Derivation of income under s 12 of the Income Tax Act 1967
The circumstances under which business income would be considered to be derived from Malaysia and so taxed in Malaysia are outlined in Section 12 of the Income Tax Act 1967 (ITA).
To complement Section 12, the Income Tax Act was updated with new sections 12(3) and 12(4) by the Finance Act 2018.
Beginning on December 28, 2018, these new provisions took effect.
According to the provisions of Section 12(3), a person is considered to have derived their business income from Malaysia if such revenue is attributable to a "Place of Business" located in Malaysia.
Section 12(4) clarifies the meaning and provides examples of what constitutes a place of business.
Guidelines On The Application Of Subsections 12(3) And 12(4) Of The Income Tax Act 1967 In Determining A "Place Of Business"
Guidelines were published on the website of the Inland Revenue Board (IRB) on May 21, 2020.
The title of the guidelines was "Guidelines on the application of Subsections 12(3) and 12(4) of the Income Tax Act 1967 in determining a "Place of Business" (Guidelines).
These guidelines were issued concerning the provisions that were discussed above.
In addition, the Guidelines include nine examples for readers to refer to.
You are strongly encouraged to read the entire Guidelines to obtain all the relevant information.
Guidelines on the application of Subsections 12(3) and 12(4) of the Income Tax Act 1967 in determining a "Place of Business
Recent changes to the Form C
Recent changes were made to Form C by the Inland Revenue Board in preparation for the YA 2022.
One of the most critical changes is for those businesses participating in transfer pricing arrangements.
As a result, the disclosure items have been significantly expanded to cover new areas.
These new areas include stating the characterisation of your company by reference to its functional profile and the business restructuring undertaken by the group during the year.
Other disclosures incorporated into the new Form C include cash pooling, permanent establishments (PEs), dividend declarations and payments, cost contribution arrangements, and others.
Permanent Establishments
Regarding Permanent Establishments (PEs), the taxpayer is responsible for conducting a careful analysis to determine whether or not any of its activities result in a PE for a foreign entity.
If so, this may affect the disclosures that are required to be included in the updated Form C. Taxpayers must disclose whether they have made any interest, royalties and service payments to their head office.
The definition of a permanent establishment, on the face of it, would require the existence of a fixed place of business.
However, a permanent establishment may be deemed to exist despite the absence of a physical fixed place of business.
For example, in the absence of employees or distinct premises, in the taxing country.
Case Law:
In a Belgian case, according to the decision of the Supreme Court, a permanent establishment in Belgium may exist whether or not the taxpayer has a representative or an employee there.
Thus, foreign enterprises owned immovable; leased properties were considered fixed installations producing income and, therefore, permanent establishments (État belge v Société de Gestion).
In an American case, A Swiss resident was found to be doing business in the U.S. through a permanent establishment as he and specially trained employees travelled around the states showing and selling logging equipment he manufactured.
This was a constructive activity in the States, and the inference was that the use of equipment in material proportions might be a permanent establishment even if no actual fixed place of business existed.
Fixed Place of Business Permanent Establishment
The term “permanent establishment” means a fixed place of business in which the company or the enterprise is wholly or partly carried on and shall include especially:
a place of management;
a branch;
an office;
a factory;
a workshop;
a mine, oil well, quarry or other place of extraction of natural resources;
a building site or installation or construction or assembly project;
a farm or plantation;
a place of extraction of timber or forest produce.
In general, therefore, a permanent establishment will usually exist in Malaysia where:
there is a continuity of activity in Malaysia; and
there is active conduct of business in Malaysia.
Example
Most fashion companies have headquarters in their home country, but their factories are usually in a different country.
Since the fashion companies operate in the foreign host country and generate revenue there, the company will be subject to different taxation requirements in each territory.
Position in Malaysia
A person shall also be deemed to have a place of business in Malaysia if the person undertakes any of the following:
carries on supervisory activities in connection with a building or work site, or construction, an installation or an assembly project, or
has another person acting on his behalf who
habitually concludes contracts, or habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification
habitually maintains a stock of goods or merchandise in that place of business from which such person delivers goods or merchandise, or
regularly fills orders on his behalf.
In general, in the Double Taxation Agreements entered into by Malaysia, when the activities of the foreign enterprise are auxiliary or preparatory concerning a business, such activities should not be viewed as a permanent establishment, even when conducted through a fixed place.
This is consistent with the approach adopted in the “permanent establishment” Article 5 of the Organisation for Economic Cooperation and Development Model Treaty.
For example:
An office of a resident of a contracting state in Malaysia which is used solely for the purchase of goods (i.e. a cost centre) does not constitute a permanent establishment in Malaysia (e.g. Article 5 of the Double Taxation Agreements between Malaysia and the Netherlands, Malaysia and Singapore, Malaysia and the United Kingdom).
But the position may be different, however, if such an establishment is also a sorting, packing or grading office.
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