i Entity selection and business operations
The most common forms of business entities are companies (private or public), partnerships, limited liability partnerships and sole proprietorships. For foreign enterprises, business activities can also be carried out through a local branch as opposed to an incorporated local subsidiary.
Under the Malaysian Income Tax Act 1967 (ITA), most of the business entities above are taxable given the non-exhaustive definition of a taxable person under the ITA. However, Malaysia offers a multitude of tax exemptions under the ITA and the Promotion of Investments Act 1986 (PIA), which exempt either the entirety of the income of an entity from tax or income in respect of specific business activities. Tax incentives are also offered in the form of allowances or increased tax deductions.
For multinational businesses considering establishing a presence in Malaysia, entity selection plays a pivotal role as it will affect the rate of tax payable and tax incentives available.
Sole proprietorships and partnerships
Sole proprietorships and partnerships are not recognised as ‘persons’ for income tax purposes. Consequently, the profits and loss of a proprietorship or partnership flow through to the business owners, who are taxed on their individual income at the graduated rates of tax for individuals. In a partnership, each partner is assessed on his or her share of the partnership income.
Companies are generally taxed at the corporate rate of 24 per cent. For a company resident and incorporated in Malaysia that has a paid-up ordinary share capital of 2.5 million ringgit or less, income tax is chargeable at a rate of 17 per cent for the first 500,000 ringgit and 24 per cent for every ringgit thereafter.
Locally incorporated and resident companies can enjoy significant tax incentives, most notably in the form of pioneer status and investment tax allowance under the PIA. Companies that are granted pioneer status by participating in a promoted activity or producing a promoted product are allowed tax exemption on 70 per cent of their statutory income for five years. Investment tax allowance, on the other hand, is granted on 60 per cent qualifying capital expenditure incurred for a period of five years, to be utilised against 70 per cent of the statutory income.
Reinvestment allowance (RA) is also available on 60 per cent of the capital expenditure incurred on a factory, a plant or machinery used in Malaysia for the expansion, modernisation, or diversification of a company’s business. As all three incentives are mutually exclusive, it may be more advantageous for businesses that qualify for both investment tax allowance and RA to apply for RA as it can be enjoyed for a longer period of 15 years.
Local branches of non-resident entities are generally treated as non-residents for income tax purposes unless it can be established that the management and control of its affairs or businesses is exercised in Malaysia. Branches are taxable at a rate of 24 per cent on income accruing in or derived from Malaysia, which is the same as the tax rate imposed on local incorporated companies.
Given their non-resident status, tax incentives under the ITA and PIA are generally unavailable to local branches. Thus, from a tax perspective, it may be more tax-efficient for foreign enterprises to carry on their business activities in Malaysia by incorporating a local subsidiary rather than by registering a branch.
In a bid to attract investors and promote the Federal Territory of Labuan as an international offshore financial centre, preferential tax rates are provided under the Labuan Business Activity Tax Act 1990 (LBATA) for companies incorporated under the Labuan Companies Act 1990 undertaking Labuan trading activities such as banking, insurance, trading, management, licensing and shipping operations. Before 1 January 2019, Labuan entities could choose between paying tax at a rate of 3 per cent or a flat rate of 20,000 ringgit per year. However, legislative amendments have now removed the tax ceiling of 20,000 ringgit.
Limited liability partnerships
Unlike conventional partnerships, limited liability partnerships (LLPs) are recognised as taxable persons for income tax purposes and are taxed at a rate of 24 per cent. Where an LLP has a capital contribution of 2.5 million ringgit or less, the LLP will enjoy a reduced tax rate of 17 per cent for the first 500,000 ringgit of its income and 24 per cent for the remainder. Significantly, profits paid or distributed to partners in an LLP are exempt from tax and no withholding tax is applicable.
Domestic income tax
Malaysia’s income tax system is territorial in nature. Income tax is levied on any person’s income accruing in or derived from Malaysia, including business gains or profits, employment income, interests, rents and royalties. However, income of a resident company carrying on the business of air or sea transport, banking, or insurance is taxable on a worldwide basis. In respect of dividends, Malaysia operates on a single-tier system where income tax imposed on a company is a final tax and dividends are tax exempt in the hands of shareholders.
Non-resident businesses are taxed on income accruing in or derived from Malaysia if they have permanent establishments in Malaysia. Recent amendments to Section 12 of the ITA have amended the definition of ‘place of business’ in the ITA to mirror the definition of permanent establishments that is commonly found in all double taxation agreements (DTAs).
Malaysia’s territorial tax system means that foreign-sourced income is not subject to income tax in Malaysia. In other words, the income of a person derived from sources outside Malaysia and received in Malaysia is tax-exempt.
In determining whether an income is a foreign-sourced income, Malaysian courts have adopted the principle enunciated by the Privy Council in Hang Seng. That is, one must see what the taxpayer has done to earn the profit. Thus, if a service is rendered or an activity is engaged in, profit will arise or will be derived from the jurisdiction where the services were rendered or the profit-making activity carried on. In Cardinal Health, for example, the High Court held that interest income received in Malaysia arising from a loan provided by a Malaysian company to a company in the Netherlands was foreign-sourced income as the provision of credit occurred in the Netherlands.
Hence, enterprises should consider factors such as the place where an agreement is entered into and the jurisdiction in which personnel carry on commercial activities when structuring their business dealings.
Legislation on thin capitalisation was introduced in Malaysia on 1 January 2009, but the Thin Capitalisation Rules for its implementation were never gazetted. With the proposal of Earning Stripping Rules (ESR) by the OECD under its BEPS Action 4 Report on Limitations on Interest Deduction, the legal provision on thin capitalisation was consequently removed with effect from 1 January 2018.
Exactly a year later on 1 January 2019, a new Section 140C of the ITA came into effect to restrict the deductibility of interest expenses between related persons. No deduction is allowed in respect of any interest expense in connection with or on any financial assistance in a controlled transaction granted directly or indirectly to that person that is more than the maximum amount of interest as determined under any rules made under the ITA.
Based on OECD recommendations, interest deductions are predicted to be limited to a fixed percentage (between 10 per cent and 30 per cent) of an entity’s earnings before interest, taxes, depreciation and amortisation (EBITDA). As the relevant rules have yet to be issued or gazetted, it remains to be seen what is the maximum amount of interest that is deductible and how the ESR are to be implemented, including whether the ESR would apply only to cross-border related party transactions and whether there would be a de minimis threshold.
ii Common ownership: group structures and intercompany transactionsOwnership structure of related parties
Unlike countries such as Australia and the United States of America, Malaysia does not allow income tax consolidation where wholly owned or majority-owned companies are treated as a single entity for income tax purposes. The ITA does, however, offer group relief for related companies incorporated in and resident in Malaysia in respect of the transfer or surrender of losses.
Under Section 44A of the ITA, a company (the ‘surrendering company’) could surrender not more than 70 per cent of its adjusted loss in a year of assessment to one or more related companies (the ‘claimant company’), with no time limitation. However, from 2019 onwards, group relief is only available to new companies. Losses can only be surrendered immediately after 12 months from the date the company first commences operation and only for three consecutive years of assessment.
While group relief is certainly advantageous, businesses should be aware that where a surrendering company furnishes an incorrect return in respect of the amount of loss surrendered, the company may be liable to a penalty equal to the amount of tax that had been undercharged on the claimant company in consequence of the incorrect information.
Domestic intercompany transactions
In Malaysia, transactions between related domestic companies are subject to the same legislative provisions and rules that govern international intercompany transactions, which are discussed below. Even though there may be no erosion of the Malaysian tax base given that both companies are taxable in Malaysia, pricing manipulation could alter the tax incidence of the related entities by shifting profits between loss-making and profit-making companies. Thus, it would be prudent for groups of companies to maintain proper transfer pricing documentation in respect of their domestic intercompany transactions, especially where there are differences in the tax incentives enjoyed by or rates of tax applicable to the related companies.
Nevertheless, tax benefits are available in the form of exemptions on stamp duty or real property gains tax (RPGT). Relief from stamp duty is available for reconstructions or amalgamations of companies or for the transfer of property between associated companies, subject of course to the fulfilment of certain conditions. Similarly, RPGT relief may be granted where real property is transferred between companies in the same group to bring about greater efficiency in operation or transferred between companies in any scheme of reorganisation, reconstruction or amalgamation.
International intercompany transactions
Apart from the ESR as described above, Malaysia has implemented transfer pricing legislation in an effort to counter BEPS. Cross-border related party transactions are subject to the transfer pricing provisions in the ITA as well as the Income Tax (Transfer Pricing) Rules 2012 (the TP Rules). Businesses must ensure that their intercompany transactions are priced at arm’s length in accordance with traditional transactional methods (comparable uncontrolled price method, resale price method, or cost plus method) or if impractical, transactional profit methods (profit split method or the transactional net margin method). Section 140A of the ITA empowers the IRB to substitute the price in respect of a related party transaction to reflect an arm’s-length price of the transaction.
Companies are also required to maintain contemporaneous transfer pricing documentation setting out, among others, the organisational structure of the business, the nature of the business, the controlled transaction, selection of the transfer pricing method, and comparability, functional and risk analyses. Given that the IRB has seven years to raise an additional assessment, businesses should ensure that their documentation is in order.
In respect of withholding taxes, tax must be withheld on the payment of interest derived from Malaysia to non-residents at a rate of 15 per cent or potentially less if there exists a double taxation treaty between Malaysia and the home country of the non-resident. No withholding tax applies to payments of dividends.
iii Third-party transactionsSales of shares or assets for cash
In general, income tax is not chargeable on income from the sale of shares unless the seller is involved in the business of trading shares. Similarly, there are largely no income tax consequences for the sale of assets as they are not the stock in trade of a business unless the sale involves capital assets for which capital allowances have been granted and the disposal value exceeds the tax written-down value of the assets.
Unlike countries such as the United Kingdom, Malaysia also has no capital gains tax, with the exception of RPGT, which is only applicable to gains from the sale or disposal of real property or shares in a real property company (RPC). An RPC is a controlled company in which real property or shares in another RPC make up at least 75 per cent of its total tangible assets. For companies, RPGT is imposed at a rate of 30 per cent for disposals within three years after the date of acquisition of the real property or RPC shares, 20 per cent for disposals in the fourth year, 15 per cent for disposals in the fifth year, and 10 per cent for disposals in the sixth year and thereafter.
The sale of shares or assets will, however, attract stamp duty. Stamp duty on the share transfer instrument is payable at an ad valorem rate, calculated on the price or value on the date of transfer. Three ringgit is payable for each 1,000 ringgit or fractional part of 1,000 ringgit. Similarly, ad valorem stamp duty is payable on the transfer instrument of any asset.
Tax-free or tax-deferred transactions
RPGT relief is available where an asset is distributed by a liquidator of a company and the liquidation of the company was made under a scheme of reorganisation, reconstruction or amalgamation.
Under the ITA, withholding tax is imposed on selected cross-border payments to non-residents, including interests, royalties, contract payments in respect of services rendered in Malaysia and special classes of income.
Notably, recent legislative amendments have widened the scope of special classes of income under Section 4A(ii) of the ITA, which provided that income in respect of ‘technical advice, assistance or services’ rendered by non-residents is subject to tax. The amendments have removed the phrases ‘technical’ and ‘technical management or administration’. Consequently, now any amount paid in consideration of any advice given, or assistance or services rendered in connection with any scientific, industrial or commercial undertaking, venture, project or scheme is subject to income tax. ‘Technicality’ is no longer required for a service to be taxed under this provision.
In effect, taxes would now have to be withheld and paid for payments made to offshore service providers for any services provided in Malaysia.
iv Indirect taxes
Holding fast to its election promise, the new government has replaced Malaysia’s goods and services tax (GST) with sales and services tax (SST), which began on 1 September 2018. Unlike GST, the scope of SST is much narrower and the number of items exempted from SST is 10 times more than that under the GST system.
Sales tax is charged on taxable goods that are manufactured in Malaysia by a registered manufacturer and sold, used, or disposed of by him or her, or imported into Malaysia. Manufactured goods that are exported would not be subject to sales tax. Unlike under the GST regime, there is no system of input tax or output tax.
Service tax is imposed on specific prescribed services provided in Malaysia by a registered person carrying on his or her business at a rate of 6 per cent. Services subject to service tax include the operation of hotels and restaurants, betting and gaming, professional and consultancy services, and IT services. Unlike under the GST regime, any service tax incurred is not recoverable and would thus be a business cost, albeit deductible for income tax purposes. From 1 January 2019 onwards, registered service tax companies enjoy exemptions on specific business-to-business service tax.