Withholding tax on foreign digital services: Yes or no?

BUSINESSES cannot operate without purchasing digital services to serve their customers, deal with suppliers and operate their business functions. Digital services are services delivered over the internet or other electronics network which cannot be obtained without the use of information technology and where the delivery of the services is essentially automated. Digital services such as digital advertising, cloud storage, software applications, payment gateways and databases are provided largely by foreign service providers such as Amazon, Facebook, Google, Microsoft and Zoom.

The view taken by the Inland Revenue Board (IRB) can be different from the view taken by the taxpayers. IRB is of the view that most of the payments made to foreign digital service providers (FSP) who have no tax presence in Malaysia should be subject to withholding tax under the royalty provisions of the Income Tax Act 1967.

However, taxpayers take a different view that the FSP provide services as opposed to payment for the use of intellectual property such as copyrights or software.

IRB’s view: Withholding tax is applicable

Although IRB has not come out openly in writing stating their reasons for taking the above position, it is based on the premise that the FSP is allowing the local users to use the software and the related copyrights when the local user uses the app or platform to carry on any of its activities.

The counterview

A simple way to analyse this issue is to look at the purchase of a book. The copyrights of the book belongs to the author. When you buy a book to use for your own personal pleasure or to use the knowledge therein in your business, it is generally accepted the local user does not pay for the use or the right to use the copyrights. The local user in this situation is merely purchasing a medium in the form of a book or a copyrighted material. In this case, it is accepted that you need not deduct withholding tax when you buy a book from an overseas author or publishing house since you are not using or exploiting their copyrights. This is equally applicable whether you buy a hardcopy or an e-copy of the book.

When you are dealing with digital services, the issue that needs to be determined is whether the payment is for royalty or for services. If it is for services provided by a foreigner or a non-tax resident in Malaysia, then a special withholding tax is applicable. However, most of the digital services provided are not provided in Malaysia and therefore should not attract withholding tax. However, if the payments are treated as royalty payments, then they attract withholding tax regardless of whether the intellectual property is provided in Malaysia or from overseas.

There is support for the view that digital services are not royalty payments on the grounds that the local user does not have the right to use or use the copyrights belonging to the FSP, nor does he have the right to use the software belonging to the FSP. The local user is merely given the right to advertise on the platform or use the platform to link up with his customers and no way does he alter or has the right to change the underlying algorithms or source codes of the software provided.

This is an important matter where the tax policymakers at the Finance Ministry have to intervene and provide us with the necessary guidance or if needed further legislations to make matters clear to the taxpayers. The policymakers need to take into account that any withholding tax imposed in such a situation in most cases will end up being a cost to the local users as the FSP are in a much stronger position to demand that they are paid net of tax.

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