THE concept of source is fundamental in the taxation of income in Malaysia. If there is no source, there cannot be income.
The analogy is of a tree and a fruit, and for tax purposes the tree is akin to the source and the fruit that comes from the tree is akin to the income. Throughout our income tax legislation, reference is consistently made to source.
Why is source important?
Malaysia only taxes income that is derived, arises or received in Malaysia. Most countries in the world will tax income that is derived from both within and outside the country. For example, a Malaysian individual will only be taxed on the income he derives from Malaysia. Foreign income or capital gains derived or sourced outside Malaysia is taxed only upon remittance into Malaysia.
It is therefore important to differentiate between domestic source income and foreign source income.
How is source determined?
This is a question of fact. You have to look at it from an ordinary persons’ perspective and ask simple questions: Where does the income come from? How does the income arise? What activity gives rise to that income? What assets give rise to that income and where are those assets located?
There are different approaches for determining different sources of income. Business income is usually determined based on where the contract is entered into, where the services are rendered, where the activities relating to the business are carried out, where the management and control decisions are made, etc. Employment income is determined where the employment is exercised.
Director’s fee is where the payer company is resident. Pension and annuity income is determined based on where the fund is located together with the locality of the fund which generates the pension and annuity. Rental income is based on where the property is located. Interest income is based on where the money is lent.
Differentiating domestic and foreign sources
Since Malaysia only taxes domestic source and foreign source is only taxed upon remittance into Malaysia, it becomes crucial to segregate the sources of income.
It is often misunderstood that once a business enterprise performs services or conducts activities outside the country, it is automatically foreign sourced, and unless it is remitted, it will not be taxed in Malaysia. This is incorrect.
Such income can be taxed in Malaysia if the Malaysian business enterprise does not have a business presence in the foreign country and brings such income to tax in that foreign country. The reason being the activity carried out overseas is controlled and managed in many cases by the Malaysian enterprise and therefore it becomes Malaysian sourced and becomes taxable in Malaysia although the monies earned from those transactions may not be remitted into Malaysia.
This will be the similar treatment for employees who principally perform their employment duties in or from Malaysia, and, at the same time, travel overseas to complement the activities they carry out in Malaysia.
Having dual contracts of employment to segregate domestic and foreign sources will be challenged by the tax authorities unless you are able to clearly show that the activities are performed only in the respective countries.
Is it compulsory for all your income to be taxed?
It is not compulsory that a taxpayer must pay tax on all his income somewhere in the world. If the taxpayer can organise his affairs in such a way that he is legally not taxable on a portion of his income, that is his personal prerogative.
Tax authorities cannot force you to pay taxes that do not come within the tax regime. However, most tax authorities around the world have signed on to the global minimum tax where they expect the larger companies whose turnover exceeds €750 million (RM3.75 billion) a year to pay at least 15% tax on their global income.
This article is contributed by Thannees Tax Consulting Services Sdn Bhd managing director SM Thanneermalai (www.thannees.com).
