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Economic Substance Requirements for Foreign Dividend Income

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On December 29, 2022, the Malaysian Inland Revenue Board (IRB) issued a press release (available only in Bahasa Malaysia) announcing an additional requirement for tax exemption on foreign-source dividend income received in Malaysia by eligible persons.

In accordance with this additional requirement, amendments have been made to the Guidelines for tax treatment in relation to income received from abroad, which were uploaded to the official IRBM portal on December 29, 2022.

This guideline is issued pursuant to the amendment of Paragraph 28 of Schedule 6, Income Tax Act 1967 (ITA 1967) by Finance Act 2021 [Act 833] which foreign income received in Malaysia by a person who is a resident will be taxable effective from 1 January 2022.

The amendment of this provision is to provide equitable tax treatment on foreign income with the income accrued in or derived from Malaysia in line with Malaysia’s commitment towards compliance with international tax best practices.

However, there are tax exemptions given in relation to foreign income received in Malaysia by a resident subject to certain conditions.

As a result of this, the previous guidelines dated September 29, 2022, have been cancelled.

The new requirement, known as the economic substance requirement as follows, must be met to qualify for the tax exemption:-

According to the media release, for Income Tax Return Forms (BNCP) submitted before or on December 29, 2022, taxpayers must submit amended forms if they do not comply with the additional economic substance qualification requirements, and no penalties will be imposed.

CTIM Comment 1:

  • Request for economic substance requirements to be applied prospectively from 1 January 2023 to avoid retrospection.
  • Companies can’t comply retrospectively as they were unaware of the requirements and could not have complied.
  • The EU only asked for measures to be taken to prevent double non-taxation of foreign source income from 1 January 2023, so Malaysia does not need to impose the requirements retrospectively.
  • Hong Kong has introduced the requirements going forward from 1 January 2023.
  • Companies currently non-compliant would require time to put in place necessary measures to satisfy the requirements and may be awaiting further guidance from IRBM.
  • Companies should be evaluated reasonably as long as they demonstrate a sufficient effort to comply with the requirements and have substance in place sometime in 2023.
  • The timing of the amended guideline release may affect dividend payments by companies with a financial year ending in 2022.

IRBM’s feedback:

Determining the effective date of the substantive requirement is a policy decision under the Ministry of Finance.

CTIM Comment 2:

Income Tax (Exemption) (No. 6) Order 2022 [P.U. (A) 235/2022] currently does not provide for economic substance requirements.

Until the P.U. Order is amended, we propose that IRBM does not encourage taxpayers to amend their tax returns which have already been submitted.

IRBM’s feedback:

P.U. (A) 235/2022 will not be amended.

Paragraph 3 of P.U. (A) 235/2022 clearly states that an eligible person must comply with the conditions imposed by the Minister as stated in the guidelines in Paragraph 5.2.1.3 (c).

Referring to Paragraph 7 of the Media Statement dated 30 December 2022, taxpayers must submit amendments to the BNCP if the additional substantive economic qualification criteria are not complied with, and no penalties will be imposed.

CTIM Comment 3:

Given that Para 5.2.1.3(c)(ii) refers to industry nature and poses questions like ‘capital or labour intensive industry’,

kindly confirm whether the number of employees and operating expenses referred to in Para 5.2.1.3(c)(i) is on an ‘entity-wide’ basis and not limited to investment holding operations.

IRBM’s feedback:

The economic substance requirement is not limited to investment holding operations only.

Paragraph 5.2.1.3(c)(i) refers to “eligible persons” as provided for under paragraph 3 of P.U. (A) 235/2022.

CTIM Comment 4:

We would like to seek IRBM’s clarification on the following:

a) Specified economic activities in Malaysia [Para5.2.1.3(c)(i)(A)]:-

  1. We would like to request a definition of the term ‘specified economic activities’ and a list of specified economic activities.
  2. We would like to ask whether ‘relevant activities’ in Para 5.2.1.3(c)(ii)(A) have the same meaning as ‘specified economic activities’ in Para 5.2.1.3(c)(i)(A).

IRBM’s feedback:

a) Specified economic activities in Malaysia [Para5.2.1.3(c)(i)(A)]:-

  1. ‘specified economic activities’ means:
    1. Holding and managing equity investments in other entities
    2. Making strategic decisions that are necessary with regard to the acquisition, holding, or disposal of an entity’s assets; and managing and assuming the main risks associated with those assets
  2. ‘relevant activities’ in paragraph 5.2.1.3(c)(ii)(A) means, in linguistic terms, pertaining to or associated with.

b) Employees (Para 5.2.1.3(c)(i)(A)) –

i) Whether company directors (non-service directors) can be viewed as “employees” for the purpose of holding and managing foreign share investments?

In cases where the holding and management of investments is relatively passive in nature (e.g. small portfolio, stable investments with no regular divestments or new acquisitions), additional headcount may not be required.

We are of the view that the requirement to have a minimum number of employees in a business that undertakes pure equity holding activities should be exempted, to be in line with the Labuan legislation [P.U. (A) 423/2021] and also consistent with Hong Kong.

In this regard, a separate category should be created for pure equity holding companies which should not be required to have employees or office space and still be seen to comply with economic substance requirements generally so long as the Companies Act requirements (e.g., having a resident secretary) are complied with and board of directors meetings is held in Malaysia.

ii) We would like to request for outsourcing arrangements (which are allowed in other jurisdictions such as HK) to be considered for the purpose of meeting the requirement on the number of employees.

It is not industry friendly to require investment holding companies to have full-time employees.

c) Capital, labour-intensive industry (Para 5.2.1.3(c)(ii)(A)) – the examples given do not appear to be directly relevant to investment holding or management. We request IRBM to clarify.

d) Premises (Para 5.2.1.3(c)(ii)(C)) – Would IRBM accept situations where there are no office premises as an office may not be needed for the purpose of holding and managing investments, especially when such activities are relatively passive in nature (mentioned in item 4(b) above)?

IRBM’s feedback:

The determination of the sufficient number of employees and the utilisation of office premises depends on a particular industry, which also takes into account the type of activity carried out and the facts of each case.

CTIM Comment 5:

We appreciate that IRBM provides flexibility to the taxpayers by not stating any minimum threshold for the economic substance requirements.

However, this may lead to uncertainty as to what is considered “adequate” in the eyes of IRBM.

A company may claim a tax exemption based on its own judgment that it has economic substance, which may be disagreed with or challenged by IRBM during a tax audit.

This may result in an increased number of appeals.

We request IRBM provide more guidance to prevent potential disputes.

Further, we request a mechanism for interested taxpayers to voluntarily seek optional pre-approval from IRBM on the satisfaction of the economic substance requirements.

IRBM’s feedback:

There is no pre-approval from IRBM. As the Malaysian taxation assessment system is based on self-assessment, there is no need to obtain pre-approval.

CTIM Comment 6:

If the company does not satisfy the economic substance requirements but other entities within the group (e.g. immediate or ultimate holding company) satisfy the economic substance requirements, there should be flexibility for IRBM to apply economic substance requirements on a ‘jurisdictional basis’.

IRBM’s feedback:

The economic substance requirement applies only to companies that directly receive income from outside the country and does not apply to other entities within the related group of companies.

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