Tax Matters – Lingering problems with foreign-sourced dividends

ON DEC 30, 2022, there was a press statement issued by the Ministry of Finance (MoF) which indicated that foreign-sourced dividends will be tax exempt.

An excerpt from the press statement:

“The government has agreed to exempt taxation on foreign-source income (FSI) for resident taxpayers to ensure the smooth implementation of the tax initiative ....

“Subject to Inland Revenue Board (IRB) criteria and guidelines, income tax exemption on dividends will be given to companies or limited liability partnerships while individuals will be tax-exempted for all types of income.”

The intention here was clearly to exempt foreign-sourced dividend income received in Malaysia. However, subsequently, when the IRB guidelines came out, the original intention of exempting dividends in totality appears to have been restricted with the requirement to comply with the stringent conditions which seems to be going against the spirit of the intention behind the press statement.

What is the problem?

In the case of resident companies, LLPs and individuals receiving income through partnerships, to benefit from the exemption, they are required to comply with three conditions:

1. The dividend income has been subjected to tax in the country of origin;

2. The highest tax rate in the country of origin is not less than 15%; and

3. The recipient has to have economic substance.

Condition 2 can easily be met because the highest tax rate in most countries is more than 15%.

The first condition requires dividend income to be subject to income tax or withholding tax in the country of origin. This condition can be satisfied if the payment is a direct payment from the foreign company to the Malaysian resident.

However, in many cases, dividends are received through companies in intermediate countries, such as Singapore or Hong Kong, China, where such income received may not be subject to taxation due to local legislation exempting such income. As the guidelines stand, they state that dividends received in Malaysia from such intermediate companies will be taxed. This is the problem.

The guidelines go further and state that if the dividends are received by an intermediate company which is exempt from tax from another company in the same jurisdiction paying taxes, and thereafter the distribution from the intermediate foreign company to the Malaysian resident company will attract income tax according to the guidelines.

However, when it comes to individuals receiving other types of income such as employment income, from a country which exempts such income from tax, or does not impose tax on such income, the income received from the foreign country is exempt.

Here, the guidelines appear to be applying different standards to individuals and companies. If one is to use an analogy in exempting individuals’ foreign-sourced income from non-dividend sources, the spirit of applying this exemption seems to be contradictory.

The third condition of requiring the recipient to have economic substance makes equally difficult to benefit from this exemption. Economic substance here requires having employees and operating expenditure with possibly business activities.

What happens to passive investment holding companies? Are they excluded from benefiting from this exemption because they won’t be able to meet this condition.

Is the original intention lost?

From the way the IRB guidelines have come out, it appears that the authorities have backtracked from the original intention of exempting foreign-sourced dividend income by imposing stringent conditions.

Changes that need to be made

Condition 1 in particular should be relooked to implement the original intention. Here, such dividend income received in Malaysia which has been exempted in the foreign country should not be taxed in Malaysia. The rationale here is to bring such income into the level playing field with the treatment accorded to individuals who receive other income from foreign locations which do not subject such income to tax.

This article is contributed by Thannees Tax Consulting Services Sdn Bhd managing director
SM Thanneermalai