Malaysia: The impact of MLI Provisions on your business

The Organization for Economic Co-operation Development (“OECD”)’s Base Erosion and Profit Shifting (“BEPS”) project aims to tighten the gaps exploited by companies in order to avoid taxation by artificially shifting operations and therefore profits to lower or no-tax jurisdictions. 

Part of the BEPS Action Plan includes changes to be made to tax treaties. As changes to individual bilateral tax treaties are a lengthy process which sometimes may take many years, the MLI was developed to overcome this challenge by enabling jurisdictions to swiftly implement the treaty based recommendations from the BEPS package.  

The MLI was signed in June 2017 by more than 70 jurisdictions, and represents one of the most important changes to-date to cross-border tax norms. Malaysia became a signatory to the MLI on 24 January 2018; and ratified the MLI on 4 August 2020 when the Malaysian MLI Order was gazetted. On 18 February 2021, Malaysia deposited the instrument of ratification with the OECD; and the MLI entered into force for Malaysia on 1 June 2021. 

The MLI contains both, mandatory and optional provisions. Malaysia has opted to adopt the following key modifications to Malaysian bilateral tax treaties. 

Malaysia has opted to include a statement of intent that a bilateral tax treaty is to eliminate double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance. Malaysia has also chosen to adopt the Principal Purpose Test (“PPT”) to prevent treaty abuse, i.e. deny a benefit under a treaty (covering all benefits such as tax reduction, exemption, deferral, refund, and relief from double taxation) if it is reasonable to conclude that obtaining the treaty benefit (directly or indirectly) was one of the principal purposes of an arrangement or transaction unless it can be established that granting that benefit would be in accordance with the object and purpose of the relevant provisions of the bilateral tax treaty. 

The scope of the PPT is wide, as obtaining treaty benefits need not be the only reason of the transaction, but it is sufficient if it is reasonably concluded that it was one of the principal purposes of the transaction. 

Fixed place PE related provisions are broadened to prevent artificial PE avoidance strategies that have been used in the past to circumvent the PE definition and to shift profits out of a country where it should have rightfully been brought to tax. The specific activities exemption list (or the negative list) refers to the list of activities generally found in bilateral tax treaties which are specifically not taken into account in determining whether a non-resident has constituted a PE. 

Malaysia has opted for the position which clarifies that each of the activities under the specific activity exemptions list needs to be of preparatory or auxiliary nature. 

For example, it is common for taxpayers to structure activities of a parent entity with a warehouse located in a foreign jurisdiction where it has a subsidiary without considering the operations and functions of the subsidiary company. With the MLI in force, the specific exemption list needs to be considered in conjunction with the anti-fragmentation rules (explained below). 

Where the warehousing activities are considered together with the operations of the subsidiary, the PE exemption would not likely apply. This is because the warehousing activities are seen as being a complementary function that is part of the cohesive business operation, which cannot be seen as being preparatory or auxiliary in nature, and could result in the existence of a PE for the parent entity in the jurisdiction of the subsidiary. 

The MLI also introduced new anti-fragmentation rules to prevent strategies for avoiding a PE status by fragmenting a cohesive operating business into smaller operations which fit the description of items under the negative list in order to argue that each transaction should not constitute a PE. The anti-fragmentation rules take a holistic view of activities by closely related persons to determine the existence of a PE. 

Agency PE rules are broadened to address the artificial avoidance of a PE status through commissionaire arrangements, sales support activities and similar strategies. The definition of a dependent agent is broadened to include a person who plays the principal role leading to the conclusion of contracts by the non-resident without material modification by the non-resident. The independent agent provision is tightened to exclude a person who acts exclusively or almost exclusively on behalf of one or more non-residents to which it is closely related. 

Malaysia will fully adopt the Mutual Agreement Procedures (“MAP”) provisions to its Covered Tax Agreements (“CTAs”) which is another minimum standard under the BEPS Action 14. When a Malaysian resident taxpayer encounters taxation, which is not in accordance with the intended application of the bilateral tax treaty provisions, the taxpayer could request for a MAP to be presented to either competent authority to resolve the dispute. Malaysia has, however, opted not to adopt the mandatory arbitration provisions. 

The extent of modification on any Malaysian tax treaty would depend on whether there is a bilateral match, i.e. where both treaty parties adopt the same choice with respect to a particular MLI position. 

This is illustrated below using the Malaysia – Singapore DTA:

¹ Option A – Clarifies that each of the activities under the specific activity exemption lists has to be preparatory or auxiliary

² Option B – Preserves the existing specific activity exemptions list under a bilateral treaty

 

The MLI provisions could affect new arrangements as well as existing structures. The introduction of the PPT to prevent tax treaty abuse - whereby bilateral tax treaty benefits will be denied if it can be “reasonably concluded” from the facts that the “principal purpose or one of the principal purposes” of entering into the transaction or arrangement was to obtain tax benefits - could have a significant impact on existing business arrangements. Businesses should look into their existing operating structures or intended new arrangements, and review the principal purpose behind entering into an arrangement.

The first step would be to check whether the relevant treaties are modified by the MLI. In other words, whether the country has a covered tax agreement with Malaysia, as the MLI provisions are effective only on covered tax agreements. The next step would be to assess when the MLI provisions are effective. There is a need to review the cross border transactions as to the effective date(s) and whether the positions Malaysia and the respective country opted for are the same. The MLI provisions adopted by Malaysia would only be effective where the corresponding country opted for the same interpretation/position on the relevant subject matter. 

 

On the basis that the MLI provisions apply/will apply in future: 

MLI is a significant change in the international tax landscape. International tax is an increasingly complex issue for groups of companies; and the introduction of the MLI provisions will exacerbate the complexity of the international tax environment. It is unclear as to how stringent a view the tax authorities (including the Malaysian tax authorities) will take, and how it will be implemented in practice. 

Taxpayers should take a proactive approach in reviewing their existing cross border structures/transactions and value chain, keeping the MLI provisions in mind to determine if any enhancements are required. Any changes to existing structures should only be done after careful assessment and consideration of the potential risks and opportunities. Any future transactions or structures should be implemented with the impact of the MLI being taken into consideration.