By Lam Kwai Soon Tax Director, Cheng & Co

Lam Kwai Soon
Tax Director, Cheng & Co

 

In the Finance Act 2016 which took effect on 1 December 2016, the amendments on a few Sections which are relevant to withholding tax have drawn serious attention of tax practitioners and businesses. The implementation of the amendments have widened the scope of coverage of withholding tax and created uncertainties in practicality and costs of business operations which results in much higher risks in the future with the possibility of disputes with the Inland Revenue Board of Malaysia (IRBM) on withholding tax treatments on certain expenses paid to non-residents.

 

 

The amendments of the relevant Sections of the Income Tax Act 1967 of withholding tax are as follows:-

  • Section 2(1) – Amendments on the definition of “Public Entertainer
    1. Old definition

“public entertainer” means a stage, radio or television artiste, a musician, sportsperson or an individual exercising any profession, vocation or employment of a similar nature;

 

  1. Amended definition

“public entertainer” includes—

  • a compere, model, circus performer, lecturer, speaker, sportsperson, an artiste or individual exercising any profession, vocation or employment of a similar nature;

or

  • an individual who uses his intellectual, artistic, musical, personal or physical skill or character in,

 

carrying out any activity in connection with any purpose through live, print, electronic, satellite, cable, fibre optic or other medium, for film or tape, or for television or radio broadcast, as the case may be;

 

The new definition has widened to cover speaker, lecturer and activities performed through electronic, satellite, cable fibre optic or other media. Under the provisions of the Section 109A of the Act, fee paid to a non-resident “Public Entertainer” for services performed in Malaysia is subject to withholding tax at 15%.

 

Double Tax Agreement

However, we may have to refer to the Double Tax Agreement (DTA) of the relevant country of the non-resident. Malaysia has entered into DTA with more than 70 countries in the world. In many of the DTAs, there is an Article “ARTISTES AND SPORTSMEN” which typically use the phrase “entertainer” in the Article which it does not provide the wide coverage as what the new definition has covered e.g. it does not provide speaker or lecturer in the Article. Based on the principles laid down by the precedent case law Euromedical case, if there is conflict between the domestic tax laws and the DTA, the provisions in the DTA will take precedent.

Nevertheless, in the Dialogue on 24 January 2017 between IRBM and professional bodies like MIA, CTIM etc., IRBM has emphasised their stand on this matter. According to them the phrase “entertainer” used in the Article of many DTAs is not a definition per se and IRBM has the taxing right and the Article does not provide the exhaustive definition of “public entertainer”.

The explanation by IRBM is if any part which is not covered by DTA, the domestic tax laws will take effect.

 

  • Section 2(1) – Amendments on the definition of “Royalty”
    1. Old definition

“royalty” includes

(a)        any sums paid as consideration for the use of, or the right to use—

(i)         copyrights, artistic or scientific works, patents, designs or models, plans, secret processes or formulae, trademarks or tapes for radio or television broadcasting, motion picture films, films or video tapes or other means of reproduction where such films or tapes have been or are to be used or reproduced in Malaysia or other like property or rights;

(ii)        know-how or information concerning technical, industrial, commercial or scientific knowledge, experience or skill;

(b)        income derived from the alienation of any property, know-how or information mentioned in paragraph (a) of this definition

 

    1. Amended definition

“royalty” includes any sums paid as consideration for, or derived from—

(a)        the use of, or the right to use in respect of any copyrights, software, artistic or scientific works, patents, designs or models, plans, secret processes or formulae, trademarks or other like property or rights;

(b)        the use of, or the right to use tapes for radio or television broadcasting, motion picture films, films or video tapes or other means of reproduction where such films or tapes have been or are to be used or reproduced in Malaysia or other like property or rights;

(c)        the use of, or the right to use know-how or information concerning technical, industrial, commercial or scientific knowledge, experience or skill;

(d)        the reception of, or the right to receive, visual images or sounds, or both, transmitted to the public by—

(i)         satellite; or

(ii)        cable, fibre optic or similar technology;

(e)        the use of, or the right to use, visual images or sounds, or both, in connection with television broadcasting or radio broadcasting, transmitted by—

(i)         satellite; or

(ii)        cable, fibre optic or similar technology;

(f)        the use of, or the right to use, some or all of the part of the radiofrequency spectrum specified in a relevant licence;

(g)        a total or partial forbearance in respect of—

(i)         the use of, or the granting of the right to use, any such property or right as is mentioned in paragraph (a) or (b) or any such knowledge, experience or skill as is mentioned in paragraph (c);

(ii)        the reception of, or the granting of the right to receive, any such visual images or sounds as are mentioned in paragraph (d);

(iii)       the use of, or the granting of the right to use, any such visual images or sounds as are mentioned in paragraph (e); or

(iv)       the use of, or the granting of the right to use, some or all such part of the spectrum specified in a spectrum licence as is mentioned in paragraph (f); or

(h)        the alienation of any property, know-how or information mentioned in paragraph (a), (b) or (c) of this definition;.

 

Apparently, the amended definition has widened the scope very much and now it covers the use or the right to use “software”. The main difference between the old and amended definition of “royalty” for software is, under the old definition a payment of fee was only regarded as “royalty” if the copyright or the right of exploitation of the intellectual property is granted. If the payment was just for purchasing the software as a product for usage without the copyright etc., it was not regarded as “royalty”. This was upheld by a Court in the case of Alcatel and Thomson Reuters.

In the Dialogue on 24 January 2017, IRBM has stressed its stand that under the amended definition the payment made for purchasing the software products for usage fall into the definition of “royalty”. If the payment is paid to a non-resident, withholding tax is applicable under Section 109 of the Act.

Other than that, IRBM has also clarified in the Dialogue that in the event the definition of “Royalty” provided in the DTA differs from the definition provided in the Income Tax Act 1967, the DTA prevails.

 

Practical Difficulties

With the new definition of “Royalty” it may lead to many unforeseen practical difficulties in complying with withholding tax. For example, if a local company purchases a software online, it has to determine the tax residence status of the software vendor moreover it is difficult to withhold the tax in the event that the software vendor is non-resident because without making the full payment the software vendor will not allow the software to be downloaded. If that local company is willing to bear the withholding tax for that non-resident software vendor, it gives rise to another issue of tax deductibility on that withholding tax borne by the local company.

 

Besides the issue of “software”, the new definition of “Royalty” has included the part that payment of consideration for a partial or total forbearance in respect of the use or right to use of the intellectual property. According to the IRBM’s explanation this is payment is like a consideration to obtain some kind of similar to exclusive right where the right to use of the intellectual property will not be granted to someone else. This is a new part under the definition which there are lack of guides and examples available at the time when this article is written.

The professional bodies urged IRBM to issue guidelines and Public Ruling on the withholding tax treatment on the newly defined Royalty since the amended legislations are in force where there are many confusions in the practices which lead the businesses to the risks of non-compliance resulting in penalty.

 

  • Section 15A – Income from Services Deemed Derived from Malaysia
    1. Amendments to the provisions of Section 15A of the Act

Gross income in respect of—

(a)        amounts paid in consideration of services rendered by a person or his employee in connection with the use of property or rights belonging to, or the installation or operation

of any plant, machinery or other apparatus purchased from, such person;

(b)        amounts paid in consideration of technical advice, assistance or services rendered in connection with technical management or administration of any scientific, industrial or commercial undertaking, venture, project or scheme;

(c)        rent or other payments made under any agreement or arrangement for the use of any moveable property, shall be deemed to be derived from Malaysia—

(i)         if responsibility for payment of the above or other payments lies with the Government, a State Government or a local authority;

(ii)        if responsibility for the payment of the above or other payments lies with a person who is a resident for that basis year; or

(iii)       if the payment of the above or other payments is charged as an outgoing or expense in the accounts of a business carried on in Malaysia.

 

The above proviso in red was deleted in the Finance Act 2016 which gives the effect that the service fee paid to a non-resident would be subject to withholding tax under Section 109B of the Act even if the services are performed outside Malaysia.

This amendment will create a great impact to businesses as the scope of the Section covers a wider range which includes technical services e.g. installation, marketing, consultancy, legal, supply of Information Technology personnel, and non-technical services e.g. administration, planning, accounting, financial management etc.

What I have found in my experience is that most of the non-residents are often not willing to bear the withholding tax and the local businesses usually would bear them instead. But the portion which is borne by local businesses are not deductible expenses for tax as the Court decided in the Esson Production Malaysia case. This will increase the cost of doing business.

However, there are some DTA which specifically dealt with the fee for “Technical” services and have provided very clearly that the fee is only subject to tax in the other country if the services are performed in that country. The examples of the DTAs that have these provisions are DTA with Singapore and Spain.

Once again, IRBM has clarified in the Dialogue that if the DTA is in conflict with the domestic tax laws, the DTA would override the domestic tax laws. Other than that IRBM has issued Practice Note 1 and Note 2 on 7 July 2017 to clarify the DTAs which have specifically provided that the services performed outside Malaysia by the non-resident are not subject to withholding tax, these DTAs are Singapore, Spain, Australia and Turkmenistan. The Public Ruing 1/2014 – Withholding Tax on Special Classes of Income will be amended accordingly to take into consideration the amendments in the Income Tax Act 1967.

In the Dialogue IRBM has at least given some guidance on the withholding tax treatment and the tax rate applicable based on the following circumstances: –

  1. Where there is no DTA
    • IRBM’s comments

Follow the tax rate in the Income Tax Act 1967 which is 10%

  1. Where there is DTA but no technical fee article in the DTA
    • IRBM’s comments

“Royalty” article where applicable or “Other Income” article will be used, subject to DTA negotiations.

  1. Where there is a technical fee article in the DTA but does not clearly provide that the fee only be taxed in the other country where the services are performed.
    • IRBM’s comments

Generally, there are is no conflict between ‘source rule’ in the “Technical Fee” article and the amendment to section 15A. Technical Fee is said to be derived from a country if the payer is a resident of that country.

[It implies that the withholding tax is applicable].

  1. Where there is a technical fee article in the DTA it does clearly provide (e.g. the DTA with Singapore) that the fee only be taxed in the Malaysia when the services are performed in Malaysia.
    • IRBM’s comments

MOF will be negotiating Malaysia’s DTAs nevertheless where the relevant DTA provides that technical fees would only be subject to tax if the services are rendered in Malaysia, S.109B withholding tax should not be applicable if the services are not rendered in Malaysia.

 

 

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