In this article, we will explore the implications of the changes in withholding tax pursuant to the Budget 2017 (see our first article here) that may impact your business, especially if your business receives or outsources skilled services from overseas.
The Expanded Scope of Withholding Tax
Withholding tax, in a nutshell, is an amount of tax that needs to be withheld by the Malaysian Resident payer on income earned by a non-resident payee, which the payer must remit to the Inland Revenue Board (“IRB”).
A simple example is when resident company pays a non-resident company or individual for technical services, the resident company may be required to withhold a portion of the fee for the IRB, before paying it out to the foreign service provider. Hence, WITHHOLDing tax. Withholding tax will apply to certain payments such as royalty, interest, contract payments and ‘special classes of income’ made to non-residents. The proposed changes in the Budget 2017 to withholding tax for ‘special classes of income’ has raised quite a few eyebrows.
Special Classes of Income – Technical Services
Under the current withholding tax regime under the Income Tax Act 1967 (“ITA”), payments made by a resident for technical advice, assistance or services in connection with technical management or administration performed by a non-resident IN Malaysia is subject to a withholding tax rate of 10% (section 4A(ii) & 109B of the ITA).
Currently, 2 tests must be met for withholding tax to apply to payments for technical services received:
- Firstly, the services performed must be ‘technical’. Examples of ‘technical management’ include provision of marketing, consultancy, architectural, computer programming, legal services, supply of technical and software personnel, and inter-company technical services. Examples of ‘administration’ include non-technical assistance, planning, direction, control, co-ordination, accounting, financial management consultation and labour negotiations. In contrast, day to day clerical/administrative work such as invoicing and book-keeping, ordinary routine services provided by a head office to its branches/subsidiaries which do not pass or transfer expert, specialised knowledge, skills or expertise, will not attract withholding tax.
- Secondly, the services must be physically performed IN Malaysia. If the project is performed partially in Malaysia and partially outside of Malaysia, only the proportion the project value attributable to the services performed IN Malaysia will be subject to withholding tax.
It is this 2nd test that the Budget 2017 seeks to change and widen, such that any “technical services, advice and assistance” performed by non-residents both inside and OUTSIDE of Malaysia will now be subject to withholding tax.
KMN International Hotel Management Ltd, a Norwegian company, entered into an agreement with KMN Hotel (M) Sdn Bhd to provide hotel management and marketing services in Malaysia in connection with:
- the supervision and control of the general manager;
- the supervision and co-ordination of staff training and development programmes; and
- the promotion and marketing plans for the hotel in Malaysia
Pursuant to the terms of the agreement, the Malaysian company will pay a monthly fee based on 5% of the gross turnover to KMN International Hotel Management Ltd for the management and marketing services provided in Malaysia. In addition, an annual fee of 2% on gross overseas sales will be charged for marketing services performed overseas.
Under the existing rules, only the monthly fees of 5% on the gross turnover is subject to 10% withholding tax while the 2% on overseas marketing is not subject to withholding tax as the service is not performed in Malaysia.
Under the new rules, both the monthly fees of 5% and 2% on overseas marketing will be subject to withholding tax.
M & A Ltd, an architectural firm in London was engaged to provide plans for a modern hospital in Kuala Lumpur. Staff from the firm came several times to Malaysia for inspection of the site, discussions with the local company and finally delivered the master plan. The plans were drawn in its office in London. It was agreed that consultancy fees of RM1,000,000 would include reimbursements payable by monthly invoices based on the progress of work done. The agreement also provided an analysis of the fees charged.
Under the existing rules, only the portion of the fees including the reimbursements related to the services performed in Malaysia is subject to withholding tax.
Under the new rules, the whole of the consultancy fees of RM1,000,000 will be subject to withholding tax. However, if it can be confirmed that M & A Ltd is tax resident in United Kingdom, then the favourable withholding tax rate is 8% on the value of services performed in Malaysia pursuant to the DTA between Malaysia and United Kingdom.
A legal firm resident in Singapore was engaged by a Malaysian company to advise on matters regarding a debt reduction agreement and an agency agreement. The services were performed wholly in Singapore.
Under the existing rules, the payment for the legal services will not be subject to withholding tax as the services are wholly performed outside Malaysia.
Under the new rules, the payment for legal services will at first glance be subject to withholding tax. However, due to the specific wording in the Malaysia-Singapore DTA (double taxation agreement), no withholding tax is applicable.
As illustrated in the above situations, the Budget 2017 has proposed for requirement of the “services being performed in Malaysia” to be removed.
The changes will impact a wide range of businesses from startups, SMEs to multinational companies which are paying for technical assistance and technical services rendered by non-residents. This would be particularly worrying for companies which have already entered into long term agreements without having prior knowledge of this change, as they will be faced with the prospect of having to pay or absorb the withholding tax on top of the agreed service fees.
How to Prepare for the Changes
To prepare for the proposed change, Malaysian businesses will have to:
- pay closer attention to all payments for technical services made to foreigners or non-residents;
- address in the agreements they are negotiating or renewing as to which party will bear the economic burden for such withholding tax;and
- keep in mind the resident taxpayer’s obligations to remit such withheld sums to the IRB within the prescribed timeframe.
This article was written by Shawn Ho & Ian Liew.
Note: This article is for information purposes only, and is not intended to act as, or substitute, legal advice. Feel free to contact us if you have any queries.