The Missing Peg in Malaysian Tax Legislation

by David Singh and Chok Wei Hong

THE Malaysian government, faced with the urgent need to fill the hole of deficit fiscal spending, has been proactive in its actions. These efforts have led to a noticeable decrease in fiscal deficits and a rise in revenue following the impact of the COVID-19 pandemic (See Chart 1 and Chart 2).

The government has taken bold measures to widen its source of revenue and dialled back some of the subsidies we are so accustomed to. These actions, along with the targeted diesel subsidy and the proposed petrol subsidy removal, are part of a comprehensive strategy adopted by the government to narrow the fiscal gap further, instilling confidence in the future fiscal situation.

Our last budget tabled anticipates collecting RM307.6 billion in revenues, of which RM106 billion will be collected from taxing corporations. This comprises 34.6% of the budgeted federal government revenue for 2024 (see Chart 3).

On the other hand, our corporate tax system has undergone a significant transition since 2008, replacing the imputation system with the single-tier system. Under this system, corporations are not required to withhold tax from dividends paid to shareholders, resulting in no tax credits to offset against the recipient’s tax liability. The dividends are also tax-exempt at the shareholder’s hands and are not required to be declared in their annual income returns to the Inland Revenue Board.

All is good, assuming businesses make money, pay taxes on profits and distribute dividends to shareholders like any other responsible business, and shareholders do not get double taxed unjustly for the same profit generated by corporations.

There are some 1.5 million corporations registered with the Companies Commission of Malaysia, most of which are private companies. Many of these private companies are closely held corporations, and corporate law clearly states that dividends paid to shareholders shall come from profits and meet the solvency test, thereby protecting the interests of other stakeholders.

"...dividends are to be paid out of distributable profits..."

These private corporations, often controlled by the same family members or close associates, have many inter-company loans to shareholders, directors or associates despite their poor profitability and doubtful solvency.

The tax treatment for these debit loans under our legislation is to recognise the interest receivable benchmarked against Malaysian Government Securities to be treated as income received for the lender.

Conversely, insiders do not need to pay taxes for the money received and are treated as borrowers. The cash is kosher tax-wise for the insiders to consume and is tax efficient.

On a broader scale, this also means cash can be funnelled to insiders through debit loans that lack justifiable business grounds, and it resembles distributing funds to insiders bypassing corporate and tax laws.

Our tax legislation permits this tax avoidance practice; surprisingly, it has yet to plug this easy practice.

In jurisdictions like India, anti-avoidance provisions are incorporated in their tax legislation to capture loans or advances made not in the ordinary course of business to shareholders. The loans or advances are construed as deemed dividend income and taxed in the hands of the shareholders under the Indian tax legislation.

In Australia, there are stringent rules to ensure that any loans or advances provided to private company shareholders, directors or associates adhere to specific criteria. If these criteria are not satisfied, the loans or advances will be treated as taxable deemed dividends for the recipient.

Of course, such anti-tax avoidance provisions are not limited to India and Australia. Many of the Organisation for Economic Co-operation and Development countries have incorporated them, and even least-developed countries like Papua New Guinea have this embedded in their tax legislation.

Closing this tax avoidance loophole has significant advantages for the government. Not only will it improve government revenue by expanding the tax net, but it will also improve the governance of many private companies.

Plus, the implementation is low-cost and less time-consuming as there are ample case references for legal drafters to cross-reference and incorporate into our legislation. The anti-avoidance provision has limited political consequences as well.

It is tax-neutral too. It does not result in double taxation, as it is clear in law that dividends are to be paid out of distributable profits, and anything beyond that given into the hands of the shareholders or associates is morally correct to be taxed.

The country needs to improve its revenue source fairly without unnecessarily burdening the everyday person on the street. Incorporating the anti-avoidance provisions, as suggested, is certainly a way forward, and in this case, plugging the dubious manner of channelling funds of closely held private corporations.

This article was first published in The Malaysian Reserve print edition on 29 July 2024 (click here). The views expressed here belong solely to the authors and do not reflect the views or opinions of any organisation or constitute any tax or legal advice.