Doing Business in Malaysia: Tax Considerations for Foreign Entities With Or Without Physical Presence In Malaysia

As a general rule, foreign businesses that wish to venture into the Malaysian market to provide goods or services in Malaysia will need to register their business in Malaysia. Where they choose to have a local entity, the common choices are an incorporated company (Sdn Bhd) or a limited liability partnership (PLT) in Malaysia for the ease of running the business.

On the other hand, a foreign company wanting to carry on business within Malaysia without incorporating a local entity in Malaysia, may nonetheless register itself as a ‘foreign company’ with an appointed agent and a registered office located in Malaysia, under the Companies Act 2016 (also known as a registered branch office).

However, in today’s ever growing digital global economy, it is increasingly possible for established foreign businesses to be able to render their services completely through the internet, directly to persons in Malaysia, without having a local physical office or formal presence in Malaysia. This is especially so for businesses that provide digital services and digital content.

In deciding whether to incorporate a local business entity, or to render services directly from the overseas foreign entity to consumers in Malaysia without a physical presence here, the potential Malaysian tax consequences arising from doing business in Malaysia should also be among the key factors to take into account. In this article, we explore the few common (non-exhaustive) list of Malaysian taxes that may be applicable to foreign corporations that intend to do business in Malaysia, either with or without a physical presence.

a) Corporate Income Tax

A foreign entity’s business profits will be subject to Malaysian income tax if the business income is attributable to a “place of business in Malaysia”[1], given that Malaysia’s tax system is territorial. A way to determine whether or not business profits are ‘derived from Malaysia’ is to distinguish between whether the foreign corporation is “trading within” Malaysia (and taxable) or “trading with” Malaysia (and non-taxable). The location where management and control is exercised during the year will then determine whether the resident tax rate (tiered) or non-resident tax rate (fixed) applies.

If the foreign entity does not have a physical presence in Malaysia

Even in the absence of a physical place of business in Malaysia (including having an office, a factory, a warehouse, a farm or building site), business income of a foreign entity may still be deemed to be derived from Malaysia and subject to Malaysia income tax pursuant to its business operations carried on in Malaysia. This concept is also commonly known as having a “permanent establishment” in Malaysia (tax treaty counties) OR a “place of business” in Malaysia (non-tax treaty countries). This could happen where a representative acting on behalf of the foreign entity habitually concludes contracts, repeatedly exercises authority, maintains a stock of goods in Malaysia sufficient to regularly fulfil orders tied to sales activities, or even appointing an authorized agent in Malaysia to fill the order and deliver the goods in Malaysia.

b) Withholding Tax

Withholding tax is applicable on certain types of income derived in Malaysia by a non-resident company, such as interest payments, royalties and special classes of income[2], and the withholding tax rates are usually between 10% to 15% but may be reduced under a tax treaty. Withholding tax is not levied on payments made between residents. Where withholding tax applies, the payer in Malaysia has the responsibility to withhold the prescribed amount from such payment due to the non-resident, and remit the withholding tax to the Inland Revenue Board on behalf of the non-resident entity.

The broad definition of ‘royalty’ and the broad scope of ‘special class of income’ may result in a wide range of services offered by a foreign entity to attract withholding tax obligations, which for example includes services relating to the right to use software, technical or non-technical services rendered in Malaysia, etc.

For example, in the situation where a Malaysian subsidiary is incorporated and the foreign entity grants a licence for the Malaysian subsidiary’s use of the foreign entity’s brand name, logo, etc, the licence fee payable to the foreign entity may constitute a royalty payment and attract withholding tax obligations.

If the foreign entity has a physical presence in Malaysia

However, if a non-resident has a permanent establishment or place of business in Malaysia, there will be no withholding tax on interest or royalties if such income is attributable to the place of business. Do note that certain income such as service fee income that is attributable to the permanent establishment or place of business for onshore services will still be subject to withholding tax, usually at a total rate of 13%.

c) Digital Service Tax

With effect from 1 January 2020, where the foreign entity renders digital services to the users in Malaysia[3], the digital service provided by a foreign registered person to consumers and businesses in Malaysia is chargeable with digital service tax at the rate of 6%. Digital service tax is levied and administered by the Royal Malaysian Customs Department[4].

A foreign service provider whose annual turnover in respect of digital service is above RM500,000 must register as a foreign service provider in Malaysia. Once registered, the foreign service provider becomes a foreign registered person and must charge 6% digital service tax on the digital service provided to the Malaysian-based customers.

If the foreign entity incorporates a local subsidiary

Malaysia’s service tax regime requires service tax to be charged and levied on any taxable service provided in Malaysia by a registered person in carrying on his business. “Digital service” is a form of taxable service under the Service Tax Regulations 2018. Hence, if the foreign business incorporates a local subsidiary and the value of taxable service exceeds the registration threshold of RM500,000, the local company is required to register as a registered person and then charge the 6% service tax on its services.

d) Transfer Pricing

Transfer pricing rules apply to transactions between associated persons, where at least one person is assessable or chargeable to tax in Malaysia. Two companies are considered as “associated companies” if one company participates directly or indirectly in the management, control or capital of the other company; or the same persons participate in the management or control of both companies (i.e under common control).

Therefore, where a local subsidiary is incorporated and there will be transactions between the local entity and the foreign entity, transfer pricing rules require transactions between related parties (i.e between the local entity and the related foreign entity) to be conducted at arm’s length. Under the arm’s length principle, transactions between related parties should be conducted at a price as if such transactions were done between independent entities.

Even if a local subsidiary is not established, transfer pricing rules also apply to transactions between a permanent establishment and its head office or related branches, whereby the permanent establishment will be treated as a distinct and separate enterprise from its head office or other related branches.

Transfer pricing rules in Malaysia require the companies who have entered into related-party transactions to prepare and maintain contemporaneous transfer pricing documentation. Taxpayer who does not prepare contemporaneous record or did not comply with the arm’s length principle risks facing penalty imposed by the Inland Revenue Board[5].

[1] The phrase ‘place of business’ was introduced in subsections 12(3) and 12(4) of the Income Tax Act 1967 on 28 December 2018, and the LHDN guidelines relevant to determining a ‘place of business’ can be found here: http://lampiran1.hasil.gov.my/pdf/pdfam/GP_21052020_2.pdf

[2] Special classes of income include payments to non-resident (a) for services rendered by the non-resident 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 non-resident; (b) for any advice given, or assistance or services rendered in connection with the management or administration of any scientific, industrial or commercial undertaking, venture, project or scheme; or (c) for rent or other payments made under any agreement or arrangement for the use of any moveable property.

[3]“Digital service” is defined under the Malaysia’s Service Tax Act 2018 as “any service that is delivered or subscribed over the internet or other electronic network and which cannot be obtained without the use of information technology and where the delivery of the service is essentially automated”.

[4][4] The RMCD guide on Digital Services by Foreign Service Provider dated 1 August 2020 is available here: https://mysst.customs.gov.my/IndustryGuides

[5] LHDN Transfer Pricing Guidelines 2012 can be found here: http://lampiran1.hasil.gov.my/pdf/pdfam/MalaysianTransferPricingGuidelines2012.pdf

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This article was written by Shawn Ho and Ee Lyne Chong.  Shawn leads the corporate practice group of Donovan & Ho, and has been recognised as a Notable Practitioner, whilst the firm has been recognised as a Notable Firm for Corporate and M&A by Asialaw Profiles 2020 and 2021.  We are also ranked as a Recommended Firm by IFLR1000 2020 and 2021.

Our corporate practice group advises on corporate acquisitions, restructuring exercises, joint venture arrangements, shareholder agreements, employee share options and franchise businesses, Malaysia start-up founders and can assist with venture capital funds in Seed, Series A & B funding rounds.  Feel free to contact us if you have any queries.

 

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