The State of the Nation: Considerations in reforming Malaysia’s tax system

This article first appeared in The Edge Malaysia Weekly, on September 17, 2018 - September 23, 2018.

The committees are part of the agenda for fiscal consolidation without undermining the economic growth and prosperity of the people

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LAST Friday, Finance Minister Lim Guan Eng announced the appointment of Tan Sri Hasmah Abdullah as chair of the newly established Tax Reform Committee. This followed his announcement weeks earlier of the setting up of the committee, along with a public finance committee, tasked with helping to reduce the country’s fiscal deficit, among others.

Lim had said then that the committees are part of the agenda for fiscal consolidation without undermining the economic growth and prosperity of the people. This is also in line with the Pakatan Harapan manifesto pledge to undertake a holistic review of the national tax system.

“Among the main objectives of the Tax Reform Committee are to reduce the existing tax gap, address tax leakage, explore new sources of revenue, study the taxation of the digital economy and review the effectiveness of various tax incentives as provided by the law,” says Lim in last Friday’s statement. The appointments of tax experts Dr Veerinderjeet Singh, Datuk Chua Tia Guan and Amardeep Singh to the committee were also announced.

The Ministry of Finance will be represented by Tax Department secretary Datuk Khodijah Abdullah, Tax Department deputy secretary Mohd Sakeri Abdul Kadir and Fiscal and Economic Department deputy secretary Mohd Hassan Ahmad.

As the committee members come together in the coming days to look into tax reform, one has to wonder: Where do they start?

Many would agree that for a country that aspires to join the ranks of developed nations, the tax system has meandered along with little broad-based tax policy in mind. This can be seen from the often ad-hoc policies and changes made to tax legislation over the years.

One key problem with the Malaysian tax system is the narrow tax base. This is a challenge for the government when trying to extract tax revenue. It has been previously reported that only 21% of registered companies in Malaysia are subject to income tax and only about 15% of the labour force is paying individual income tax. But, of course, part of the problem is that wages are too low, an issue various agencies and economists have repeatedly raised.

Chartered Tax Institute of Malaysia president Seah Siew Yun says the tax system has not been reviewed for a long time.

“In the past, reviews have been done on a very selective basis. Not on a scale of a reform. ‘Reformation’ in itself is a very big word and you cannot expect it to happen overnight. We also have to bear in mind that even the slightest change can impact the economy,” she says.

Seah adds that reformation cannot be only about cutting tax rates; there must be measures to spur economic growth and create a level playing field for businesses to compete.

At this juncture, Veerinderjeet, the chairman of Axcelasia Inc, believes that what is needed is a holistic review of the entire tax system.

(Note that The Edge spoke to Veerinderjeet before his appointment was announced.)

“This should be done to establish if the system we have now is the most appropriate one to take us through the next 20 to 30 years,” he says.

However, Seah feels that reforming the tax system would be more effective if it is done from a short to medium-term perspective, but would have an immediate impact on the economy.

Amarjeet Singh, EY Malaysia’s tax leader, is of the view that what is most important now — at a time when the government debt is huge — is to take steps to reduce it. While measures have been taken to address the country’s fiscal position through the postponement and cancellation of various mega infrastructure projects, he believes the government needs to be mindful of the impact this would have on the economy.

He says the private sector needs to be encouraged to fill the gap arising from the cancellation of the projects.

“Hence, in my view, the most important reform is to identify new areas of growth and to consider how the government can use taxes as a tool to encourage more private-sector investment and attract foreign direct investment (FDI) into these areas for economic growth.

“From a tax angle, perhaps one area to consider for reform would be the application of our tax laws to the current global business environment such as the digital economy and cryptocurrency. How business is done has evolved significantly and at a rapid pace. Our tax laws need to address these developments to give certainty to businesses,” he says.

Deloitte Malaysia country tax leader Sim Kwang Gek shares a similar view. She believes that what is crucial in tax reform at this juncture is to broaden the tax base, given that tax revenue will now be reduced as a result of the abolition of the Goods and Services Tax.

“Based on government statistics, the reversion to the Sales and Services Tax system is expected to result in an annual shortfall of RM20 billion versus the GST. We cannot be overly dependent on oil-related revenue,” she says.

Oil-related revenue made up 14.9% of total federal government revenue last year, based on the 2017 Economic Report. However, it should be noted that crude oil prices have been weak since 2015.

One way the government can increase its revenue base, says Sim, is to consider a form of digital tax, taking into account that technological developments have enabled business to be carried out virtually anywhere without the need to have a physical presence.

“Currently, we do not have specific provisions under the Income Tax Act 1967 to deal with e-commerce or digital businesses, and it is time for an in-depth study of the current tax legislation to ensure that we do not lose our fair share of taxes,” she says.

It is worth noting that Deputy Finance Minister Datuk Amiruddin Hamzah said last week that the government is considering a digital tax on overseas content and services providers as a potential new revenue source.

Many tax consultants agree that the tax incentive regime is due for a revamp and it is something global business unions have been calling for.

“As a developing country, the tax incentive structure could be the weakest link as we may have given away too much in our effort to attract investment and too many entrenched parties may have leveraged these incentives,” says Veerinderjeet.

Sim believes it is time for the government to take a step back, to assess the effectiveness of the tax incentives being dished out.

“The list of promoted products or activities should be reviewed to ensure that we are getting the investments that outweigh the tax revenue loss, promote research and development, technology, innovation and are friendly to the environment,” she says.

Amarjeet says areas of tax reform that can be looked into are the equity of the provisions in our tax laws and tax provisions as well as the need for more consultation in formulating and introducing new tax laws or policies.

“In terms of equity, for example, penalties on the understatement of tax are imposed on the total tax liability of the taxpayer, without taking into account the tax instalments already paid. There is a need to undertake a comprehensive review of the tax legislation to identify inequitable provisions and consider amendments to such laws and, in addition, where possible, to simplify the tax administration,” he says.

He also hopes there will be more consultation in the process of introducing new tax laws or policies as this would allow different perspectives to be considered to refine the legislation.


New taxes to increase government revenue?

Many anticipate that new taxes will soon be introduced to make up for the shortfall in tax revenue arising from the abolition of the GST. Moreover, with the mountainous debt the government recently revealed, it is a fact that the nation’s coffers need to be replenished somehow.

While reducing expenditure and tax leakages and promoting compliance with tax law can help stem shortfalls in the near term, raising revenue is also a crucial aspect as taxation is one of the main revenue streams for governments.

“As a nation that competes for investments in the region, we have constraints on how high our tax rates can go. In fact, many nations have lowered their corporate tax rates, which is the ideal way forward, provided the country’s financial situation and the economic environment are managed well,” says Veerinderjeet.

Sim believes that new taxes, such as a digital tax, can be introduced in line with digital and e-commerce development.

“However, before making fundamental changes to the tax system, there must be engagement with a wide range of taxpayers and other stakeholders to enable a thorough review of how value is created by digitalisation and how this can be encouraged through pro-growth and fair tax policies,” she says.

Amarjeet, meanwhile, does not favour the introduction of new taxes.

“The risk of introducing new taxes, or expanding the existing scope, may make doing business in Malaysia more expensive. While there may be a short-term gain in tax revenue, the mid to long-term risk is that businesses may move out of the country, which will eventually result in an overall reduction in tax revenue.

“If we can introduce measures that attract private-sector involvement and FDI, perhaps through lowering tax rates, more businesses will be encouraged to reinvest in Malaysia, thereby resulting in higher overall tax revenue in the long run,” he says.

Seah says new taxes or increases in taxes could cause an adverse reaction among those impacted. But, if the new taxes are narrow in scale, to prevent a broader adverse reaction, she questions whether they would be effective at the end of the day.

Before any new taxes are introduced, she adds, a holistic review of the entire tax system should be done to understand the potential implications of the new tax.

“If new taxes target only a small group, will they be effective? We will also have to consider if the collection will have an impact on the nation’s coffers. Otherwise, that is a lot of time and resources spent on implementation,” she muses.

At the end of the day, one thing for sure is that the Tax Reform Committee has a gargantuan task ahead in reforming the tax system.



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