Malaysian Taxation on Foreign-Sourced Income
Malaysia adopts a territorial system of income taxation.
Scope of charge
The chargeability of income is governed by Section 3 of the Income Tax Act, 1967 (ITA) which states that “income shall be charged for tax for each year of assessment (“YA”) upon the income of any person accruing in or derived from Malaysia or received in Malaysia from outside Malaysia”.
The phrase accruing in or derive from Malaysia connotes the source of income must be in Malaysia.
Income accrued in or derived from Malaysia will be taxed at the time of accrual or derived notwithstanding the fact that the income may not have been received in Malaysia.
Section 3 of the ITA extends its territorial scope to include foreign source income received in Malaysia from outside Malaysia. Foreign source income refers to income which is accrued in or derived from a tax jurisdiction outside Malaysia.
With effect from YA 2004, foreign source income derived from sources outside Malaysia and received in Malaysia by any person (other than a resident company carrying on the business of banking, insurance or sea or air transport) is not subject to Malaysian income tax.
Derivation of business income
Derivation of business income is defined in Section 12 of the ITA.
Pursuant to Section 12(1)(a) of the ITA, so much of the gross income from the business as is not attributable to operations of the business carried on outside Malaysia shall be deemed to be derived from Malaysia.
Section 12(1)(a) serves as a residual section, to tax whatever gross income that is not attributable to operations of business carried on outside Malaysia would be deemed Malaysian derived income. The scope is wider than merely to treat gross income that is attributable to business operations carried on in Malaysia.
Therefore, if the gross income is related to the work performed outside Malaysia and the taxpayer wishes to treat it as foreign source income, the taxpayer would need to substantiate that it is attributable to operations of business carried on outside Malaysia.
If the business consists wholly or partly of the manufacturing, growing, mining, producing or harvesting in malaysia of any article, product, produce or other thing, the gross income from the sale of such articles, etc., outside Malaysia in the course of carrying on business shall be deemed to be derived from Malaysia. This is provided under Section 12(1)(b)(i).
Where such articles, products, etc are exported in the course of carrying on the business and Section 12(1)(b)(i) does not apply, then the market value of the article, product, etc. at the time of export shall be deemed to be gross income derived from Malaysia [Section 12(1)(b)(ii)].
Operations of business carried on in Malaysia
Determining the locality of the source of income can be complex and contentious. There is no universal rule that can be applied to every scenario to determine whether an income is Malaysian-sourced or foreign-sourced. It depends on the nature of the profits and of the transactions which give rise to such profits.
Some of the factors that should be taken into consideration to determine whether a business is carried on in Malaysia are:
- Whether contracts are concluded in Malaysia;
- Whether stocks are maintained in Malaysia from which orders are fulfilled;
- Whether the passing of ownership and risk of trading stocks in Malaysia;
- Whether proceeds of sales are received in Malaysia;
- Whether services are rendered in Malaysia.
These factors are not conclusive on their own and must be considered collectively.
Changes Effective From 2022
In the 2022 Budget announcement, it is proposed that with effect from 1 January 2022, foreign-sourced income (FSI) of Malaysian tax residents (both companies and individuals) which is received in Malaysia will be subject to tax. There will be a transitional period from 1 January 2022 to 30 June 2022 where FSI remitted to Malaysia will be taxed at the rate of 3% on gross income. FSI remitted to Malaysia will be taxed at the prevailing tax rate from 1 July 2022 onwards.
Further to feedback received from various parties on the proposed removal of the income tax exemption on FSI received in Malaysia by Malaysian tax residents, the Ministry of Finance (MOF) has issued a media release dated 30 December 2021 and has agreed to exempt the following FSI received in Malaysia by Malaysian tax residents based on the following category and substantive conditions:
|Category of Taxpayer||Type of FSI exempted from Tax||Eligibility Condition|
|Company/ Limited Liability Partnership (LLP)||Dividend income||Subject to eligibility conditions that will be detailed in the LHDNM Guidelines to be issued |
|Individual||All types of FSI|
This exemption will be effective from 1 January 2022 to 31 December 2026. Other than as mentioned above, FSI is subject to tax in Malaysia when received in Malaysia by Malaysian tax residents with effect from 1 January 2022.
For the category of individual taxpayers, the Government grants exemption to all individuals except those carrying out partnership business in Malaysia, which will be subject to tax for the FSI received in Malaysia. Whereas, the category of non-residents (individuals, companies, etc.) still remain eligible for income tax exemption.
Following the announcement made by MOF on 30 December 2021, the following Exemption Orders have been gazetted on 19 July 2022.
- Income Tax (Exemption) (No. 5) Order 2022 – Exemption of FSI received by resident individuals
- Income Tax (Exemption) (No. 6) Order 2022 – Exemption of FSI received by resident companies, LLP and individual in relation to a partnership business in Malaysia
Based on the Exemption Orders, the following categories and sources of FSI received in Malaysia from outside Malaysia are exempted from tax from 1 January 22 to 31 December 2026.
|Category of Taxpayer||Type of FSI exempted from Tax|
|Resident Individuals||All sources of income (excluding a source of income from a partnership business in Malaysia, which is received in Malaysia from outside Malaysia).|
|Resident Company/ Limited Liability Partnership (LLP) |
Resident individuals (who has dividend income received in Malaysia from outside Malaysia in relation to a partnership business in Malaysia)
|Dividend income received in Malaysia from outside Malaysia.|
The income exempted shall have been subjected to tax of a similar character to income tax under the law of the territory where the income arises.
For dividend income, the dividend shall have been subjected to tax of a similar character to income tax under the law of the territory where the income arises and the highest rate of tax of a similar character to income tax charged under the law of the territory which the income arises at that time is not less than 15 per cent.
The above is subject to compliance of conditions in the guidelines which will be issued by the IRB.