My wish list for Budget 2018 is simply this:
- Reduce the tax burden of resident individuals to compensate for the Goods and Services Tax (GST);
- Review the tax on software by reviewing the definition of “royalty”; and
- Review the source rule for services rendered by non-residents.
My first wish is a repeat of last year’s call for a tax rate reduction. The tax rates should be reviewed and reduced. While the top rate for individuals (those with chargeable income of RM1 million and above) is fine, the lower tax bands should be reviewed so that the middle-income group is not squeezed by taxes and higher prices brought about by GST.
My second wish is for the tax authorities to rethink their approach to taxing payments for the use of software that was adopted under Budget 2017. My third wish is the reinstatement of the source rule for taxing payments for services by non-residents.
Wish No 1: Relieve the tax burden of lower and middle-income groups
The introduction of GST on April 1, 2015, has brought about price increases and increased the tax burden of the people. Especially hard-pressed are the lower and lower-middle-income groups because they spend practically all, if not all, their income. The ubiquitous and invasive nature of this consumption tax means that these groups have had their disposable income effectively reduced by 6%.
Therefore, to compensate for this additional burden, which comes either in the form of GST or higher prices, it is proposed that the income tax rates for the lower and middle tax bands be reduced by one or two percentage points while those for the higher tax bands be increased by one percentage point, with the top rate retained at 28% (see table).
The rationale for the above is as follows:
• It is proposed that residents with chargeable income of up to RM20,000 be relieved of having to file tax returns, thus freeing up the tax authorities’ manpower and resources. While they are currently not required to pay tax because of the RM400 rebate, they still have to file their tax returns. So, there is no tax loss for the government plus a reduction in workload for the tax authorities.
• For those with chargeable income of up to RM35,000, we propose a reduction of the marginal tax rate by one percentage point (from 5% to 4%). This saves the taxpayer RM250 after discounting the RM400 rebate, which will help lighten the GST burden.
• The next two tax bands are for those with chargeable income of up to RM50,000 and RM70,000. We propose a rate reduction of two percentage points each. These taxpayers are from the lower-middle-income group, so the tax savings of RM550 and RM950 are fully justified to compensate for their share of GST.
For those in the next tax band, with chargeable income of up to RM100,000, we propose a lower tax rate of 20%, from 21% currently. The proposed rate is still higher than in our neighbouring countries.
We propose that the tax rate for those with chargeable income of up to RM250,000 be kept at 24% while the higher bands have a one percentage point increase — from 25% to 26% and from 26% to 27%.
It is proposed that the top rate of 28%, for those with chargeable income of RM1 million and above, be maintained.
There will be no loss of revenue for the government. These proposals will lead to the higher-income group paying more tax to make up for the loss of revenue from the lower and middle-income groups.
Wish No 2: Rethink tax on payments for use of software
Under Budget 2017, among the many amendments to the Income Tax Act, two have led to a significant broadening of the tax scope with regard to software and services in cross-border activities. The first amendment concerns the definition of “royalty” while the second changes the source rule for income from the rendering of services.
Definition of software
Among other things, the definition of royalty income was amended by inserting the word “software”. Previously, royalty included income from the use of or right to use the copyright (of literary works such as books and software).
With the amendment, royalty includes the use of or the right to use the copyright, software and so on. Therefore, as the law stands, royalty includes payment for the use of or right to use software.
At this juncture, it is useful to draw an analogy between software and published books. If you write a book and have it published, you own the copyright to the book. You allow the publisher to use your copyright, produce a quantity of your book and sell them to the public. The publisher pays you a sum of money for each copy printed and sold. This is called royalty. The reading public who purchased the book did not pay royalty — they purchased a product.
Using the same analogy, if you write an accounting software, you own the copyright to the software. By paying a fee, businesses subscribe to the use of the software. They do not pay you royalty as they have merely bought a copy of your software (as in the case of the published book).
But if a business pays you to use your accounting software as well as the right to adapt it to its needs, or the right to replicate it and allow others to use it, the business is paying you to use your copyright to the software. This payment is rightly called royalty.
With the amendment
Any money paid for the use of or the right to use software is “royalty” for tax purposes. So? What’s the big deal?
The fact is, nowadays, there is embedded software in nearly everything we buy — washing machine, refrigerator, mobile phone, car. In all these products, it can be said that part of the purchase cost relates to the use of or right to use the software. So, part of the purchase cost is royalty payment in nature.
The tax impact
If you purchase such products from a non-resident, you are obliged to withhold tax of 10% at the source. And if you fail to do so, very punitive penalties await you.
Potentially, the cost of doing business goes up if the Malaysian buyer has to bear the tax. So, in the business context, when you acquire equipment, machinery and so on from overseas, you are likely to be confronted with this withholding tax problem. Since January, when the new definition came into effect, there has been unease within the business community over this matter.
I hope the tax authorities will rethink the definition of royalty and revert to the internationally accepted concept of royalty, as being for the use of the copyright of the software instead of mere usage of the software.
Wish No 3: Source rule for income from services
The other impactful amendment relates to the rules to determine whether payment for services from foreign persons is sourced or derived from Malaysia. The significance is the recipient of such payments is only subject to tax in the country if the income is derived or sourced from Malaysia.
Previously, if a Malaysian business procured services from outside the country, the services had to be rendered in Malaysia. The payment for such services would have been deemed to have been derived from Malaysia and, hence, would be subject to local tax laws.
By implication, if the services were performed outside Malaysia, the payment would not be considered derived or sourced from the country and would not be subject to local tax laws.
With the amendment
The requirement for services to be rendered in Malaysia was removed. With this removal, if a Malaysian resident pays a non-resident for services, or the payment is charged as an expense against any business carried out in Malaysia, regardless of whether the service is rendered in the country, the payer must withhold tax of 10% at the source and only pay the remaining 90% to the non-resident service provider. Again, any failure to comply with the withholding tax law will result in punitive penalties.
By way of illustration, an infrastructure project in Malaysia encounters a technical problem and seeks advice from a foreign company with the requisite experience/expertise. Through conference calls, the advice and experience are shared and the problem is solved. The foreign party will understandably argue that the fee for technical assistance was not derived from Malaysia as they had never set foot in the country.
Imposing tax in such a case will result in double taxation by Malaysia and the foreign country. Even if a double tax treaty between Malaysia and the foreign country subsists, the foreign country’s tax authorities may decline to grant double tax relief because the subject payment would not be recognised as derived from Malaysia under international tax concepts/principles.
The tax impact
The business community is rightly concerned about this. Many services are rendered by foreigners from their overseas bases without having to set foot in Malaysia. Understandably, they may resist having to bear the withholding tax in Malaysia, thereby resulting in the local business having to pick up the tab.
The potential increase in the cost of procuring services from outside Malaysia and the potential unintended non-compliance with the Malaysian withholding tax regime do not help generate a climate of business confidence. I urge the government to consider reinstating the requirement that services must be performed in the country for them to be considered sourced from Malaysia and be subject to local tax laws.
I do not believe that the above is wishful thinking. I hope that the powers that be will give the proposals more thought for the sake of a more business-friendly environment in Malaysia.
Yong Siew Chuen has wide experience in Malaysian taxation. She now focuses on tax training and coaching. Comments: [email protected].