The State of the Nation: The digital tax conundrum

This article first appeared in The Edge Malaysia Weekly, on April 15, 2019 - April 21, 2019.

Senthuran : The new digital service tax is only intended to apply to consumers as businesses are already taxed under the current regime, hence clear guidelines will be needed to avoid confusion. Photo By Deloitte Malaysia

Amarjeet: Governments around the world are considering various options in implementation and enforcement. Photo By Ernst & Young Tax Consultants

Raja Kumaran: We need details of how this is going to be implemented, such as what documentation is needed. Photo By PWC Malaysia

Poon: Income earned may not be territorial anymore for tax purposes. It could be borderless and taxed in many countries. Photo By Crowe Malaysia

Kishenjeet: The potential impact for leakage of government revenues could increase exponentially over the next few years. Photo By Crowe Malaysia

Source: Deloitte Tax Services

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THE 6% digital service tax, announced by the government last week and coming into force on Jan 1 next year, may face hurdles in its execution given that the foreign service providers caught under this tax may not have a physical presence in the country.

The digital tax conundrum is not unique to Malaysia, says Amarjeet Singh, Malaysia tax leader at Ernst & Young Tax Consultants Sdn Bhd. “Governments around the world are considering various options in implementation and enforcement,” he says.

He points out that a key issue in enforcing the tax is how to encourage or ensure compliance among foreign entities with no physical presence here.

“We would expect the large players to take steps to comply with the obligations for reputational reasons. However, foreign service providers can be from any part of the world and the speed of trends these days means it will be difficult to accurately identify or anticipate the actual size and scope of digital services that will be covered under the digital tax scope,” says Amarjeet.

“Potential sources of information could be through financial institutions or payment gateways, which would help the authorities identify the foreign service providers, but this would likely entail costs for both the authorities and the information providers.”

Tax experts agree that more information is needed on the implementation.

“We need details of how this is going to be implemented, such as what documentation is needed and the registration and submission process. We hope to get the details fast. Most businesses want some kind of timeline with regard to the implementation. It is good that the legislation is already out, with the bill passed in parliament last week,” says Raja Kumaran, executive director and indirect tax leader at PwC Malaysia.

“This digital tax is a global phenomenon. Many countries are implementing it, so there should be consistency among the different countries,” he tells The Edge.

Meanwhile, Deloitte Malaysia indirect tax partner Senthuran Elalingam points out that as with any new tax, there will be some teething issues in the implementation.

“In particular, clarification is needed on the scope and definition of digital services and how to distinguish between a Malaysian consumer (individual) and a Malaysian business (corporate). The new digital service tax is only intended to apply to consumers as businesses are already taxed under the current regime, hence clear guidelines will be needed to avoid confusion,” he says.

On enforcement, Senthuran reckons that large global digital companies and platforms will take steps to comply with the requirements to register and collect the tax, as they have done in other countries that have implemented it.

“This should account for the bulk of the digital services Malaysian consumers consume,” he says.

For the smaller providers, he expects the authorities to first try and encourage them to comply by making it easier for them to, for example, register online with simpler information requirements, and pay the tax online.

“If these initial efforts of encouragement do not work, the authorities may then look at other alternatives, including requesting the regulator, the Malaysian Communications and Multimedia Commission (MCMC), to block the IP address of the service provider,” Senthuran says.

Crowe Malaysia managing partner and tax partner Poon Yew Hoe expects the authorities to first encourage foreign service providers to voluntarily register. “If they don’t adhere, then the authorities can, as a last resort, block the IP addresses and the foreign service provider will not be able to undertake their business here. This would also result in consumers not being able to consume the service here,” he explains.

PwC’s Raja Kumaran reckons the challenge in collecting the digital service tax is business-to-consumer transactions because it could be tough to track consumers. “The liability falls on the service supplier — the company providing the services will have to register and pay the tax.  Most  businesses will want to be compliant. I don’t foresee the government having any difficulty in getting them to register in Malaysia,  but those who try to get away with not registering...  MCMC will be able to track the IPs of these companies, although they are not physically in Malaysia,” he says.

The draft legislation of the digital service tax, released last week, sets out the proposed implementation framework. It requires foreign service providers providing digital services exceeding RM500,000 in annual turnover to register with the Customs Department and charge 6% service tax on these services to certain consumers.

Tax experts The Edge spoke to do not have any estimates as yet on how much the Malaysian authorities can collect from the digital tax.

Sunway University Business School economics professor Dr Yeah Kim Leng told The Edge Financial Daily that a tax rate of 6% could potentially yield about RM2.4 billion in digital tax revenue, based on the Statistics Department’s survey that estimated Malaysia’s e-commerce income at RM398 billion in 2015.

However, Deloitte’s Senthuran says the figure above may fluctuate as the e-commerce revenue includes business-to-business transactions, which are already taxed indirectly. “The current 6% announced is for electronic services such as purchase of e-books and digital music or streaming of shows. It is not on physical goods, but when it comes to the e-commerce data, it includes physical goods. So the actual amount the government may be able to collect remains unknown.”

While the amount that can be collected from the digital tax next year is not known, what is known is the approximately RM21 billion shortfall that needs to be filled following the government’s abolition of the Goods and Services Tax (GST) and bringing back the Sales and Service Tax (SST).

 

What about the income of digital service providers?

For now, the digital service tax is an indirect tax — it is based on transactions and not income.

What about digital income earned in Malaysia by foreign services providers that do not have a presence here?

“At this stage, it is not certain how Malaysia will proceed with taxing the digital economy from a direct tax perspective. The authorities are studying various options and also keeping a close eye on international trends prior to formulating an appropriate policy. The option chosen should be one that is fair and easy to implement so as to make it easy for taxpayers to comply with the law in a cost-efficient manner,” says EY’s Amarjeet.

Crowe’s Poon says there continues to be this question of whether a digital tax should be an indirect or direct tax. “It is something countries will have to look into as business models and how income is earned evolves. Income earned may not be territorial anymore for tax purposes. It could be borderless and taxed in many countries,” he points out.

Indeed, countries are aware of leakages in taxes when it comes to digital income.

Last month, German Finance Minister Olaf Scholz raised concerns about tech giants paying tax “nowhere” and stressed the need for the world to find a solution.

Google, Amazon, Facebook and Apple have faced intense criticism in various countries for not paying enough tax.

Scholz told CNBC that coming to an agreement on tax reforms to match the digital age remains a “global” problem.

Interestingly, France has introduced a 3% levy on the revenue of tech companies that earn more than €750 million worldwide each year with €25 million from within France. The UK has also proposed a 2% digital services tax on tech firms that make at least £500 million a year in global revenue.

 

Social media tax next?

Another rising digital trend likely to be on the radar screen of tax authorities is the use of social media as an income platform.

Kishenjeet Dhillon, manager of tax transfer pricing at Crowe Malaysia, points out that social media is increasingly being used as an income avenue.

“The potential impact for leakage of government revenues could increase exponentially over the next few years. A study by GlobalWebIndex notes that social media commerce gained momentum last year. Consumers are increasingly likely to search for products through platforms, such as Instagram, before making a purchase and are even more likely to purchase the product directly if that option is available. Hence, greater questions need to be asked about how administrators can start to tackle the untaxed economy.

“This means that persons operating their businesses through online platforms, like Instagram, would hardly have a business presence in any particular country. Just imagine this scenario: A person develops a large social media following, in excess of 100,000 followers, and thus has sufficient scale to market a particular product around the world. That person then decides to sell products by advertising them through these social media channels and completes the transactions via an online transfer of funds or cash on delivery. These are the types of transactions that are increasingly difficult to track and have become the bane of tax administrators worldwide. Developed nations are scrambling to legislate ways to plug these potential leakages in revenue,” he says.

The digital tax is a sign of the times. Business models and consumer preferences have evolved over time and tax treatments will have to develop too. The question is, can tax structures evolve fast enough to plug the leakages?

 

 

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