Managing unintended tax consequences

Managing the unintended tax consequences of COVID-19
By Tan Hooi Beng & Kelvin Yee

The COVID-19 situation affects everyone. Lockdown and travel restrictions implemented by many countries, including Malaysia, impact the mobility of personnel immensely. Unintended tax consequences are imminent.  Further ramifications may arise if those tax issues are not dealt with.

Consider this real case - Anthony, formerly a Malaysian, holds a passport of Country X, which has a tax treaty with Malaysia. Anthony works for a large foreign company, ABC Ltd, a tax resident in Country X. While Anthony is predominantly based in Country X, he is required to travel overseas for short-term projects. He has been in Malaysia since early January 2020 and is supposed to provide some technical input to a Malaysian client of ABC Ltd. Originally, he expects to complete his assignment and return to Country X, latest by the end of May. Given the implementation of the Movement Control Order, he is unable to be at the client’s place and has to work from his mother’s home in Kuala Lumpur. Anthony is likely to extend his stay in Malaysia and only return to Country X in the middle of July, as part of his work needs to be performed at client’s premises. 

The above is a typical inbound scenario of mobile employees who are tax residents in another country and have been sent on short-term assignments to Malaysia (usually, less than 182 days). Generally, the residence status would not be impacted. 

Strictly from the domestic tax law perspective, the day count test applies in ascertaining Anthony’s tax residency. As he is physically present in Malaysia for more than 181 days, he will be a Malaysian tax resident. A force majeure like COVID-19 is irrelevant in the test.

What is so bad of becoming a Malaysian tax resident? Instead of having to pay a flat tax rate of 30% as a non-resident, he will be able to enjoy a scale rate for personal tax and certain personal reliefs. Is that not a good thing? 

However, the key point is that Anthony, being a tax resident only in Country X (in the absence of an overstay here), would have been exempted from Malaysia personal tax, if he is in Malaysia for no more than 183 days. This is also on the basis that ABC Ltd does not have a permanent establishment (PE) here, under the tax treaty. 

Interestingly, while Anthony would attain his Malaysian tax residency unintentionally, the domestic tax legislation in Country X could still regard him as a tax resident there. The dual residence issue will be solved by the tie-breaker rule under the relevant tax treaty.  Anthony is likely to end up as a tax resident in Country X, for treaty purpose. However, he will not be able to enjoy the 183 days treaty exemption given his extended stay in Malaysia. In essence, he will be subject to tax, in both Country X and Malaysia. This is how complex international tax is. If possible, it is best to avoid this complication.

The moment Anthony is subject to tax in Malaysia, the issue of monthly tax deduction and other employer’s tax obligation would arise. The Malaysian client may need to pick this up unless ABC Ltd registers a PE in Malaysia.

The issues do not end here. Anthony would also need to worry about his employer’s position. A non-resident company that carries on business in Malaysia through a place of business or PE would be subject to Malaysian tax. While the lodging of Malaysian corporate tax return by the foreign company may be a normal compliance exercise, the more challenging issue here is the profit attribution for the Malaysian operations, which is complex and often subject to dispute.

Under the tax treaty between Malaysia and Country X (and with most other countries as well), if not for COVID-19, ABC Ltd would not be subjected to Malaysian tax, as a PE would not have been triggered. The general rule of thumb for PE creation is 6 months.

The Organisation of Economic Co-operation and Development (OECD) considers it unlikely that COVID-19 will create PE issues given the temporary nature of the situation. Australia, UK and Ireland seem to support this position. OECD also views that home offices do not necessary result in a PE for employers. However, it is important to note that not all countries are members of the OECD. 

Individual countries may view this differently and may apply the 6- month threshold strictly. The OECD has encouraged tax administrations to provide guidance on the application of the domestic law threshold requirements, domestic filing, and other guidance to minimise or eliminate unduly burdensome compliance requirements for taxpayers in the context of the COVID-19 crisis. On the local front, we are sanguine that the Malaysian tax authorities would adopt a pragmatic and reasonable approach during these trying times.

From the outbound standpoint, if employees are stranded overseas, Malaysian employers will also need to assess if PEs have been triggered, and if so, what the relevant employers’ tax obligations are. The compliance of immigration issues are vital. Where a Malaysian individual becomes a tax resident in other country, taxation on worldwide income may kick in.

Increase in the use of technologies such as Skype and Zoom is expected. The arising issue however is if Malaysian withholding tax applies to the payments for these services.  Digital service tax may also apply to certain non-resident service providers. As physical board meeting is unlikely to be held during this period, the determination of corporate tax residency needs to be re-assessed. 

Residency is often determined by exercising management and control (determined through directors' meetings). Will virtual board meetings change the position? What are the consequences of a company becoming non-resident? Suffice to say, there will be a host of tax consequences to contend with. Even though unforeseen, they must be managed.

By Tan Hooi Beng, Deputy Tax Leader and Kelvin Yee, Associate Director of Deloitte Malaysia.