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The Sun Daily: Tax treatment of payments made to overseas vendors of digital services

Repost of publication on The Sun Daily on 15 February 2021.
TODAY’S businesses cannot function independently from the digital economy. The digital economy is a result of a transformative process brought by information and communication technology.

Some of the core digital services such as online advertising, online hosting, data analysis, software applications, content management, cloud-based hosting are largely being provided by foreign multinationals such as Facebook, Google, Microsoft, Alibaba, etc. Usually, these firms have their tax presence outside Malaysia. Malaysian businesses are making substantial payments to these foreign companies.

What are the tax obligations of the Malaysian firms when making such payments?

Withholding Tax

Malaysian firms need to withhold taxes if the payments made to the foreign companies fall within the definition of royalties and in simple terms, this will be generally for the use of or right to use copyrights, patents, software, know-how, secret processes, etc. Withholding tax will also apply for payments made for technical services provided in Malaysia by the foreign companies. The normal rate is 10%; however, it can differ depending where the foreign company is located and for this clarification you need to look at the double tax agreements.

Any ambiguities?

As far as Inland Revenue Board (IRB) is concerned, the majority of these types of payments attract withholding tax under the royalty provisions under the Income Tax Act. However, from a taxpayer’s perspective, it can be argued that these payments are not for the use of any copyrights per se.

For example, in the case of software, the Malaysian users will not be given the right to the source codes. In majority of the cases, they can only use the software as a tool to run the business and therefore they are not entitled to use the copyrights. This is akin to a person buying a book that is copyrighted by the author. The reader of the book doesn’t get to use the copy right but allowed to enjoy the contents of the book. When it is a purchase of a book, it appears the tax treatment is very clear and withholding tax doesn’t apply. However, the same principles do not flow through when the payments are made for the use of the software, etc.

This is an area of tax law where there is a divide between the IRB and the tax professionals. This controversy will carry on.

Service Tax

Any information technology services provided by any person located outside of Malaysia are deemed as an importation of services where the Malaysian business recipient of the services is required to self-account for services tax at 6%. Unless the foreign service provider is registered for service tax on digital services, the Malaysian business is then exempted from self-accounting.

Practically all payments made to foreign service providers of digital platforms, content providers, cloud-based computing, data centre, software, etc will attract service tax.

It is important to note that the Royal Malaysian Customs Department takes the view that where the withholding tax under the Income Tax Act has been paid, the value on which the 6% service tax is imposed will be on the transaction value plus withholding tax paid.

At the end of the day, contracts with foreign digital service providers will ensure that the tax costs are borne by the Malaysian taxpayer.