Knowing cross-border tax issues for 2023

"With or without a global crisis, international business still goes on. There has been a phenomenal e-commerce expansion, and the modus operandi for doing business has seen a paradigm shift. Today, working from home is the norm, and the latest technology in virtual meetings and communications is key to executing deals. For tax authorities around the globe, they are preparing for the largest tax reform in the history of mankind, - the Global Minimum Tax. Elsewhere, tax rules and regulations are being tightened to safeguard revenue collection and combat aggressive tax avoidance. Here are some international tax issues we should watch out for in 2023.

Remote working arrangement

The recent lockdown and travel restrictions have impacted personnel mobility immensely. This, coupled with efforts to win talent, have influenced the trend of remote working policy among multinational corporations (MNCs).

However, remote working may create several unintended tax consequences. For example, a foreign IT consulting company allows its engineers to work from anywhere in the world, and a non-Malaysian citizen personnel has chosen to work from Malaysia. While the company does not have an office in Malaysia, the above arrangement may give rise to a taxable presence risk in Malaysia for the foreign company. The corporate profits attributable to the taxable presence and the employment income will be subject to Malaysian tax. Employer’s obligations in Malaysia (such as payroll withholding etc.), as well as immigration aspects, are relevant. Therefore, while succeeding in the war for talent is important, tax compliance is equally crucial.

Access to tax treaty

CFOs need to revisit the group’s international holding, financing, and licensing structures to ensure that they are compliant from the tax treaty perspective. Malaysia and other countries have adopted the Principal Purpose Test (PPT) to prevent treaty abuse. Under the PPT, treaty benefits will be denied if it is “reasonable to conclude” from the facts that “the principal purpose or one of the principal purposes” of entering into a transaction or an arrangement was to obtain such tax benefits (unless the transaction is in accordance with the object and purpose of the treaty). Reduced or zero foreign withholding tax rates on dividend, interest, and royalty or even capital gains tax exemption enjoyed in the past may no longer apply. A proper level of economic substance may aid in reducing the risk of the said denial.

Increased risk of taxable presence

The foreign operating models of Malaysia-headquartered MNCs as well as Malaysian operations of foreign-based MNCs should be reviewed. A non-taxable presence position taken previously may no longer be valid. A marketing company structure in another country may now create a taxable presence there. The non-taxable presence argument on certain activities like storage may no longer hold water if the activity could not be regarded as a “preparatory or auxiliary” character.

The new anti-fragmentation rules require an analysis of the operations of a company and its related companies in another jurisdiction holistically to assess whether a taxable presence could arise as a result of the combination of activities Where a taxable presence exists, the profit attribution exercise could be complex and is often subject to debate.

Global Minimum Tax (GMT)

The largest tax reform in history is coming to town. GMT is applicable to MNCs operating in at least two jurisdictions, with an annual consolidated group revenue of at least EUR 750 million in at least two of the four immediately preceding fiscal years of the tested fiscal year. With GMT, wherever you operate (be it in a country that offers high tax, low tax, tax haven, or tax holiday), you will need to pay a minimum tax of 15%, or top up to 15% if the effective tax rate (ETR) in the country is below 15%. ETR is calculated with a very complex formula. Malaysia is expected to implement this alongside Qualified Domestic Minimum Top-Up Tax (QDMTT) in 2024.

Therefore, the affected taxpayers should undertake an impact assessment and evaluate their date readiness in early 2023. Early understanding of the impact of GMT and preparation will be key to an effective and efficient implementation. Even if there is no top-up tax, various compliance obligations need to be met. Upon impact assessment, diagnosis on data readiness and the need for additional resources would be critical. The impact on the existing tax incentive and new applications must also be duly considered by the affected taxpayers. The ability to disclose and accrue for GMT for the purpose of financial reporting will be crucial. Organisations need to urgently assess the implications of GMT on the group’s cash flows, dividend pay-out, tax position, etc.

Changes in the tax landscape for Foreign Source Income (FSI)

Prior to 1 January 2022, Malaysia adopted a territorial based taxation system where only income accruing in or derived from Malaysia would be subject to Malaysian income tax. Income derived from sources outside of Malaysia and received in Malaysia is exempted from tax. The exceptions are resident companies in the business of banking, insurance, sea or air transport which are taxed on worldwide income. Effective 1 January 2022, the tax exemption on FSI is restricted to non-Malaysian residents. FSI of a Malaysian tax resident will be subject to Malaysian income tax when it is received in Malaysia (transition period from 1 January 2022 until 30 June 2022), where the FSI is taxed at a concessionary rate of 3% on a gross basis. The FSI received in Malaysia from 1 July 2022 onwards would be subject to tax, based on the prevailing income tax rates.

However, certain exemptions are still available if the relevant conditions (e.g. subject to tax, economic substance, etc) are met. The removal of tax exemption on most FSI effective 1 January 2022 left an impact on taxpayers receiving FSI in Malaysia, which in the past was exempted. It is crucial to understand the intricacies of the rules including those pertaining to the exemption. Taxpayers that are already receiving FSI or intend to undertake investment opportunities abroad need to review their holding, financing, and operations structures and understand the relevant tax implications.

Withholding Tax (WHT) on payment for software and software-related items

Payments for the use of software or software-related items have always been controversial, especially in cases where tax treaties are in existence. Pursuant to the Malaysian tax law, payment for the use of software to a non-resident would constitute a royalty payment. Hence, a WHT at 10% (may be reduced by certain treaties) is triggered. There is nothing abnormal about this position as the Malaysian domestic tax law is clear. In practice, the very same position seems to be adopted even if there is a tax treaty. This deviates from the position taken by the OECD which expresses that the payment for software without commercial exploitation to reproduce and distribute the same is not a royalty payment under the Double Taxation Agreements (DTA).

In this digital age, it is very common for taxpayers to engage service providers who provide services mainly through technology-enabled platforms [software-as-a-service (SaaS) / platform-as-a-service (PaaS)] such as social network advertising. The technology-enabled services could be regarded as a royalty payment instead of payment for services. Therefore, the character of each payment must be analysed carefully in determining the applicability of WHT.

While the issues above are discussed mainly from the Malaysian perspective, the select issues could also be applicable to other jurisdictions."

The views and opinions expressed in this article are those of Tan Hooi Beng, Deputy Tax Leader of Deloitte Malaysia and Vincent Lui & Francis Tan, winners of Deloitte Tax Challenge 2022.

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