MALAYSIA: An Introduction to Tax

Tax: Malaysia 

2023 has been an eventful year for the Malaysian tax sphere. In the first half of 2023, the Finance Minister enacted the Income Tax (Transfer Pricing) Rules 2023 (TPR23), introducing provisions that garnered considerable attention from transfer pricing (TP) experts. Later in 2023, the Government presented the largest budget in the nation’s history, totalling RM393.8 billion, featuring numerous tax reforms, such as the introduction of capital gains tax and e-invoicing. This article explores the latest trends and developments shaping the Malaysian tax landscape as we enter 2024.

Tax Audits and Investigations  

Tax audits and investigations by the Inland Revenue Board (IRB) and the Royal Malaysian Customs Department are routine in Malaysia. Recently, the IRB has been increasingly conducting investigations on company directors who failed to submit tax returns under Section 77A(1) of the Income Tax Act 1967 (ITA). This non-compliance can result in fines, imprisonment, or both under Section 112 of the ITA, along with a special penalty of the tax charged.

Another key audit area relates to whether the gains from real property disposal are subject to income tax or real property gains tax (RPGT). In the recent decision of Ketua Pengarah Hasil Dalam Negeri (KPHDN) v Cash Band (M) Bhd, the taxpayer subjected gains from the disposal of a golf course through a joint venture to RPGT. However, the IRB argued that the gains should be subject to income tax. The High Court ruled in the taxpayer’s favour and the IRB withdrew its appeal to the Court of Appeal.

The IRB also frequently audits taxpayers who have claimed tax incentives, such as reinvestment and industrial building allowances, which are subject to specific legal requirements or conditions. In Seiwa-Podoyo (M) Sdn Bhd v KPHDN, the High Court held that the Public Ruling issued by the IRB on reinvestment allowance has no force in law and cannot be used to disallow the taxpayer’s reinvestment allowance claim.

Judicial Trends  

The courts have held in 2023 that fees paid to State Governments for releasing reserved property units, which are exclusively designated for specific groups in Malaysia, are deductible under Section 33(1) of the ITA. This position was recently affirmed in KPHDN v Mitraland Kota Damansara Sdn Bhd, where the Court of Appeal confirmed that the release fee is deductible.

Further, in the recent constitutional challenge of Mohd Najib bin Hj Abd Razak & Anor v Government of Malaysia, the Federal Court ruled that the ‘pay first, dispute later’ tax model and the recovery mechanism under Sections 103 and 106 of the ITA cannot amount to a suspension of judicial power and are, therefore, constitutional. Nevertheless, the Federal Court also stressed that the right of judicial review and grant of stay are not ousted by the ITA.

The High Court also recently examined the rarely litigated tax area of excise duty in Hicom Automotive Manufacturers Sdn Bhd v Director General of Customs (DGC), where the taxpayer included the investment amortisation rate (IAR) based on the planned sales volume, at the DGC’s request, in computing the open market value for excise duty (HPTE). Subsequently, the DGC sought to amend the IAR formula to be based on actual sales volume, resulting in an increase in excise duty payable. The taxpayer argued against this retrospective change and that the inclusion of the IAR in computing the HPTE is not legally required. The High Court ruled in the taxpayer’s favour.

Moreover, in 2023, it was decided that an ITA provision is unconstitutional and void. In Wiramuda (M) Sdn Bhd v KPHDN, the Federal Court held that Section 4C of the ITA, which deems compensation from compulsory acquisition as a form of taxable gain, conflicts with Article 13(2) of the Federal Constitution. This is because Article 13(2) requires adequate compensation to be provided in a compulsory acquisition, and the taxation of this compensation under Section 4C would result in inadequate compensation.

Further, judicial review (JR) remains an option to pursue tax disputes involving questions of law and the DGIR’s or DGC’s lack of jurisdiction, blatant failure to perform statutory duties or serious breach of natural justice. This is demonstrated in the recent case of ATM Sdn Bhd & Anor v KPHDN, where the High Court allowed the taxpayer’s application for leave for JR and stay of the IRB’s decision to subject payments from a services agreement to withholding tax, even though the payments did not qualify as royalties under Section 2 of the ITA. JR is a preferred method for resolving tax disputes due to its expeditious nature and the availability to seek a stay of the DGIR’s and DGC's decisions.

TPR23 

On 5.4.2023, the High Court in KPHDN v Sandakan Edible Oils, made several significant TP-related findings. It was held that TP adjustments under Section 140A of the ITA should not be made when a taxpayer's financial results already fall within the interquartile range. Furthermore, the court decided that the median point is a poor determinant of arm's length pricing. Instead, a range should be used to determine arm's length pricing.

Conversely, just over a month after the judgment for the Sandakan Edible Oils, the Finance Minister gazetted TPR23 on 29.5.2023, introducing provisions diverging from both Sandakan Edible Oils and international TP standards. TPR23 introduced an unprecedented arm's length range of 37.5th to 62.5th percentiles, compared to the typical international standard range of 25th to 75th percentiles. It also empowered the DGIR to adjust the arm’s length price to the median or higher, even when the price is within arm's length range, provided comparability defects exist. Further, TPR23 provided that the arm's length price will automatically be adjusted to the median when the price falls outside the arm's length range. These provisions are in contrast with Sandakan Edible Oils which states that median is an “arbitrary measure” as it artificially assumes a company is engaged in TP if it does not outperform at least 50% of its competitors each year.

Budget 2024  

In Budget 2024, several tax reforms were introduced, including the implementation of e-invoicing, a digital transaction record, for companies with an annual turnover exceeding RM100 million, starting from 1.8.2024. e-Invoicing is not required for employment income, pension, alimony, certain dividend distributions, zakat, and scholarships. With e-invoicing, the IRB will have access to a significant amount of taxpayers' data through the MyInvois System, an e-invoicing system developed by the IRB. This is concerning, as the DGIR had previously, without specific reason, compelled a taxpayer to provide protected data of a large number of its customers by invoking Section 81 of the ITA in Genting Malaysia Bhd v Pesuruhjaya Perlindungan Data Peribadi & Ors. The High Court, upholding the Federal Court and Court of Appeal’s decision in KPHDN v Bar Malaysia, held that the IRB was not allowed to conduct such “fishing expedition”, and it contravened the Personal Data Protection Act 2010 and the right to privacy under Art. 5(1) of the Federal Constitution.

Starting from 1.3.2024, a Capital Gains Tax (CGT) on unlisted share disposal by companies will also be introduced. The CGT rate varies depending on the acquisition dates. For shares acquired before 1.3.2024, taxpayers can choose between a 10% CGT on the net gain or a 2% CGT on the gross sales value. For shares acquired on or after 1.3.2024, a flat 10% CGT on the net gain applies. Exemptions are granted for share disposals related to approved Initial Public Offerings and intra-group share restructuring. It is anticipated that disputes on valuation of shares, timing of disposal and whether the gains are subject to income tax or CGT may arise.

Further, a High Value Goods Tax (HVGT) of 5% to 10% will be implemented starting on 1.5.2024. A luxury goods tax (LGT) was previously proposed in the re-tabled Budget 2023. HVGT is likely introduced to replace the LGT, as the latter faces an inherent challenge in defining what constitutes "luxury goods", which is open to debate and interpretation. HVGT is more straightforward, as based on its terminology, it clearly implies that it is levied based on the goods’ threshold value.

Conclusion 

Given the numerous tax reforms and developments introduced in 2023, along with the government's commitment to reducing Malaysia's fiscal deficit to 4.3% of the Gross Domestic Product, one thing is certain: tax audits and investigations will persist to ensure tax compliance by taxpayers. While some of these audits and investigations may have merits, it is inevitable that there will be findings that are unreasonable, arbitrary, or illegal. In such instances, these findings are subject to legal challenges.