Updated: Sep 19
With the release of revised technical guidelines on December 29, 2022, and a media release (only in Bahasa Malaysia) on December 30, 2022, the Inland Revenue Board (IRB) of Malaysia added a new requirement (an economic substance requirement) to qualify for the tax exemption for foreign-source dividend income received in Malaysia by qualifying persons.
This comes after the IRB published technical guidelines (only in Bahasa Malaysia) on September 29, 2022, about how the tax laws apply to foreign source income (FSI) received in Malaysia by Malaysian tax residents, and after the Minister of Finance gazetted:
the "Income Tax (Exemption) (No. 5) Order 2022" (P.U.(A) 234/2022) and
the "Income Tax (Exemption) (No. 6) Order 2022" (P.U.(A) 235/2022).
The economic substance requirement was added as an extra requirement for qualifying people to show that Malaysia is committed to following international tax standards to stop tax evasion and double non-taxation, which aligns with the conditions set by the EU.
As a result, foreign-source dividend income received by a qualifying person in Malaysia is exempt from tax only if the economic substance requirement is met. This is in addition to the conditions set by P.U.(A) 235/2022, which say that foreign-source dividend income must be taxed in the jurisdiction of origin and that the headline tax rate in that jurisdiction must be at least 15%.
Following this, The Chartered Tax Institute Of Malaysia received the Ministry of Finance’s (“MOF”) response on 12 July 2023 to CTIM's request for reconsideration of foreign source income exemption (“FSIE”) conditions for dividends set out in the revised technical guidelines in respect of the following:-
1) Multi-tier holding structures [Appendix 1 of HASiL’s Guidelines]
CTIM's proposal: To allow exemption in multi-tier scenarios
IRBM's response: The decision not to allow a multi-layered structure is in line with international taxation practices to avoid round-tripping, which leads to money laundering to avoid traceable income that might be taxed in Malaysia.
However, to facilitate businesses, the application will be processed by MOF on a case-by-case basis.
2) Choice of year in which the headline tax rate of the foreign jurisdiction should be at least 15%
CTIM's proposal: Choice of year in which the headline tax rate of the foreign jurisdiction should be at least 15%.
The year of dividend paid is usually for the previously declared dividend. Therefore, there will be an issue if there are changes in the country’s tax rate.
IRBM's response: For clarity, the choice of the year would be the year the profit is taxed.
It is unlikely that the country would go below the minimum rate of 15% based on the latest developments in other countries. Therefore, this issue is not likely to be raised in the future.
3) Imposition of economic substance requirements
CTIM suggested this condition should only be applied if the company could not fulfil the first 2 conditions as it aligns with Hong Kong's practice.
MOF agrees in principle to take effect from YA 2023.
CTIM: It should not be retrospective to 1 January 2022, as this condition was only added on 29 December 2022, which backdating would be unfair to the taxpayers.
IRBM's response: Any potential increase in tax arising from this new substance requirement will lead to tax adjustment, which would generally be subject to penalty.
However, the affected parties may appeal to IRBM for consideration on a case-by-case basis.
CTIM: The substance requirement can also be widened to include other entities within the group rather than just restricting it to the company of the entity that is receiving the dividend income.
MOF and LHDNM are studying the issues highlighted on the imposition of substance requirements regarding investment holdings companies in the MNE for the upcoming Budget 2024.
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