The Impact Of The Finance Act 2017 On Withholding Tax In Malaysia.

3 November, 2017

IN THIS ARTICLE, AMANDA HOI CONSIDERS THE IMPACT OF THE FINANCE ACT 2017 ON WITHHOLDING TAX IN MALAYSIA.
 
Overview of the law relating to withholding tax
 
To cover situations where income is derived from Malaysia by non-residents who are outside the reach of the Malaysian Inland Revenue Board (“IRB”) as they have no presence in Malaysia, withholding tax is charged on such income under the Income Tax Act 1967 (“ITA”), whereby liability is imposed on the entity in Malaysia which is responsible for making payments of the income to the non-residents.
 
A prime example is section 4A of the ITA, which charges tax on certain special classes of income derived by a non-resident from Malaysia whilst section 109B of the ITA enforces the charge by requiring the payer in Malaysia to withhold the tax on the income of the non-resident. What amounts to “derived from Malaysia” is set out in section 15A of the ITA.
 
The payer is responsible to withhold the tax and remit the tax to the IRB within one month of paying or crediting the payment to the non-resident. Although withholding tax is charged on the income of the non-resident, non-compliance with the relevant legal provisions would result in penalties and adverse tax implications for the payer.
 
A shift in the law in Malaysia
           
Early this year, the Finance Act 2017 (“FA”) was gazetted. It introduced several amendments to the ITA, including a shift in the law governing withholding tax (with effect from 17 January 2017).
 
Prior to the amendments, section 15A of the ITA stated that income derived by a non-resident under certain circumstances shall be deemed to be derived in Malaysia, provided that the services were performed in Malaysia (“the Proviso”).
 
However, section 15A of the ITA has been amended by removing the Proviso, which leads to the imposition of withholding tax on payments to non-residents regardless of whether the services were performed in or outside Malaysia.
 
Consequently and, unsurprisingly, much confusion and uncertainty arose. Questions revolved around the impact of the amendment on: 

 

• transitional issues; and
• its application vis-à-vis existing Double Taxation Avoidance Agreements (“DTAs”) that state otherwise. 

 

In response to these pressing issues, the IRB published guidance in the form of Practice Notes 1/2017 and 2/2017 on 23 June 2017, which are explored below.
 
Transitional Issues
 
As is the case when any amendment is introduced, transitional issues come into play. For example, what if the parties had already signed a contract prior to the amendment? Is the amendment still applicable if services had already been performed? Does it make a difference when payment is made?
 
Practice Note 1/2017 clarifies the position in four possible scenarios:  

 

Please click on the tables to enlarge.

It appears that the common thread between the scenarios above is that withholding tax will always apply if services are performed outside Malaysia after 17 January 2017 — unless both the contract was signed and payment was made before 17 January 2017.                                                                                              
 

What about DTAs that state otherwise?
 
Malaysia has entered into effective DTAs with 74 countries as at 30 May 2017[1]. Double taxation refers to “the imposition of comparable taxes in two (or more) States on the same taxpayer in respect of the same subject matter and for identical periods”[2]. Hence, DTAs are contracts signed between countries to avoid double taxation.
 
Certain DTAs may provide that withholding tax is only applicable to payments for services when services are performed in that country. This is contrary to the amended section 15A, which had removed the Proviso. Further, certain DTAs may state that withholding tax is entirely inapplicable to payments for services.
 
With the amended section 15A of the ITA and the existing section 109B of the ITA, Malaysia has taken the stand that it has the right to impose withholding tax on payments for services performed — be it in or outside Malaysia.
 
However, the IRB’s Practice Note 2/2017 has clarified that this right is restricted in DTAs with specific countries: 

 

• Payments to Singapore and Spain residents for services performed outside Malaysia are NOT subject to withholding tax; and
• Payments to Australia and Turkmenistan residents for services (performed both in and outside Malaysia) are NOT subject to withholding tax. 

 

In summary, Malaysian businesses and companies that engage the services of non-residents from the aforementioned countries need not remit withholding tax to the IRB if the requirements above are met.
 
Conclusion
 
The IRB’s guidance is most welcome as it offers necessary clarification on the impact of the amended section 15A of the ITA on transitional issues and its application concerning DTAs that state otherwise.
 
Malaysian businesses and companies should review their existing contracts with non-residents to ascertain the impact of the amended section 15A of the ITA on those contracts.

 

[1]IRB official website.
[2] OECD Tax Convention on Income and on Capital (Volume I, July 2008)

 

 

For further information, please contact:

 

Amanda Hoi, Shearn Delamore & Co​

amanda.hoi@shearndelamore.com