This article first appeared in Corporate, The Edge Malaysia Weekly, on April 18 - 24, 2016.

THE competition for foreign direct investment (FDI) in Asean will heat up if Indonesia goes ahead with plans to cut corporate tax rates to 20% from 25% this year to lure more investments into the archipelago.

“We’re seeking a figure that is in line with neighbouring countries but also not too far from other Asean countries. So we think 20% is still competitive in Asean,” Indonesian finance minister Bambang Brodjonegoro reportedly said on April 11. The move still requires parliamentary approval.

While the planned tax cut is being put forward at a time when Indonesia is trying to boost revenue, many market watchers reckon such a move by Asean’s most populous country would certainly impact Malaysia’s FDI in one way or another.

Jakarta’s measures to increase revenue include offering a tax amnesty to encourage rich Indonesians — individuals and businesses — to bring money home from abroad.

Thanks to a 1% reduction for the 2016 year of assessment, Malaysia’s 24% corporate tax rate is currently the second highest in Asean. It is just behind Indonesia’s 25%, while Singapore and Thailand’s rates are 17% and 20% respectively. The tax rate divide between Malaysia and the other three important economies in Asean will widen if Indonesia slashes its corporate tax to 20%. It will make Malaysia’s rate the most expensive for businesses.

“Taxes are a very important factor for businesses when deciding whether to set up operations in a country. Malaysia has cut its corporate tax rate over the years, but not as much as what we have seen in Singapore,” says an economist with a local research house.

RHB Research economist Peck Boon Soon sees a 20% corporate tax rate as “very competitive”, and one that might be just enough to tip some FDI over to Indonesia, given its huge domestic market where the availability of labour may be less of an issue compared with Malaysia.

Nevertheless, United Overseas Bank (UOB) economist Julia Goh highlights that taxes are not the only factor that determines FDI flows.

“The tax rate is one of the reasons, but there are also other factors such as cost, markets, infrastructure, technology, political, legal, social and cultural. Stability in policies and government efforts to improve economic conditions could also shape the decision,” she says.

While Malaysia may be behind the curve currently in terms of tax rates, economists agree the country has a competitive advantage over its larger neighbour.

“In terms of infrastructure, we do have the advantage over Indonesia. I would say that we presently have a more skilled labour force than Indonesia, but they will catch up,” says Peck.

UOB’s Goh adds that in terms of ease of doing business, Malaysia is ranked higher than Indonesia — 18th for Malaysia versus 109th for Indonesia. Among the four neighbouring countries, Singapore takes the lead at the top spot (No 1 in the world), followed by Malaysia (18), Thailand (49) and Indonesia (109), based on the World Bank’s 2016 ranking.

“Malaysia has several tax incentives that could offer partial or total relief from income tax payment for certain periods in selected incentivised areas. In these areas, Malaysia would be a more compelling place,” opines Goh.

Even so, Malaysia’s approved FDI has been trending lower in recent times. In 2015, total approved FDI fell to RM36.1 billion compared with RM64.6 billion in 2014, reports the Malaysian Investment Development Authority (Mida). Approved FDI for both the manufacturing and services sectors saw a decline in 2015.

Admittedly, Malaysia went through a rough patch last year. Not only did the ringgit plunge to new multi-year lows against the US dollar, political uncertainties were heightened and investor confidence was shaken.

The ringgit’s rapid decline amid the heightened political uncertainties could have been one factor for the lower FDI inflows last year, one economist says. Nonetheless, she opines that the sentiment has improved somewhat as investments have been trickling back into the country. “Hopefully, it is a sustainable turnaround,” she says.

UOB’s Goh reckons that Malaysia has not lost its appeal to foreign investors.

“The currency has fluctuated, but we are seeing a turnaround in investor sentiment on Malaysia. There are still some silver linings in the country that would make Malaysia an attractive gateway into Asean. The infrastructure investments in transport and eco-friendly policies will help elevate Malaysia as a place to invest and live in,” she says.

That said, it does not mean that competition to attract FDI is getting any easier these days.

“Many countries are using the same model, which is to attract FDI, to build their economies. The competition is getting more intense,” says Peck.

FDI is an important part of the economy, given its multiplier impact in driving long-term growth, jobs, skills and innovation, says Mida in an investment performance report.

“It has enabled Malaysia to upgrade and diversify the range of products from advanced electronics to semiconductor equipment, medical devices and advanced aerostructures. The strong presence of FDI in the manufacturing sector has also helped enlarge the market through the growth of the supply chain ecosystem and allied services industry.

“Foreign companies have had a significant impact on the manufacturing sector, contributing an estimated 44% of total output, 39% of jobs, 56% of employee compensation and 37% of gross capital formation,” it says.

Economists agree that the country has certainly come a long way from attracting low-value investments to high-value investments, but there is undeniably room for improvement.

“Malaysia has definitely attracted investments that are higher up the value chain. But, China is catching up in terms of attracting high-value-add investments, while the number of high-value-add investments in Malaysia doesn’t seem to be as significant anymore,” says Peck.

Goh, on the other hand, believes there is a need to review and streamline some of the tax incentives offered to businesses. To ensure the country remains competitive to FDI dollars, she also reckons that Malaysia would be in a position to consider a gradual lowering of individual and corporate tax rates, once revenue from the Goods and Services Tax stabilises.

There is another crucial factor to getting the quality FDI Malaysia wants: “To sustain FDI inflows, it is crucial to ensure that we have a supply of educated, skilled and relevant workers, besides ensuring that local businesses are well-equipped and ‘teched-up’ to bolster the domestic supply chains,” she says.

The continued availability of a sizeable, competent and competitive talent pool would likely be the bankable determining factor for investments beyond the simple tax rate lure. 

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