions.
On December 17, 2021, the Inland Revenue Board published a PKPP FAQ (PKPP FAQ), which provides that taxpayers can report their participation in the PKPP in an online form through MyTax.
Basis of the change in tax treatment of wealth tax
According to the 2022 Budget Speech, the reasons for the proposal to tax ISPs received in Malaysia by Malaysian residents are to ensure sustainable income for Malaysia and to comply with international tax best practices.
For context, on October 5, 2021, the Council of the European Union included Malaysia in its “gray list” as a jurisdiction that has committed to change its exemption regime “detrimental” to ISPs by now. December 31, 2022. Other jurisdictions like Hong Kong, Costa Rica, Qatar and Uruguay have also been included in the Gray List on the same basis.
Although the Malaysian government is expected to change the existing tax regime to address EU concerns, many had not anticipated the general removal of the FSI exemption for Malaysian residents. This is all the more true given that the EU has clarified in its guidance that ISF exemption regimes are not in themselves problematic and that the concern is over the “double non-taxation” circumstances that can occur. arise with respect to the passive income of a business that has no substance in the country.
Hong Kong, which adopts a source-based tax regime similar to Malaysia’s, announced the same day that the gray list was released that it will continue to adopt the principle of territorial source taxation despite its inclusion. in the gray list. However, to address EU concerns, it will change its legislation by the end of 2022 and the proposed legislative changes will only target businesses (and not individuals) that earn passive income, especially those that do not. no substantial economic activity in Hong Kong.
Malaysia’s immediate neighbor, Singapore, which was not on the gray list, imposes taxes on ISPs while maintaining certain exemptions for certain categories of income (for example, foreign-source dividends, branch profits or corporate income). income from professional, advisory and other services) subject to the fulfillment of the specified conditions. Individuals who are not residents of Singapore are generally exempt from tax on their ISP.
Indonesia recently introduced the Omnibus Law, one of the main amendments being the introduction of a tax exemption for dividends received by Indonesian tax residents from offshore companies, provided that the income is reinvested in Indonesia for a certain period of time. period and other qualifying investment requirements.
The jurisdictions mentioned above seem to consciously adopt tax policies in a targeted manner to ensure that they remain attractive for investment, while balancing other considerations such as the need to maintain a sound tax base and the character. defensible tax system under international law. meticulous examination.
Likewise, in an era of globalization and increased international scrutiny of the tax regimes of each jurisdiction, the challenge for Malaysia would be to respond to international tax concerns with a focused and measured approach, in order to remain competitive on the scene. global as an attractive jurisdiction. for investments and business operations.
Considerations for Malaysian Residents
Removal of the FSI exemption for Malaysian residents will mean that FSIs such as dividends distributed by foreign companies, interest from foreign loans granted outside Malaysia or foreign bonds, rental income from real estate located outside Malaysia, and even employment income earned by Malaysian tax residents outside Malaysia will be subject to Malaysian income tax when received in Malaysia on or after January 1 2022.
Below we summarize the main issues Malaysian residents should consider when considering the implications of this new tax development.
- Definition of “receipt”
ISPs that are not received in Malaysia will not be taxed. The Budget Bill and Malaysia’s Income Tax Act (ITA) currently do not specify the definition of “receipt”. As a result, on the sole basis of legislation, there is uncertainty as to whether certain transactions, such as contra transactions between related entities or the settlement of a debt incurred in respect of a company in Malaysia, could potentially be considered received in Malaysia.
However, the Inland Revenue Board recently clarified in the PKPP FAQ that only income remitted, imported or transferred to Malaysia from (i) physically, or (ii) through the banking system, will be considered “received” income. in Malaysia. In light of this, it appears that contra transactions may not be counted, but the transfer of funds in Malaysia to a creditor in settlement of a debt can potentially be counted.
Since the meaning of “receipt” is crucial in determining whether a tax is owed under the ISP, this clarification is welcome.
- Distinction between income and capital
ISP tax will only affect a receipt that is “income” in nature. Capital gains remain outside the scope of income tax under the ITA, even if they are from a foreign source and subsequently received in Malaysia. This was also confirmed by the Inland Revenue Board in the PKPP FAQ.
Resident taxpayers will need to determine whether their receipt qualifies as income or capital based on all of the circumstances and factors surrounding the receipt. Specific types of revenue such as dividends, royalties, and interest will generally fall under the income category.
From a practical standpoint, it will be difficult for taxpayers to prove the nature of a receipt to the satisfaction of the Inland Revenue Board, especially if the receipt in Malaysia is from funds that have been kept outside Malaysia. for a longer period.
Going forward, taxpayers will need to be more diligent in keeping records of their earnings (both income and capital) and money transfers to and from Malaysia.
ISFs received in Malaysia may have already been taxed elsewhere. To combat double taxation of the same income, the ITA provides relief in the form of (i) bilateral tax credits, when the relevant foreign country in which the tax was paid has a Double Taxation Agreement (DTA) with Malaysia; or (ii) unilateral tax credits, where the relevant foreign country in which the tax was paid does not have a DTA with Malaysia.
Based on the PKPP FAQ, these credits must be claimed for the FSI received in Malaysia within two years of the end of the relevant valuation year in which the FSI is reported. Taxpayers are required to keep proof of foreign taxes that have been paid under the FSI.
In practice, it will be difficult for resident taxpayers to prove that tax has been paid in the foreign jurisdiction with respect to the amount that is remitted in Malaysia, especially if the amount remitted comes from funds that have been kept out. of Malaysia for a number of years.
Taxpayers should begin to compile and prepare supporting documentation proving that foreign taxes have been paid on the income they plan to remit as an ISP in Malaysia after January 1, 2022, to ensure that any claim for tax credit can be justified.
Going forward, taxpayers will need to continue to keep similar supporting documents for their ISPs.
Applying for tax credits can be administratively burdensome for resident taxpayers, especially individuals. It remains to be seen whether the Inland Revenue Board will be able to reduce administrative challenges for taxpayers by simplifying how to claim tax credits.
The PKPP FAQs suggest that existing income tax reporting forms will be updated to include a new line for taxpayers to report the amount of FSI received in Malaysia from tax year 2022. Taxpayers should stay within the scope of tax. ” keep an eye out for developments regarding reporting obligations, to ensure that they comply with any new rules.
Although the effective date of the removal of the ISP exemption is fast approaching, some uncertainty remains from a technical and administrative point of view.
In these final days leading up to the New Year, it will be important for individuals and businesses residing in Malaysia to take a closer look at their financial affairs, assess potential tax risks, and plan ahead to ensure that ‘they are in the best position to face the tax challenges ahead.
This column does not necessarily reflect the opinion of the Bureau of National Affairs, Inc. or its owners.
Yvonne Beh is a partner and Irene Khor is a partner at Wong & Partners, a member firm of Baker McKenzie in Malaysia.