Revisiting single-tier tax on dividends

Malaysia should tax the dividends repatriated to foreign multinational corporations and foreign shareholders with equity stakes in companies listed on Bursa Malaysia.

BASED on Bursa Malaysia’s total market capitalisation of just over RM2 trillion, and with a dividend yield of approximately 4%, Corporate Malaysia is essentially dishing out some RM80bil in dividend payout alone to shareholders annually.

Of course, a significant portion of these dividends goes to the major shareholders, including local institutions, entrepreneurs (for family-owned businesses) that are the main drivers of the business, as well as foreign shareholders.

As almost 20% of the local bourse is owned by these foreign shareholders, their share of dividends can be said to total some RM16bil per annum and this is generally repatriated to their country of origin.

Prior to 2008, Malaysia had an imputation system of how dividends were taxed.

A company’s ability to pay dividends was subject to tax franking credit under Section 108 of the Income Tax Act, 1967, and its distributable reserves.

Under this system, shareholders receiving the dividends are deemed to have suffered tax at source or the prevailing corporate tax rate and given as a tax credit to the shareholders.

This was later removed and Malaysia adopted the single-tier tax system with effect from the year of assessment 2008.

Companies are no longer required to deduct tax from dividends paid to shareholders, and no tax credits will be available for offset against the recipient’s tax liability either.

Corporate shareholders receiving exempt single-tier dividends are also able to distribute such dividends to their shareholders, without being subject to any further income tax.

The move towards single-tier was driven by the argument that the imputation system was rather complicated, troublesome and at the same time restrictive if a company did not have enough tax franking credits.

It was also administratively difficult as there were shareholders who had no other income other than dividend income and tax refunds were time-consuming and slow.

Another argument for the single-tier tax on dividends is the fact that as the company has already paid tax on its earnings and dividends are declared after tax, imposing another tax on the dividend income to shareholders would be a second bite of the cherry as the taxman is able to tax twice on the same income or a case of double taxation.

The first tax is on the chargeable income of the corporation and the second tax is on the chargeable income of the shareholders who received these dividends.

Global practices

Globally, a dividend tax or even a capital gains tax is imposed when that income is passed to its shareholders as either dividends or capital gains. In some countries, these practices are no longer valid as they have adopted a single-tier system.

In the European Union (EU), countries that impose a tax on dividends range from as low as 5% in Georgia and Bulgaria to as high as 51% in Ireland and 42% in Denmark.

The United Kingdom is the third highest at 39.35% followed by Norway at 37.84% and France at 35%.

On average, among the 25 nations in the EU, dividend tax is at about 20.4%.

The United States too imposes a tax on dividends and this depends on a complicated method of calculations.

Dividends are taxed differently based on whether they are considered qualified or ordinary dividends under the US tax law.

Qualified dividends get taxed at favourable rates of between 0% and 20%, while non-qualified or ordinary dividends are taxed at a marginal income tax rate of between 10% and 37%.

In Asia, Malaysia joins countries like Singapore, Hong Kong, Taiwan, and the United Arab Emirates where dividends are not subject to tax but in other jurisdictions, tax on dividends ranges from as low as 5% in Saudi Arabia and New Zealand (which is an additional from the 28% deducted from the corporate tax) to 10% in countries like Indonesia, the Philippines, Thailand and India and as high as 20% in China and Japan.

Meanwhile, Australia has adopted an imputation tax system on dividends paid by corporations.

In every jurisdiction where a tax on dividends is imposed, there are also other rules depending on whether the recipient is a tax resident or non-resident, individual or corporate.

Draining reserves

Over many decades, Malaysia has attracted massive amounts of foreign direct investments (FDIs) and these investments received many tax breaks, incentives as well ease of ownership.

These FDIs, attracted by the benefits Malaysia offers, are likely very profitable and are able to repatriate earnings from their business operations back to their home country via dividends.

According to the Statistics Department, the total FDI stock in the country stood at RM926bil as at the end of last year and generated some RM89.1bil in total income.

Assuming, conservatively, that some 50% to 70% of the earnings are repatriated to the home country in the form of dividends, Malaysia experienced between RM46bil and RM62bil outflows last year from income earned by these foreign entities!

Taken together with the estimated RM16bil outflow from companies listed on Bursa Malaysia, Malaysia probably saw an outflow of between RM62bil and RM78bil in the form of dividends paid out without any taxes imposed on them.

Withholding tax

Presently, Malaysia does not impose any withholding tax on dividends as we have adopted the single-tier tax on dividends. However, for real estate investment trust (REIT), there is a withholding tax imposed on recipients of the dividends if a REIT distributes at least 90% of its total income during the year.

For distribution made to individuals and all other non-corporate investors, including institutional investors, the withholding tax rate is at 10%, while for resident or non-resident corporates, the prevailing statutory tax rate of 24% applies.

Globally, tax on dividends is rather normal and it is only in select countries that dividends are treated as non-taxable under the single-tier tax system.

While imposing a withholding tax on all dividends may not be appropriate as it will impact local large institutional shareholders as well as retail investors who are dependent on dividend income, Malaysia should tax the dividends repatriated to foreign multinational corporations (MNCs) and foreign shareholders with equity stakes in companies listed on Bursa Malaysia.

Assuming that the dividends repatriated by all the MNCs in Malaysia and the dividends received by foreign shareholders of Malaysian listed companies are combined, a 10% withholding tax could generate between RM6.2bil and RM7.8bil in revenue to the government and reduce the budget deficit of the country by between 0.3 and 0.4 percentage point.

The withholding tax is double the tax savings the government expects to generate from the recent subsidy rationalisation for diesel and it is the right step forward for the government to earn based on incentives the government has provided to these MNCs.

Pankaj C. Kumar is a long-time investment analyst. The views expressed here are the writer’s own.