My Say: Tax implications of mergers and acquisitions in Malaysia

This article first appeared in Forum, The Edge Malaysia Weekly, on February 5, 2018 - February 11, 2018.
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While mergers and acquisitions (M&A) slowed globally in 2017, Malaysia was an exception. It recorded US$17.57 billion (RM68.24 billion) from 408 M&A, the highest in five years, according to Duff & Phelps’ latest Transaction Trail report published in December. This can be attributed to the inbound investments in financial services sectors as well as in the energy, construction and consumer sectors.

M&A is one of the strategies companies employ to avoid competition among themselves and to add to their market offerings. It is for the mutual advantage of the acquirer and acquired companies. It serves as an apt method of corporate restructuring to bring about a change for the better and make the business environment competitive. Most such transactions, especially the more complex ones, take place in the Greater Klang Valley region as it has the largest concentration of banks, financial advisers, investment banks, accounting firms, law firms, valuers and appraisers as well as other consultants.

Mergers involve the combination of two companies to form one, while an acquisition happens when one company is taken over by another. The general reasoning behind M&A is that two separate companies coming

together create more value compared with being

separate entities. With the objective of wealth maximisation, companies keep exploring different options through the M&A route.

In Malaysia, M&A can take place in numerous ways. The most common ways are purchasing assets, purchasing common shares, exchanging shares for assets and exchanging shares for shares. However, there are other ways, such as:

•     Formation of a joint-venture company;

•     Acquisition of certain public companies listed on the Malaysian stock exchange pursuant to mandatory takeover requirements under the Malaysian Code on Take-Overs and Mergers 2016;

•     Selective capital reduction under the Companies Act 2016; and

•     A scheme of arrangement sanctioned by court order under the Companies Act.

In Malaysia, tax is mainly governed by the Income Tax Act 1967 (ITA), Stamp Duty Act 1949 and Real Property Gain Tax Act 1976. Stamp duty on share transfers is generally lower than on asset transfers, which is 1% to 3% depending on the value of the transaction.

There is also no capital gains tax on the sale of shares with the exception of shares in “real property companies” (RPCs).  An RPC is a controlled company that owns real property or shares in another real property company or both, whereby the defined value of real property or shares, or both, owned is not less than 75% of the value of its total tangible assets.

Besides stamp duty and real property gains tax, one would need to be mindful of transfer pricing and anti-avoidance rules. Anti-avoidance rules are included to defeat or pre-empt

avoidance schemes or mischief, or to plug loopholes.

Some of the anti-avoidance provisions under ITA that may be applicable to M&A include the power the director-general has to disregard transactions, in particular between related parties, that he believes produce the effect of altering the incidence of tax, relieving from tax liability, evading or avoiding taxes, or hindering or preventing the operation of the Act on the grounds that such transactions are not at par with transactions between independent parties dealing at arm’s length.

Section 140 of ITA is pertinent here. If an M&A structure chosen by the taxpayer is uncommon, inappropriate or strange (if the structure does not make sense from an economical point of view); or it appears that the structure has been chosen only to save taxes that would normally be due; and the structure would result in a substantial tax saving if accepted by the tax authorities, the director-general may invoke Section 140 either to disregard or vary such a transaction to counteract its intended effect.

Thus, to ensure that the planning of any business activities and transactions between related parties is considered legitimate, the following factors should be considered:

•     There should be a proper legal form that is enforced or enforceable;

•     The transaction must be proven to have commercial substance such as an effective business model or established brand;

•     It must not be a sham transaction devoid of any substance or purpose other than to avoid tax;

•     The transaction must be carried out in the ordinary course of commercial activity and not contrived purely to achieve a tax advantage; and

•     it must be transacted at arm’s length at the prevailing market price, that is, it can stand up against a transfer pricing scrutiny.

Section 140A came into effect on Jan 1, 2009, specifically addressing transfer pricing issues. The section requires taxpayers to determine and apply the arm’s length price on controlled transactions. The director-general is allowed to make an adjustment to reflect the arm’s length price, or interest rate, for that transaction by substituting or imputing the price or interest, as the case may be; and to disallow considerations for controlled financial assistance that is deemed excessive in respect of a person’s fixed capital.

A share acquisition merger that involves transferring of inherent liabilities via debt assignment by the seller in a target company to the acquiring company may warrant non-deductibility of the interest expense if it is akin to a debt push-down structure. This would not have happened in an asset acquisition situation where the buyer avoids undertaking any contingent risks associated with the target company, be it legal, commercial, operational or taxation-related risks.

Asset acquisitions between related parties are subject to rules relating to disposals that are subject to controls as provided for in paragraphs 38 to 40 of Schedule 3 of the ITA. This is to address the possibility that a disposal price can be manipulated.

The limitations on deductibility of interest on borrowings are as follows:

•     Under the single-tier dividend system introduced in 2008, dividends will be treated as tax-exempt income and interest on borrowings used to finance acquisition of shares in companies will be disregarded or not available for deduction. Any strategies to push debt down to operating company levels and innovative finance instruments, including offshore finance structures, will be scrutinised thoroughly for eligibility of interest deduction against the related sources of income.

•     BEPS Action Plan 4 addresses the use of related-party and third-party’s debt to achieve excessive interest deductions or to finance the production of exempt or deferred income and other financial payments that are economically equivalent to interest payments.

•     Earnings Stripping Rules (ESR), which will come into force on Jan 1, 2019, can be used to limit the excessive interest expenses claimed as deductions by companies. The amount of interest to be restricted is ascertained by a ratio to be determined, ranging from 10% to 30% of the company’s profit before tax using either earnings before interest and taxes (Ebit) or earnings before interest, taxes, depreciation and amortisation (Ebitda). Interest in excess of the prescribed ratio will not be deductible in the year it is incurred.

Manipulation of withholding tax using a related Malaysian incorporated company in Labuan as a conduit for payments made to a non-resident person, which otherwise would have been paid directly to the non-resident person and subject to withholding tax, is considered as an avoidance act.

In addition to the above, there are other industry-specific rules that the relevant companies should familiarise themselves with when undertaking M&A to stay on the right side of the law. Finally, all companies must stay abreast of amendments to tax legislation and ensure voluntary compliance.

Datuk Seri Sabin Samitah is CEO of the Inland Revenue Board

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