{Tax Update} Withholding Tax on Royalties

Latest Development on Royalties

In a significant development impacting cross-border software and intellectual property transactions, the Inland Revenue Board (IRB) has recently issued Practice Note No. 3/2023 dated 5th December 2023.

This document provides essential clarifications on the tax treatment of copyright and software payments made by distributors and resellers to non-residents.

This update highlights the categorization of such payments as royalties, bringing them under the purview of withholding tax as per Section 109 of the ITA, thereby affecting numerous businesses engaged in digital transactions and software distribution.

Key Takeaway of PN 3/2023 Tax Treatment on Copyright and Software Payments by Distributor & Reseller to Non-Resident

The payments for the use or right to use copyright and software, even when modified, exploited, or distributed, are considered royalties.
These royalties are subject to withholding tax under section 109 of the Income Tax Act 1967, especially when paid to non-residents who do not have a permanent establishment in Malaysia.
This applies regardless of the rights granted to the distributor or reseller.
Reference should be made to Double Taxation Avoidance Agreements for specific cases.

Drafted PR on Tax Treatment Regarding Royalties for Payment of Software to a Non-Resident on October 2023

Key points include:

Definition of royalties and service fees:

Royalties are defined as payments for the purchase or use of, or the right to use, an application, including purchases where the intellectual property belongs to the original owner.

Service fees, on the other hand, refer to payments for services provided by the non-resident, such as developing relevant functions for the payer's use.

Withholding tax implications:

Royalty payments to non-residents are subject to withholding tax under section 109 of the Income Tax Act 1967. This is a critical point as failure to comply with withholding tax requirements can result in significant penalties.

Payments considered service fees fall under a different category and are subject to withholding tax under section 109B of the ITA.

Consequences for non-compliance:

If a payer fails to deduct and remit the required withholding tax, the unpaid amount will increase by 10%, becoming a government debt.

Additionally, payments that are not compliant with withholding tax requirements may be disallowed as expenses in the taxpayer's tax computation.

Relief and appeal processes

The ruling also discusses relief and appeal processes in cases where taxpayers believe their software royalties' tax treatment is incorrect. This could involve Double Taxation Avoidance Agreements (DTA) and domestic tax laws.

Source

IRB PN 3/2023 https://www.hasil.gov.my/media/jfldzhcy/practice-note-no-3_2023-tax-treatment-on-copyright-and-software-payments-by-a-distributor-and-a-reseller-to-a-non-resident.pdf

Consult a tax professional opinion to examine the transaction and understand the potential implications.

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