Prior to 31 December 2021, foreign source income (“FSI”) received in Malaysia by an individual or company carrying out business other than banking, insurance, or sea or air transport was exempt from income tax. However, the Malaysian government amended the tax law in December 2021 to restrict this exemption to only apply to non-residents. With the amendment, starting from 1 January 2022, FSI remitted to Malaysia by tax residents (including individuals and companies) would be subject to Malaysian tax, unless exempted.
As a transitional measure, from 1 January 2022 until 30 June 2022, the FSI received in Malaysia would be taxed at a 3% rate on a gross basis. After that period, starting from 1 July 2022, it would be taxed based on the prevailing income tax rate.
To provide further cushioning to this drastic change of tax law, 2 exemption orders were gazetted on 19 July 2022:
1. INCOME TAX (EXEMPTION) (NO. 5) ORDER 2022
2. INCOME TAX (EXEMPTION) (NO. 6) ORDER 2022
Pursuant to these gazetted orders, the exemption period is from 1 January 2022 to 31 December 2026. Individuals are exempted from all categories of income including income from employment, dividend, rental and interest. On the other hand, companies and LLPs are exempted from foreign dividend income only.
Pre-conditions are to be met to qualify for the exemption, as summarised here:
Types of Tax-Exempt Income
All types of income other than partnership income
The income has been subjected to tax in the country of origin.
Company, LLP, individual partner in relation to a partnership business in Malaysia
(i) The dividend income has been subjected to tax in the country of origin;
(ii) The highest tax rate (headline tax) in the country of origin is not less than 15%; and
(iii) Comply with the economic substance requirements.
a. Foreign income received by a Malaysian resident, where the FIS is subjected to tax in the country of origin
Eric, a Malaysian resident, works as an accountant in an architectural firm in Singapore from 2020. Eric and his family live in Johor Bahru and he commutes from his house to Singapore every day. At the end of each month, he brings back the salary received from his employment in Singapore to Malaysia and the employment income is taxed in Singapore. Part of his salary was credited to a retirement fund in Singapore by his employer.
Under the Income Tax (Exemption) (No. 5) Order 2022, the income arising from Singapore brought into Malaysia by Eric is exempted from tax in Malaysia since the income has been taxed in Singapore.
b. Dividend income received by a Malaysian resident company, where the dividend is subject to tax in the country of origin in which the income arises
United Ltd is a resident company in Country T. On 15.2.2021, United Ltd paid dividends to Deco Co. which is a resident in Malaysia with a tax rate imposed in Country T of 10%. The headline tax rate of country T in YA 2021 is 20%. And assuming United Ltd has met the economic substance requirements.
Ringgit Malaysia (RM)
Less: Tax Rate (10%)
Deco Co. deposited the net dividend income of RM18,000 into its account in country T. On 5.1.2022, Deco Co. transferred that income from Country T's account to its account in Malaysia. The headline tax rate in country T (20%) fulfilled the condition of not less than 15%, therefore, the dividend income received in Malaysia from Country T is tax-exempt, pursuant to Income Tax (Exemption) (No. 6) Order 2022.
The exemption orders appear to be more favourable for individual tax residents, as meeting the exemption criteria is relatively straightforward.
On the other hand, corporate taxpayers may find the exemption is limiting as it only applies to dividend income. FSI that do not meet the exemption requirements above would be subjected to tax when remitted to Malaysia, for example:
a. Dividends (that do not meet the exemption requirements)
Malaysian tax residents can receive tax relief for foreign tax paid on the FSI. Bilateral relief applies when a double tax agreement (DTA) exists between Malaysia and the foreign country, while unilateral relief applies when there is no or limited double tax agreement in place. Bilateral relief is calculated based on a prescribed formula and is limited to the maximum of the Malaysian tax suffered. Whereas unilateral tax relief automatically halves the foreign tax paid.
In general, if the source of the FSI is a country with high tax rates and a DTA with Malaysia, it is likely no additional tax will be imposed on the FSI remitted to Malaysia as the bilateral relief would offset the tax related to the FSI. However, if the FSI comes from a country with low tax rates or without a DTA with Malaysia, the FSI remitted to Malaysia would likely attract additional tax in Malaysia.
For further reading, please refer to the “Tax Treatment In Relation To Income Received From Abroad (Amendment)”