Malaysia’s tax landscape for foreign-sourced income (FSI) has seen significant clarifications, particularly concerning economic substance requirements and the applicability of tax exemptions and credits. This article synthesizes key insights from the Inland Revenue Board of Malaysia (HASiL)’s guidelines and subsequent clarifications sought by the Chartered Tax Institute of Malaysia (CTIM) for taxpayers.
Key Takeaways
- In order to qualify for tax exemptions, companies, LLPs and partnerships must show adequate economic substance in the form of adequate employees, expenditure, and premises in Malaysia. Failure to meet substance requirements may lead to foreign dividend income being taxed
- From 1 Jan 2022, foreign dividends may qualify for exemption if they either meet the 15% participation exemption test or comply with economic substance requirements. Resident individuals generally do not enjoy these exemptions.
- Taxpayers can claim bilateral or unilateral tax credits on foreign income to reduce double taxation. If no credit is claimed, the net amount received will still be taxed in Malaysia.
Economic Substance Requirements for Foreign Dividend Income
For a resident company, resident Limited Liability Partnership (LLP), or a resident individual engaged in a partnership business in Malaysia to be considered as having economic substance for foreign dividend income, they must:
- Employ an adequate number of employees with the necessary qualifications to conduct specified economic activities in Malaysia.
- Incur an adequate amount of operating expenditure for these activities in Malaysia.
The assessment of “adequate” is not based on fixed minimum thresholds but depends on the specific facts of each case and varies by industry. Factors considered include the nature of the activities (e.g., capital or labor-intensive), whether employees are full-time or part-time, and the adequacy of office premises for the activities.
On the other hand, failure to meet these requirements for foreign dividend income can result in the income being subject to tax in Malaysia, as it would not qualify for exemption. The effective date of these guidelines has retrospective implications, potentially affecting previously declared dividends.
Clarifications on Economic Substance:
- Effective Date: The effective date of the amended guideline on December 29, 2022, is a policy decision by the Ministry of Finance. CTIM has raised concerns about its retrospective application, particularly for companies that declared dividends out of profits before factoring in potential tax implications due to non-compliance with economic substance requirements. This could lead to profits being reduced or even negative, which has wider implications under the Companies Act 2016 (Sections 131, 132, and 133).
- Specified Economic Activities: For entities other than investment holding companies, such as manufacturing companies, “specified economic activities” refer to the business operations conducted in Malaysia. For manufacturing companies deriving foreign dividend income from a passive Hong Kong subsidiary, the economic substance requirements refer to the manufacturing entity in Malaysia.
- Employees and Directors: Service directors who are employed under a “contract of service” are considered employees. However, non-service directors are not regarded as employees for economic substance purposes. The definition of “employee” under Section 2 of the Income Tax Act 1967 (item b) may include office holders, but HASiL maintains the distinction between service and non-service directors for this purpose.
- Outsourcing Arrangements: Outsourcing of specified economic activities by companies, LLPs, or individual partners in Malaysia to an outsourced entity is permissible for meeting employee requirements.
- Office Premises: The necessity and adequacy of office premises depend on the industry, type of activity, and specific case facts. While CTIM suggested that passive investment holding might not require office premises, HASiL emphasizes a case-by-case determination.
Exemption Criterias for Foreign Sourced Income in 2025
Based on the FSI Guideline dated December 29, 2022, foreign income is eligible for exemption if:
- Dividends have been subjected to tax in the country of origin.
- The headline tax rate in the country of origin is at least 15%.
- The company complies with economic substance requirements.
However, these conditions have been amended. Taxpayers now only need to meet either the “participation exemption” condition (dividend subjected to tax in the country of origin with a headline tax rate of at least 15%) or the “economic substance” condition, as per the GP FSI dated June 20, 2024, effective January 1, 2022.
HASiL has clarified that dividends received by a Malaysian company from a BVI (British Virgin Islands) company, where the BVI company’s profits (e.g., from UK rental income) have been subjected to tax in another jurisdiction, may qualify for tax exemption under the participation exemption, provided traceability is maintained. This exemption is subject to the facts of the case.
Generally, foreign dividend income received by resident individuals is not eligible for tax exemption under the updated guidelines, distinguishing their treatment from companies or LLPs.
Bilateral or Unilateral Tax Credit Can Be Claimed Conditionally
Foreign income received in Malaysia that has been taxed by other jurisdictions, either through withholding tax or income tax, can claim bilateral or unilateral tax credit under Sections 132 and 133 of the ITA 1967.
Regarding whether the actual (net) amount received would be subject to income tax if bilateral/unilateral credit is not claimed, HASiL confirmed that if a taxpayer chooses not to claim bilateral/unilateral credit, the net remitted amount will be taxed, regardless of whether records are available or destroyed. However, such transactions remain subject to HASiL’s auditing. For gross dividend income, if a bilateral tax credit is claimed, the gross amount before foreign tax is considered for assessment (e.g., RM143 gross income if RM100 is received after a 30% foreign tax).
Qualifying Conditions for Foreign Income Received by a Resident Individual
For resident individuals, the treatment of foreign dividend income is specifically outlined.
Foreign dividend income received in Malaysia by a resident individual from a BVI company is generally not eligible for tax exemption, as per the FSI Guideline dated June 20, 2024, specifically section 5.2.2.2(b) under “Foreign dividend income [(i) or (ii)]”. For foreign income other than dividends, the qualifying conditions for tax exemption refer to the same guideline, section 5.2.2.2(b) under “Foreign income other than dividend income [(i), (ii) or (iii)]”.
How Malaysia Taxes Foreign Source Business Income and Credits
For foreign source business income, if the foreign corporate tax paid by a permanent establishment is ignored and no foreign tax credit is claimed, then no foreign tax credit is available to the Malaysian tax resident. If a taxpayer opts not to claim bilateral/unilateral credit, the net amount received can be subject to tax. However, if the taxpayer chooses to claim a tax credit, the gross taxable income would be determined as per the relevant guideline.
This overview aims to provide clarity on the complex aspects of tax treatment for foreign-sourced income in Malaysia, based on the latest guidelines and clarifications. Taxpayers are encouraged to refer to the official HASiL guidelines for detailed information and specific case applications.
Similar to dividends, foreign source business income received in Malaysia is taxable, but foreign tax credit can be claimed to mitigate double taxation. If no credit is claimed, the net remitted amount is subject to tax.
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