Budget 2022 – Impact on investment management

The Budget 2022 proposed that foreign sourced income received in Malaysia would be subject to income tax in Malaysia with effect from 1 January 2022. It is assumed that this effective date refers to the date of the remittance received in Malaysia for ease of administration. While relatively straightforward, this proposal does have far reaching implications to the Malaysian investment management community.

The current position in the Malaysian Income Tax Act, 1967 (MITA) states that foreign sourced income (i.e. income that has been derived from sources outside of Malaysia) when received in Malaysia is exempt from income tax, except in the case of a resident company engaged in the business of banking, insurance, sea transport, or air transport. This is provided for under Paragraph 28 of Schedule 6 of MITA. This exemption made Malaysia a jurisdiction that afforded favourable tax treatment to outbound investments, akin to Hong Kong and Singapore. The proposal announced on 29 October 2021 intends to repeal this exemption, in line with Malaysia’s commitment to address the European Union’s concerns of harmful tax practices.

The repeal of this exemption could have significant implications on the post-tax returns of investment vehicles in Malaysia that have built up a portfolio in non-Malaysian securities and instruments. Where these investments currently provided tax exempt income in the form of foreign interest, coupon, and dividends; moving forward, this income would be taxable at 24% effective from 1 January 2022. In the short-term, this means a 24% haircut on the investment returns of these vehicles will the borne by the investors when the profits are distributed. Depending on the laws of the investors’ jurisdiction, they may or may not get a relief on the 24% tax suffered at source.

In the case of unit trust structures, the tax impact appears restricted to the income flow from the holding of these non-Malaysian investments, and does not impact any gains from the sale/realisation of the investments directly as Section 61(1) of MITA provides that gains arising from the realisation of investments shall not be treated as income of a unit trust. In summary, unit trust funds will lose a significant portion of investment returns in non-Malaysian investments as it will now be subject to 24% tax. However, any profits/gains from the divestment of such investments will not be taxed.

In light of this, let’s consider what alternative unit trust funds and investment vehicles have, to preserve the anticipated returns on investments from non-Malaysian securities. Paragraph 35 of Schedule 6 provides that interest paid or credited to any unit trust and listed closed-end fund is tax exempt provided:

a. The interest is in respect of securities or bonds issued or guaranteed by the Government; or
b. The interest is in respect of debentures or sukuk (other than convertible loan stock) approved or authorised by or lodged with the Securities Commission.

Similar paragraphs exist in Schedule 6 to exempt interest income, but they require the underlying instrument to be issued in Malaysia or by the Government of Malaysia or lodged with the Securities Commission. Current investment vehicles in Malaysia with a non-Malaysian investment portfolio have limited to no alternative options to preserve the tax exempt returns of their investments unless they divest their non-Malaysian investments and reinvest in instruments originating from Malaysia, that have been approved by the Government or lodged with the Securities Commission.

With no comparable exemption on foreign sourced income available, this reality leaves investment managers with very little options and very little time to act. So, here’s what investment managers in Malaysia with a sizable non-Malaysian investment portfolio should consider:

1. The non-Malaysian investments need to be reevaluated to determine if holding to maturity or divestment of the investments would yield a better return for the investor. Taking into consideration that the income stream from holding will be subject to 24%, whereas the gains would not be subject to tax as they would be capital gains or simply not taxable in the case of a unit trust fund in Malaysia.

2. Divestment of these investments, particularly debt securities, is not a straightforward decision, as one must consider the implications to the longer-term yield and returns promised to investors. In some situations where capital was guaranteed or a certain level of return was promised, these instruments were acquired after considering the longer-term potential. This future potential has been abruptly disrupted and the projections and commitments of the future are now in jeopardy with the sooner than anticipated divestment.

3. Investment managers will need to reevaluate the new post-tax returns of these non-Malaysian investments compared to their Malaysian counterparts. Dividends sourced from Malaysia under the single-tier system are still tax exempt and the tax legislation continues to provide a wide range of tax exemptions on Malaysian sourced interest income from securities and debt approved by the Securities Commission.If the Malaysian equities and debt securities can provide a better return net of tax, then with all other factors remaining constant, a migration of the portfolio towards more Malaysian-based investments could be considered. This would also revitalise the Malaysian capital markets scene. This is good news for Malaysian corporates planning debt and equity issuances in 2022 as they now have a 24% post tax upside over comparable foreign investments.

4. From an administrative perspective, investment managers will need to update their prospectus and information memorandums to reflect the new tax position moving forward. This could be a one-time cost incurred to undertake this exercise across the board which would marginally impact the returns of investors subject to the requirements of the Securities Commission.

5. Because a unit trust funds generally enjoyed a wide range of tax exemptions, it is assumed they would generally have submitted an annual tax estimate of “nil”. With this repeal expected, the asset managers would need to re-evaluate the tax position of all their funds with non-Malaysian investments to determine if this annual tax estimate needs to be revised. Any unit trust fund with an accounting period ending in 2022 should undertake this exercise to update their annual tax estimate with the Inland Revenue Board to avoid potential penalties that may be imposed for under-estimation of tax when the funds file their tax returns for the year of assessment 2022.

As the actual legislation is expected to be gazette and receive royal assent in December 2021, for changes to take effect on 1 January 2022, time is running out for investment managers to reorganise their portfolios. Perhaps as a compromise, the Government may want to provide a grace period for Malaysian investment vehicles, particularly retail investment vehicles such as unit trust funds and investment linked funds, so that the Malaysian public is not inadvertently burdened financially. Similar transitional provisions were granted when the Government withdrew the tax exemption from wholesale money market funds a few years ago.

The views and opinions expressed in this article are those of Mark Chan, Financial Services Industry Tax Leader of Deloitte Malaysia.