In Malaysia, income tax is charged based on income accruing in, derived from, or received in the country, as stated under Section 3 of the Income Tax Act 1967 (ITA). However, certain types of income specified in Schedule 6 of the ITA, such as foreign source income (as per paragraph 28 of Schedule 6) are exempt from income tax.
The recently legislated Finance Act 2021 amended paragraph 28 of Schedule 6 to restrict the foreign source income tax exemption.
Background
Prior to December 31 2021, paragraph 28 of Schedule 6 provided that foreign source income received in Malaysia by an individual or company carrying out business other than banking, insurance, or sea or air transport is exempt from income tax.
However, Section 27 of the Finance Act 2021 amended paragraph 28 of Schedule 6 to read as follows: “The income arising from sources outside Malaysia and received in Malaysia by any person who is not resident in Malaysia” is exempt from income tax.
Legally speaking, the amendment restricts the income tax exemption on foreign source income to only foreign source income that is received by a person who is not resident in Malaysia. This sudden amendment to the law without any consultation with the business community and tax professionals attracted criticism from companies.
During the transitional period, the Inland Revenue Board (IRB) announced a Special Income Remittance Programme (SIRP) where the foreign source income remitted under this programme will be taxed at a flat rate of 3%, subject to certain terms and conditions.
The IRB announced that they will accept foreign source income submitted under the SIRP in good faith, as the IRB will not engage in any audit or inquiry on the taxpayer.
In light of the continued public dissatisfaction with the amendment to the law, the Ministry of Finance announced a concession whereby:
“Subject to Inland Revenue Board criteria and guidelines, income tax exemption on dividends will be given to companies or limited liability partnerships while individuals will be tax-exempted for all types of income.”
To date, further details in relation to the concession, including the guidelines, have yet to be issued.
Source of income
The word ‘source’ is not defined in the ITA and, therefore, case law acts as a guide to determine the source of income. Guidance to determine the ‘source’ in relation to foreign source income can be found in the case Commissioner of Inland Revenue v Hang Seng Bank Ltd [1991] 1 AC 306.
In this case, a Hong Kong SAR-based taxpayer bank invested certificates of deposit, bonds, and gilt-edged assets in the Singapore and London markets. These investments were kept in an offshore bank until they could be sold for a profit. The question was whether the proceeds from the sale of those investment certificates were taxable in Hong Kong.
The Privy Council dismissed the Hong Kong SAR tax authority’s contention that the income was earned in Hong Kong SAR because the bank's operations were solely conducted there.
It was established in this case that “the question [of] whether the gross profit resulting from a particular transaction arose in or derived from one place or another is always, in the last analysis, a question of fact, depending on the nature of the transaction”.
In summary, the Broad Guiding Principle was introduced by the Privy Council to determine the ‘source’ of income. The two key questions are:
What has the taxpayer done to earn the profit in question?
Where did the transaction that produced the taxpayer’s profit take place?
The Broad Guiding Principle in Malaysia
The principle has been extensively applied by the Malaysian courts, including in some cases that are detailed below.
Ketua Pengarah Hasil Dalam Negeri v Cardinal Health Malaysia 211 Sdn Bhd [2011] 3 CLJ 196
The Malaysian taxpayer firm invested surplus cash, including income, from its Malaysian operation in Allegiance Netherlands (a Dutch company within the same business group as the taxpayer) by way of loans.
The question was whether the taxpayer's passive income, derived from the loans in the form of interest payments, was considered foreign source income.
The High Court held that the Special Commissioners of Income Tax (SCIT) correctly concluded that the interest income was sourced in Netherlands. Therefore, it was a foreign source income.
Aneka Jasaramai Express Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri [2001] 1 LNS 166
The SCIT held that the taxpayer’s income from the sale of bus tickets in Singapore was not income accrued in, or derived from, Malaysia.
The High Court agreed, observing that “the sale of tickets took place in Singapore. The contract was entered in Singapore. The money was received in Singapore”.
Kyros International Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri (2013) MSTC 30-056
The franchise agreements were engaged by the taxpayer to provide franchisees (of a kebab fast food chain) with the sole and exclusive right (Kyros’ own trademark and operating system) to create and operate in a specified location, including overseas.
The Court of Appeal upheld the SCIT’s finding that the franchise fees overseas were received from overseas as all activities in respect of the franchising agreements had taken place overseas.
Final take-aways
In essence, the source of profit and the location of a business are distinct from each other. In addition to satisfying the Broad Guiding Principle to determine a company’s source of income, companies in Malaysia should also consider the implications of the new Finance Act 2021 which is more restrictive. Legally speaking, only non-resident companies are exempt from income tax on foreign source income, under paragraph 28 of Schedule 6.
However, the concession announced by the Ministry of Finance would mean that income tax exemptions on foreign source dividends will be given to companies.
