This article first appeared in The Edge Malaysia Weekly on January 15, 2024 - January 21, 2024

THE new and expanded tax regime under the unity government is expected to eat into the returns of unit trust funds with exposure to bonds and overseas markets, affecting more than 10 million investors. With the implementation of the capital gains tax (CGT), unit trust funds that make a profit from the trading of bonds will be taxed at 10%.

Also, in line with the introduction of CGT, foreign-sourced income (FSI) will be extended to include capital gains from overseas investments. This means unit trust funds, including feeder funds, with overseas exposure will be taxed at an income tax rate of 24% on the capital gains repatriated to Malaysia.

CEOs of asset management firms were shocked when they found out that CGT applies to bonds as well, not just unlisted shares.

“Yes, it caught everyone by surprise that the definition of ‘shares’ under the CGT includes bonds and debentures,” says Danny Wong, CEO of fund management company Areca Capital Sdn Bhd.

Deloitte Malaysia’s financial services industry tax leader Toh Hong Peir says CGT only applied to the disposal of unlisted shares when it was announced in Budgets 2023 and 2024.

“However, the tax law that gives effect to the CGT provides a broad definition of the word ‘shares’,” he explains.

The Finance (No 2) Act 2023 (passed in parliament on Dec 13 and gazetted on Dec 29 last year) refers to “shares” as “stock and shares in a company”. It is also defined as “loan stock and debentures issued by a company or any other corporate body incorporated in Malaysia”.

This means that capital gains from the disposal of loan stocks, debentures, bonds and sukuk will be subject to CGT.

“In the case of CGT, the disposal of unlisted ‘shares’ (including bonds), the tax rate is generally at 10%. The returns [on bonds and other funds that invest in bonds] will be impacted,” says Toh.

For context, the Finance Bill is passed every year after the budget is announced and debated. It becomes law once it receives the royal assent and takes effect when it is published in the government Gazette.

“Unit trusts had been exempted from tax on gains arising from the realisation of investments. With the introduction of CGT, unit trusts no longer enjoy such exemptions. Instead, gains arising from the realisation of investments will be treated as capital gains and subject to CGT.

“For non-unit trust set-ups, gains from the trading of securities are generally subject to tax as [a form of] business source income at 24% tax rate, which means they are not affected by the introduction of CGT,” says Toh.

With the introduction of CGT, the taxation of FSI will be extended to include gains from disposals of foreign capital assets, on top of other forms of income, such as coupons, dividends and rental income that have already been taxed since 2022.

Certain entities that meet the definition of “qualifying person” have been exempted from FSI tax — excluding capital gains — since 2022. Unfortunately, unit trust funds are not on the list, which means they have been taxed on FSI at 24% since 2022.

Effective Jan 1, 2024, unit trusts will also be taxed on capital gains from FSI at 24%. Having said that, the Ministry of Finance tells The Edge it is looking into the fund management industry’s request for exemption “favourably”.

CGT and the extension of FSI to include capital gains are a double whammy for the unit trust industry.

Nevertheless, double taxation agreements between Malaysia and other countries should provide some respite from the impact of the new tax regime.

Federation of Investment Managers Malaysia (FIMM) CEO Kaleon Leong says the organisation and Securities Commission Malaysia (SC) are communicating with the government to resolve tax issues affecting the unit trust industry.

At the moment, CGT does not apply to individuals if they were to trade bonds themselves. Individual tax residents and non-residents are also exempted from income tax on foreign sources until Dec 31, 2026 under the existing exemption order, according to Deloitte’s Toh.

However, if the government’s goal is to tax corporations and business entities without burdening individuals, it would be better to continue providing tax exemptions to unit trusts, as almost all unitholders are individuals.

“There were over 25 million [unit trust accounts] in 2022. Even if a person has two to three accounts, I estimate there are more than 10 million individuals who invested in unit trust funds locally.

“More than 98% of investors in unit trust funds are individuals, with several having exposure to foreign investments, bonds, sukuk or unlisted investments,” says Leong.

Under the new tax regime, those who invest in unit trusts under the Employees Provident Fund Members Investment Scheme (EPF-MIS) and Amanah Saham Nasional could also be affected.

According to the SC’s 2022 annual report, local fund management companies had assets under management (AUM) of RM906.46 billion as at end-2022, of which RM487.94 billion (53.83%) came from unit trust funds. Furthermore, RM157.83 billion (17.41%) came from the EPF and RM76.5 billion (8.44%) from wholesale funds mainly accessible only by high-net-worth individuals.

From an asset class perspective, of the RM906.46 billion, about RM210 billion (23.25%) invested in fixed income.

From a geographical viewpoint, RM281 billion (31.06%) was invested outside of Malaysia.

For comparison, Bursa Malaysia’s 2022 annual report shows that the total central depository system (CDS) accounts stood at 3.1 million as at end-2022, up from three million the previous year.

Active CDS accounts in 2022 stood at 2.1 million, as compared with two million in 2021. These numbers show that many more Malaysians invested in the financial markets through unit trust funds than directly in the stock and bond markets. It also does not help that many Malaysians are already not saving enough for retirement, a situation exacerbated by the Covid-19 pandemic.

“There are about four million EPF members who diversified their investments into unit trust funds, most of whom have exposure to foreign investments, bonds and sukuk. The pandemic has affected the retirement savings of many people. The imposition of taxes on unit trust funds will further deplete their nest egg,” says Leong.

He says diversification is a key and basic principle in investing, and investors shouldn’t be discouraged from diversifying their investments abroad through unit trust funds. Furthermore, on the grounds of parity, individuals who invest directly in overseas markets are not subject to the FSI (exemption until Dec 31, 2026). Hence, individuals who invest through unit trusts with foreign exposure should also be exempted from it, he adds.

Individuals aside, industry experts say the new tax regime would weigh on the bond market and increase the funding cost for corporates who raise funds through debt instruments.

Areca’s Wong says the CGT would hit a wide range of investors as they could be taxed not only when they trade bonds, but also when buying bonds at a discount and holding them until maturity. “The bond market is already not very robust due to the attractiveness of yields and liquidity. The CGT will further dampen market sentiment, making it very challenging for corporates to expand their businesses through issuance of bonds.”

If nothing changes, Wong expects a major pullback in demand for bonds. Most funds will instead be channelled into low-cost, passive investment instruments such as exchange-traded funds (ETFs).

“Passive investments [that track index performance] will not channel investors’ money to the right segments of the economy [that are most in need of funds and with the potential to grow],” he adds.

RAM Holdings Bhd group CEO Chris Lee says that on the surface, CGT should not affect bond issuers as long as stamp duty exemptions remain and coupons paid on bonds issued can be deducted from the taxable profit of the issuers. “Nonetheless, bought deals, where the primary bond subscriber buys up the whole bond issuance and subsequently sells it to other investors for capital gains, may be less profitable if the sale is subject to CGT.

“Primary bond subscribers may also try to pass on the cost of CGT to the issuers by demanding higher primary yields, thus increasing funding costs for the issuers,” he says, adding that if CGT is only applied to “profit upon disposal”, then it shouldn’t affect hold-to-maturity bond investors.

“Even so, more hold-to-maturity investors will be negative for bond secondary market liquidity as bondholders, who act as the sellers, will need to factor in CGT in their trading decisions. This could disrupt the price discovery process in the form of wider bid-ask spread,” he says.

Already, bond trading activity in Malaysia has been fairly low, with the turnover ratio on a declining trend over the years. Low trading activity is especially pronounced for corporate bonds, as compared to government bonds, says Lee.

“For 2023, the turnover ratio for corporate bonds is around 0.2 times while for Malaysian Government Securities (MGS) and Government Investment Issues (GII), it is around 0.8 times,” says Lee.

According to the tax consultant who doesn’t want to be named, the introduction of CGT is also due to pressure from the European Union (EU) and the US to align tax rates globally as much as possible.

“They want to see Asian countries implementing capital gains tax as many don’t have CGT. We didn’t see it in Malaysia, Singapore or Hong Kong.

“So, to some extent, Asia is perceived as a tax haven. Some companies will use Asian countries to invest in Europe or elsewhere through various vehicles to avoid CGT.

“However, I would say that the way CGT has been rolled out here is a bit haphazard. Many investors are affected and have been caught by surprise,” he says.

The good news, perhaps, is that industry players are proposing potential solutions to the government. It is understood that regulators are engaging the government to address challenges posed by CGT as well.

FIMM’s Leong says the government could “reinstate Schedule 61 of the Income Tax Act 1967 for unit trust funds”, which means exempting unit trust funds from the CGT. The government could also consider exempting unit trust funds from FSI tax.

That could happen, as it wasn’t the government’s intention to impose CGT on individuals, based on the announcement for Budget 2023 and 2024, says Deloitte’s Toh.

“We also understand that the vast majority of the unitholders in unit trust funds are individuals. As such, the government should continue to exempt unit trust funds from CGT, and include unit trust as ‘qualifying person’ for purposes of the FSI exemption order.

“Alternatively, if the government intends to tax non-individual unitholders [of unit trust funds], they can continue with the tax exemption at unit trust level, but impose withholding tax on distributions by unit trusts, which is similar to the current withholding tax on retail money market funds.

“The government is aware of these issues and is working with the industry towards a better solution,” he says. 

* After this article came out in The Edge Malaysia's January 15 issue, Finance Minister II Datuk Seri Amir Hamzah Azizan announced on Jan 16 that unit trusts would be exempted from capital gains tax and tax on foreign-sourced income. 
 

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