Withholding Tax Audit

Cracking Down the Certainty of Boundaries

by


Choong Kwai Fatt*




Introduction

 

Withholding tax audit which is part of the self-assessment regime, allows the Inland Revenue Board (“IRB”) to carry out audits to ensure the taxpayer is in full compliance with withholding tax payments to the IRB. Withholding tax is a tax levied on non-residents and it applies with limited scope. It is governed by the Income Tax Act 1967 (“the Act”).

 

Non-compliance with withholding tax will result in the business expenditure not being able to be deducted in the tax computation, coupled with a late payment penalty of 10% on outstanding withholding tax due to the government. There is also the possibility of incorrect returns penalty of 45% on tax undercharged.

 

The practical applications of withholding tax, its implications and complications are illustrated in the recent decision of the High Court in Alwan Enterprise Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri (“Alwan Enterprise”).1 This article attempts to highlight the essential legal principles on withholding tax and to demystify the myth on withholding tax, as well as the misconception by most taxpayers.

 

Scope of charge

 

Malaysian taxation operates on a territorial scope basis. This means that income derived from Malaysia will be taxed in Malaysia. In relation to withholding tax, the scope of charge shall be levied on non-residents carrying on construction business in Malaysia, public entertainers, those earning interest, royalties, as well as income and other income that fall under special classes, such as commissions and ad-hoc income.

 

Section 3 of the Act sets out the landscape of Malaysian taxation, i.e. the territorial scope on income derived from Malaysia. Sections 4 and 4A enumerate various classes of income such as royalty which falls under s 4(d) and specific services which fall within the ambit of s 4A. Section 15 (on royalty) and s 15A (on specific services) deem the income to be derived from Malaysia and the responsibility for payment lies with the person who is resident for that basis year.

 

The ambit of income, the derivation of income and sections applicable to comply with withholding tax are tabulated as follows:

 

Scope of charge (s 3)

Classes of income (s 4)

Withholding tax

1. Income

(a) business

s 107A – construction business 

 

(b) employment

s 109A – public entertainers, lecturers, trainers, speakers, etc.

 

(c) interest

s 109 – interest 

 

(d) royalty

s 109 – royalty 

 

(e) –

 

s 109F – commission, ad-hoc income

 

 

(f) other income 

 

 

Special classes of income (s 4A) 

s 109B – special classes of income 

 

(i) installation services 

 

 

(ii) specific services 

 

 

(iii) lease rental of moveable property 

 

2. Derived from Malaysia 

ss 15A/15B – payment by resident

 

 Withholding tax compliance

 

As stated earlier, withholding tax is a tax imposed on non-residents. The entire withholding tax provision operates on an “income deemed derived” basis. As long as payment of services by a Malaysian resident company is made to overseas service providers, withholding tax is almost a certainty.

 

Deducting withholding tax is mandatory and it must be accounted to the IRB once such income is deemed derived from Malaysia. Sections 15 (interest and royalty) and 15A (special classes of income) clearly state that the payment lies with the person who is a resident where it is deemed that the income is derived from Malaysia.

 

Once withholding tax is crystalised on the basis of income deemed derived, the collection mechanism sets in. Sections 109 (for royalty) and 109B (for special classes of income) mandatorily requires the payer to withhold the withholding tax and account to the IRB within one month upon payment being made to the non-resident person.

 

It is a settled principle that the double taxation agreement (“DTA”) between Malaysia and the treaty countries provide situations where the business income derived by the non-resident is only taxed in Malaysia if permanent establishment is established. Permanent establishment refers to a fixed place of business through which the business of the enterprise is wholly or partly carried on, i.e. where the said non-resident is trading in Malaysia by setting up a business presence in Malaysia, such as a factory, an office or even warehouses in Malaysia. In the event the non-resident can establish that there is no permanent establishment in Malaysia, then no tax would be imposed on business income. Withholding tax, however, continues to apply but at a preferential rate.

 

In Ketua Pengarah Hasil Dalam Negeri v Teraju Sinar Sdn Bhd,2 the Court of Appeal held that the charging law is the Act and not the DTA. The DTA merely determines the availability of relief from tax. In the event the DTA is available, it is the duty of the recipient to seek a refund from the IRB. The payer remains mandatorily obligated to account the withholding tax to the IRB.

 

In this case, the taxpayer (“Teraju Sinar”) had claimed deductions for payments made to Union Concept Manufacturing Pte Ltd (“Union Concept”) in Singapore for years of assessment (“YAs”) 1998, 1999, 2000 and 2002 for “handling and repacking” services rendered by Union Concept in Singapore. The services rendered were actually service to dismantle imported electrical equipment, the component parts of which were then marked, wrapped with other units and exported to Teraju Sinar in Malaysia as completely knocked down or semi-knocked down electrical equipment which was then assembled in Malaysia for sale.

 

Due to the failure by Teraju Sinar to deduct withholding taxes under s 109B of the Act from payments made to Union Concept, additional assessments were imposed after disallowing deductions under s 39(1)(j) of the Act. 

 

It is a finding of fact by the Special Commissioners of Income Tax (“SCIT”) that the “handling and repacking” services fall within s 4A(ii) of the Act. It is also not a disputed fact that Teraju Sinar (resident company) made payment to the Singapore company under s 15A(b) of the Act. Therefore, the Court of Appeal concluded that s 109B of the said Act applies. Section 39(1)(j) of the Act allows the IRB to disallow deductions for the payer for its failure to pay the withholding tax to the IRB.

 

The Court of Appeal confirmed that ss 4A, 15A and 109B of the Act are plain and clear in their ordinary and literal meaning. Once ss 4A and 15A are fulfilled, the payer is obliged to deduct 10% withholding tax to remit to the IRB. The intention of the Legislature is stated in clear terms. It is for the Singapore company to avail itself of the relief under the DTA. It is the recipient company that took up the claim against the IRB and not the taxpayer. In short, the taxpayer cannot use the defence of the DTA to excuse itself from non-compliance. The Court of Appeal’s decision reminds us time and time again, of the statutory duty of the payer to deduct withholding tax once ss 4A and 15A are complied with.

 

Abdul Wahab Patail JCA held on pp 82-83:

It is trite the relationship between the ITA and the DTA is that the charging law is the ITA and not the DTA which only determines availability of relief from tax…

 

But the party that is relieved of the liability to tax by the DTA is not Teraju but Union Concept. Section 4A created three special classes of income derived in Malaysia, of a person not resident in Malaysia may be chargeable to tax. Section 15A deems these three classes to be derived from Malaysia if any one of three conditions are met, and the payer in Malaysia is imposed the duty to make deductions of withholding tax to the KPH. That is a responsibility entirely distinct or separate from the liability of Union Concept under paragraph (ii) of s 4A notwithstanding the provisions of s 4. It is then for Union Concept to avail itself of the relief under the DTA.

 

Practical applications

 

In Alwan Enterprise, the crux of the dispute was whether withholding tax applied on the lease rental paid on bareboat charter. In this case, the company had entered into a bareboat chartering agreement with Fukada Salvage &

Marine Works Co Ltd (“Fukada”) for the boat known as “Shin Chou Maru” (later renamed as “Omni Taran”) for a period of five years.

 

Lease rental has been paid to Fukada and withholding tax, however, was not withheld. Pursuant to a withholding tax audit, the IRB contended that withholding tax of 10% was applicable being lease rental on moveable property as stated in s 4A(iii) of the Act. The DTA between Malaysia-Japan states that such payment falls under article 12, being royalty. The IRB demanded withholding tax for YAs 2007-2010, amounting to RM3,105,615. An additional 10% penalty of late payment amounting to RM310,561 was levied.

 

The company contended that withholding tax is not applicable on lease rental for bareboat charter as Fukada (non-resident) is eligible to rely on article 8 of Malaysia-Japan DTA for withholding tax exemption. Fukada satisfied all the prerequisites to be complied with as required in article 8, which are:

 

  1. Fukada does not have a permanent establishment in Malaysia;
  2. Fukada is an international shipping company, carrying on the business in international waters/traffic;
  3. Fukada engaged in international operation of ships in the transportation of passengers or cargo; and
  4. The bareboat chartering is an ancillary business of Fukada.

 

These positive assertions by the company, however, were supported only by secondary documentary evidence being documents downloaded from reliable websites. In relation to paragraphs (a) and (b), the company merely exhibited a company’s profile downloaded from the internet. In relation to paragraph (c), the company exhibited a “Lesen Membekal Peralatan/Memberi Perkhidmatan Kepada Syarikat-Syarikat Carigali dan Pengeluar Minyak/Gas di Malaysia” issued by Petronas. In relation to paragraph (d), the company relied on the report prepared by RAM Credit Information Sdn Bhd (“RAM”) with a clear disclaimer that RAM does not guarantee the accuracy of information provided.

 

The High Court held that the exhibits and reports provided by the company were unreliable and the court could not come to a definitive conclusion as to the ascertained facts. The company should have provided an affidavit from Fukada to state the fact that it has no permanent establishment in Malaysia, or that it carries on its business in international waters or that bareboat chartering is only its ancillary business. The failure to provide these primary sources of documentation was fatal on the company.

 

The company, however, argued that the IRB’s failure to produce anything to the contrary to disprove the information provided by the company meant that the court had to accept these documents as accurate. The High Court emphasised that the burden of proof was on the company to establish the facts asserted and there was no onus on the IRB to disprove the information provided.

 

In Lower Perak Co-operative Housing Society Bhd v Ketua Pengarah Hasil Dalam Negeri,3 the Supreme Court succinctly laid down the trite principle that the onus is on the taxpayer to demonstrate that the assessment should not have been made. The assessment should stand unless the taxpayer is able to satisfy the SCIT that the assessment is excessive and wrong. Failure to do so would mean the assessment by the IRB is correct. The court was of the opinion that the documents from the secondary sources were unreliable and the authenticity had not been verified. To ask the court to accept these statements as true, was clearly unacceptable.

 

The High Court further held that the IRB was correct to demand payment of withholding tax from the taxpayer. Lease rental which is governed by s 4A(iii) of the Act, coupled with the payment by the taxpayer (resident person) would mean that the non-resident, i.e. Fukada, derived income from Malaysia. The statutory duty of the company is merely to withhold the tax portion of Fukada and transmit the same to the IRB. If Fukada takes the position that their income can only be taxed in Japan under the Malaysia-Japan DTA, they must make the application to the IRB.

 

Judicial review or appeal to SCIT?

 

In this case, the taxpayer had pursued the tax dispute with the IRB through judicial review at the High Court. Judicial review is premised on s 25 of the Courts of Judicature Act 1964, read with Order 53 of the Rules of Court 2012 (or the then Order 53 of the Rules of the High Court 1980). It is a court proceeding where a challenge is made by a taxpayer on the lawfulness of the IRB in issuing a notice of assessment on withholding tax. It commences at the High Court and may be further appealed to the Court of Appeal and from there to the Federal Court.

 

The High Court, in a judicial review exercise, is not concerned with the merits of the IRB’s decision but with the validity of the decision-making process. Hence, there is no evaluation of evidence in a judicial review and the facts are taken as they are. The High Court, in exercising judicial review, focuses its attention on the lawfulness of the decision making process, i.e., whether the IRB has acted in excess of its jurisdiction (illegality), made errors in law and thus acted unfairly to the taxpayer (procedural impropriety), and blatantly failed to perform its statutory duty (irrationality).

 

The High Court opined that this case very much concerns whether the lease rental on bareboat charter falls under article 8 or article 12 of the Malaysia-Japan DTA. There are disputed facts and contradicting statements between both parties. Without proper ascertainment and findings of fact, the court cannot come to a definitive conclusion. It is on this basis, that this matter is best dealt with before the SCIT as the SCIT are the judges of the fact in tax matters.

 

In an appeal before the SCIT, the taxpayer would be given every opportunity to produce books, papers or documents or even request the attendance of witnesses to establish their position and to show where the IRB went wrong. In short, before the SCIT, the taxpayer would have every opportunity to ventilate his disgruntlement to undo what the IRB had determined.

 

The taxpayer here had circumvented the SCIT from resolving this issue and chosen judicial review. Therefore, the High Court had to accept the facts that the lease rental payment on bareboat charter by resident person was true and unwittingly leaving the deeming provision unrebutted. That being so, withholding tax is applicable. The withholding tax liability crystalised with certainty. It is fatal to the company.

 

Conclusion

 

Global trade increasingly demands the import of various services as well as the leasing arrangement from overseas parties. Malaysian companies need to be aware of the mandatory responsibility to withhold withholding tax and timely payment to the IRB to avoid late payment penalty and also to mitigate non-deductibility of business expenses. Non-residents remain liable for the tax until primary evidence is adduced to seek relief relying on the DTA articles. The DTA is at all-time merely to relieve tax. The charging section remains with the Act.


* PhD, Advocate and Solicitor.

1 [2019] 2 AMR 28, HC.

2 [2014] AMTC 71, CA.

3 [1979-1996] AMTC 1638; [1994] 2 AMR 1735, SC.