Malaysia’s Position on the MLI

The Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI) has to date been signed by more than 90 jurisdictions, accelerating the process of modifying and updating existing double taxation agreements (DTAs) so as to reduce, if not eliminate, opportunities for non-taxation or reduced taxation through tax evasion or avoidance.

Malaysia signed the MLI on Jan. 24, 2018 and deposited a provisional list of its expected reservations and notifications in connection with the MLI (Provisional Reservations) with the Organization for Economic Cooperation and Development (OECD). Thereafter, the Double Taxation Relief (Multilateral Convention To Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting) Order 2020 [P.U.(A) 224] (the Order) implementing the MLI was gazetted and came into force on June 1, 2021.

Scope of MLI

To date, Malaysia has concluded 73 comprehensive DTAs, which apply to taxes levied under the Income Tax Act 1967 (ITA) and the Petroleum (Income Tax) Act 1967. Although intended to apply to all 73 DTAs (Covered DTAs), owing to the bilateral nature of DTAs the MLI provisions cannot be applied to a Covered DTA if only one treaty partner does so, or if the position taken by a treaty partner on a particular MLI provision differs from that taken by the other partner, as there are various options available under the MLI.

Malaysia’s Position

In line with Article 6 of the MLI (Purpose of a Covered Tax Agreement), a statement of intent would be included in the preamble of Malaysia’s Covered DTAs that they are not intended to create opportunities for non-taxation or reduced taxation through tax evasion or avoidance, including through treaty-shopping arrangements.

Applying the Principal Purpose Test

With respect to Article 7 (Prevention of Treaty Abuse), Malaysia has opted for the principal purpose test, which denies treaty benefits to taxpayers if the principal purpose or one of the principal purposes of the arrangement or transaction was to obtain treaty benefits, and that arrangement had, directly or indirectly, resulted in such benefit.

At this juncture, it is unclear how this would be interpreted and applied by the Inland Revenue Board of Malaysia (IRB). The test ought to be an objective one—whether it is reasonable to conclude in the light of all relevant facts and circumstances that obtaining that benefit was one of the principal purposes of that arrangement/transaction. If that test is met, treaty benefit will only be granted if the taxpayer can establish that the grant of the benefit is in accordance with the object or purpose of the relevant provisions of the Covered DTA.

However, this provision appears to give tax authorities a wide latitude to examine cross-border transactions with a view to denying treaty benefits and may defeat the very purpose of DTAs, as taxpayers would have to prove that obtaining that benefit was in accordance with the treaty’s object or purpose.

Changes to Concept of Permanent Establishment

Malaysia has reserved its position not to apply a number of “optional” MLI provisions such as Article 3 (Transparent Entities), Article 4 (Dual Resident Entities), Article 5 (Application of Methods of Elimination of Double Taxation), Article 10 (Anti-Abuse Rule for Permanent Establishments Situated in Third Jurisdictions) and Article 14 (Splitting-up of Contracts), among others.

However, Article 12 of the MLI has been adopted, which concerns the artificial avoidance of a permanent establishment (PE) through commissionaire arrangements and similar strategies. A foreign enterprise shall be deemed to have a PE in respect of activities undertaken by a person acting on its behalf who habitually concludes contracts, or habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise.

Such contracts refer to those concluded in the name of the enterprise, contracts for the transfer of the ownership of, or for the granting of the right to use, property owned by that enterprise or that the enterprise has the right to use, and contracts for the provision of services by that enterprise.

In this regard, the IRB has indicated that an arrangement where an agent or intermediary plays the principal role in concluding substantively finalized business contracts in Malaysia on behalf of a foreign enterprise will constitute a PE in Malaysia.

Article 12(2) of the MLI also provides that where such activities are undertaken on behalf of the foreign enterprise by an independent agent acting in its ordinary course of business, this would not constitute a PE of the foreign enterprise, thus maintaining the existing exclusion under the Covered DTAs for independent agents. However, intermediaries acting exclusively or almost exclusively on behalf of an enterprise to which they are closely related would not be regarded as independent agents.

With respect to Article 13 (Artificial Avoidance of PE Status through the Specific Activity Exemptions), Malaysia has opted for Option A. That is, activities expressly provided by Covered DTAs as not constituting a PE, such as the use of facilities or maintenance of a stock of goods solely for storing, displaying or delivering goods belonging to the enterprise, or the maintenance of a fixed place of business solely for collecting information, would continue not to be regarded as a PE, provided that the overall activity is of a preparatory or auxiliary character.

The IRB has indicated that only genuine preparatory or auxiliary activities will be excluded from the definition of PE and that related entities will be prevented from fragmenting their activities in order to qualify for this exclusion.

Conclusion

While the MLI has not resulted in a wholesale rewriting of DTAs, there are significant ramifications for PEs and the availability of treaty benefits, among others. The latter provision, in particular, would benefit from more specific and detailed guidance from the OECD to prevent it being used carte blanche by tax authorities to deny treaty benefits to legitimate transactions. This may trigger a spate of tax litigation to determine the exact perimeters of the principal purpose test.

This column does not necessarily reflect the opinion of The Bureau of National Affairs Inc. or its owners.

Irene Yong is a Partner with Shearn Delamore & Co.

The author may be contacted at: irene.yong@shearndelamore.com