MALAYSIA adopts a territorial tax regime, where only Malaysian-sourced income is within the ambit of its tax net. That said, banking, insurance, or sea and air transport sectors are taxed on a worldwide basis. Last Tuesday, the European Commission announced updates to the European Union (EU) grey list.
Malaysia, together with Hong Kong, Costa Rica, Qatar, and Uruguay are in the list. The grey list are countries that have yet to comply with international tax standards but have made the commitment to reform tax policies.
As a result of the foreign source income exemption regimes review, the EU considers Malaysia’s territorial sourced tax regime harmful. The EU has granted Malaysia a deadline of Dec 31, 2022 to amend its regime, and it is understood that Malaysia has agreed to do so. As a result of Malaysia’s willingness to respond to the EU’s concerns, defensive measures by the EU will be suspended, subject to the passing of those amendments.
Certain defensive measures that may be applied by EU member states includes non-deductibility of costs, controlled foreign company rules, withholding tax measures, among others.
Review of territorial source regime
Based on the EU’s guidance, foreign source income exemption regimes that apply on a territorial basis are not inherently problematic. However, the EU is concerned where such regimes create situations of double non-taxation. In particular, they are concerned with the non-taxation of passive income in the form of interest or royalties where the income recipient has no substantial economic activity.
Our observation
Malaysia should not be hasty in amending its tax regime and should continue its good practice of consulting relevant stakeholders. A robust review is essential including analysing the regimes of countries that are not on the list or have moved out from the list. Take for example Singapore’s territorial and remittance basis regimes, and Hong Kong’s proposed legislative amendments targeting corporations with no substantial local economic activity who are receiving passive income that is not chargeable to tax in Hong Kong, are something for Malaysia to ponder. It was reported that Hong Kong will continue to adopt the territorial source principle.
If Malaysia decides to amend its territorial source tax regime, it is interesting to note that the timing coincides with that of the BEPS 2.0 Pillar Two project (Global Minimum Tax) ie Jan 1, 2023. For taxpayers with consolidated revenues over €750 million (RM3.6 billion), the impact of Pillar Two is likely to be far more significant than the impact of the territorial regime revisions in response to the EU concerns, as their effective tax rate as a whole will be required to be at least 15%. Accordingly, while revisions to Malaysia’s territorial regime will be of interest, the focus of these taxpayers should remain on Pillar Two. However, groups with consolidated revenue of less than €750 million that have implemented intellectual property planning or financing structures involving the receipt of offshore royalty and interest income will need to understand the impact on their current structures and consider making adjustments to preserve their current tax profile.
Conclusion
It is understood that Malaysia has committed to amending its tax law by Dec 31, 2022. This is not unexpected as our country has always been a jurisdiction that promotes tax fairness and transparency. This is evident with our membership in the OECD BEPS Inclusive Framework where we recently supported the Global Minimum Tax proposal. Malaysia also amended its Labuan and other tax incentive regimes previously to be in full compliance with the generally accepted international tax standards.
It is thus a matter of time before Malaysia moves to the white list. As such, there is no need for anyone to push the panic button.
This article was contributed by Deloitte Malaysia international tax leader Tan Hooi Beng. The above views are his own.
