Taxability of Foreign Sourced Income

Malaysia adopts a territorial principle of taxation in that only income accruing in or derived from or received in Malaysia from outside Malaysia is subject to income tax in Malaysia pursuant to Section 3 of the Income Tax Act, 1967 (“ITA”).

With effect from the year of assessment (“YA”) 2004, tax exemption is given on “income received in Malaysia from outside Malaysia” or foreign source income (“FSI”) received by Malaysian taxpayers pursuant to Paragraph 28, Schedule 6 of the ITA (“Para 28”). 

Under this law, exemption is given to any person, other than a resident company carrying on the business of banking, insurance or sea or air transport, in respect of income derived from sources outside Malaysia and received in Malaysia. 

FSI is taxable effective 1 January 2022

On 29 October 2021, it was announced in the Budget 2022 that the exemption under Para 28 will no longer be applicable to tax residents with effect from 1 January 2022. The law was made effective when the Finance Act 2021 was gazetted on 31 December 2021 whereby Para 28 is amended by removing the exemption previously enjoyed by tax residents. Effectively, income tax will be imposed on resident persons in Malaysia on income derived from foreign sources and received in Malaysia with effect from 1 January 2022. Such income will be treated equally vis-à-vis income accruing in or derived from Malaysia and taxable under Section 3 of the ITA.

In summary, the tax treatments for income of a person in Malaysia are depicted as follows:

MoF’s Announcement on Tax exemption for FSI on 30 December 2021

Due to concerns raised by various parties on the possible ramifications of removing the exemption for FSI remitted to Malaysia, the Ministry of Finance (“MoF”) had, on 30 December 2021, announced that this exemption from income tax will be given, by concession, for a period of five (5) years from 1 January 2022 to 31 December 2026 on certain categories of FSI received by the following groups of tax residents:

• Individuals – All categories of foreign sourced income are exempted.
• Companies – Foreign sourced dividend income is exempted.

The MoF is expected to give effect to the above income tax exemption vide the issuance of a Ministerial exemption order in due course. It is noted that the above income tax exemption will be subject to a set of eligibility requirements which will be detailed out in the guidelines to be issued by the Inland Revenue Board of Malaysia (“IRBM”).

In addition, the MoF has clarified in the same announcement that the taxable FSI received by companies in the year of assessment 2022 will not be included in the calculation of chargeable income of a company for the purposes of “Cukai Makmur”. “Cukai Makmur” is a one-off tax imposed at the rate of 33% on the chargeable income of companies that exceeds RM100 million for the year of assessment 2022.

This announcement by the MoF to exempt foreign source dividend income for Malaysian corporate tax residents for the next 5 years provides relief for those who are caught in the FSI situation and left stranded on the possibility of paying top-up taxes in Malaysia particularly if the same income has already been taxed in a foreign country. Concurrently, it also allows time for Companies to address the administrative complications surrounding the reporting of foreign source income and the claiming of double taxation relief.

Who are affected?

 
Double Tax Relief on Foreign Tax Suffered

Where a Malaysia tax resident has suffered foreign tax on the FSI, the taxpayer is given bilateral or unilateral tax credit relief against the Malaysian tax payable on the same FSI. Bilateral relief is given under Section 132 of the ITA when the foreign country has a double tax agreement with Malaysia e.g. Singapore, Indonesia, Japan, China, Australia, South Africa, United Kingdom, France, etc. 

On the other hand, unilateral relief is given under Section 133 of the ITA when there is no double tax agreement between Malaysia and the foreign country e.g. British Virgin Islands, Taiwan, United States of America, etc. While full relief may be possible under a double tax agreement, the final amount is calculated based on a prescribed formula and relief is only given up to the maximum of the Malaysian tax suffered. As for unilateral tax relief, the foreign tax recognized is automatically halved. 

In addition, the Malaysian  tax resident is required to substantiate the amount of tax paid in overseas with the relevant supporting documents from the tax authorities in the foreign countries in order to claim the said tax relief in his tax return.

What are not taxable?

Tax at 3% under the Special Income Remittance Program 

1. During the period from 1 January to 30 June 2022 (6 months) – FSI remitted shall be taxed at a fixed rate of 3% on the gross amount of income remitted as announced by the IRBM in their PKPP (below).
2. On or after 1 July 2022 – FSI remitted shall be taxed at the prevailing tax rate applicable to tax residents on the statutory income (i.e. gross FSI less expenses attributable to the FSI).  

On 16 November 2021, the IRBM announced a Special Income Remittance Programme (Program Khas Peremitan Pendapatan or PKPP) which will take place between 1 January 2022 and 30 June 2022. Subject to certain terms and conditions, the FSI remitted during the PKPP period will be taxed at 3% on the gross income. 

FSI remitted under the PKPP will be accepted in good faith by the IRBM as the IRBM will not conduct any audit or investigation on the taxpayer. In addition, the IRBM will not impose any penalty on FSI remitted during the PKPP period.  

Subsequent to the MoF’s announcement on 30 December 2021, the IRBM announced on 11 March 2022 that the PKPP will be terminated with effect from the date of the announcement. With the termination of PKPP, the IRBM will be able to conduct audits or investigations on a taxpayer who remits FSI after 1 January 2022 and impose penalties if the taxpayer is found to have under-reported FSI.