Foreign-sourced income should be exempted from tax

According to Deloitte Malaysia, focus should be placed on passive income that creates tax arbitrage such as interest and royalty


DELOITTE Malaysia said certain income such as foreign-sourced dividends, foreign branch profits and foreign-sourced service income would continue to be exempted from taxation in Malaysia, following Putrajaya’s proposal of taxing foreign-sourced income (FSI) received in Malaysia from Jan 1 next year.

According to Deloitte Malaysia, many countries do not tax inbound dividends under their participation exemption rules. If alignment with best international practice is key, focus should be placed on passive income that creates tax arbitrage such as interest and royalty.

“On the enhancement of tax collection, a wide inclusion of all types of FSI may work in the short run, but the long-term implication on Malaysia’s competitiveness needs to be considered,” it said in its Highlights of Budget 2022 — Part II, Finance Bill 2021 Tax Espresso (Special Edition) report.

Currently, Malaysia adopts a territorial based taxation system where only income accruing in or derived from Malaysia would be subject to Malaysian income tax.

Income derived from sources outside Malaysia and received in Malaysia is exempted from tax. The exceptions are resident companies in the business of banking, insurance or sea or air transport, which are taxed on worldwide income.

As a transition, the government has proposed that FSI received in Malaysia from Jan 1, 2022, until June 30, 2022, be taxed at 3% on a gross basis.

Given the recent inclusion of Malaysia into the European Union’s (EU) grey list where Malaysia’s territorial-sourced tax regime is considered harmful, the firm said this proposal in is not a total surprise.

“However, since the EU is concerned only where such regimes create situations of double non-taxation, income such as dividend would not be a concern as it would not rank for a deduction.

“That being said, the Finance Bill 2021 seems to cover all kinds of FSI, including foreign dividends received in Malaysia,” it added.

For companies, this means that dividends received in Malaysia by Malaysian resident companies from foreign subsidiaries would be taxed in Malaysia with effect from Jan 1, 2022, said Deloitte Malaysia.

“Foreign dividend withholding tax suffered would be creditable against Malaysian tax payable. Certain tax treaties allow foreign tax paid by subsidiary companies in respect of their income out of which dividends are paid to be part of the credit.

“Another common situation would be the 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,” it added.

As for the impact on individuals, Deloitte Malaysia said one common situation involves rental income earned by a Malaysian tax resident from a real property located outside of Malaysia.

Citing a rental income from Singapore as an example, Deloitte Malaysia said this income is a form of FSI and would not be taxed in Malaysia presently, but from Jan 1 next year, the income remitted to Malaysia would be taxed.

“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 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.”

Another common situation, according to Deloitte Malaysia, involves a Malaysian who lives in Johor Baru and commutes daily to Singapore for work.

“He draws a salary from his Singaporean employer. Under the tiebreaker rule, he is a Malaysian tax resident given that his permanent home is in Johor Baru. Before Jan 1, 2022, he can remit his salary into Malaysia without paying Malaysian tax.

“Under the new rule, his remittance would be subject to Malaysian tax. The Singapore taxes 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.”

Deloitte Malaysia believes an immediate course of action would be to identify any FSI (which may not have been given much attention before this), the 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 the year of assessment 2022 is close.

“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.”