REVOLUTIONARY changes in the international tax landscape are underway.
On October 5, 2021, the European Union (EU) approved commitments by Malaysia and other countries to reform their Foreign Source Income Exemption (FSIE) regimes.
Days later, the Organization for Economic Co-operation and Development (OECD) updated its two-pillar solution to tackle the tax challenges of the digitization of the economy (commonly referred to as BEPS 2.0), which promises to make the most significant changes to international tax rules in over a century.
Despite its title, BEPS2.0 will impact all large multinational companies and not just digital businesses.
The OECD BEPS 2.0 project
The OECD’s two-pillar solution will result in the reallocation of profits from the largest multinational enterprises (MNEs) to market jurisdictions for tax purposes.
In addition, large MNEs will be subject to an overall minimum tax rate of 15% from 2023.
In the first pillar, part of the profits made by a multinational with a worldwide turnover exceeding 20 billion euros (RM97bil) and a profit margin above 10% can be taxed in the countries where their customers or users reside.
The turnover thresholds will be lowered to 10 billion euros (48 billion RM) in 2031.
This is a significant departure from current tax rules, which generally only allow corporate profits to be taxed in places where a business has a physical presence. Unlike less populous countries like Singapore and Hong Kong, Malaysia could potentially increase its tax revenue through this proposal.
On the other hand, with such high initial revenue thresholds and due to some exclusions, Malaysian corporate groups are generally not expected to be affected when implementing the first pillar in 2023.
The second pillar introduces a global minimum tax (GMT), set at 15% for groups with incomes above 750 million euros (3.6 billion RM).
Given the lower threshold compared to the first pillar, more MNEs, including Malaysian groups, will be impacted by the second pillar.
Simply put, under the second pillar, parent entities can expect to pay an additional tax on the income of non-taxable subsidiaries of at least 15%.
Malaysian subsidiaries of large multinationals that benefit from tax incentives typically pay favorable tax rates well below 15% and may be affected by GMT.
Likewise, groups headquartered in Malaysia and benefiting from tax incentives or low overseas tax rates may be subject to additional tax in Malaysia.
Malaysia will need to rethink its approach to tax incentives and preferential tax regimes in light of the GMT.
Competition for foreign direct investment between countries will remain high, and we can expect to see creative solutions to meet increasingly personalized investor incentive demands.
To continue to attract investors, Malaysia will need to strike a balance between meeting OECD recommendations and flexibility in its approach, and we expect non-tax incentives to play a more important role.
When Malaysia adopts GMT, any additional taxes collected should be allocated to make the country more investor friendly.
Inclusion of Malaysia on the EU watch list
On 5 October 2021, the EU added Malaysia, Hong Kong and three other countries to its Annex II stocktaking document, also known as the EU’s ‘gray list’, by because of their FSIE schemes.
Companies that receive passive income from foreign sources such as dividends, interest and royalties in Malaysia will pay particular attention to this development.
While the Malaysian government has yet to publicly comment on this recent EU announcement, we should expect changes to the country’s FSIE rules in due course as Malaysia has committed to the EU. remove or modify certain aspects of its FSIE regime by December 31, 2022..
Once this commitment is fulfilled, Malaysia will be removed from the gray list.
In the meantime, there will be no negative consequences for Malaysia.
Changes to Malaysia’s FSIE rules would be a fundamental change in the country’s tax system. Before making any changes, the government should:
> Consult the relevant stakeholders
> Consider whether Malaysia can adopt a response similar to Hong Kong’s.
Hong Kong has pledged to maintain its territorial tax system, but will impose additional conditions on FSIE claims made by corporations.
EU guidance suggests that the implementation of substance requirements may be sufficient.
> Analyze other territorial regimes, including those not on the EU gray list like Singapore, to see what we can learn
Policy makers should be aware that the EU does not view territorial tax regimes as inherently problematic and allows countries to continue adopting ESIF regimes, provided that appropriate countermeasures are introduced.
In its first pre-budget statement, Malaysia reaffirmed its commitment to the OECD’s BEPS 2.0 project, but refrained from providing an overview of the changes to our corporate tax and incentive systems that will inevitably have to occur. in response to these developments.
Budget 2022 provides the government with an opportunity to build investor confidence by providing companies with direction on the strategic options that are currently being explored.
Anil Kumar Puri is a partner at Ernst & Young Tax Consultants Sdn Bhd. The opinions expressed here are those of the author.