REVOLUTIONARY shifts in the international tax landscape are afoot.
On Oct 5, 2021, the European Union (EU) endorsed commitments by Malaysia and other countries to reform their foreign-sourced income exemption (FSIE) regimes.
A few days later, the Organisation for Economic Co-operation and Development (OECD) updated its Two-Pillar Solution to address the tax challenges arising from the digitalisation of the economy (commonly referred to as BEPS 2.0), which promises to bring the most significant changes to international tax rules in over a century.
Despite its title, BEPS2.0 will impact all large multinational businesses and not just digital enterprises.
OECD’s BEPS 2.0 project
The OECD’s Two-Pillar Solution will result in profits of the largest multinational enterprises (MNEs) being reallocated to market jurisdictions for tax purposes.
Further, large MNEs will be subject to a minimum 15% global minimum tax rate from 2023.
Under Pillar One, a portion of profits derived by an MNE with global turnover exceeding €20bil (RM97bil) and a profit margin above 10% may be taxed in countries where their customers or users reside.
The turnover thresholds will be lowered to €10bil (RM48bil) in 2031.
This is a significant deviation from current tax rules, which generally only allow business profits to be taxed in locations where a company has physical presence. In contrast with countries with smaller populations such as Singapore and Hong Kong, Malaysia potentially stands to increase its tax revenue from this proposal.
On the other hand, with such high initial turnover thresholds and due to certain exclusions, Malaysian corporate groups are generally not expected to be impacted when Pillar One is implemented in 2023.
Pillar Two introduces a global minimum tax (GMT), set at 15% for groups with revenues of above €750mil (RM3.6bil).
Given the lower threshold relative to Pillar One, more MNEs, Malaysian groups included, will be impacted by Pillar Two.
In simple terms, under Pillar Two, parent entities can expect to pay a top-up tax on income of subsidiaries that are not subject to tax of at least 15%.
Malaysian subsidiaries of large MNEs that enjoy tax incentives typically pay concessionary tax rates far below 15% and may be impacted by the GMT.
Similarly, Malaysia-head-quartered groups that enjoy tax incentives or low tax rates overseas may be subject to a top-up tax in Malaysia.
Malaysia will need to rethink its approach to tax incentives and preferential tax regimes in light of the GMT.
Competition for foreign direct investment between countries will remain high, and we can expect to see creative solutions to meet increasingly bespoke incentive demands from investors.
To continue attracting investors, Malaysia will need to balance compliance with OECD recommendations with flexibility in its approach, and we expect to see non-tax incentives playing a more important role.
Where Malaysia adopts the GMT, any additional taxes collected should be earmarked towards making the country more investor-friendly.
Malaysia’s inclusion on the EU watchlist
On Oct 5, 2021, the EU added Malaysia, Hong Kong and three other countries to its annex II state of play document, also known as the EU’s “grey list”, due to their FSIE regimes.
Companies that receive passive foreign-sourced income such as dividends, interest and royalties in Malaysia will be paying close attention to this development.
Though the Malaysian government has yet to issue public feedback on this recent EU announcement, we should expect changes to the country’s FSIE rules in due course, as Malaysia has committed to the EU to remove or amend aspects of its FSIE regime by Dec 31, 2022.
Once this commitment is fulfilled, Malaysia will be removed from the grey list.
In the meantime, there will be no negative consequences to Malaysia.
Amendments to Malaysia’s FSIE rules would be a fundamental change to the nation’s tax system. Before any changes are made, the government should:
> Consult relevant stakeholders
> Consider if Malaysia can adopt a similar response to Hong Kong.
Hong Kong has committed to maintain its territorial system of taxation, but will impose additional conditions on FSIE claims made by corporations.
EU guidance suggests that implementing substance requirements may be sufficient.
> Analyse other territorial regimes, including those not on the EU grey list such as Singapore, to see what we can learn
Policymakers should be aware that the EU does not consider territorial tax regimes to be inherently problematic and permits countries to continue adopting FSIE regimes, provided that appropriate countermeasures are introduced.
In its maiden pre-budget statement, Malaysia reaffirmed its commitment to the OECD’s BEPS 2.0 project but stopped short of providing insight on the alterations to our corporate tax and incentive systems that will inevitably need to occur, in response to these developments.
Budget 2022 provides the government with an opportunity to strengthen investor confidence by providing businesses with direction on the policy options that are currently being explored.
Anil Kumar Puri is a partner in Ernst & Young Tax Consultants Sdn Bhd. The views expressed here are the writer’s own.