Withholding Tax (WHT) on Foreign Service Providers in Malaysia
During the last few years, there have been significant growth for e-commerce players in the market which have been accelerated with the Covid-19 pandemic lockdown, driving online shopping into new heights.
This change isn’t limited only to e-commerce players but also traditional businesses where many have started to embrace technology for their business, for instance social media marketing, cloud-based accounting software etc.
In 2017, LHDN expanded the scope of withholding tax to capture services performed to the e-commerce industry which includes services performed by foreign providers outside of Malaysia. With this, many parties have suddenly started asking what is WITHHOLDING TAX?
1) What is Withholding Tax (“WHT”)?
WHT is an amount withheld by the party making payment (payer) on income earned by a non-resident (payee) and this amount have to be paid to Inland Revenue Board Malaysia or Lembaga Hasil Dalam Negeri Malaysia (“LHDN”).
In common man language, if you are paying non-local (foreign) vendors, you need to withhold a certain % of the invoiced amount and pay to LHDN as a form of tax, and the remaining balance to be paid to your foreign vendor.
WHT is not new and has been in existence since Income Tax Act 1967 (“ITA”) and it covers payment such as:
a. Contract payment
d. Special classes of income: Technical fees, payment for services, rent/payment for use of moveable property
e. Interest (except exempt interest) paid by approved financial institutions
f. Income of non-resident public entertainers
Each type of payment will have different withholding tax rates and may enjoy preferential tax rate if there is a double taxable agreement between Malaysia and the country where the non-resident (foreign party) is a tax resident of. The table below details the relevant forms for different withholding tax payments (Source: Official website of LHDN).
|Payment Type||Income Tax|
|Contract payment||Sections 107A|
and 107A (1)(b)
|Special classes of|
income (i.e. Technical Fees, payment for services)
|Interest (except exempt interest) paid by approved institutions||Section 109C||5%||CP37C|
|Income of non-resident public entertainers||Section 109A||15%||Payment memo issued by assessment branch|
2. Does WHT cover services rendered outside of Malaysia?
Prior to 2017, WHT is only applicable for services rendered in Malaysia by non-local vendors but effective 17 January 2017, LHDN expands the scope to cover services rendered outside of Malaysia.
This immediately affected many services provided by foreign providers such as Facebook, Google Ads, Stripe, GoDaddy etc and fee paid to overseas service providers.
For this publication, we will focus on two types of payments under WHT:
i) Royalty Income under paragraph 4(d) of the ITA;
ii) Special classes of Income under paragraph 4A of the ITA;
These two types of income are usually the services that involves foreign service providers.
3. What is Royalty Income? And what will be considered as Royalty Income?
As per LHDN, royalty is defined as any sums paid as consideration for the use of or the right to use:
• Copyrights, artistic or scientific works, patents, designs or models, plans, secret processes or formulae, trademarks or tapes for radio or television broadcasting, motion picture films, films or video tapes or other means of reproduction where such films or tapes have been or are to be used or reproduced in Malaysia or other like property or rights;
• Know-how or information concerning technical, industrial, commercial or scientific knowledge, experience or skill; or
• Income derived from the alienation of any property, know-how or information mentioned in above paragraph of this definition.
Based on GUIDELINES ON TAXATION OF ELECTRONIC COMMERCE TRANSACTIONS released by the LHDN on 13th May 2019, it considers payments made to Facebook, Google and the like to be similar to payment for the use and right to use the platform.
4. What are Special classes of Income?
As per LHDN, the income of a non-resident from the following special classes of income is chargeable to tax in Malaysia if it is derived from Malaysia:
a) amounts paid in consideration of services rendered by the non-resident person or his employee in connection with:
(i) the use of property or rights belonging to him; or
(ii) the installation or operation of any plant, machinery or other apparatus purchased from him [paragraph 4A(i) of the ITA];
b) amounts paid to a non-resident person in consideration of any advice given or assistance or services rendered in connection with management or administration of any scientific, industrial or commercial undertaking, venture, project or scheme [paragraph 4A(ii) of the ITA]; or
c) rent or other payments made under any agreement or arrangement to a non-resident person for the use of any moveable property [paragraph 4A(iii) of the ITA].
This usually happens when you hire non-resident contractors to perform work for you e.g. software development or engage an overseas marketing agency to manage your social media marketing accounts.
5. Why it is important to differentiate between Royalty Income or Special Classes of Income?
This is due to different preferential withholding tax rate which may be available for different type of payments under Double Taxation Agreement with different countries. For example:
Assuming that the foreign service provider is based in Singapore, if the service is considered under Special Classes of Income (e.g. Technical Fees), it will be withheld at 5% rather than 8% (% to be withheld if it is considered as “Royalty”).
6. Does it mean all payments made to non-resident in relation to project or assignment undertake by them will be subjected to WHT under Special Classes of Income?
With effect from 6th September 2017, there is an Exemption Order granted on payments made in relation to Special Classes of Income where a non-resident shall be exempted from the payment of income tax on the fees if the services are performed by the non-resident outside Malaysia. In other words, withholding tax is exempted if the services are performed outside Malaysia.
7. How to calculate the Withholding Tax?
In the past, the payer is required to calculate the WHT tax due based on re-gross method.
Fee charged by Foreign Service Provider : RM100,000
Withholding tax : 10%
Withholding tax due : RM100,000 / 0.9 * 0.1 = RM11,111
However, with LHDN announcement on 5th December 2018, WHT is to be computed on the gross amount paid to a non-resident.
Fee charged by Foreign Service Provider : RM100,000
Withholding tax : 10%
Withholding tax due : RM100,000 * 0.1 = RM10,000
8. How to pay WHT and penalty if WHT is not paid:
The payer must, within one month after the date of payment to the non-resident, remit the withholding tax to LHDN. Failing of doing so, you may face the potential risks of:
- 10% late WHT payment penalty
- Ineligibility to claim advertising cost as your business expenses in your annual return (if your advertising costs are from for example foreign providers such as Facebook, Google)
- At least 45% penalty on tax avoidance, according to paragraph 113(2) of ITA.
If you require in-depth study on Withholding Tax for your business, contact us at firstname.lastname@example.org to arrange a consultation session.
Please note that this publication is based on the publicly available information and as tax policies may change from time to time, you may need to consider the latest tax developments when planning your withholding tax. Further, the above examples are for illustration purposes only and should not constitute as tax consultation.
STAY TUNED: In the next article, we will be writing on Digital Tax, a topic many have asked alongside Withholding Tax.
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