An overview of taxation regulations relevant to doing business in Sarawak

The business climate in Sarawak is generally open and encourages foreign investors to invest in and establish businesses in the state. Additionally, with structured tax laws and a broad range of incentives, the tax environment in Sarawak also makes it a favourable destination for investors.

Taxation in Sarawak is governed by the general policies of the Malaysian federal government. Malaysia has a territorial basis of taxation (except for certain specialised industries which are taxed on a worldwide basis), and this applies to all states in the country, including Sarawak. Any income accrued in or derived from Malaysia is taxable in Malaysia. Similarly, nonresidents are only taxable on income accrued in or derived from Malaysia. Hence, any foreign-sourced income is tax-exempt.

TYPES OF TAX: Broadly, there are two main categories of tax, namely direct tax and indirect tax. The rules and regulations relating to both types are governed by the Malaysian Treasury, and are implemented and enforced by the Inland Revenue Board or the Royal Malaysian Customs Department, respectively.

Direct tax is mainly income tax. Capital gains are not subject to tax in Malaysia except for gains arising from the disposal of real properties and shares in real property companies. Indirect tax comprises sales tax, excise duties, import and export duties, and service tax. In addition to this, stamp duty is also imposed on certain instruments and documents.

WITHHOLDING TAX: Apart from the income tax collected from taxpayers in general, withholding tax also applies. Withholding tax is generally imposed on nonresidents who have business dealings in Malaysia and therefore derive income from Malaysia. Withholding tax of between 10% and 15% is imposed on royalties, interest, rental of moveable properties, payments for technical or consultancy services, contract payments, and income of a public entertainer, as well as “other income” paid to a non-resident, such as commissions, guarantee fees and introducer fees. Basically, this is a mechanism to collect tax in advance within 30 days upon paying or crediting non-residents.

DOUBLE TAXATION AGREEMENTS: Malaysia has signed or concluded double taxation agreements (DTAs) with many countries, and these apply to Sarawak as well. To date, there are 72 such treaties in force. Preferential rates, instead of the normal withholding tax rates, may be imposed where a country has a DTA with Malaysia. DTAs also provide double taxation relief in respect of income which may be subject to tax twice.

INCOME TAX: Income is generally subject to tax in Malaysia if it falls into one of the following classes of income:

• Gains or profits from a business;

• Income from employment;

• Dividends, interest or discounts;

• Rents, royalties or premiums;

• Pensions, annuities or other periodical payments not falling under any of the above; and

• Other gains or profits not falling under any of the above.

CORPORATE TAX: Business income is subject to income tax and, generally, expenses which are incurred wholly and exclusively in the production of income are claimable as a tax deduction. Expenses which are capital in nature are generally not tax deductible. However, certain qualifying capital expenditures can qualify for capital allowance or industrial building allowance at various specified rates. Capital allowance and industrial building allowance are only deductible against business income. These allowances are not claimable against investment income such as rental income, interest income or dividend income.

Presently the corporate tax rate is 25% for resident and non-resident companies. A concessionary tax rate is given to small and medium-sized enterprises (SMEs). The concessionary tax rate is 20% on the first RM500,000 ($152,100) of chargeable income, and the balance is taxed at 25%. The rate will decrease by one percentage point to 24% from year of assessment (YA) 2016. SMEs will be taxed at a rate of 19% on the first RM500,000 ($152,100) of chargeable income, and the balance will be taxed at 24%.

DIVIDENDS: Effective from YA 2008, the net profit of a company which is already subject to tax can be used to pay single-tier dividends to its shareholders. Single-tier dividends are not taxable in the hands of the shareholders.

GROUP RELIEF FOR LOSSES: With effect from YA 2006, group relief for losses is claimable for companies in a group provided that certain conditions are satisfied. One of the conditions is that both the surrendering and claimant companies must be associated whereby at least 70% of the shares of one company is held by the other. A deduction of up to 70% of adjusted losses of the surrendering company against the aggregate income of the claimant company is allowed. The group relief for losses is a most welcome incentive for companies in a group as it promotes greater tax efficiency.

PERSONAL INCOME TAX: Individuals are also subject to income tax on the different classes of income mentioned above under the paragraph on income tax. The main difference is that scaled rates apply to individuals instead of a flat rate. Presently, the scaled rates range from 2% to 26% and the first RM5000 ($1521) of chargeable income is not subject to any income tax. From YA 2015 onwards, the scaled rates will be reduced to a range from 1% to 25%.

Total employment income includes salary, bonuses, gratuity, perquisites, benefits-in-kind, value of living accommodation and compensation for loss of employment. In order to arrive at the chargeable income of an individual, personal reliefs and rebates are deductible. However, personal reliefs and rebates only apply to an individual who is a tax resident. The reliefs cover a range of items from child relief, medical expenses and life insurance premiums, to books, fees for acquiring tertiary education and purchase of computers, among others.

Sarawak, like the rest of Malaysia, has a “pay as you earn” system in respect of employment income. Under this system, income tax is deducted from the monthly salary by the employer under the Schedular Tax Deduction Scheme. Any tax balance is payable upon submission of the income tax return by April 30th or June 30th.

RESIDENT STATUS: The resident status of a person is important as certain rules which apply to residents do not apply to non-residents. For example, an individual who is a non-resident is taxed at a flat rate of 26% instead of at scaled rates, and no reliefs or rebates shall be given. Furthermore, withholding tax will only apply to payments made to a non-resident company or individual. The resident status of an individual is determined by the number of days an individual is present in Malaysia. An individual is a tax resident under the following circumstances:

• He is physically present in Malaysia during the calendar year, amounting to 182 days or more; or

• He is in Malaysia for a period of less than 182 days, but that period is linked by or to another period of 182 or more consecutive days in the calendar year preceding or succeeding the year in quesdar year and in any three out of the four immediately preceding calendar years he was either a resident or in Malaysia for 90 days or more; or

• With reference to a particular calendar year, he is a resident in the calendar year immediately following and was resident for the three preceding years. For a company, the residence status depends on whether the management and control of the company are exercised in Malaysia. Generally, the place where the board of directors meets to make decisions is the place of residence of a company.

SELF-ASSESSMENT: Sarawak, as part of Malaysia, is presently under a self-assessment system of taxation. This means that a taxpayer makes an assessment of his own income tax liability and submits a tax return accordingly. The onus of computing the tax liability correctly is now shifted from the Inland Revenue Board to the taxpayer. The taxpayer has an obligation to understand the tax laws, guidelines and regulations correctly and to apply them accordingly.

Under the self-assessment system, a company is required to determine and submit an estimate of its tax payable for a year of assessment 30 days before the beginning of the basis period. Subsequently, the company is required to remit this amount to the Inland Revenue Board in equal monthly instalments.

PUBLIC & ADVANCE RULINGS: To enhance compliance with the tax laws, the Inland Revenue Board has issued approximately 81 public rulings to date. Public rulings represent the Inland Revenue Board’s interpretation of particular areas of the Income Tax Act 1967. To some extent, these help taxpayers understand and apply the relevant tax laws correctly and therefore minimise penalties for incorrect tax returns.

With effect from January 1, 2007, it is also possible to obtain an advance ruling from the Inland Revenue Board in respect of a specified arrangement being seriously contemplated. This, therefore, provides certainty and clarity to a taxpayer prior to carrying out a specified arrangement, which is important in a self-assessment environment.

TAX AUDIT: This is the Inland Revenue Board’s key enforcement tool to ensure that taxpayers make an effort to comply with tax laws and file tax returns in accordance with the law. Taxpayers are selected based on certain criteria like business performance, industry type, performance records and third-party information. Tax audits are generally performed at regular intervals but could be carried out as necessary.

TRANSFER PRICING: This is an area of increasing focus for the Inland Revenue Board in recent times. As an anti-avoidance measure, transfer pricing is now incorporated into the Income Tax Act 1967 under the new Section 140A. Basically, the arm’s length standard is required for any related-party transactions and taxpayers are expected to keep contemporaneous records to support their transfer pricing policies. In addition, the Income Tax (Transfer Pricing) Rules 2012 and the Transfer Pricing Guidelines 2012 have also been gazetted or issued to provide further clarifications on transfer pricing rules.

THIN CAPITALISATION: Section 140A also encompasses the thin capitalisation rules. However, the implementation of the thin capitalisation rules has been deferred until December 31, 2015.

TAX INCENTIVES: Malaysia offers a range of incentives to attract investments and spur economic activities in key sectors. These incentives also apply to Sarawak. For Sarawak, the key sectors include manufacturing, tourism, agriculture, oil palm plantation, timber and high technology industries. Where incentives apply, the effective tax rates can be much lower than the actual corporate tax rate of 25%. The main incentives are elaborated below.

PIONEER STATUS (PS): The PS incentive is an income tax exemption of as much as 70% to 100% of a company’s statutory income for a period of generally up to 10 years. The tax relief period for a PS company commences from its “production day” as determined by the minister of international trade and industry. Based on a corporate tax rate of 25%, the effective tax rate for a PS company is 7.5% only where the income tax exemption is up to 70%.

In order to qualify for the PS incentive, the product or activity of a company must be on the “promoted” list of products and activities. In the event that a PS company makes losses during the pioneer period, the unutilised losses and capital allowances may be carried forward to the post-pioneer period for an indefinite period of time to be set off against future business income of the company relating to the same promoted product or activity.

INVESTMENT TAX ALLOWANCE (ITA): ITA is an allowance in addition to capital allowance for qualifying costs for factories, plant and machineries incurred by a company during the ITA period. The normal rate is 60% to 100% of the qualifying capital expenditure, which can be set off against 70% or 100% of the statutory income. The ITA period is generally up to 10 years.

Any unutilised allowances claimed during the ITA period can be carried forward to future years indefinitely to be set off against future business income relating to the same product or activity in the postITA period. In order to qualify for the ITA incentive, the product or activity of the company must be on the “promoted” list of products and activities.

PS and ITA are mutually exclusive and both are granted under the Promotion of Investments Act 1986. Both incentives are mainly for activities in manufacturing, processing, agriculture, hotel, tourism, high technology, and research and development.

TOURISM SECTOR: A company in the hotel and tourism industry which further invests in expansion, modernisation or renovations is also eligible for the PS or ITA incentives of up to five years. In addition, the hotel building qualifies as an industrial building whereby industrial building allowance is claimable. Overseas expenses incurred by hotels and tour operators for the overseas promotion of tourism can also qualify for double deductions.

With effect from YAs 2013 to 2015, a 100% income tax exemption is also applicable to local tour operators who organise tour packages to Malaysia for no fewer than 750 inbound tourists or who organise tour packages within Malaysia for no fewer than 1500 local tourists. This is aimed at further stimulating the growth of the tourism industry.

APPROVED SERVICE PROJECT (ASP): ASP refers to a project in relation to transport, communications and utilities. Companies undertaking ASPs qualify for tax exemption of up to 70% (or 85% for ASP projects in Sarawak), except for projects of national and strategic importance, which qualify for 100% exemption. Alternatively, an ASP may qualify for ITA of 60% (or 80% for an ASP in Sarawak) of qualifying capital expenditure which can be set off against 70% (or 85% for an ASP in Sarawak) of statutory income.

DOUBLE DEDUCTIONS FOR FREIGHT CHARGES: undefined Freight charges incurred for the export of rattan and wood-based products (excluding veneer and sawn timber) qualify for double deductions up to YA 2016. Freight charges for shipping manufactured goods from Sarawak to any port in Peninsular Malaysia also qualify for double deductions.

FOREST ALLOWANCE: This is especially relevant to Sarawak, where timber activities remain important. Capital expenditure incurred in the construction of a road in a forest and used for a business which consists of the extraction of timber from the forest, or a building used as accommodation or welfare for persons employed for such extraction of timber, shall qualify for forest allowance of up to 10% or 20%.

OTHER INCENTIVES: Apart from the above, other incentives include tax exemption of income, extra allowances on capital expenditure incurred, double deduction of expenses incurred, special deduction of expenses, preferential tax treatment for promoted sectors, reinvestment allowance and tax exemption for the setting up of regional distribution centres, international procurement centres, treasury management centres and operational headquarters in Malaysia. Some of these are elaborated below.

RE-INVESTMENT ALLOWANCE (RA): RA is available for manufacturing companies and companies engaged in certain agriculture projects. It is an allowance in addition to capital allowance. RA is 60% of the qualifying plant, machinery and factory expenditure and this is set off against 70% of the statutory income. However, companies which have achieved the level of productivity as prescribed by the minister of finance shall be allowed to set off against 100% of their statutory income. Any unutilised RA may be carried forward indefinitely. A company may claim RA up to 15 years from the first year of claim. The RA incentive is granted under the Income Tax Act 1967. Unlike PS or ITA, this incentive does not require prior approval from any authorities.

REGIONAL DISTRIBUTION CENTRE (RDC): This incentive is applicable to a group of companies which produces and sells its own brand of products. An RDC is a company or a division of a company incorporated in Malaysia which carries on a business of providing a collection and consolidation centre for finished goods, components and spare parts produced by its related companies for its own brand, within or outside Malaysia, to be distributed to dealers, importers, subsidiaries or other unrelated companies within or outside Malaysia. The activities carried out by an RDC include bulk breaking, repackaging and labelling.

An approved RDC enjoys income tax exemption of its statutory income for 10 years. For direct export, the tax exemption is 100%, whereas drop shipment export or local sales are partially exempted based on a formula. An RDC must satisfy several criteria, including minimum annual sales of RM100m ($30.4m), of which RM50m ($15.2m) is from direct export and RM30m ($9.1m) from drop shipment export by the third year of operation, and it must be located in free zones, licensed warehouses or licensed manufacturing warehouses.

INTERNATIONAL PROCUREMENT CENTRE (IPC): undefined An IPC is a company or a division of a locally incorporated company which carries on a business in Malaysia to undertake procurement of raw materials, components and finished products from related or unrelated companies within or outside Malaysia and sells them to related or unrelated companies within or outside Malaysia.

The statutory income of an IPC is exempted from income tax for a period of 10 years. For direct export, the exemption is 100%, whereas for drop shipment export or local sales, the exemption is partial based on a formula. An IPC must also satisfy certain criteria similar to those applicable to an RDC.

TREASURY MANAGEMENT CENTRE (TMC): A TMC is a locally incorporated company providing centralised treasury management services for its group of related companies within or outside Malaysia. An approved TMC enjoys 70% income tax exemption of its statutory income in respect of qualifying services provided to its related companies outside Malaysia for a period of five years. A partial exemption based on a formula is also granted on the statutory income derived from the provision of qualifying services to its related companies in Malaysia. The qualifying services include cash, financing and debt management, providing or arranging financing, providing or arranging guarantees, investment services, financial risk management or current account management for its group of companies. Other benefits include exemption from withholding tax on interest payments arising from borrowings, and stamp duty exemption on all loan or financing agreements executed by a TMC in Malaysia. A TMC must fulfil several criteria which include providing qualifying services to at least three related companies outside Malaysia in each year of assessment and having a minimum operating expenditure of RM1.5m ($456,300) excluding interest expenditure and depreciation.

OPERATIONAL HEADQUARTERS (OHQ): This may be relevant to a multinational company which intends to centralise its management and operational services in Malaysia. An OHQ enjoys income tax exemption of its statutory income for 10 years. The statutory income derived from the provision of qualifying services to its related offices or companies outside Malaysia is fully exempted, while the statutory income in respect of the provision of qualifying services to its related companies in Malaysia is partially exempted based on a formula. The qualifying services include general management, administration, business planning and coordination, procurement of raw materials, components or finished products; technical support and maintenance; marketing control and sales promotion planning; data/information management; processing, treasury and fund management services to offices or related companies outside Malaysia, of corporate financial advisory services to its offices or related companies outside Malaysia; research and development; and training and personnel management services. An OHQ also has to fulfil certain criteria similar to those applicable to a TMC.

GREEN TECHNOLOGY: There are also incentives to promote energy conservation and the generation of renewable energy. Companies undertaking generation of energy using biomass, or generation of hydropower or solar power, shall qualify for income tax exemption of up to 100% of statutory income for a period of 10 years. Companies that incur capital expenditure for energy conservation for their own consumption are eligible for an ITA incentive of up to 100% of qualifying capital expenditure for a period of five years. This can be set off against 100% of statutory income. Import duty and sales tax exemptions apply on equipment used for such activities. Companies providing energy conservation services enjoy PS (for 10 years) or ITA (for five years) incentive of up to 100%. Import duty and sales tax exemptions apply to equipment used for such activities.

STAMP DUTY: Apart from income tax, stamp duty is also applicable in Sarawak, chargeable on certain instruments and documents. The rate of duty varies according to the nature of the instruments or documents and the transacted values.

With effect from January 1, 2011, ad valorem duty at 0.5% applies to all loan and service agreements, except education loan agreements, which only attract a fixed duty of RM10.00 ($3.04). It is possible to apply for stamp duty exemptions provided that certain conditions are satisfied.

REAL PROPERTY GAINS TAX: There is no capital gains tax in Malaysia other than real property gains tax imposed on gains from the disposal of real properties or shares in a real property company at a rate of 0% to 30% for Malaysian citizens and permanent residents and 5% to 30% for non-Malaysian citizens or non-permanent residents, depending on the period of ownership. It is possible to apply for exemptions provided certain conditions are fulfilled.

STATE SALES TAX: In addition to federal taxes, the Sarawak state government also imposes a local sales tax on the sale of lottery tickets (10%) and production of crude palm oil (2.5% to 5%).

INDIRECT TAX: Currently, the main types of indirect taxes in Malaysia are sales tax and service tax. A sales tax ranging from 5% to 25% is imposed on certain imported goods and on certain locally manufactured goods. A service tax of 6% is imposed on the performance of specified services in Malaysia.

The country also imposes other indirect taxes such as import, export and excise duties. There are special facilities granted such as licensed manufacturing warehouse status, which exempts companies from import duties and sales tax, and free zones, which generally exempt firms from Customs and excise duties and sales and services tax.

GOODS & SERVICES TAX (GST): Currently there is no GST in Malaysia. However, as of April 1, 2015, both the sales and service taxes will be replaced by a GST – a broad-based 6% tax on consumption similar to the value-added tax implemented in other countries.

The GST is a multi-stage consumption tax applicable to the taxable supply of goods and services made in Malaysia, as well as to the import of goods and services into Malaysia. Input tax credits can be claimed against output tax collected on supplies of goods and services which are standard rated or zero rated. Input tax credits will not be available for supplies that are exempt, which include transport, residential property, private education and health care. The Royal Malaysian Customs Department is responsible for implementation of the GST and has issued guidelines as well as updates relating to the GST regime.