WITHHOLDING taxes on interest and royalties have existed in Malaysia since the enactment of the Income Tax Act 1967.
Significant changes to the withholding tax regime took place in 1983 when withholding tax was extended to contract payments made to non-resident contractors. Later that year, the scope was expanded to cover special classes of income such as technical fees, services and rental of movable property. To add to the menu of withholding taxes, Section 4(f) and its related derivation provision were introduced in January 2009.
Taxpayers’ dilemma
Taxpayers have long faced a dilemma in determining whether a payment made to a non-resident is subject to withholding tax and, if so, which category of withholding tax applies.
The confusion arises because the boundaries between the various withholding tax provisions are often blurred. A common example is distinguishing between service fees, royalties and contractor payments, or determining whether a payment should fall under contractor withholding tax or special classes of income.
To add more confusion to the “melting pot”, the wording of the legislation has led to differing interpretations. This is evident from the evolution of the special classes of income provisions.
Initially, services were subject to withholding tax only if provided in connection with the management and administration of a scientific, industrial or commercial undertaking, venture, project or scheme. Over time, this provision has been interpreted more broadly to cover a wider range of services.
The interpretation has also continued to evolve through Inland Revenue Board (IRB) pronouncements and court decisions.
Another recurring area of dispute between IRB and taxpayers is the interaction between domestic legislation and double tax agreements (DTA). The domestic provisions do not always align with DTA provisions, which are generally modelled on the United Nations or Organisation for Economic Cooperation and Development model treaties.
A notable example is the definition of “royalty”. Malaysian domestic law specifically includes “the use of or the right to use software”, whereas DTA generally refer to “the use of or the right to use any copyright”.
In many software licensing arrangements, the user does not acquire any copyright rights. Nevertheless, IRB often takes the view that payments for access to digital platforms or software are subject to withholding tax because software is being used.
Unfortunately, it is not a simple matter of whether it is correct or incorrect and disputes of this nature do not help the taxpayer to arrive at a decision as these matters are continuously being litigated in the courts.
What is IRB doing now?
It is a current practice for IRB to issue letters to Malaysian businesses paying non-residents to ask for information and documents to assess whether you are complying with the withholding tax provisions. The information commonly requested are the creditors ledger, contracts/agreements, invoices, payment slips, etc. The intention here is to collect the withholding taxes and penalties from the non-compliant taxpayers.
Our recommendation
The government recently encouraged voluntary compliance through programmes such as the stamp duty and sales and service tax voluntary disclosure initiatives.
In the same vein, serious consideration should be given to introducing a withholding tax voluntary disclosure programme. Such a programme would save administrative resources and provide taxpayers who do not wish to dispute the IRB’s position with an opportunity to regularise their withholding tax affairs.
This article is contributed by Thannees Tax Consulting Services Sdn Bhd managing director SM Thanneermalai (www.thannees.com).
