INDIVIDUALS and other taxable entities such as companies, trusts, limited liability partnerships, cooperatives, etc, exporting goods and services or carrying on business overseas may be subject to foreign taxes on the profit and capital gains generated overseas.
Passive income such as interest income, rental income, dividend income, royalty income may be subject to foreign income tax in the form of withholding tax.
Can Malaysian taxpayers claim tax credits in Malaysia for taxes suffered overseas? Yes, you can claim the tax credits, but it will be confined to the taxes defined in the double tax agreements.
Taxes based on fixed assets or turnover may not qualify for tax credits unless they are specified in the double tax agreements. In case the taxes are suffered in countries where there are no double tax agreements, the income should be similar to the income recognised in Malaysia for income tax purposes.
The tax suffered overseas will only be available for crediting against the similar income being taxed in Malaysia. It is possible for the foreign income to be brought into the Malaysian books of accounts such as interest income or rental income earned overseas without being taxed in Malaysia on the grounds that the income was not remitted into Malaysia.
In this case, the tax credit will not be available at the time of recognition of the income. However, the same income to be remitted later at which point in time the tax credit will be available to be offset against the Malaysian tax payable on that income.
Until Dec 31, 2026, all entities other than individuals will be exempted from Malaysian tax on foreign-sourced dividends and capital gains remitted into Malaysia. Individuals are exempted on all income remitted into Malaysia until Dec 31, 2036. During this period, the tax credits cannot be utilised against Malaysian taxes on sources of income.
There are two types of tax credits – bilateral credits and unilateral credits. An election should be made within two years after the end of the year of assessment.
In the case of bilateral tax credits, the claim cannot exceed the Malaysian tax imposed on the foreign income. Unilateral credit is applicable where the foreign income is derived from a country with which Malaysia does not have a full double tax agreement.
In the case of unilateral credits, the claim will be limited to half of the foreign tax imposed on the foreign income or the Malaysian tax chargeable in respect of the foreign income, whichever is lower.
Any unutilised tax credits which cannot be offset against Malaysia taxes cannot be carried forward.
Foreign income will be subject to Malaysian tax if it is derived or sourced from Malaysia. A simple example would be where a Malaysian IT company enters into a contract with a foreign company to install software overseas by deploying its people for short periods in the overseas country. The staff installing the software will be under the direction of the Malaysian company, and the business relationship will be maintained between the overseas customer and the Malaysian headquarters. In such an instance, since the brains of the business and the direction of the business are in Malaysia, it will be regarded as income sourced in Malaysia and taxable in Malaysia.
Planning the recognition and the flow of foreign income into Malaysia is crucial to take advantage of the benefits provided under the double tax agreement to avoid double taxation. It is also important to understand the anti-avoidance provisions such as the principal purpose test and the general anti-avoidance provisions that are embedded in many treaties to avoid taxpayers from treaty shopping.
However, you can avoid these problems provided the substance requirements can be met in the respective countries where the income is generated and flows through finally back into Malaysia.
This article is contributed by Thannees Tax Consulting Services Sdn Bhd managing director SM Thanneermalai (www.thannees.com).
