INDUSTRIES that require significant expenditure in infrastructure and plant and machinery together with specialised technology from overseas will engage foreign contractors to implement such projects, and the cost of such contracts could run into hundreds of million, and even billions in some cases, of ringgit.
These contracts are found in the oil and gas industry, power sector and large government infrastructure projects, among others. To execute such contracts, there will be a need to bring in foreign contractors to supply specialised equipment, technology and specialist people. The contracts would involve engineering, design, procurement, construction, testing and commissioning. In short, they are called EPCC contracts.
Taxation of EPCC contracts
It is not uncommon to expect the whole of the contract value to be brought to tax in Malaysia. However, in practice, this does not normally occur because there is a tendency to break up or fragment the contract into different parcels. The intention here is to minimise the taxes in Malaysia and the multinationals that enter into such contracts will use tax planning to locate the profits outside Malaysia possibly back to their home country, or to countries where taxes are lower than in Malaysia.
If the foreign EPCC contractor declares the full profits in Malaysia, then it will be subject to tax at 24% of the profits in Malaysia. Any payments to non-residents by the EPCC contract will attract withholding taxes and imported service taxes.
Tax planning measures
Normally, such large contracts will be broken up into work carried out in Malaysia and the work carried out overseas. The large foreign taxpayers have a tendency to shift a larger part of the profits outside of Malaysia on the basis that a significant value of the work is actually performed overseas and consequently a significant part of the profits should be allocated to the overseas operation on the basis that the value created overseas is greater than the value created in Malaysia.
Transfer pricing methodologies will be used to support the shifting of the profits overseas.
What will the tax authorities do?
Many authorities around the world are aware of this practice and view such shifting of profits out of the home country such as Malaysia as aggressive tax planning. They are already attacking such transactions from different perspectives: It could be from a transfer pricing perspective by challenging whether the profit left behind in Malaysia does not meet the arm’s length test, and/or may challenge such allocations using the anti-avoidance provisions on the basis that the split of the profits may not be commercially explainable.
The tax authorities have significant information that they can use to challenge such treatment of the taxation. The information easily available to them from the larger companies will be the CbCR (Country-by-Country Reporting) documentation which contains the information of the total multinational group. In addition, if the authorities were to request for information on the total profits of the contract made in Malaysia and overseas, the local tax authorities can see the full picture of the operations and can compare the level of profits left behind in Malaysia.
Such exchange of information is possible because, in most cases, the tax treaties allow the tax authorities to obtain the information from the other member states. Malaysia has more than 70 tax treaties with other countries and obtaining information from most developed countries cannot be ruled out. Among the larger countries, it is only with the United States that we do not have a full tax treaty.
The tax authorities in Malaysia are tracking such large contracts and are aware of such tax planning measures. In most cases, these issues will come up when the multinationals revert to the Malaysian authorities to obtain a refund of the excess withholding taxes paid. Inevitably, such refund applications will lead the Inland Revenue Board to examine each contract in depth.
This article is contributed by Thannees Tax Consulting Services Sdn Bhd managing director SM Thanneermalai (www.thannees.com).
