Why the Malaysia Holding Company is the Best Vehicle for Investments
Companies from the US are in good stead to set up a Malaysia holding company for their investments in the Asia Pacific region and especially for their Indian investments. Malaysia and the US have always shared a strong bilateral relationship that was further enhanced with the signing of the US – Malaysia Free Trade Agreement on January 1, 2004. The FTA not only enhanced the trading volumes between the countries but also amped Malaysia’s traction as an investment destination.
Malaysia is now the third largest recipient, behind Canada and Australia, of US foreign direct investment (FDI) in the Asia Pacific region, with over $116 billion of cumulative FDI, and over 1,500 US companies operate in Malaysia. With the increase in economic engagements of the US in the region the role of Malaysia in the equation has been growing in importance.
Malaysia has been the most preferred holding company jurisdiction for outbound investments targeting the emerging markets of Asia owing to its strategic geographic location, economic connectivity, world class infrastructure, presence of international financial institutions, robust legal framework, international reputation, open immigration policy, simple tax system, competent workforce and neutral political relationship with neighbors.
One of the key driver of preference for Malaysia as a location for holding companies is the taxation system. The following report provides an overview of the dynamics that make Malaysia the preferred holding company location among US companies for their Indian investments.
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[wc_accordion_section title=”India, a promising market”]
As one of the fastest growing economies in the world with an average GDP growth of nearly 8% in the recent years, India has evolved into a hot investment destination. The economic reforms initiated since 1991 have been paying off. The International Monetary Fund (IMF) estimates a GDP growth forecast of around 7.7% per year until 2017.
With more than 50% of the population aged below 25 years, the demography of the nation is also favorable for investors underscoring the potential growth in employment, real income, disposable income and consequently a spike in consumption of products and services. India is offering compelling investment opportunities in sectors such as the infrastructure, communication, healthcare, education, entertainment and consumer goods sector.
Post-liberalization, the country has been attracting a steady influx of FDI that is further propelled by the network of trade agreements that India has established with global economies.
[wc_accordion_section title=”Malaysia as a preferred holding company jurisdiction”]
Investing in an Indian company through an intermediate holding company in a tax-favorable jurisdiction may offer various advantages. It helps in pooling offshore investments and also helps in globalization or restructuring of a company at a later stage. US companies targeting India will benefit by establishing a holding company in Malaysia with which India has strong bilateral ties and a DTA.
Malaysia also has a comprehensive network of FTAs with the regional economies that are surging ahead in growth. As such, investors and enterprises from the US find Malaysia an ideal location to hub and spoke their investments in the region by leveraging on the advantages of the FTA arrangements.
The Inland Revenue Authority (IRAS) the tax authority of Malaysia is vigilant on fraudulent activities and insists strongly on commercial substance of holding companies. Therefore, Malaysia is generally regarded as a legitimate holding company jurisdiction.
[wc_accordion_section title=”Tax Benefits”]Interposing a Malaysia holding company for investments made in India brings significant tax savings and tax deferral opportunities for US companies under the Malaysia India DTA.
The headline corporate tax rate in India is 30% excluding surcharge and education cess. The US headline federal corporate tax rate is 35% and the headline corporate tax rate in Malaysia is 17%.
The US-India DTA and India-Malaysia DTA both, subject to certain conditions, allows for Foreign Tax Credit (FTC) whereby a company can claim credit against tax charged in the treaty country, when the income sourced in the treaty country is received in the home country.
It must be noted that India does not charge tax on dividends, on the assumption that the profits out of which the dividends are distributed are subjected to tax.
Dividends when received in the US by the US holding company, are subjected to federal corporate tax of 35%. In Malaysia, subject to conditions, under the Foreign Sourced Income (FSI) Exemption Scheme, foreign sourced dividend incomes are exempt from Malaysia tax. In the case of other incomes such as interest and royalties received in Malaysia from the Indian company, the Malaysia holding company can reap further benefits from the Foreign Tax Credit (FTC) scheme and the credit pooling system (FTC Pooling System is discussed in detail later).
Alienation of shares by the US holding company in its direct Indian subsidiary will attract capital gains tax of 20%. Under the Malaysia – India DTA, capital gains from the alienation of shares in a company are not taxable in the country where the company is located, rather, in the country where the seller is resident. However, in Malaysia there is no tax on capital gains. Therefore, the Malaysia holding company can dispose the Indian subsidiary without any tax implications.
Let us assume a fictitious US company, ABC, making investments in India under two scenarios.
Scenario 1: The US company ABC (US) makes its investments in India through a wholly owned direct subsidiary in India, ABC (I).
Scenario 2: The US company ABC routes its investments in Indian company ABC (I) through a Malaysia holding company ABC (S).
When ABC (I) distributes dividends and interest to the holding companies, the tax liabilities significantly differ in the two scenarios. Let us examine the tax liability if the incomes are received in the holding company’s jurisdiction.
The tax liability is compared in case of the two scenarios as below.[/wc_accordion_section]
[wc_accordion_section title=”Foreign Tax Credit Pooling System”]
Malaysia’s FTC pooling system provides a distinct benefit. The system was introduced with effect from YA 2012 with the objective of providing businesses greater flexibility in using their foreign tax credit and to simplify tax compliance. The system reduced the tax liability on the foreign income received in Malaysia.
Without the pooling system, any FTC for a particular stream of foreign income that is in excess of Malaysia tax payable is disregarded and cannot be used to offset the Malaysia tax payable on another source of foreign income that is subject to tax in Malaysia. The pooling system allows FTC to be computed on a pooled basis, rather than on a source-by-source and country-by-country basis for each particular stream of income. The amount of FTC to be granted will be based on the lower of the pooled foreign taxes paid on the foreign income and the pooled Malaysia tax payable on such foreign income.
[wc_accordion_section title=”Ideal for Hub & Spoke Investment Structures”]
Malaysia has a comprehensive network of Avoidance of Double Taxation (DTA) with its neighboring economies. The region is touted as the growth engine of the world for a foreseeable future, and investing in the key economies of the region is an inevitable option for global enterprises.
Another significant advantage of having a Malaysia holding company is the redeployment of earnings to other regional economies, without directing the earnings into the US, where it may attract tax liabilities. Given that dividends from India as well as other subsidiaries of the Malaysia holding company will not be subject to Malaysia tax by virtue of Foreign Sourced Income Exemption Scheme it will be the most ideal hub & spoke structure for deployment of earnings from one subsidiary to the other. If Malaysia has a DTA in place with such recipient countries, it will be a prudent structure that further maximizes benefits for the company.
For instance, if the US company wants to invest in China, it can take advantage of the Malaysia-China DTA which provides for preferential treatment of dividends, interests and capital gains. In addition, it can be entitled to foreign tax credit and pooling system and take advantage of the tax regime of Malaysia.
According to the Malaysia-China DTA, the withholding tax on dividends charged by China is 5%. On the other hand, it is 10% in the China-US DTA. With respect to gains derived by the Malaysia holding company from the disposal of shares of the China subsidiary, any gains derived by the Malaysia holding company from such disposals would be subjected to withholding tax at 10% in China.
Malaysia has been strengthening its DTA network progressively and has to date over 70 comprehensive DTAs. Among its top 15 destinations for FDI, Malaysia has DTAs with 10. The DTAs are of significance to companies with cross border operations and business units. Although Hong Kong is touted to be the close competitor for routing of FDIs into Asia, Malaysia wins hands down because of its extensive network of treaties.
[wc_accordion_section title=”Headquarters Program”]
Companies, which provide headquarter (HQ) related support services on a regional / global basis enjoy concessionary tax rate under the program. More than 300 US companies have set up their regional headquarters in Malaysia. Some of the US companies that have setup HQ operations in Malaysia recently include Procter & Gamble, Life Technologies and Kulicke & Soffa.
Under the regional HQ award, companies that meet the qualifying conditions enjoy concessionary tax rate of 15% for 3+2 years on incremental qualifying income from abroad. If the applicant company satisfies all the minimum requirements by Year 3 of the incentive period, it will enjoy the 15% concessionary tax rate for an additional 2 years on qualifying income.
For companies that commit to significantly exceed the minimum qualifying conditions* of the regional HQ, the EDB is prepared to negotiate customized incentive packages with lower concessionary tax rates.
Companies that are well established in their sector and have attained a critical size in terms of capital, assets employees etc, generally qualify for this program, provided they act as nerve center of the organization with a clear management and control structure.
* Qualifying conditions include:
- Paid up capital of S$0.2 million and S$0.5 million by the end of Year 1 and Year 3 of the incentive period respectively;
- 3 qualifying HQ activities to group entities based in 3 countries outside Malaysia by the end of Year 1;
- 75% skilled employees. Skilled employment refers to at least an NTC2 Certificate qualification;
- Additional 10 professionals in Malaysia by the end of Year 3 Professionals refer to at least a diploma qualification;
- 5 management executives each earning an average annual remuneration of S$100,000 by the end of Year 3;
- Additional S$2 million in annual total business spending in Malaysia by the end of Year 3;
- Additional S$3 million in total business spending cumulatively for the first 3 years of the incentive period.
Qualifying HQ activities include the following:
- Strategic Business Planning and Development
- General Management and Administration
- Marketing Control, Planning and Brand Management
- Intellectual Property Management
- Corporate Training and Personnel Management
- Research, Development and Test Bedding of New Concepts
- Shared Services
- Economic or Investment Research and Analysis
- Technical Support Services
- Sourcing, Procurement and Distribution
- Corporate Finance Advisory Services
It must be noted that companies that engage in R&D activities can further benefit from the enhanced Productivity and Innovation Credit (PIC) scheme. R&D is one of the six qualifying activities under this scheme. The scheme provides for 400% tax deduction, for YA 2013 – 2016, with an expenditure cap of S$1.2 million in R&D.
[wc_accordion_section title=”Global Trader Program”]
Under this scheme, an approved GTP company is granted a concessionary rate of 5% or 10% on its qualifying offshore trading income. The qualifying transactions include principal trades with offshore parties or other GTP status companies on both the buying and selling legs of the transaction. GTP is available for entities engaged in offshore trading, transshipment, and re-export of approved commodities.
US companies can optimize tax savings if they engage the Malaysia holding company to directly trade with the regional markets while the subsidiary companies in the respective markets provide supporting services such as liaison and after sales services for example. Presently there are over 300 companies under the GTP.
International Enterprises (IE), the administering body of the program, offers an initial, non-renewable 3-year GTP status. If the company establishes its global trading network and demonstrate sustainable growth projections during this period, with Malaysia as its base, it can apply for the renewable 5-year GTP status.
Some of the factors that are considered for qualifying for the GTP are, substantial offshore physical trading, local business spending, local employment creation and investment in training and education, substantial offshore trading activities, use of Malaysia as a nerve center to conduct and support offshore trading activities and significant use of Malaysia’s banking and financial services as well as ancillary services.
In light of these factors, Malaysia emerges as the most ideal choice for US companies with Indian investments. The Malaysia holding company also functions as a vehicle for them to gain access to Asia’s emerging markets. In addition, the city state’s pro-business environment, business-friendly tax framework, sophisticated infrastructure as well as strategic location and node connectivity provide an ideal ecosystem to get the best of their presence in Asia.
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