Essential Information on Withholding Tax in Malaysia

Understanding Withholding Tax in Malaysia

Withholding tax in Malaysia is imposed on income paid to non-resident individuals or entities. The payer, typically a Malaysian company or government agency, deducts a portion of the payment and remits it to the Inland Revenue Board (IRB) on behalf of the non-resident. This ensures compliance with tax obligations and streamlines the collection of taxes on cross-border transactions.

The primary purpose of withholding tax is to provide the government with a stable revenue stream while mitigating the risk of double taxation. It applies to various payments, including those made by Malaysian entities or foreign companies remitted to non-resident recipients.

Understanding Taxation on Foreign Source Income

Foreign individuals working in Malaysia as public entertainers, including artists, athletes, musicians, radio personalities, and sportspersons, are subject to a 15% withholding tax on their gross income. This tax must be paid by the sponsor to the Immigration Department before the non-resident entertainers are allowed entry into Malaysia.

Exploring the Income Tax Act 1967 (ITA)

The Income Tax Act 1967 (ITA) governs the tax treatment of foreign-sourced income (FSI) in Malaysia. According to Section 3 of the ITA, income derived from sources outside Malaysia and received by Malaysian residents is taxable. Effective January 1, 2022, FSI received between January 1, 2022, and June 30, 2022 was taxed at a 3% gross rate, with income received from July 1, 2022, subject to the prevailing tax rate. However, in a recent policy shift, the government announced that eligible tax residents can enjoy a five-year tax exemption on FSI, from January 1, 2022, to December 31, 2026, subject to specified conditions.

The amendment aligns Malaysia with international tax standards, ensuring sustainable revenue while curbing tax evasion. It reflects the government’s focus on balancing fiscal responsibility with economic competitiveness, using collected revenues for public services such as healthcare, education, and welfare.

Withholding Tax Rates in Malaysia

Under the Income Tax Act 1967, non-residents are liable to pay tax on specific types of income deemed derived in Malaysia, excluding income earned by non-resident public entertainers. This tax must be paid to the Director General of Inland Revenue within one month of the non-resident receiving the income.

Types of Payment	Withholding Tax Rate
Contract Payment	10% + 3% of the gross payment
Interest	15% of the gross payment
Royalty	10% of the gross payment
Public Entertainer	15% of the gross payment
Special Classes of Income	10% of the gross payment
Other Income	10% of the gross payment

Applicability of Withholding Taxes

Withholding tax applies to non-residents without a business presence in Malaysia, requiring them to deduct and remit tax on any income deemed to be sourced from Malaysia. Foreign individuals or entities with no employment or business operations in Malaysia are obligated to withhold tax when receiving such income, ensuring compliance with Malaysian tax regulations.

Criteria for Withholding Tax on Payments

Withholding tax applies to payments made to non-resident recipients for services or specified income, provided they do not have a business presence in Malaysia.

Withholding Tax on Services Supplied Outside the Country

Royalty Income

According to the LHDN, royalty income refers to payments made for the use of or the right to use intellectual property such as copyrights, patents, designs, trademarks, secret processes, and scientific works. It also extends to compensation for technical, industrial, or commercial expertise, as well as income derived from the transfer or alienation of such rights or know-how. This applies to various media formats, including films, video tapes, and broadcasting materials used or reproduced within Malaysia.

The LHDN’s guidelines on electronic commerce, issued on May 13, 2019, classify payments to digital platforms as royalties. These payments are treated as compensation for the use or right to use their platforms, aligning with the broader definition of royalties under Malaysian tax law.

1. Special Classes of Income

Non-residents are subject to Malaysian tax on specific income categories derived from the country. This includes payments for services performed by the non-resident or their employees related to the use of property or rights, as well as the installation or operation of machinery or equipment supplied by them. Additionally, payments for management, consultancy, or administrative services linked to scientific, industrial, or commercial ventures are also taxable.

Rent or other payments for the use of movable property under agreements with non-residents are equally liable to tax. These provisions typically apply when businesses engage non-resident contractors for services such as software development or when outsourcing tasks to overseas firms, such as social media marketing management.

2. Importance of Differentiating Between Types of Income

It is essential to distinguish between royalty income and special classes of income due to varying preferential withholding tax rates under Double Taxation Agreements (DTAs). Different payment types may benefit from reduced rates, depending on the specific DTA. For example, if a foreign service provider based in Singapore offers services classified as technical fees, which is a special class of income, the withholding tax rate may be 5%, compared to 8% if the payment is categorized as royalty.

Implications of Failing to Deduct and Remit Taxes

Failure to properly deduct and remit withholding tax can result in serious financial and legal consequences. A penalty of at least 10% may be imposed on unpaid taxes due to non-deduction or late remittance, along with interest charges on the outstanding amount.

Non compliance includes failing to withhold tax at the correct rate, missing the 30-day deadline for remittance, or neglecting to settle increased penalties for late payment. Additionally, if withholding tax and related penalties are not paid by the tax return’s due date, the payer may lose the ability to claim deductions and could face further liabilities under Section 113(2) for filing an incorrect return.

However, the Director General has discretionary power to remit penalties if a valid reason is presented. In such cases, any amount already paid may also be refunded at the Director General’s discretion. Ensuring timely compliance helps avoid these penalties and maintains smooth business operations.

Double Tax Agreements and Their Impact on Withholding Tax in Malaysia

Role of DTAs 

Malaysia has established an extensive network of Double Tax Agreements (DTAs) with over 70 countries to prevent double taxation and encourage cross-border trade and investment. These agreements play a crucial role in reducing the tax burden for non-resident entities that receive income from Malaysian sources. In the context of withholding tax in Malaysia, DTAs can significantly influence the final tax rate applied to payments made to foreign recipients. 

DTAs Affect Withholding Tax Rates 

Under the domestic tax framework, payments such as royalties, interest, and technical service fees to non-residents are subject to withholding tax in Malaysia at standard rates ranging from 10% to 15%. However, if the non-resident is a tax resident of a country that has a DTA with Malaysia, they may be eligible for a reduced rate or even full exemption, depending on the specific terms outlined in the treaty. For instance, certain DTAs provide for reduced rates on interest or royalty payments, while others may offer more favorable terms for income derived from technical services. 

Documentation for DTA Benefits 

To benefit from these treaty provisions, the non-resident recipient must typically furnish a Certificate of Residence from their home country’s tax authority. This certificate serves as evidence that the individual or entity qualifies for the DTA relief. Additionally, proper documentation and timely submission to the Inland Revenue Board of Malaysia (LHDN) are essential to claim these benefits. Failure to comply with these administrative requirements may result in the denial of the reduced rates, leaving the payer responsible for the full statutory withholding tax amount. 

Importance of DTA Awareness 

Understanding the application of DTAs in withholding tax in Malaysia is essential for businesses engaged in international transactions. Misinterpretation or oversight of treaty terms can lead to unnecessary tax costs, compliance issues, or disputes with tax authorities. Therefore, staying informed about current treaties and their implications ensures that businesses can make informed decisions when dealing with cross-border payments. 

Considering Double Taxation Agreement

The Double Taxation Agreement in Malaysia is a treaty with other countries to prevent double taxation of profits and income. 

Country	Rate of Withholding Tax
	Interest	Royalties	Technical Fees
Albania	10% or Nil	10%	10%
Australia	15% or Nil	10%	Nil
Austria	15% or Nil	10%	10%
Bahrain	5% or Nil	8%	10%
Bangladesh	15% or Nil	10% or Nil	10%
Belgium	10%, 15% or Nil	10%	10%
Bosnia & Herzegovina	10% or Nil	8%	10%
Brunei	10% or Nil	10%	10%
Cambodia1	10% or Nil	10%	10%
Canada	15% or Nil	10% or Nil	10%
Chile	15%	10%	5%
China, People’s Republic	10% or Nil	10%	10%
Croatia	10% or Nil	10%	10%
Czech Republic	12% or Nil	10%	10%
Denmark	15%	10%	10%
Egypt	15% or Nil	10%	10%
Fiji	15% or Nil	10%	10%
Finland	15% or Nil	10% or Nil	10%
France	15% or Nil	10% or Nil	10%
Germany	10% or Nil	7%	7%
Hong Kong	10% or Nil	8%	5%
Hungary	15% or Nil	10%	10%
India	10% or Nil	10%	10%
Indonesia	10% or Nil	10%	10%
Iran	15% or Nil	10%	10%
Ireland	10% or Nil	8%	10%
Italy	15% or Nil	10% or Nil	10%
Japan	10% or Nil	10%	10%
Jordan	15% or Nil	10%	10%
Kazakhstan	10% or Nil	10%	10%
Korea Republic	15% or Nil	10% or Nil	10%
Kuwait	10% or Nil	10%	10%
Kyrgyz Republic	10% or Nil	10%	10%
Laos	10% or Nil	10%	10%
Lebanese Republic	10% or Nil	8%	10%
Luxembourg	10% or Nil	8%	8%
Malta	15% or Nil	10%	10%
Mauritius	15% or Nil	10%	10%
Mongolia	10% or Nil	10%	10%
Morocco	10% or Nil	10%	10%
Myanmar	10% or Nil	10%	10%
Namibia	10% or Nil	5%	5%
Netherlands	10% or Nil	8% or Nil	8%
New Zealand	15% or Nil	10% or Nil	10%
Norway	15% or Nil	10% or Nil	10%
Pakistan	15% or Nil	10% or Nil	10%
Papua New Guinea	15% or Nil	10%	10%
Philippines	15% or Nil	10% or Nil	10%
Poland	15% or Nil	10% or Nil	10%
Poland (New)1	10% or Nil	8%	8%
Qatar	5% or Nil	8%	8%
Romania	15% or Nil	10% or Nil	10%
Russian Federation	15% or Nil	10% or Nil	10%
San Marino	10% or Nil	10%	10%
Saudi Arabia	5% or Nil	8%	8%
Senegal	10% or Nil	10%	10%
Seychelles Republic	10% or Nil	10%	10%

4 Commonly Encountered Compliance Errors Related to Withholding Tax in Malaysia

1. Late or Missed Tax Deductions 

Taking on withholding tax requirements in Malaysia involves strict adherence to regulatory guidelines and procedural obligations. Common yet avoidable mistakes often lead to compliance challenges for many businesses. One of the most frequent mistakes is the failure to deduct withholding tax at the time of payment or crediting the amount to a non-resident. 

This misstep may occur due to unfamiliarity with which payments are subject to tax or due to oversight in internal payment procedures. Even if the payment is not remitted but merely recorded as payable, the tax obligation still applies. This is a critical distinction that many companies overlook. 

2. Misclassification of Payment Types 

Another recurring issue is the misclassification of payment types. For instance, payments made for technical advice may be wrongly recorded as general consulting fees, leading to incorrect tax treatment. The Inland Revenue Board of Malaysia (LHDN) has issued guidance on interpreting payment types, and failure to apply the correct classification can result in underpayment or overpayment of tax, each with its own set of consequences. 

3. Missed Filing Deadlines 

Late submission of Form CP37, which is required when remitting withholding tax, is also a common compliance lapse. The law mandates that the tax be paid and the form submitted within one month from the date of payment or crediting. Missing this deadline can trigger late payment penalties and additional interest charges. 

4. Staying on Track with Compliance 

Staying compliant with withholding tax rules in Malaysia requires diligence, a clear understanding of tax classifications, and timely submissions. Avoiding these common pitfalls is vital to ensure smooth operations and to uphold the company’s fiscal responsibility in cross-border dealings. 

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