The Income Tax (Exemption) (No. 9) Order 2017 (Exemption Order) was published in the Federal Gazette on 24 October 2017. The Exemption Order exempts a non-resident from the payment of income tax in respect of certain categories of income derived from Malaysia under certain circumstances, and stipulates that the withholding tax obligations under Section 109B of the Malaysian Income Tax Act 1967 (Act) will not be applicable to the exempted income.
Section 4A of the Act outlines several classes of income which are regarded as special income that is chargeable to income tax if derived from Malaysia. This includes, amongst others:
(i) amounts paid in consideration of services rendered by a person or his employee in connection with the use of property or rights belonging to, or the installation or operation of any plant, machinery or other apparatus purchased from, such person; and
(ii) amounts paid in consideration of technical advice, assistance or services rendered in connection with technical management or administration of any scientific, industrial or commercial undertaking, venture, project or scheme.
(collectively referred to as "Fees" in this alert).
The Fees would be subject to Malaysian withholding tax at the statutory rate of 10% under Section 109B of the Act if the Fees are deemed to be derived from Malaysia.
Prior to 17 January 2017, the derivation rules set out in Section 15A of the Act provided that the Fees shall be deemed to be derived from Malaysia if (i) responsibility for the payment lies with the government, a state government, a local authority, or a person who is resident in Malaysia; or (ii) the payment is charged as an outgoing payment or expense in the accounts of a business carried on in Malaysia, provided that the amount is attributable to services which are performed in Malaysia.
However, with effect from 17 January 2017, the deemed derivation rules were amended by deleting the proviso. This had serious implications for suppliers of cross border services – the Fees paid by a Malaysian resident to a non-resident supplier would be deemed to be derived from Malaysia even if the services were wholly performed by the non-resident supplier outside Malaysia, resulting in the imposition of Malaysian withholding tax under Section 109B of the Act.
The removal of the proviso gave rise to difficulties for businesses both from a commercial perspective in terms of affecting the profit margins of businesses, and from a technical perspective as regards the application of double tax agreements.
The Exemption Order
The Exemption Order provides that a non-resident shall be exempted from the payment of income tax on the Fees if the services are performed by the non-resident outside Malaysia.
It is noteworthy that the Exemption Order does not change the deemed derivation rules. In other words, the Fees will continue to be regarded as Malaysian-sourced income under Section 15A of the Act, but will be exempted from withholding tax if the services are performed outside Malaysia.
The Exemption Order is deemed to come into operation on 6 September 2017. From a timing perspective, this means that the Malaysian payor would not be required to deduct and remit the withholding tax in respect of any Fees that is paid or credited to a non-resident service provider from 6 September 2017 onwards.
However, the Exemption Order does not apply to the period from 17 January 2017 to 5 September 2017, and therefore, the withholding tax provisions under Section 109B would continue to apply within that period even if the services were performed outside Malaysia (subject to any relief under an applicable double tax agreement).
Wong & Partners have worked closely with various industry groups and chambers of commerce to highlight to the Ministry of Finance various issues and concerns arising from the removal of the proviso. We welcome the issuance of the Exemption Order by the Minister of Finance as it alleviates much of the withholding tax issues faced by businesses arising from the removal of the proviso in January 2017.
However, there are still practical issues that must be ironed out when implementing the Exemption Order due to the retroactive effect of the Exemption Order. Given the gap in timing between the coming into operation of the Exemption Order (i.e., on 6 September 2017) and the publication of the Exemption Order (i.e., on 24 October 2017), it is unclear whether the Malaysian Inland Revenue Board will provide a refund for payments of withholding tax for the period from 6 September 2017 that have already been made.