Scope of exemption
As announced during Budget 2022 and later implemented by way of the Finance Act 2021, FSI received by residents in Malaysia would have been generally subject to tax with effect from 1 January 2022. However, just before this came into effect, the Malaysian Ministry of Finance (MOF) announced on 30 December 2021 that certain exemptions on the taxation of FSI will be introduced.
On 19 July 2022, consistent with the MOF's announcement, the government published two income tax exemption orders relating to the taxation of FSI in Malaysia ("Exemption Orders"):
1. Income Tax (Exemption) (No. 5) Order 2022
This order exempts individual residents in Malaysia from income tax on all types of FSI received in Malaysia, save for income received from a partnership business in Malaysia. This exemption is subject to the condition that the exempted FSI must have been subjected to tax of a similar character to income tax, under the laws of the territory where the income arises ("Tax of a Similar Character").
2. Income Tax (Exemption) (No. 6) Order 2022
This order exempts from income tax foreign-sourced dividends received in Malaysia by:
- any individual in relation to a partnership business in Malaysia;
- any limited liability partnership registered under the Limited Liability Partnerships Act 2012; and
- any company incorporated or registered under the Companies Act 2016,
except for those carrying on the business of banking, insurance, or sea or air transport.
This exemption only applies to foreign-sourced dividends that satisfy the two conditions below:
- the foreign-sourced dividends must have been subjected to Tax of a Similar Character; and
- the highest rate of such Tax of a Similar Character at that time must be not less than 15%.
Notably, the imposition of the condition that the exemption only applies where the foreign-sourced dividends have been subjected to at least 15% tax ensures that there is no "double non-taxation", which is in line with Malaysia's participation in OECD efforts to enforce a global minimum corporate tax rate of 15%. The proposed refined FSI exemption regime announced by Hong Kong recently also includes a similar condition, i.e., that the participation exemption for dividends and disposal gains is not available where the income concerned or the profits of the investee company is subject to tax in the foreign jurisdiction at a headline rate of below 15%.
Both the Exemption Orders are effective for five years, i.e., from 1 January 2022 to 31 December 2026.
Any deductions in relation to exempted FSI or foreign-sourced dividends under both the Exemption Orders should be disregarded for the purposes of determining chargeable income.
The exemptions under the Exemption Orders mentioned above do not absolve the relevant individuals or entities from complying with their obligations to submit any tax return or information under the Income Tax Act.
What does this mean for taxpayers?
Although the Exemption Orders provide some additional clarity as to the scope of the exemptions announced by the MOF at the end of 2021, there remains to be a few outstanding issues that require further clarification:
1. Tax of a Similar Character
Both Exemption Orders specify that only FSI that has been subjected to Tax of a Similar Character qualify for the exemption and state that an income is only regarded as subjected to Tax of a Similar Character if conditions imposed by the MOF, which is set out by the Inland Revenue Board (IRB) in the guidelines on tax treatment in relation to income which is received from abroad ("IRB Guidelines"), have been complied with.
The IRB Guidelines have not been issued at the time of writing, and we understand from informal feedback that the IRB Guidelines will likely be issued around September. Taxpayers are encouraged to stay on top of the developments in order to ascertain the conditions to be complied with.
2. Definition of FSI "received" in Malaysia
The Exemption Orders state that FSI "received" in Malaysia from outside Malaysia refers to income arising from outside Malaysia which is "brought into" Malaysia. The Exemption Orders do not go further to specify when and how such income will be deemed to have been "brought into" Malaysia. It remains to be seen whether the IRB Guidelines will provide additional clarification in this respect.
For completeness, in relation to FSI which does not qualify for any exemptions, taxpayers would recall that a reduced tax rate of 3% was afforded for residents receiving FSI in Malaysia during the period of 1 January 2022 to 30 June 2022. As the period for such reduced tax rate has now ended, taxpayers receiving non-exempted FSI in Malaysia from 1 July 2022 onwards will be taxed at the prevailing tax rates according to their respective categories under the ITA.
Finally, taxpayers should also be reminded of the importance of assessing whether remittances from outside Malaysia would be characterised as income or capital in nature at the outset, as capital gains are still not taxable in Malaysia (save for gains arising from the disposal of real property or real property shares, which are subject to real property gains tax). In other words, remittances received in Malaysia which are capital in nature would not be subject to tax, regardless of whether the Exemption Orders apply.
As some uncertainties in respect of the exemptions remain, it is crucial for taxpayers intending to rely on the Exemption Orders to keep an eye out for the IRB Guidelines in order to determine whether the exemptions apply to their FSI.
In the meantime, we would advise that taxpayers remain diligent in maintaining records of their gains and transfers of money into and out of Malaysia and to record the nature of such remittances. Taxpayers should also assess the characteristics of such remittances as to whether they are income or capital in nature, to determine whether they are subject to tax.
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