A business in Malaysia can exist in various forms, namely:
Each form differs on the level of ownership and extent of the owner’s liability. Nevertheless, it is more common for businesses to adopt a corporate form (as opposed to a sole proprietorship or conventional partnership) when setting up a business in the country.
Companies and LLPs acquire the characteristics of a separate legal entity and are treated as a separate “person” in law. Given this, the owners or shareholders of a company or LLP will not be personally liable for the company’s or partnership’s debts, save for the amount which they have paid or agreed to contribute.
Conventional partnerships and sole proprietorships, however, do not acquire the characteristics of a separate legal entity under the law. The owners of a partnership (or sole proprietorship) may therefore be personally liable without any limit for the partnership’s debts and be sued in their personal capacity in respect of the partnership’s obligations.
Another key difference between the various forms of business entities is the financial and compliance requirements. For instance, a company is legally required to prepare audited accounts and circulate the same to its shareholders every year. Such requirement does not exist for conventional partnerships or sole proprietorships. It is also not mandatory for LLPs to prepare annual audited accounts unless stated otherwise in the partnership agreement.
Companies and LLPs, being separate legal entities, will file their own tax returns and be taxed as corporate entities. On the other hand, while conventional partnerships and sole proprietorships are also required to file their own tax returns, their business profits will be taxed as the owners’ chargeable income.
In the case of a conventional partnership, the business profit will be apportioned among the partners according to their rights in the partnership.
The commonly used transparent entities in Malaysia are conventional partnerships (if there are two or more partners) and sole proprietorships (if there is only one partner). As discussed in 1.1 Corporate Structures and Tax Treatment, both entities are not regarded as separate legal entities and do not have to pay their own taxes.
The business profits will be taxed as the owners’ chargeable income and be subject to the graduated tax rates applicable to individuals. Nevertheless, conventional partnerships and sole proprietorships are required to file their own tax returns on an annual basis.
A business entity will be regarded as a tax resident in Malaysia if, at any time during an assessment year, the management and control of its affairs are exercised in Malaysia. Management and control are generally regarded as exercised in Malaysia if the board of directors (or partners) holds a meeting in Malaysia to conduct the business affairs of the company (or partnership). Management and control may also be established if the entity has a fixed place of business in Malaysia.
Companies and LLPs are generally subject to a corporate tax rate of 24%. However, companies or LLPs with paid-up ordinary share capital of MYR2.5 million or less and gross income of not more than MYR50 million will be subject to a two-tier tax rate of 17% and 24%. Transparent entities such as conventional partnerships or sole proprietorships, on the other hand, will be taxed at the owners’ level at the graduated rates applicable to individuals, which range from 0% to 30%.
In general, taxable profits are calculated by deducting allowable expenses incurred in the production of gross income and certain other allowances provided under the law from the said income. Taxable profits are computed based on accounting profits subject to the necessary adjustments provided under the Income Tax Act 1967 (ITA).
Such adjustments include the deduction of non-taxable income and exempt income, capital or reinvestment allowances, current year or carried forward losses, and other expenses allowed under the ITA. Disallowable expenses and any balancing charges will also be added back into the computation of the taxable profit. Profits are taxed on an accrual basis.
Other than those provided under the ITA, tax incentives are provided under the Promotion of Investments Act 1986 (PIA), which is a statute specifically enacted to promote investments via the provision of tax incentives.
Companies intending to participate in promoted activities or produce promoted products in areas of new and emerging technologies (“High Technology Companies”) are qualified to apply for incentives in the form of a Pioneer Status or Investment Tax Allowance under the PIA. Upon receiving Pioneer Status, the High Technology Companies would enjoy a 100% exemption of their statutory income for a period of five years. Under the Investment Tax Allowance, up to 60% of such company’s qualifying capital expenditure can be utilised to offset against 100% of its statutory income.
Companies engaged in research and development (R&D) activities or the provision of R&D services in Malaysia can apply for similar incentives, depending on the nature and recipient of the R&D activities. Applications for such incentives should be submitted to the Malaysian Investment Development Authority and would be subject to the approval of the Minister of International Trade and Industry.
A Malaysian company which operates as a principal hub and undertakes research, development, and innovation activities in addition to business unit management activities (which is compulsory) to its network companies are also given tax exemption in respect of its value-added income and intellectual property income. Further, special incentives are given to companies involved in green technology activities, such as Green Investment Tax Allowance (GITA) and Green Income Tax Exemption (GITE). Companies incurring capital expenditure in green technology projects and in acquiring green technology assets will qualify for such GITA and companies providing green technology services can claim GITE up to 100% of their statutory income.
Additionally, the ITA allows additional incentives in the form of double deduction of revenue expenditure and industrial building allowance. For example, companies can enjoy double deduction on revenue expenditure incurred for research that is approved by the Minister of Finance. Double deductions are also available for contributions and donations to approved research institutes, and payments for the services of approved research institutes and companies, R&D companies, or contract R&D companies.
Upon fulfilment of certain criteria, local and foreign companies involved in ICT related businesses can apply for Multimedia Super Corridor (MSC) Malaysia Status which entails, amongst other incentives, 70% to 100% exemption from income tax. From 1 January 2019 onwards, the number of promoted activities for income tax exemption has been revised to 16 activities, including big data analytics, artificial intelligence, financial technology, cybersecurity, and robotics.
Generally, Malaysia provides a broad range of tax incentives for the promotion of investments in selected industry sectors. Examples of such tax incentives include:
Different incentives are applicable to each specific industry and the industries include manufacturing, agriculture, ICT, education, tourism, healthcare, financial services, biotechnology, communications, utilities, transportation, green technology, waste recycling, real estate investment trust (REIT), Islamic financing, venture capital industry, shipping, and integrated logistics services.
Corporate loss relief can be claimed in the current year or carried forward to subsequent years. Carry back losses are not allowed.
In computing a company’s chargeable income (ie, income that will be charged to tax) for a current year, the cumulative losses of the company from all of its sources of income (business or otherwise) can be set-off against income from any of its sources of income.
Any unutilised business losses can be carried forward to the subsequent years and be utilised against income from any business source. From the year of assessment (YA) 2019 onwards, unutilised business losses can only be carried forward for a maximum period of seven consecutive YAs. This time limitation applies to all unutilised business losses accumulated up to YA 2018 which must be fully utilised by YA 2025 and will be disregarded in YA 2026.
For dormant companies, the accumulated tax losses cannot be carried forward if there was a substantial change in the shareholding of the company, ie, more than 50%.
Further, the ITA allows a group of Malaysian companies to claim group relief whereby companies are allowed to surrender up to 70% of their adjusted losses to one or more of its related companies. From YA 2019 onwards, this relief has been restricted to only allow losses of new companies to be surrendered for three consecutive YAs following the company’s first 12-month fiscal year operations. Prior to this, there was no time limitation.
If the claiming company has unutilised investment tax allowances or adjusted losses from a pioneer business, it will not be entitled to the group relief.
It is highlighted that interest expenses incurred for capital or revenue purposes are deductible under the ITA, whereas other expenses are not deductible if they are capital in nature. However, if borrowings made for business purposes are partly used for non-business purposes such as the provision of loans or investments which are not part of the company’s business, the interest relating to the portion used for the non-business purposes are restricted and would not be deductible. The portion of the interest expenditure restricted can be deducted against the company’s other sources of income, wherever relevant.
Earning Stripping Rules
With effect from 1 July 2019, a new provision was inserted into the ITA to provide for the application of Earning Stripping Rules (ESR) in Malaysia. This initiative reflects Malaysia’s commitment to adhere to the recommendations in the BEPS Action 4 Final Report. Essentially, ESR restricts the interest deductible by a company for any financial assistance granted in a controlled transaction, ie, transactions between parties controlled by the same person, or where one party has control of the other party.
The details of the ESR as contained in the Income Tax (Restriction on Deductibility of Interest) Rules 2019 (“ESR Rules”) are as follows:only applicable to business interest expenses incurred in relation to a business source;
The ESR does not apply to the following:
It is stated in the Restriction of Deductibility of Interest Guidelines issued by the Malaysian tax authority, name the Inland Revenue Board of Malaysia (IRB), that the ESR will only apply to cross-border financial transactions. However, this concession by the IRB does not have any force of law as the ESR Rules do not make such distinction and adopts a blanket approach to apply to all financial transactions.
Consolidated tax grouping is not permitted in Malaysia and each company is required to file separate tax returns. However, locally incorporated companies with paid-up capital of ordinary shares exceeding MYR2.5 million at the beginning of the basis period can claim for group relief to utilise separate company losses, subject to the requirements provided in Section 44A of the ITA (see 2.4 Basic Rules on Loss Relief).
Capital gains are not taxed in Malaysia save for gains derived from the disposal of real property or shares in a real property company (RPC) which will be taxed in the form of a real property gains tax (RPGT).
The amount of RPGT payable is dependent on the period between the acquisition date of the real property and the date of disposal. The rate for disposals made within three years from the acquisition date is 30% and is 20% for disposals in the 4th year, 15% for disposals in the fifth year, and 10% for disposals in the sixth year and thereafter. Disposals by foreign companies within five years are subject to a flat rate of 30% and 10% thereafter.
The scope of RPGT is fairly wide as "real property" is defined to include any interest, option, or other right in or over land. Further, once a taxpayer obtains RPC shares, the gains derived from the disposal of the RPC shares would still be chargeable to RPGT even after the company ceases to be an RPC. An RPC is a company in which the value of its real properties or RPC shares is at least 75% of its total tangible assets.
In computing the gains from the disposal of a real property, taxpayers can deduct all expenditures incurred to enhance or preserve the value of the asset as well as incidental costs relating to the disposal. It is highlighted that transactions between related parties are deemed to not be at arm’s length and the consideration for the transaction would be based on the asset’s market value.
However, certain transactions are deemed to have no gain, ie, the disposal price is deemed to be the same as the acquisition price, and no RPGT would be payable. Such transactions include conveyance of an asset by way of security, disposal due to compulsory acquisitions, and disposals due to a financing scheme approved by the Central Bank or Securities Commission which is in line with the principles of Syariah (Islamic Law).
The Minister of Finance is also able to provide RPGT exemptions. Examples of such exemptions given by the Minister include disposal of assets to a REIT or property trust fund (PTF), restructuring scheme of a licensed insurer or takaful operator which is approved by the Central Bank, and disposal of assets to a trustee manager on behalf of a business trust.
If a transaction involves the execution of instruments, such instruments would be liable to stamp duty and the amount chargeable is dependent on the type of instruments. Certain instruments such as agreements for conveyances, services, loans, and charges would be charged to stamp duty at ad valorem rate. The stamp duty for other instruments would be at a nominal rate of MYR10.
A transaction may also attract indirect tax, ie, sales tax and service tax.
Sales tax is a single-stage tax imposed on taxable goods manufactured locally by a registered manufacturer or goods imported into Malaysia. All goods are taxable unless specifically exempted by the Minister of Finance. The standard rates for sales tax are 5% and 10%, depending on the class of goods.
Service tax is a consumption tax levied on taxable services provided in Malaysia including, amongst others, the provision of accommodation and foods and beverages, certain professional services, certain telecommunication services, domestic flight services, and management services. With effect from 1 January 2020, digital services are also included as a taxable service. However, certain intra-group services would not be taxable subject to the fulfilment of certain criteria. Service tax is levied at a rate of 6%.
There is no value-added tax in Malaysia since the abolishment of the goods and service tax (GST) regime.
Other notable taxes include custom duties (import and export duties) and excise duties.
Import duties are levied on goods imported into the country on an ad valorem basis or on a specific basis. The current ad valorem rate ranges from 2% to 60%, depending on the type of goods imported. Export duties are generally imposed on Malaysia’s main export commodities, such as petroleum and palm oil.
Excise duties are levied on a selected range of goods manufactured in or imported into Malaysia. Examples of such goods are alcoholic beverages/spirits, tobacco products, and motor vehicles. Similarly, the excise duty rates are either specific or ad valorem.
Employers and Property
Employers in Malaysia are also required to deduct and withhold tax from their employees’ salaries each month and remit such taxes to the revenue authorities. Employers are also required to make social security contributions on behalf of their employees to the Employees’ Provident Fund (12% or 13%) and Social Security Organisation (up to MYR69.06).
Each state also levies “quit” rent on real properties at varying rates each year.
Most of the closely held local businesses operate in a corporate form.
The highest corporate tax rate is 24% whereas the tax rate of the highest tax bracket for individuals is 30%. There is no tax rule which prevents professionals from earning income in a corporate form. Subject to the respective code of conduct, professionals are allowed to form any business entity which they deem fit. For instance, accounting firms can operate as LLPs whereas law firms are still confined to conventional partnerships only.
There are no rules in place to prevent closely-held corporations from accumulating earnings for investment purposes. There are, however, mechanisms in place which encourage distribution of earnings to the investors. For instance, REITs and PTFs are exempted from paying income tax if they distribute at least 90% of their income to the unit holders.
Malaysia adopts a single-tier system whereby shareholders are exempted from paying taxes on dividends which they receive. Individuals (or shareholders) are also not required to pay capital gains tax for the sale of shares in a company, unless the company is an RPC, see 2.7 Capital Gains Taxation.
Similar to 3.4 Sales of Shares by Individuals in Closely Held Corporations, individuals are exempted from paying taxes on dividends which they receive. They are also not required to pay capital gains tax on the sale of shares in a company, unless the company is an RPC. This is the position notwithstanding the fact that the company is a public listed company.
However, individuals who actively engage in the buying and selling of shares in publicly traded companies for the purposes of earning profit (or income) may be regarded as being in the business of trading in publicly listed shares. In such cases, the gains received by the individual will be subject to income tax.
Ordinarily, payment of royalty and interest by a Malaysian tax resident to a non-resident is subject to withholding tax at the rate of 10% and 15% respectively. Payment of dividends, however, is not subject to withholding tax.
Apart from payment of royalty and interest, there are other types of payment which are subject to withholding tax in Malaysia, for example, payment for services or advice, rental of movable property, and contract payments. The withholding tax rate imposed by the ITA would apply unless reduced under a double taxation treaty.
The Minister of Finance can also grant certain exemptions or reliefs for withholding tax. For example, companies are exempted from their withholding tax obligations in respect of payments made for advice given or services rendered outside of Malaysia.
Malaysia has executed double taxation treaties with various countries to minimise (or prevent) double taxation of the same income in two countries in an international trade or cross-border transaction. Nevertheless, the majority of foreign direct investments in Malaysia are from Asian countries, with the most common being China, Japan and Singapore.
The IRB, generally, will not challenge the use of double taxation treaties by non-treaty country residents, unless there are instances of tax avoidance.
On 24 January 2018, Malaysia became a signatory to the OECD Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI) and has committed to implement a number of the OECD’s BEPS recommendations, including BEPS Action 6 which is aimed at tackling treaty shopping or treaty abuse practices. This will see Malaysia adopting the “principal purpose test” for all its double taxation treaties upon ratification, whereby treaty benefits will be denied if it is reasonable to conclude that obtaining the treaty benefit is one of the principal purposes of a particular transaction.
One of the biggest transfer pricing issues in Malaysia is arguably the IRB’s selection of comparables for benchmarking analysis. The revenue authority tends to limit the selection of comparables to local companies and at times, fails to appreciate that the selected comparables have radically different business plans or are in a different market group.
There are also instances where the IRB may have inadvertently misused transfer pricing principles to adjust related parties’ transactions which are profitable or beneficial to the Malaysian company but detrimental to the overseas counterpart.
Arrangements and transactions between related companies (one of which could be a limited risk company) for the sale of goods or provision of services locally are subject to transfer pricing rules. Any transaction which has a direct or indirect effect of altering the incidence of tax which is payable by one party to a transaction or relieving any tax liability may be varied and adjusted by the IRB. The test is whether the related companies engaged in the arrangement or transaction at arm’s length.
The transfer pricing rules in Malaysia are largely based on the OECD Transfer Pricing Guidelines. Companies in Malaysia are generally advised to follow the OECD standards in respect of its transfer pricing documentation. The local transfer pricing guidelines issued by the IRB are also based on the arm’s length principle as set out under the OECD Transfer Pricing Guidelines.
Other than cross-border transactions, Malaysia’s transfer pricing rules also apply in a domestic context, that is resident companies within the same group would also need to adhere to all transfer pricing rules and regulations.
If a transfer pricing adjustment is made on one of the parties to a transaction, the law allows the other party to request for an offsetting adjustment to be made on the tax assessment of the other party.
A local branch of a non-resident company and a local subsidiary of the non-resident company are taxed similarly, where all income of both entities derived in Malaysia is subjected to corporate tax at a rate of 24%.
However, if the management and control of a branch are exercised outside of Malaysia, the local branches will be treated as non-residents in Malaysia.
Thus, the key difference between a local branch and local subsidiary of non-resident companies lies in the ineligibility of the local branch to claim for tax incentives provided under the ITA and PIA which would otherwise be available to local subsidiaries. Further, certain payments (for example, royalties, interest, and services fees) made to a local branch would be subject to withholding tax.
As there is no capital gains tax in Malaysia, capital gains earned by non-residents would similarly not be taxed, save for gains derived from the sale of real property or shares in an RPC (see 2.7 Capital Gains Taxation).
Hence, capital gains of non-residents from the disposal of shares in a company will not be taxed unless the shares in question are shares of an RPC.
There are no change of control provisions in Malaysia which will trigger tax or duty charges. However, if there is a major change in the shareholding of a dormant company, any unutilised losses of the company cannot be carried forward to subsequent years. Certain tax incentives relating to transactions between related parties would also be revoked if there is a change in control which renders the parties to cease being related parties.
There are no special formulas used to determine the income of foreign-owned local affiliates in Malaysia. Local affiliates of foreign companies will be taxed on all income accrued or derived in Malaysia and the chargeable income (income which is taxable) will be computed in the same manner as local companies.
Payments made by a local affiliate to its foreign affiliate for management and administrative expenses incurred by the foreign affiliate will be allowed as a deduction if the payments are made at arm’s length, and services rendered by the non-local affiliate has conferred economic benefit or value to the local affiliate’s business. Further, such services cannot be duplicative or involve shareholder activities.
All related-party borrowings are required to comply with transfer pricing laws, ie, the interest rates must be charged at arm’s length. Further, the deductibility of interest expenses by the borrowing company is subject to the ESR, see 2.5 Imposed Limits on Deduction of Interest.
Interest paid by a local subsidiary to a non-resident would also be subject to withholding tax at 15% (or any other rate stipulated in the applicable double taxation treaty).
The income of local corporations derived from outside Malaysia but received in Malaysia is exempted from income tax, except for companies engaged in the business of banking, insurance, sea transport or air transport.
Generally, only expenses incurred wholly and exclusively in the production of gross income is deductible. As foreign income is exempted from tax and would be disregarded for the purpose of the ITA, all expenses attributable to such foreign income correspondingly cannot be deducted.
Dividends received by resident companies from foreign companies are still generally regarded as foreign-sourced income. Thus, these dividends would also be exempted from tax unless the resident company is engaged in the business of banking, insurance, sea transport, or air transport.
If a foreign related company is licensed to use intangibles developed by a local Malaysian company, such transactions would be subject to transfer pricing laws. If the ownership of the intangible property does not vest with the developer of the property, the developer shall receive an arm’s length consideration for the development of the property.
Malaysia does not have controlled foreign corporation (CFC) rules.
There are no rules relating to substance requirements of non-local affiliates.
As there is no capital gains tax in Malaysia, gains from the sale of shares in non-local affiliates will not be taxed. However, gains received from the disposal of shares in a non-local affiliate will be subject to RPGT if the non-local affiliate is an RPC. See 2.7 Capital Gains Taxation for the definition of an RPC.
Section 140 of the ITA is a general anti-avoidance provision which provides wide powers to the IRB to disregard or vary a transaction and to recompute the tax liability of a taxpayer. The revenue authority may do so where there is reason to believe that any transaction alters the incidence of tax, relieves a person from tax liability, evades or avoids any duty or tax liability, or hinders or prevents the operation of the ITA. There are procedural safeguards that must be complied with before the anti-avoidance provision can be invoked, namely that the revenue authority must identify the purported effect of the taxpayer’s transaction and provide grounds for recomputing the tax payable.
In determining whether a transaction constitutes tax avoidance, regard must be had to the dominant purpose of a transaction. While taxpayers have the freedom to structure their transactions to their best tax advantage, there must be genuine commercial purpose to the transaction apart from tax savings in order for the transaction to not be caught within the meaning of tax avoidance.
In addition, the ITA also contains a specific transfer pricing provision (Section 140A) which empowers the IRB to substitute an arm’s length price of a transaction between related parties.
The IRB does not have fixed audit cycle for each taxpayer and taxpayers can be audited at any time. Businesses are selected for audit through a computerised system based on various risk assessment criteria and information, including the taxpayer’s own tax returns and information from third parties. The revenue authority may also select companies based on their participation in targeted industries or their locality.
In general, the IRB will audit businesses on their returns for the past three to five years. However, the IRB can raise tax assessments going as far back as five years and if evidence shows that there is any element of fraud, negligence, or wilful default, there is no limitation period.
There are two types of audits carried out: desk audits and field audits.
Desk audits are typically used for simpler and straightforward issues which can be resolved via correspondence, ie, letters and email. The IRB will review documents and information submitted by taxpayers and may require taxpayers to attend interviews at the IRB’s office if necessary.
Field audits involve a review of the taxpayer’s business records at the taxpayer’s premises. Taxpayers will usually be given prior notice of a field audit.
The IRB has resolved to complete all tax audits within 90 days.
Malaysia has implemented a number of reforms arising from OECD’s BEPS recommendations. Malaysia has introduced transfer pricing legislation in 2012 (BEPS Actions 8-10), and subsequently country-by-country reporting and automatic exchange of information between tax authorities (BEPS Action 13) in 2016. Recently, Malaysia has also implemented ESR (BEPS Action 4), which is explained in further detail at 2.5 Imposed Limits on Deduction of Interest.
In addition, a comprehensive review of both IP and non-IP tax incentives (including principal hub, Multimedia Super Corridor (MSC) Malaysia, and pioneer status incentives) was carried out to eliminate harmful tax practices identified by the Forum on Harmful Tax Practices (FHTP) (BEPS Action 5). For IP incentives, Malaysia has amended its existing incentives so that tax exemption is only given where R&D expenditures is incurred and carried out in Malaysia. For non-IP incentives, legislation was passed to enable the incentive regimes to comply with the substantial activities requirement and to remove ring-fencing.
Malaysia also became a signatory to the MLI (BEPS Action 15), although the MLI has yet to be ratified domestically. Significantly, Malaysia has introduced a tax on digital services in a bid to address the taxation of the digital economy (BEPS Action 1) (see 9.13 Digital Taxation).
Although Malaysia is not a member of the OECD, the Malaysian government remains committed in implementing the BEPS Action Plan and adhering to the OECD Inclusive Framework on BEPS’ (IF) minimum standards, as evident from the reforms undertaken over the past years following the country’s entry as an Associate Member to the IF in 2017. Malaysia is focused on countering harmful tax practices in preferential regimes; preventing the granting of treaty benefits in inappropriate circumstances; complying with OECD standards for transfer pricing documentation and country-by-country reporting; and increasing the efficacy of dispute resolution mechanisms under double taxation agreements.
From an enforcement perspective, the IRB has increasingly been conducting transfer pricing audits on multinational enterprises. While some of the BEPS reforms introduced in Malaysia are at their infancy and thus far, there has yet to be any indication of BEPS centred audits, it is expected that the IRB will begin scrutinising compliance with new legalisation such as the ESR when carrying out its routine audits.
In Malaysia, international tax does not generally have a high public profile beyond multinational corporations and tax practitioners. However, there is certainly growing awareness amongst taxpayers in light of recent BEPS measures introduced by the government as well as increased cross-border economic activities by businesses.
Malaysia’s economic objectives for 2020 include increasing the level of foreign direct investment in the country. The government aims to do so by embarking on a comprehensive review and revamp of the existing incentive framework under the PIA and providing special incentive packages and incentives under the ITA. This new framework is anticipated to be ready by 1 January 2021.
Nevertheless, as discussed above at 9.2 Government Attitudes, Malaysia has undertaken to implement the OECD BEPS standards and to review its legislation and tax regime for compliance. Thus, Malaysia will likely ensure that any incentives it offers or introduces will meet the OECD requirements. Further, as more and more jurisdictions in the region also implement BEPS-related measures, there will be less concerns of needing to reduce or limit the introduction of BEPS reforms to maintain Malaysia’s competitiveness.
Malaysia’s preferential regimes that offered incentives in respect of mobile geographical services activities related to IP and non-IP services are a key attribute of the country’s competitive tax policy. However, as discussed above at 9.1 Recommended Changes, these regimes were identified by the FHTP as having features that would facilitate BEPS and Malaysia has subsequently addressed these vulnerabilities through various regulations, orders, and guidelines.
Unlike other jurisdictions, Malaysia has not enacted any rule specifically addressing the tax treatment of hybrid instruments and whether such hybrid instruments are debts or equities for income tax purposes. Further, notably, although Malaysia is a signatory to the MLI, Malaysia has reserved its right to opt-out of most of the treaty-based measures aimed at neutralising the effects of hybrid mismatch arrangements, including Article 5 which deals with double non-taxation that may arise from cross-border hybrid instruments.
This may indicate that Malaysia is still contemplating the appropriate methods of addressing hybrid mismatches which would require considerations of domestic legislation (such as the use of general anti-avoidance provisions in the ITA) as well as national treaty policies. It remains to be seen whether Malaysia would adopt the approach taken in other jurisdictions of denying or restricting deductions for cross border payments made to related entities on hybrid instruments if such payments are not correspondingly taxed in the recipient country.
Malaysia has territorial tax regime where income tax is levied on any income accruing in or derived from Malaysia. As discussed in 2.5 Imposed Limits on Deduction of Interest, Malaysia recently introduced ESR to restrict the deductibility of interest expenses paid between related parties in cross-border transactions. Companies are only allowed to deduct a maximum interest expenditure of 20% of the taxpayer’s tax EBITDA. However, the ESR only applies where the total interest expense of a taxpayer is more than MYR500,000 a year.
Malaysia currently does not have any CFC rules. Given that Malaysia has a territorial tax system, CFC rules that require taxation of offshore subsidiaries regardless whether any substantial activity or economic nexus has been established in Malaysia or not would appear to be fundamentally at odds with the tax regime. Hence, if any CFC rules were to be implemented, these rules may likely be designed narrowly to only apply to income that should have been subject to tax in Malaysia and would also necessarily be limited to targeting profit shifting.
Further, given that there are considerations such as double taxation, overlap with existing transfer pricing legislation, maintaining competitiveness with jurisdictions without CFC rules, and administrative and compliance burdens that will need to be taken into account, this may give Malaysia pause in introducing CFC rules any time soon.
Consequent to the signing of the MLI by Malaysia, an anti-abuse provision will be incorporated into all of Malaysia’s double taxation treaties. Malaysia has chosen to adopt the principal purpose test as opposed to a limitation on benefits provision, see 4.3 Use of Treaty Country Entities by Non-treaty Country Residents.
In respect of anti-avoidance rules, Malaysia’s tax legislation contains general anti-avoidance provisions (see 7.1 Overarching Anti-avoidance Provisions). Given that many jurisdictions are similarly adopting anti-abuse provisions in respect of their double taxation treaties, it is difficult to envisage any significant impact that the provisions or rules may have on inbound and outbound investors.
Malaysia’s existing transfer pricing regime is largely based on governing OECD standards and the general arm’s length principle. Thus, it is unlikely that the proposed transfer pricing changes by the OECD, including the revisions to its Guidelines, will radically alter the structure of the transfer pricing framework in Malaysia. For example, the Malaysian Transfer Pricing Guidelines 2012 have been amended to adopt the recommendations on BEPS Actions 8-10 relating to intangibles without causing any major upheaval to the current system or controversy.
Malaysia has introduced legislation on country-by-country reporting and automatic exchange of information indicating Malaysia’s approval of enhancing transparency in combatting BEPS. In line with OECD recommendations on BEPS Action 13, country-by-country reporting only applies to multinational corporation groups which have their ultimate holding company in Malaysia and have a consolidated minimum group revenue of MYR3 billion. Local subsidiaries are generally not required to file a country-by-country report (CbCR) as Malaysia will obtain the CbCR via automatic exchange of information with the jurisdiction of the parent companies.
However, in a situation where a CbCR has been filed in another jurisdiction and that jurisdiction does not have a tax treaty or a multilateral competent authority agreement with Malaysia, local subsidiaries are not compelled to file the CbCR locally. This means that Malaysia will not have access to this information, giving rise to a potential for any BEPS to remain undetected.
Malaysia has recently introduced a tax on digital services by widening the scope of its existing service tax. With effect from 1 January 2020, foreign service providers of digital services must now register with the Royal Malaysian Customs Department and charge 6% service tax on all digital services provided to consumers in Malaysia.
"Digital service" has been defined broadly under the Service Tax Act 2018 and according to Customs, includes services such as providing software, applications, and music; live streaming services; digital advertising services; and offering online platforms to sell products and services. Thus, companies such as Netflix, Spotify, and Google are now expected to register and remit service tax to Customs. Foreign service providers must be registered if the value of the digital services provided by it to consumers in Malaysia exceeds RM500,000 over a period of 12 months.
As discussed above, Malaysia’s current approach to taxing the digital economy is to expand the scope and application of its service tax to digital services rendered by foreign service providers. There has yet to be any indication so far of Malaysia’s position in respect of the proposals by the OECD on digital taxation, namely the allocation of taxing rights in favour of market and user jurisdictions and implementing a global minimum tax. Given Malaysia’s commitment in principal to implementing the OECD BEPS actions, Malaysia could in the future adopt the consensus-based solution by the IF which is expected to be finalised by the end of 2020.
Malaysia’s tax regime generally imposes a 10% withholding tax on all royalties paid to non-residents and makes no distinction where the IP owner is resident in a tax haven. However, IP owners who are resident in jurisdictions which have a double taxation treaty with Malaysia could avail themselves to any preferential withholding tax rate in the treaty.
Malaysia’s tax regime has seen some significant changes as the country continues to review its tax structure and implement OECD BEPS recommendations. Having signed the MLI, the next step for Malaysia would likely be to work towards ratification in the coming years.