WHENEVER there are payments being made to non-residents, the paying enterprise, whether it is a company or otherwise, should be mindful of the need to deduct withholding taxes.
If there is a failure to deduct withholding taxes, there are severe consequences which could result in the payer being denied a tax deduction for the expenditure, together with late payment penalty of 10% being imposed, and possibly a further penalty for underdeclaring your tax liability.
Effectively, if there was a 10% withholding tax that should have been deducted on a RM100 expenditure, any failure to do so could result in additional taxes and penalties amounting to about RM45. If the payer settles the withholding tax after the due date, his liability will be capped at about RM21. Failure to deduct withholding taxes is an expensive affair.
Importance of deducting the correct withholding taxes
The majority of withholding taxes under the Malaysian tax regime are 10%, except for payments to non-resident contractors with a business presence in Malaysia, which is 13%, and interest payments to non-residents, which is 15%. The 10% withholding tax is applicable to royalties, special classes of income such as payment for services performed in Malaysia, and rental of movable equipment. The rates can be reduced based on tax treaties.
Services versus contract payments
There is a lack of understanding in differentiating the 13% withholding tax versus the 10% withholding tax because reading the law on the surface, there appears to be an overlap. There is no overlap if you look at the law and the underlying principles carefully.
The answer lies in the fact that if the services are provided in Malaysia over a period of time, and there is business activity in Malaysia, it will trigger a business presence in Malaysia or a permanent establishment under the double taxation treaties.
If a business presence or a permanent establishment is triggered, then the withholding tax to be deducted is the contractor’s 13% withholding tax under Section 107A, and it is collected as a payment on account of the contractor’s and its expatriate employees’ Malaysian tax liability. The foreign contractor must file a tax return in Malaysia for activities carried out in Malaysia.
If the foreign contractor does not have a business presence or permanent establishment in Malaysia, then the services rendered in Malaysia will attract 10% withholding tax, which is normally regarded as the final tax and does not require the filing of a tax return in Malaysia.
From a payer’s perspective, if you deduct the 10% withholding tax as opposed to the 13% withholding tax, the Inland Revenue Board (IRB) can disallow the total payment and apply the relevant penalties on the grounds you have misdirected yourself.
Royalties versus services
If the payments are caught within the royalty definition such as payments for use of or right to use copyrights, patents, software, trademarks, designs, models, secret processes, knowhow, etc. Withholding tax of 10% kicks in whenever you make payments to the non-residents.
The recipients will be overseas recipients and, at the moment, the IRB is of the view that if you pay for digital services such as Facebook, Google, Amazon, etc, the royalty withholding tax is applicable.
However, if these services are viewed as purely services since there is no involvement of the use of software or copyrights, and if the services are provided from outside Malaysia, the payer need not deduct the withholding tax.
Currently, taxpayers are at loggerheads on this issue. Unless these matters are litigated at the highest court in Malaysia, IRB has an upper hand on this matter and will insist on collecting the royalty withholding tax.
This article is contributed by Thannees Tax Consulting Services Sdn Bhd managing director SM Thanneermalai (www.thannees.com).
