Comprehensive Overview of Withholding Tax on Foreign Service Providers in Malaysia

Malaysia withholding tax may apply to payments made to non-residents, including foreign service providers, depending on the nature of the payment and whether the income is treated as derived from Malaysia under the Income Tax Act 1967. The Malaysian payer is responsible for withholding and remitting the tax to the Inland Revenue Board of Malaysia. Failure to comply may result in penalties and disallowed tax deductions. In certain cases, double taxation agreements may reduce the applicable withholding tax rate.

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 withholding tax in Malaysia is all about.

This article explains how Malaysia’s withholding tax on service fees applies, particularly for foreign service providers operating across borders.

What is Withholding Tax (WHT) in Malaysia?

Withholding tax (WHT) is the amount withheld by the party making a payment (the payer) on income earned by a non-resident (the payee), which must then be remitted to LHDN.

In simple terms: if you’re paying a foreign vendor, you withhold a set percentage of the invoiced amount and pay it to LHDN, sending the remaining balance to your 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 movable 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 a preferential tax rate if there is a double tax agreement between Malaysia and the country where the non-resident (foreign party) is a tax resident. The table below details the relevant forms for different payments for the withholding tax in Malaysia.

Does Withholding Tax Apply to Services Rendered Outside Malaysia?

Prior to 2017, the WHT in Malaysia applied only to services rendered in Malaysia by non-local vendors. From 17 January 2017, the scope of withholding tax was expanded to cover certain payments to non-residents, including cases where services are rendered outside Malaysia, subject to how the income is characterised under Malaysian tax law.

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 Income Tax Act 1967;
• Special classes of Income under paragraph 4A of the Income Tax Act 1967;

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

What Counts as Royalty Income Under Malaysia Withholding Tax Rules?

As per Section 2 of the Income Tax Act 1967, 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;
• Software licences and subscription payments to purchase, use, or acquire the right to use a digital application, including where the application is later modified or distributed by the user;
• Know-how or information concerning technical, industrial, commercial or scientific knowledge, experience or skill; or
• Income derived from the alienation, sale or complete transfer of ownership of any property, know-how, or information mentioned above.

Based on the GUIDELINES ON TAXATION OF ELECTRONIC COMMERCE TRANSACTIONS released by LHDN on 13 May 2019, LHDN treats payments made to Facebook, Google and similar platforms for self-managed digital advertising as payments for the use of, or right to use, the platform and classifies them as royalty income accordingly.

What Are Special Classes of Income in Malaysia?

As defined under Section 4A of the Income Tax Act 1967, special classes of income refer to specific streams of income earned by a non-resident, subject to a 10% withholding tax on the gross amount where the income is derived from Malaysia, covering:

• 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.

Royalty Income vs Special Classes of Income in Malaysia: Key Differences

Both royalty income and special classes of income are taxed at the same domestic rate of 10%, so classification only changes the outcome once a DTA is involved, since treaties frequently set a lower rate for technical fees than for royalties. 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”).

This is one of the most common areas of confusion, particularly when engaging foreign service providers across borders.

Are payments to Non-Residents in Malaysia subject to WHT under Special Classes of Income?

With effect from 6 September 2017, the Income Tax (Exemption) (No. 9) Order 2017 [P.U.(A) 323] exempts a non-resident from income tax on fees falling under Sections 4A(i) and 4A(ii) of the Income Tax Act 1967 where the services are rendered and performed outside Malaysia. Where the exemption applies, the withholding obligation under Section 109B does not arise.

Three limits apply:

• The exemption covers 4A(i) and 4A(ii) only. Rent or other payments for the use of movable property under 4A(iii) remain subject to withholding tax.
• The exemption does not extend to royalties. A payment characterised as royalty under Section 109 remains subject to 10% withholding tax regardless of where the underlying service is performed.
• Where a contract is performed partly in Malaysia and partly outside, the contract value must be reasonably apportioned.

The exemption does not change the deemed derivation rules under Section 15A. The fees remain Malaysian-sourced income and are exempted from withholding rather than removed from charge. Payers should retain documentation evidencing where the services were performed, as this is what LHDN will look for on audit.

How to Calculate Withholding Tax for Foreign Service Providers in Malaysia?

In the past, the payer was required to calculate the withholding tax in Malaysia based on the 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:

Practical Examples of Withholding Tax in Malaysia

• A Malaysian company engages a Singapore-based consultant to perform services in Malaysia. Withholding tax may apply as the services are performed locally.
• A Malaysian company pays an overseas IT provider for services delivered entirely outside Malaysia. Withholding tax may not apply, depending on how the services are structured.

How to Pay the Malaysian Withholding Tax and Penalties for Late Payment?

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 costs as your business expenses in your annual return (if your advertising costs are from foreign providers such as Facebook and Google)
• Penalties may also be imposed under the Income Tax Act 1967 for non-compliance, depending on the circumstances of the case.

Withholding tax and self-billed e-invoicing

A foreign service provider cannot issue an invoice through MyInvois. The Malaysian payer must therefore issue a self-billed e-invoice to document the transaction, using the foreign supplier’s details and the placeholder TIN code published by LHDN where no Malaysian TIN exists.

This matters for withholding tax because the validated self-billed e-invoice and the CP37 or CP37D remittance now sit in the same LHDN records. A mismatch between the value recorded in MyInvois and the amount actually withheld is visible without a separate audit trigger. Reconcile the two in the same monthly close rather than running e-invoicing and withholding tax as separate workflows.

The validated self-billed e-invoice is also the documentary evidence supporting your corporate tax deduction for the imported service. Without it, the deduction may be disallowed on audit.

What Are The Key Considerations for Businesses Engaging Foreign Service Providers?

When working with foreign vendors or regional service providers, businesses should assess:

• Whether the services are performed in Malaysia
• The applicable withholding tax rate
• Whether a double taxation agreement applies
• The responsibility for withholding and remittance

Incorrect classification may result in penalties or disallowed tax deductions during tax filing.

Understanding whether withholding tax applies is not always straightforward, particularly for cross-border service arrangements. A short discussion can help clarify your obligations and reduce the risk of misclassification or penalties.

To sum up, you must be well aware of the ongoing changes in the withholding tax in Malaysia for your business. At InCorp Malaysia, we ease your load through our comprehensive tax advisory services, or try our free corporate tax calculator now.

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.