Over the years, Malaysian corporations have grown and expanded their business footprint, not only to neighbouring countries, but also to other continents in many parts of the world. It is not uncommon to see many Malaysian companies receiving income from their business and investment
ventures in foreign countries, hence we need to understand about the issue of tax on foreign income.
These income sources include sales from exports of goods and services, dividends and interest income from foreign investments, royalty fees from licensing of intangible assets, rental from properties located overseas, and commission from acting as agents.
Generally, income received from out of Malaysia has been exempted from tax. However, in the Budget 2022, the Government announced removal of the tax exemptions on such income.
The rationale quoted for the removal, other than a measure by the Government to raise revenue collection, is that it is a step taken by the country to comply with the global tax standards on harmful tax practices.
Tax On Foreign Income
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 enjoy tax exemption on the “income received in Malaysia, from outside Malaysia”, also called foreign sourced income (FSI), under Paragraph 28, Schedule 6 of the ITA (Para 8).
In short, while the FSI received by Malaysian tax residents are taxable under the Section 3 of ITA, the amount are exempted under Para 28. (Note:
the exemption excludes those engaged in banking, insurance or sea or air transport businesses)
However, not all FSI income received are exempted as it has to be truly “sourced from outside Malaysia”.
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, it is argued that interest income from investment funds placed and managed outside the country is foreign sourced and thus, exempt
under Para 28.
Tax Treatment On FSI From 1 January 2022
Effective 1 January 2022, the tax exemption for FSI received by Malaysian residents provided for under Para 28 was removed, following the Budget 2022 made on 29 October 2021. The implementation of the legislation is staggered into two remittance timeline of FSI into Malaysia:
January to June 2022 @ 3%:
Taxpayers are given this 6-months transitional period to remit their foreign sourced income in order to enjoy the lower tax on foreign income rate of 3% calculated on the gross income remitted (Part XX, Schedule 1 of the ITA)
Subsequent to 30 June 2022:
Remittance will be subjected to the normal tax rates.
In summary, the tax treatments for the income of a person residing in Malaysia are depicted as follows:
Special Remittance Programme Terminated
In November 2021, the Inland Revenue Board of Malaysia (IRBM) introduced the Special Income Remittance Programme (Program Khas Peremitan Pendapatan or PKPP) to help taxpayers in the transition to the new FSI regime.
The FSI remitted during the PKPP period (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. In addition, there will be no penalties imposed for the remittance during the PKPP period.
However, this programme is shortlived and was revoked on 11 March 2022, as it is deemed not relevant, after the Ministry of Finance (MOF) announced in December 2021 on a concession to exempt certain categories of FSI for a period of five years from 2022 to 2026.
Concession: 1 January 2022 – 31 December 2026
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.
It is also seen as a stumbling block to attract foreign direct investment (FDI) in Malaysia, thus affecting Malaysia’s competitive position in the global trade map.
On 30 December 2021, MOF 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 to individuals, partners in conventional partnerships, limited liability partnerships (LLP) and companies.
The exemption period granted 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. Meanwhile companies and
LLPs are exempted on foreign dividend income only.
However, there are the preconditions set in the Exemption Orders to qualify for the exemption during the fi ve 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”.
- For 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%”.
IRBM is to issue the relevant guidelines on the applicable tax treatments, which are yet available at the time of writing. Clearly, taxpayers will need to meet certain conditions to enjoy the tax exemption during the five years concession period as it may not be as straight forward to qualify.
The limelight is now on the IRBM 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.
Tax Exemption Of FSI From 1 January 2022 To 31 December 2026
Taxable FSI Received By Corporate Investors
For now, FSI other than dividend income received by Malaysian corporate tax residents will be subject to tax in Malaysia. Notably, where the foreign dividends are received by a legal corporate 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 tax on foreign income is set out below:
Common Situation Of Taxable FSI
Double Tax Relief On Foreign Tax Suffered
The tax on foreign income received in Malaysia may be reduced by the foreign tax credit paid. 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 eg Singapore, Indonesia, Japan, China, Australia, South Africa, United Kingdom, France, etc. Under a double tax agreement, a full relief may be possible based on the calculation of a prescribed formula, but the relief amount is only up to the Malaysian tax suffered.
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 eg British Virgin Islands, Taiwan, United States of America, etc. For such relief, the foreign tax recognised is automatically halved.
One is required to substantiate the amount of tax paid overseas with the relevant supporting documents from the tax authorities in the foreign
countries, in order to claim the aforementioned tax relief in their tax return.
Capital Receipts Are Non-Taxable
The tax on foreign income 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, and foreign investment papers. However, these assets have been held as long-term investments.
Whether the gains are “income” or “capital” in nature, the onus of proof lies with the taxpayers. 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.
Action Plan
The year 2022 marks an impact on investors with foreign asset holdings, in navigating a new tax landscape going forward with the removal of tax exemption under Para 28. The imminent measures include evaluation of the financial returns on their existing overseas investments, net of all tax costs. In sourcing new investment opportunities overseas, such investors shall need to factor in the additional tax costs in Malaysia.
Here are a few suggestions on the action that affected investors should look into:
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 will have different
tax implications.
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 will need to include transfer pricing
considerations to avoid tax pitfalls in the future.
If guidance is required on the issue of tax on foreign income, consider seeking professional advice from a tax consultant. This would help you avoid stepping into potential tax landmines that could be uncovered in the future, when the company is audited by the IRBM.
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