MALAYSIA has a wide variety of incentives which include incentives granted through income exemption or by way of allowances.
There are specific criteria and rules that govern the treatment of tax incentives.
For example, where incentives are given by way of allowances, any unutilised allowances may be carried forward indefinitely to be utilised against future statutory income except for certain incentives such as reinvestment allowance and investment allowance for approved service projects where a seven-year limitation applies.
Tax incentives have been useful to a certain extent in the past to attract foreign direct investments into Malaysia.
As the country increasingly develops and focuses on certain specific high-value sectors, new incentives that are formulated tend to be tailored toward these specific industries in line with Malaysia’s investment aspirations.
Due to the greater scrutiny and discussion at the Organisation of Economic Co-Operation and Development (OECD) level on the preferential tax rulings and incentives regime and related abuses, Malaysia has taken some initial steps and amended the legislation in relation to the tax incentives to:
> Remove ring-fencing features
> Exclude intellectual property income from the incentives, and
> Stipulate the substantial activities requirements.
Factors that attract foreign direct investments
Based on studies carried out on the main factors affecting foreign investment location decisions, the most important ones are market size and real income levels, skill levels in the host economy, the availability of infrastructure and other resources that facilitate efficient specialisation of production, trade policies, and political and macroeconomic stability of the host country.
Control of government finances is also identified as a key element, which helps to provide stability in tax laws and thus greater certainty over tax treatment, as well as greater stability and less risk in the economy overall.
Additionally, the location of foreign direct investment (FDI) may be influenced by various incentives offered by governments to attract multinationals such as reduced corporate tax rates, financial incentives such as grants and preferential loans to multinationals, as well as other incentives like market preferences and monopoly rights.
However, survey analysis shows that host country taxation and international investment incentives generally play only a limited role in determining the international pattern of FDI.
Transparency, simplicity, stability and certainty in the application of the tax law and in tax administration are often ranked by investors ahead of special tax incentives. Many foreign investors in Malaysia are frustrated when they are granted tax incentives by Malaysian Investment Development Authority (Mida) but subsequently face challenges with the tax authorities in relation to the incentives claimed.
To the government, the associated costs of tax incentives can be classified in four main categories:
1. Forgone revenue
The losses in tax revenue from tax incentives mainly come from the forgone revenue that otherwise would have been collected from the activities undertaken and lost revenue from investors and activities that improperly claim incentives (abuse by taxpayers) or shift income from related taxable entities to entities qualifying for favourable tax treatments.
2. Resource allocation costs:
When tax incentives create distortions on investment choices among sectors or activities instead of correcting market failures.
3. Enforcement and compliance costs
These costs increase with the complexity of the tax system and the system of fiscal incentives (in terms of qualifying and reporting requirements).
Initiatives by the OECD
There are growing concerns that tax laws have not kept pace with the global integration of corporations and the rise of the digital economy, with the G20 requesting the OECD to consider and recommend specific action plans to tackle concerns on potential international tax avoidance mechanisms used by multinational corporations to reduce their tax burdens.
This resulted in the OECD’s Action Plan on Base Erosion and Profit Shifting (BEPS), which identified 15 specific actions plans outlining the recommendations and measures which may be implemented to prevent improper profit shifting to low-tax or no-tax jurisdictions.
The key initiatives covered by the BEPS project include addressing the tax challenges of the digital economy, hybrid instruments, preferential tax rulings and incentives regimes, potential treaty abuse, artificial avoidance of permanent establishment status, as a well as a myriad of transfer pricing considerations.
On the tax incentives front, the BEPS action plan focuses on the use of preferential rulings and grants, and in particular, whether the tax benefits correlate with substance requirements.
As it is, Malaysia’s tax incentives are generally tied to substantial substance requirements in Malaysia
Although there are some variations depending on the incentive, in general, a company must meet the following substance requirements:
> Have an adequate number of full-time employees in Malaysia to carry out the qualifying activity; and
> Incur an adequate amount of annual operating expenditure in Malaysia to carry out the qualifying activity, or have an adequate investment in fixed assets in Malaysia to carry out the qualifying activity.
If a new qualifying activity is approved after Oct 16,2017, the company concerned must meet the requirements from Dec 31,2018 in relation to the new activity.
Companies approved for an incentive after Oct 16,2017 need to meet the substantial activities requirements from Dec 31,2018.
The government is currently undertaking a comprehensive study of the existing tax incentive structure to provide a competitive, transparent and more attractive tax incentive framework.
Harvindar Singh is Tax Partner at SCS Global Consulting (M) Sdn Bhd. Views expressed here are the writer’s own.