2009 MALAYSIAN BUDGET HIGHLIGHTS

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1 2009 MALAYSIAN BUDGET HIGHLIGHTS The budget proposals for 2009 were tabled in Parliament on 29 August 2008 by the Prime Minister who is also the Finance Minister. The measures introduced were not unexpected given the environment of high food and petrol prices, weaker consumer demand and the recent spike in the inflation index to a high of 8.8%. Thus there were a slew of measures aimed at providing relief for consumers particularly those in the lower income group ranging from the reduction of import duties on a broad range of consumer products to spending on enhancing public transportation, health care, education and housing. The Government s budget deficit position which had gradually improved over recent years suffered a set-back and the deficit is expected to be around 4.8% of GDP for This is despite the recent cut back of fuel subsidies. This is not seen as a recurring trend as the Government has expressed its commitment to bring it down to 3.6% next year. Despite the challenging domestic and external environment, the economy is expected to continue to perform credibly, generating a GDP growth rate of 5.4 % in 2009 compared to 5.7% in No major tax changes were introduced though there were a few surprise measures affecting the corporate sector. We offer below an insight to some of the more significant developments arising from the 2009 Budget. Corporate Tax Transfer Pricing and Thin Capitalisation Transfer pricing guidelines were first introduced in Malaysia in 2003 and took effect under the general anti-avoidance provision in Section 140 of the Income Tax Act, 1967 (ITA). Recognising weaknesses in the use of Section 140 in dealing with transfer pricing situations, a new provision, Section 140A, will be introduced in the ITA to specifically address transfer pricing, focussing on the supply of property or services. In the absence of a definition of property or services, the question of whether this would include interest free loans remains uncertain. Advance pricing arrangements (APAs) may be sought in relation to cross-border transactions between associated persons. APAs should avoid controversies and undue litigation costs when properly implemented. In a tax treaty situation, this exercise could involve the respective treaty partners coming to a common ground. Several countries have APAs including the United States, China, Japan, etc. Countries such as the United Kingdom and India have yet to introduce APAs given the complexities involved in undertaking the appropriate economic and functional analyses in arriving at APAs. While the move to introduce APAs is welcome, there is a clear need for specialised expertise to be involved as the exercise requires full acceptance by multinational enterprises who are really the ones who would consider using such arrangements.

2 In addition, the new Section 140A also heralds the introduction of thin capitalisation rules in Malaysia, whereby a deduction for interest will be denied in respect of interest payments made to associated companies in respect of financial assistance, subject to certain criteria and conditions. It is understood that the Inland Revenue Board (IRB) will be issuing guidelines before the end of the year setting out the rules in relation to the application of the thin capitalisation provisions. Withholding Tax There have been several changes in relation to withholding taxes that warrant attention. Firstly, an unexpected change has been introduced whereby, non-residents will now be subject to withholding tax of 10% in respect of gains or profits under Section 4(f) of the ITA. Section 4(f) covers gains or profits which do not fall within the other classes of taxable income (under Section 4 of the ITA). The examples given in the Budget proposals include commission fees, guarantee fees and introducer s fees paid to non-residents. Business structures involving payments to non-residents which fall out of the other withholding tax provisions will now need to be reviewed. Unlike the other withholding tax provisions which impose an obligation to withhold on gross payments, the mechanism for collecting the withholding tax in this instance (as provided in the new Section 109F) will place the onus on the payer to withhold tax in respect of payments to a non-resident in relation to any gains or profits. This poses some difficulties as the payer is in no position to determine the actual profit or gain which becomes chargeable under Section 4(f). Secondly, to make investments in REITs more attractive, the rate of withholding tax on REIT distributions to foreign institutional investors will be reduced from 20% to 10%, while distributions to non-corporate investors (which would include resident and non-resident individuals) will be reduced to 10% from the current rate of 15%. Distributions to nonresident companies will continue to attract withholding tax at the prevailing corporate tax rate. This measure will be welcomed by the industry players although some would have wished the rate to be Nil for all individual investors as is the case in Singapore. Lastly, the contentious issue of the application of withholding tax to reimbursements has been partially addressed in the Budget proposals, which indicate that reimbursements in relation to hotel accommodation costs will not be taken as part of gross technical fees (under Section 4A of the ITA) for withholding tax purposes. The more significant question of whether reimbursements actually constitute income of the non-resident has not been addressed. Group Relief Heeding the call of the private sector to allow for 100% of losses to be group relieved, a compromise allowing 70% rather than 50% of losses to be group relieved has been given. Small & Medium sized Enterprises (SMEs) Under the ITA, SMEs are companies whose paid up capital does not exceed RM2.5 million. Such companies enjoy a 20% tax rate on the first RM500,000 of chargeable income and are not required to pay taxes via instalments for the first 2 years of assessment. The definition of SMEs has been tightened in the Budget proposals and in addition to the requirement that the

3 company s paid up capital should not exceed RM2.5 million, there are now additional requirements including the following: - more than 50% of the company (SME) cannot be held by a company with paid up capital in excess of RM2.5 million - the company (SME) cannot hold more than 50% of any other company with a paid up capital in excess of RM2.5 million. SMEs will therefore be restricted to smaller stand-alone companies, rather than those which are controlled by a larger company or which are part of a larger group of companies. As an added benefit to SMEs to cope with the increasing costs of doing business, such companies will now be entitled to accelerated capital allowances of 100% in respect of all plant and machinery purchased in the years of assessment 2009 and Reinvestment Allowance (RA) The RA has been an attractive incentive for investors considering expansion or diversification. The rules were somewhat liberal in certain areas and it is now considered that these should be tightened quite significantly as follows: - RA will only be available to companies which have been in operation for 36 months, rather than 12 months - RA will no longer be available in respect of assets acquired from related companies under the controlled transfer provisions - RA will be clawed back for disposals within a 5 year period, rather than a 2 year period - A definition of manufacturing has been introduced for the purposes of RA claims Capital Markets There continue to be incentives for the Islamic sector this year, the Budget proposals provide for tax exemption on fees earned by approved institutions from the arranging, underwriting and distribution of non-ringgit Sukuk (i.e. Islamic bonds) issued in Malaysia and distributed outside Malaysia as well as on profits received from the trading of non-ringgit Sukuk in Malaysia. Secondly, to attract foreign companies and foreign product listings on the Malaysian stock exchange (Bursa Malaysia), tax exemption will be given to corporate advisors on fees received from the primary listing, dual listing or cross-listing of companies with foreign based operations, REITs with foreign based assets, foreign listed securities and foreign financial instruments. Personal Tax Tax Rates Personal tax rates have only been marginally reduced with the top bracket and non-resident tax rates being reduced from 28% to 27%. Additionally, the tax rate for the chargeable income bracket of RM35,000 to RM50,000 has been reduced from 13% to 12%. The tax savings from the reduced rates are minimal and this measure falls short of what was widely

4 called for i.e. the alignment of the top marginal personal tax rate with the corporate tax rate which will be 25% next year. Benefits-in-kind (BIK) Of greater significance than the personal tax rate changes are the changes to the tax treatment of BIKs. Several BIKs that were previously taxable will now fall out of the tax net effective from the year of assessment These include petrol and travel allowances of up to RM2,400 per annum, parking benefits, the payment by employers of mobile phone and internet bills, etc. There are opportunities for employers to structure some of the new tax exempt BIKs into employee remuneration packages to make these more tax effective for employees, while entitling employers to a tax deduction for such costs. It should be noted that the exemptions will not apply to directors of controlled companies, sole proprietors and partners. Bonuses and Directors Fees Bonuses and directors fees will now be taxable in the year of receipt, thus easing compliance by eliminating the need for reporting such income when received in relation to the period for which such income was receivable. Indirect Tax There were no significant developments in relation to indirect taxes. The date of implementation of the Goods and Services Tax (GST) remains unannounced due no doubt to the uncertainty as to when the climate of high prices and escalating inflation is likely to change for the better. The Budget proposals in relation to indirect tax include a reduction of sales tax and import duties in relation to several items. This is intended to relieve the burden of consumers but could also result in making domestic industries more competitive viz-a-viz foreign producers of these same products. Environmental concerns are reflected in the reduction of duties and taxes in relation to environmentally friendly items, such as hybrid cars, energy conservation equipment, etc. Additionally, duties/taxes have been reduced/abolished in respect of certain items, including fertilizers and pesticides, certain heavy machinery, certain basic food products, etc. Tax Administration On the tax administration front, changes have been proposed to allow taxpayers to amend their tax returns within six months from the due date for filing of their returns. Where a taxpayer revises a tax return within the prescribed time frame, penalties will not be imposed in respect of additional taxes. However, late payment penalties will be imposed, which is necessary to prevent abuse. Another area of change relates to non-chargeability situations, whereby appeals will now be allowed. This may arise where taxpayers are dissatisfied with their tax loss positions for instance. The mechanism for such appeals necessitates a notification of non-chargeability from the IRB which the taxpayer will then appeal against. From a self-assessment perspective, the proposals are welcomed as the tax system progresses towards being more taxpayer-friendly.

5 Conclusion The above provides a snap-shot of the key proposals. There are several other proposals which have not been highlighted including incentives for venture capital companies, accelerated capital allowances on ICT equipment, incentives for hotels in Sabah and Sarawak, stamp duty changes, etc. The introduction of thin capitalisation provisions, and the widening of the withholding tax net to include Section 4(f) income will arguably increase the costs of doing business with non-residents, while the relaxation of the group relief provisions, accelerated capital allowances for SMEs, etc. will be useful in balancing this. Overall, it is clear from the 2009 Budget Proposals that the Government is concerned about conserving its tax revenue base and thus has not been more forthcoming in granting tax concessions.