Comprehensive Overview of Withholding Tax on Foreign Service Providers in Malaysia

During the last few years, there has been significant growth for e-commerce players in the market, which has been accelerated by the COVID-19 pandemic lockdown, driving online shopping to new heights.

This change isn’t limited only to e-commerce players but also traditional businesses, where many have started to embrace technology for their business, for instance, social media marketing, cloud-based accounting software etc.

In 2017, the Inland Revenue Board Malaysia or Lembaga Hasil Dalam Negeri Malaysia (LHDN) expanded the scope of withholding tax in Malaysia to capture services performed in the e-commerce industry. This includes services performed by foreign providers outside of Malaysia. Therefore, many parties have suddenly started asking what is withholding tax in Malaysia all about?

What is Withholding Tax (WHT) in Malaysia?

In Malaysia, the withholding tax is an amount withheld by the party making payment (payer) on income earned by a non-resident (payee). This amount has to be paid to LHDN.

In simpler terms, if you are paying non-local (foreign) vendors, you need to withhold a certain % of the invoiced amount and pay to LHDN as a form of tax, and the remaining balance to be paid to your foreign vendor.

The withholding tax in Malaysia is not new and has been in existence since the Income Tax Act 1967 (ITA), and it covers payments such as:

• Contract payment
• Interest
• Royalty
• Special classes of income: Technical fees, payment for services, rent/payment for use of moveable property
• Interest (except exempt interest) paid by approved financial institutions
• Income of non-resident public entertainers

Each type of payment will have different withholding tax rates and may enjoy preferential tax rate if there is a double taxable agreement between Malaysia and the country where the non-resident (foreign party) is a tax resident of. The table below details the relevant forms for different payments for the withholding tax in Malaysia.

Does the WHT in Malaysia cover services rendered outside the country?

Prior to 2017, the WHT in Malaysia was only applicable for services rendered in Malaysia by non-local vendors. However, from 17 January 2017, LHDN expanded the scope to cover services rendered outside of Malaysia.

This immediately affected many services provided by foreign providers, such as Facebook, Google Ads, Stripe, GoDaddy, etc., and the fees paid to overseas service providers.

For this publication, we will focus on two types of payments under the WHT in Malaysia:

• Royalty Income under paragraph 4(d) of the ITA;
• Special classes of Income under paragraph 4A of the ITA;

These two types of income usually involve services from foreign service providers.

What is Royalty Income in Malaysia?

As per LHDN, royalty is defined as any sums paid as consideration for the use of or the right to use:

• 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;
• Know-how or information concerning technical, industrial, commercial or scientific knowledge, experience or skill; or
• Income derived from the alienation of any property, know-how or information mentioned in the above paragraph of this definition.

Based on GUIDELINES ON TAXATION OF ELECTRONIC COMMERCE TRANSACTIONS released by the LHDN on 13th May 2019, the LHDN considers payments made to Facebook, Google, and the like to be similar to payment for the use and right to use the platform.

What are Special Classes of Income?

As per LHDN, the income of a non-resident from the following special classes of income is subjected to tax in Malaysia if it is derived from Malaysia:

• Amounts paid in consideration of services rendered by the non-resident person or his employee in connection with:
  • the use of property or rights belonging to him; or
  • the installation or operation of any plant, machinery or other apparatus purchased from him [paragraph 4A(i) of the ITA];
• Amounts paid to a non-resident person in consideration of any advice given or assistance or services rendered in connection with the management or administration of any scientific, industrial or commercial undertaking, venture, project or scheme [paragraph 4A(ii) of the ITA]; or
• Rent or other payments made under any agreement or arrangement to a non-resident person for the use of any moveable property [paragraph 4A(iii) of the ITA].

This usually happens when you hire non-resident contractors to perform work for you, e.g. software development, or engage an overseas marketing agency to manage your social media marketing accounts.

Why is it important to differentiate Royalty Income vs Special Classes of Income?

This is due to different preferential withholding tax rates, which may be available for different types of payments under Double Taxation Agreements with different countries. For example:

Assuming that the foreign service provider is based in Singapore, if the service is considered under Special Classes of Income (e.g. Technical Fees), it will be withheld at 5% rather than 8% (% to be withheld if it is considered as “Royalty”).

Are payments to non-residents subjected to WHT in Malaysia under Special Classes of Income?

With effect from 6th September 2017, there is an Exemption Order granted on payments made in relation to Special Classes of Income where a non-resident shall be exempted from the payment of income tax on the fees if the services are performed by the non-resident outside Malaysia. In other words, withholding tax in Malaysia is exempted if the services are performed outside Malaysia.

How to calculate the Withholding Tax in Malaysia?

In the past, the payer was required to calculate the withholding tax in Malaysia based on the re-gross method.

 Formula:  Withholding Tax Due     =    (Fee Charged  X Tax Rate) / 1−Tax Rate

Example:

However, with the LHDN announcement on December 5, 2018, WHT is to be computed on the gross amount paid to a non-resident.

Example:

How to pay Withholding Tax in Malaysia and penalty if not paid:

The payer must, within one month after the date of payment to the non-resident, remit the withholding tax to LHDN. Failing to do so, you may face the potential risks of:

• 10% late WHT payment penalty
• Ineligibility to claim advertising cost as your business expenses in your annual return (if your advertising costs are from foreign providers such as Facebook and Google)
• At least 45% penalty on tax avoidance, according to paragraph 113(2) of ITA

To sum up, you must be well aware of the ongoing changes in the withholding tax in Malaysia for your business. At InCorp Global Malaysia, we ease your load through our comprehensive tax advisory services. So what are you waiting for?

Please note that this publication is based on publicly available information. As tax policies may change from time to time, you may need to consider the latest tax developments when planning your withholding tax. Further, the above examples are for illustration purposes only and should not constitute tax consultation.