Changes in the tax landscape for financial institutions in Malaysia

KUALA LUMPUR, 5 May 2021 – The year 2021 promises to be an interesting yet challenging one for the financial services industry (“FSI”) in terms of tax developments locally and globally. Mark Chan, Financial Services Industry Tax Leader and Subhabrata Dsagupta, Transfer Pricing Leader, Deloitte Malaysia look at some of the tax related topics, that are anticipated to present opportunities and impediments to the FSI players in the market.

IBOR transition

Interbank Offered Rates (“IBORs”), including the London Interbank Offered Rate (“LIBOR”), have a key role in financial markets in underpinning trillions of dollars in notional value of financial products. However, work is underway in multiple jurisdictions to transition to risk-free rates (“RFRs”), for the interest rate index used in calculating floating or adjustable rates for loans, bonds, derivatives, and other financial contracts. RFRs that are alternatives to LIBOR include the Sterling Overnight Index Average (SONIA) benchmark.

While the LIBOR transition is not a taxing event, the way the transition is undertaken could result in tax exposure. Modifying or replacing a contract with substantially different terms and/or the de-recognition and subsequent recognition of a new instrument, could give rise to Profit and Loss (“P&L”) adjustments. To ensure potential disputes with tax authorities both in Malaysia and the counterparty’s jurisdiction are amicably addressed, the taxability of these P&L adjustments should be taken into consideration early.

Where these adjustments result in one-time payments, the nature of these payments and receipts should be considered to determine if withholding taxes are applicable. There is also the question as to whether (if at all) stamp duty would be applicable on the modified contracts.

It is not uncommon that these instruments fall outside the purview of the organisation’s tax and finance department, given that the custodians of these documents are often the treasury or legal department. It is thus imperative for finance and tax leaders to undertake an extensive review of their existing instruments to determine which instruments will be impacted and how. This will enable them to address the organisation’s potential tax exposure comprehensively. Management of the potential financial impact and tax risks needs to happen proactively before the transition occurs (i.e. documents/agreements are executed). Where the transition impacts intra-group transactions, the potential transfer pricing implications should also be considered.

MFRS 17 implementation

While the deadline for MFRS 17 implementation has been deferred to 2023, the fact remains that the tax related ambiguities associated with MFRS 17 are unresolved. As the Inland Revenue Board (“IRB”) intensifies its audit activities on the insurance industry, the attention and resources necessary to proactively resolve the tax issues are in short supply.

The taxation of insurance and takaful companies are governed under Sections 60 and 60AA of the Income Tax Act, 1967 (“ITA”). The IRB takes a literal reading approach to interpreting these two sections of the ITA when determining the tax treatment of transactions undertaken by insurance and takaful companies in Malaysia. Several of the industry’s significant tax disputes stem from a difference in interpretation between the taxpayer and the IRB. While MFRS 17 will fundamentally change the financial reporting presentation and terminology for insurance and takaful companies, there is cause for concern on how the Government and the IRB will address this change in regime in the tax legislation.

The deferment of the MFRS 17 go-live date is an excellent opportunity for taxpayers and the IRB to come to the discussion table to proactively identify and address the potential tax issues related to the adoption of MFRS 17. Early engagement and consensus will give the Government sufficient time to ensure adjustments are made to the tax legislation with a view of safeguarding the interest of all parties and avoiding future interpretation disputes. The industry associations and the IRB should also consult Bank Negara Malaysia (“BNM”) as the FSI regulator in Malaysia, to ensure that any modifications to the tax legislation with respect to MFRS 17 is in line with the country’s regulatory framework for insurance and takaful companies.  Financial reporting, tax reporting and the regulatory framework are all part of the same regulatory ecosystem for the insurance and takaful industry, and it is imperative that all three elements are in harmony as the industry makes this monumental transition.

Transfer pricing

The Finance Act 2020 introduced a new penalty and a surcharge relating to transfer pricing, and these take effect for all tax audits commenced on or after 1 January 2021. The two key changes are:

• Introduction of Section 113B of the ITA, imposing a penalty of between RM20,000 to RM100,000 per year of assessment for failure to furnish contemporaneous TP documentation; and
  
• Introduction of subsection 140A(3C) of the ITA imposing a new surcharge of not more than 5% on the TP adjustment made in an audit. This surcharge is imposed regardless of whether the TP adjustment results in additional tax payable.

It is definitely time for some housekeeping, especially for organisations who have not prepared TP documentation for the open years (statute of limitations for TP is seven years). For those who have, it is important to keep your documentation updated in a timely manner, and no later than the due date for filing the return. Foreign headquartered FSI organisations should also consider ensuring their TP documentation prepared at the group/regional level are in compliance with the Income Tax (Transfer Pricing) Rules 2012, to mitigate the risk of penalty under this new Section 113B. For any audit commenced on or after 1 January 2021, the taxpayer would only have 14 days to submit the TP documentation, and any request for extension may be deemed as a failure, attracting the penalty.

The new surcharge under subsection 140A(3C) further elevates the TP risk for FSI players. These companies generally have very high value intragroup transactions. Even a slight adjustment to interest rates or premium values can result in a significant TP adjustment that would be subject to this new surcharge. Similarly, most FSI players have intragroup management service arrangements, the fees for which could be substantial, and have always been a favourite area of scrutiny in outbound payments, with respect to benefits test, need test, and rendition test. If the TP documentation and policies are not robust, it could result in significant additional tax and/or surcharge exposure. Finally, with this new surcharge, the TP risk is not only limited to entities that are chargeable to tax, but also any group entities in Malaysia that may have sufficient tax attributes to otherwise shelter against any TP adjustments, such as those with unabsorbed carry forward business losses, tax incentives/allowances, etc.

The coming months will prove to be interesting yet challenging for financial institutions as they grapple with the economic recovery from the pandemic, and the ensuing tax issues.  

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