By Nicolaos Giannopoulos
(Published in ‘Campus & Beyond’, a weekly column written by Swinburne academics in the Borneo Post newspaper)
Malaysians are going overseas! In particular overseas investments by Malaysian companies totaled RM22.2 billion for the 2006 calendar year, according to the Malaysian Industrial Development Authority. These investments were in a variety of locations: from oil and gas fields in Nigeria to manufacturing operations in China.
Driven by the economic growth policy of the Malaysian government, these investments bring foreign exchange earnings back into the treasury coffers, create jobs for Malaysians and increase the international competitiveness of Malaysian companies.
So how does tax fit in all of this?
An important part of any cross border investment decision requires a thorough knowledge and analysis of how other nation’s tax laws and international tax treaties operate and impact in relation to your investment decisions.
Take for example a Malaysian resident company manufacturing goods here in Kuching. With Malaysia having what’s called a “territorial tax system” this company pays Malaysian tax on business profits sourced only in Malaysia. Overseas sourced profits are excluded from Malaysian taxation. This feature of the Malaysian tax system has been one of the main catalysts for Malaysian companies increasing cross border activity.
If the company generates RM1 million of business profits from the sale of the manufactured goods, these profits will be sourced in Malaysia and taxed by Malaysia at 26% in the 2008 year of assessment, equating to a RM260,000 Malaysian tax liability.
Let’s assume the company now decides to increase their international presence as part of a worldwide market expansion plan. They select Australia as a possible new market. Are there any ‘additional’ tax implications for the Malaysian company if they decide to export and sell their goods to Australia?
The company’s board of directors (BOD) has proposed various business models to undertake the expansion. They have suggested using an agent in Australia through which to sell the goods in Australia or licensing an Australian company to manufacture and sell the goods in Australia or establishing a subsidiary company in Australia to manufacture and sell the goods. From a tax (and profit) perspective, will each proposal have the same outcome?
As an international tax treaty (also known as a double tax agreement DTA) exists between Malaysia and Australia the provisions of this treaty override the domestic tax laws of both our countries. These DTAs are international agreements which are governed by the rules prescribed in the Vienna Convention of the Law of Treaties 1969.
Under article 7 of the DTA, a Malaysian company’s business profits cannot be subject to Australian taxunless the Malaysian company carries on business in Australia through what is termed a ‘permanent establishment’ (PE) in Australia, and the business profits are attributable to that PE.
The concept of PE implies that the Malaysian company must have some physical presence in Australia to which the business profits can be attributed before an Australian tax liability is triggered. The business of simply importing – exporting without a business presence in Australia will not trigger an Australian tax liability.
So do any of the proposed business models establish a PE in Australia and thus expose the Malaysian company to an additional Australian tax liability?
The use of an independent, bona-fide agent in Australia to export and sell the goods will not be deemed a PE in Australia under Article 5(6) of the DTA. In this instance, the RM1 million business profits will not be taxed by Australia and the tax liability of the company will remain RM260,000.
However, if the agent acting for the Malaysian company has the authority to negotiate and conclude sales contracts on behalf of the company, then they will have what’s termed a ’dependent agent’ operating in Australia. A dependent agent is deemed to be a PE in Australia. Now the RM1 million profits will be taxed by Australia at 30% i.e. RM300,000 Australian tax payable.
The effect is that the company’s business profits will be taxed by both Australia and Malaysia.
However under the DTA, the Malaysian company will be entitled to what’s called a foreign tax credit (FTC) for the amount of Australian tax paid. This FTC can be offset against their Malaysian liability up to RM260,000, effectively reducing their Malaysian tax liability to zero!
As a result of having a dependent agent, the company will have a total tax liability of RM300,000 (i.e. 4% higher). And worse still is that the Malaysian Inland Revenue Board would receive no revenue in this instance – the tax revenue being transferred to the Australian treasury.
The Malaysian company could incorporate a wholly-owned subsidiary company to undertake the sales in Australia. In this parent-subsidiary scenario, there are two separate legal entities: one a Malaysian company, the other an Australian company. The Malaysian company will not be deemed to have a PE in Australia merely because they control the Australian subsidiary company.
The RM1 million pre-tax profits derived by the Australian subsidiary could be distributed to its Malaysian parent as an unfranked dividend. Article 10 of the DTA applies a maximum 15% dividend withholding tax (RM150,000) on the gross amount (RM1 million). The Malaysian company would receive RM850,000. And as the business profits would be Australian sourced, it would not be subject to any Malaysian tax!
Establishing a licensing agreement with an Australian company is not enough to establish a PE in Australia. The Malaysian company could receive income in the form of a royalty, based on the amount of sales by the Australian subsidiary.
Article 12 of the DTA will impose a maximum 15% royalty withholding tax on the gross amount RM1 million. The Malaysian company would receive RM850,000 in its pocket. And again as the business profits would be Australian sourced, it would not be subject to Malaysian tax!
Such a hypothetical and quite feasible scenario is evidence that international tax treaties affect everyone with cross border activity: individuals, corporations and governments alike.
And here at Swinburne, students undertaking the Bachelors of Business, Accounting and International Business streams, are now acquiring such skills and knowledge. They are fully aware of the importance of tax considerations when companies make investment decisions.
And for the students, professional accounting firms and companies are always on the lookout to hire graduates with tax knowledge to help them decipher and apply complex tax laws. The demand and rewards for such skilled individuals is high. The area is constantly evolving, making a career in taxation interesting and challenging.
As the economic world shrinks with globalization, the reach and importance of taxation has lengthened to all corners of the globe, including the students here in Kuching!
Nicolaos Giannopoulos is a lecturer with the School of Business and Enterprise at Swinburne University of Technology Sarawak Campus. He can be contacted at email@example.com