Budget 2018 was widely labelled the “mother of all budgets”, if you recall, as it was tabled in the run-up to Malaysia’s 14th general election. We are now several days away from Budget 2019 and it is just as highly anticipated, if not more, being the maiden budget of the Pakatan Harapan government. Crafting Budget 2019 would have been a delicate balancing act as the government strives to continue to sustain the upward trajectory of Malaysia’s economy against the backdrop of our country’s overwhelming debt burden and continued fiscal deficit.
Two promises in PH’s election manifesto specifically addressed taxation. The first was the abolition of the Goods and Services Tax (GST), which was achieved in the first 100 days of the new administration. The second was to introduce a friendlier tax system, one that was more efficient, neutral and progressive while ensuring sustainable economic growth with minimal burden to the rakyat. To realise this, the Ministry of Finance recently formed the Tax Reform Committee, comprising tax and finance experts, to conduct a holistic review of the tax system.
Taking the developments of the past few months into account, here is what we expect to see when Budget 2019 is announced on Nov 2.
1. Widening the tax net
There has been much speculation about whether the government will introduce new taxes as part of its fiscal consolidation. Will there be a capital gains tax, an inheritance tax or a soda tax?
Or will sin taxes increase? Will the scope of personal taxes be broadened?
The gradual introduction of new taxes should be viewed positively as it would diversify the country’s sources of tax revenue. Currently, the country relies heavily on direct taxes. Over the medium term, the additional income derived should provide room for the government to consider reducing Malaysia’s headline corporate income tax rate (currently 24%). Finance Minister Lim Guan Eng has mentioned that this rate will remain for at least the next two years, given the immediate focus on reducing the country’s debt. But we believe a further reduction to between 20% and 22% over the mid-term would be much welcomed by corporations and improve our competitiveness as a location to do business.
For the man on the street, any broadening of the scope of personal taxes should be balanced with a review of the current rates and brackets as well as relief available.
The introduction of any new taxes or broadening of existing ones should be preceded by a detailed study, paired with a robust consultative process with relevant stakeholders such as regulators and industry representatives. Given these intricacies, we think that an entirely new tax regime at this stage may be too much for us to chew on. It is more likely that we will see a broadening of the scope of existing taxes instead.
2. Taxing the digital economy
Despite the exponential growth in the digital and sharing economies over the last couple of years, this segment of the economy remains largely untaxed due to the borderless nature of its operations. However, this is changing fast. Singapore, for example, has already confirmed that GST will be imposed on digital services imported by consumers based in Singapore with effect from Jan 1, 2020. Thailand is also proposing to impose value-added tax (VAT) on imported digital services. Globally, more countries are closely monitoring and introducing measures to deal with this business model.
We expect Budget 2019 to propose some gradual form of taxes on the digital and sharing economies either through a withholding tax or service tax. If Malaysia were to follow current global trends, foreign providers may be obliged to register and pay taxes on the products and services sold in Malaysia.
3. Assistance to SMEs
Reforms to the tax system should be more inclusive, benefiting small and medium enterprises, which form the backbone of the economy. According to 2017 statistics, SMEs contributed 37.1% to Malaysia’s GDP in 2017. A tax resident SME here is entitled to a reduced tax rate of 18% on the first RM500,000 of chargeable income, with any excess taxed at 24%.
But there is currently a mismatch between the tax definition for SMEs and that adopted by SME Corporation Malaysia. The former is based on the paid-up capital of the company while the latter is based on sales turnover or employee headcount. We believe the paid-up capital of a company may not accurately measure whether it is an SME. Thus, we believe the tax definition should be aligned with that of SME Corporation, allowing more SMEs to enjoy the reduced tax rate.
A bolder move would be to prescribe a simpler set of tax rules for SMEs, which would reduce their compliance costs and administrative requirements. Another consideration is for SMEs below a certain threshold to be taxed based on a fixed prescribed amount or a percentage of audited net profit. A simpler tax system would not only help accelerate the growth of SMEs but it could also potentially increase voluntary compliance among them.
4. A review of the current tax incentive regime
In the coming fiscal year, we anticipate a tightening of incentives, given Malaysia’s commitment to prevent base erosion and profit shifting (BEPS). There will be greater expectation of companies to have adequate commercial substance in Malaysia, such as business spending and employees with the relevant skills, if they wish to qualify for incentives. The finance minister himself has been managing expectations by informing the rakyat to brace for a budget with “no goodies”.
However, we believe the existing tax incentive regime, which is predominantly manufacturing-driven, needs to be reviewed holistically and a targeted approach should be adopted so that the government can stimulate the growth of the new economies.
We hope that the incentives currently available to the service industry will be enhanced, specifically those that focus on R&D and innovation. For example, tax incentives for automation given to manufacturing companies for Industry 4.0 investments should be extended to include the service sector.
To increase our R&D capabilities, tax exemptions should perhaps also be given to royalty income derived from locally developed intellectual property.
5. Amendment of legislation to enforce compliance and increase transparency
It was certainly a relief for businesses when the finance minister shared that the Inland Revenue Board of Malaysia (IRB) had been asked to adopt a friendlier approach to auditing taxpayers. In keeping with this spirit, we hope Budget 2019 will introduce some changes to provide taxpayers with a better experience while ensuring the correct amount of taxes is paid.
An immediate recommendation is in relation to the current rule requiring a taxpayer to settle tax liabilities first regardless of whether an appeal will be made. Where the tax bill is substantial, this “pay first, talk later” approach may be costly for businesses, especially SMEs, as they will then have to obtain short-term external financing to meet their working capital requirements, incurring additional interest cost in the process. To ensure a win-win situation for both parties, we believe the government should consider introducing an interest mechanism in relation to outstanding tax liabilities under appeal.
There are currently two legal provisions that empower the finance minister to exempt any person from paying tax. One is by way of statutory order, which must be laid before parliament, while the other is merely an approval letter from the finance minister. In the case of the latter, there has been a suggestion to repeal this discretionary power granted to the finance minister on the grounds of transparency.
This suggestion certainly has some merit, if we look at past media reports that have exposed the various sweetheart tax deals granted by certain European countries to reputable multinational companies in order to attract their investments. However, the potential time and uncertainty involved in going through parliament should not be discounted as this does not bode well from a commercial perspective.
Instead, more checks and balances should be incorporated into the process. A way of doing this is for all tax exemption applications to be evaluated and approved by one body — the National Committee on Industry (NCI), comprising representatives from various regulatory agencies, including the Ministry of Finance and IRB. This would be consistent with the NCI’s current role of approving tax incentive applications received by the Malaysian Investment Development Authority (MIDA).
Everyone, from the ordinary Malaysian to local and international investors and businesses, will no doubt be keeping a close watch on Budget 2019 for a sense of the direction in which the country is headed. Being the current administration’s first budget, it will likely be seen as a benchmark for the development of future economic and fiscal policies. While more belt-tightening measures are expected this time around, we are hopeful that Budget 2019 will pave the way for more strategic improvements to the economy and well-being of the rakyat.
Steve Chia is a partner and Lee Boon Siew is a senior consultant at PwC Taxation Services Sdn Bhd