Tax on digital economy
The Government has proposed to collect GST from foreign companies operating in Malaysia under the digital economy
THE tax offices of governments around the world are getting pretty worked up about the digital economy. They seem to be playing catch-up with businesses that are able to stealthily move into their countries without a traditional physical presence. And not only that, their product offerings are entirely in the form of bits and bytes.
What this means is that there isn’t any physical goods coming into the country through Malaysian ports or airports, where taxing them is easy.
These tech companies are able to run a thriving business in the country and yet fall within a grey area of the law as far as tax collection is concerned.
Present laws and enforcement actions do not cater to the workings of global companies ranging from Uber to Netflix to Airbnb. And these are only the established names. There could be hundreds if not thousands of other providers of products ranging from e-books and mobile games to the purchase of songs through Internet-based platforms that are already making brisk business selling their wares to people around the world, including Malaysians.
This is why the Government reckons that billions of ringgit are being lost in tax collection every year from the digital economy. Will it be able to collect this money?
According to Customs Department director-general Datuk Seri Subromaniam Tholasy, the plan is to amend the goods and services tax (GST) Act 2014 to enable the Government to collect taxes from foreign service providers operating in Malaysia under the digital economy.
Subromaniam says the Customs Department aims to propose the amendments when the Dewan Rakyat reconvenes next month.
So, why don’t the current laws capture the digital economy tax?
Under conventional tax rules, two key taxes are noteworthy in this context, namely, the income tax and the consumable tax, the latter now consolidated into the GST in Malaysia. Individuals and corporations pay income tax, the latter referred to as corporate tax.
These taxes are traditionally linked to the location of where businesses are operated from.
If one is based in Malaysia, for example, one pays income tax under Malaysian tax laws. And consumption tax is based on where one consumes that product or service. In Malaysia’s case, it is clear that the Government has set its attention on the GST for the digital economy because of the significant amount of digital services Malaysians are consuming.
For example, while Malaysians use a lot of ride-hailing apps, it is likely that neither Uber nor Grab is collecting the GST for the Malaysian Customs, as customers’ receipts do not indicate this.
However, both organisations have said that they are open to discussions with the Malaysian government on paying the GST.
Tax challenges
But even before the dawn of the digital economy, tax issues have been complicated as governments strove to catch large companies from avoiding taxes. Large companies often have operations in multiple countries to produce one end product. So, the question is, where does that company pay its tax? This is where the old problem of transfer pricing had first come about in the 1980s, when some multinationals were accused of transferring their profits to locations with the lowest tax requirements.
Over the years, though, various efforts have been made to make these large organisations pay their fair share of taxes. The official name given to this method of tax avoidance is base ero- sion and profit shifting or BEPS.
According to the Organisation for Economic Cooperation and Development (OECD), BEPS refers to tax avoidance strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations.
And now bodies like the OECD are after the tech companies operating in the digital economy.
According to reports, tech giants are stashing billions in offshore tax havens. According to Bloomberg, home-sharing platform Airbnb manages its finances “via units in Ireland and tax havens like Jersey in the Channel Islands” that will allow it to avoid the grasp of the Internal Revenue Service.
Uber, meanwhile, uses a Netherlands entity headquartered in Bermuda to shield its non-US income from US taxes, according to Fortune.
The problem with trying to tax foreign digital service providers is that most of these companies are not located in the same country as their consumers.
Here is where there is a “leakage or a gap from a tax perspective”, says Malaysia Tax Leader at Ernst & Young Tax Consultants Sdn Bhd, Amarjeet Singh.
In order to collect the GST from consumers, the GST system requires the supplier making the final sale to the consumer to be registered for the tax, collect it from the local consumer and pay it to Customs.
But services to Malaysian consumers by these foreign providers selling movies, games and ride-hailing applications are currently outside of the GST net.
On the advent of these new digital business models, Amarjeet explains that governments around the world are increasingly of the view that many providers of digital services may well pay little or no tax.
“The OECD as well as the European Union (EU) finance and economic ministers are already looking into this. As part of its anti-BEPS initiative, the OECD has issued an action plan relating to the digital economy, while the EU finance ministers are seriously discussing the adoption of a short-term equalisation levy. The equalisation levy, also known as an ‘equalisation tax’, is a proposed tax on the turnover of Internet and digital companies,” he tells Star Biz Week.
He points out that the European Commission has just published a paper discussing different options for taxing the digital economy. The European Commission has suggested that where it takes too long for solutions to be developed at an international level, there should be a focus on developing harmonised solutions at the EU level.
“In addition to the work being done by the OECD and the ongoing discussions within the EU and European Commission, countries are also working on how best to address the digital economy in their domestic tax laws.
“Countries are facing a fair balancing act. They must find a way to extract their fair share of taxes from the digital economy, but the rules should not be so onerous that they are difficult to comply with or enforce.
“Countries would also want to avoid the unintended cons sequence of overly-complex tax laws stifling business and innovation. Thus far, many countries have focus sed on indirect taxes such as the GS TG and the valued-added tax or VA AT to tax the digital economy,” he sa ays.
Senthuran Elalingam, Asia-Pacific Indirect Tax Clients, Markets and Industries Leader of Deloit Malaysia, notes that the EU South Korea, Japan and most recently Australia and New Zealand have implemented rules to tackle the issue of consumption tax for digital goods and service providers.
If Malaysia does not follo ow suit, it disadvantages its own businesses and reduces its own tax collection, he says.
He reckons that Malaysia a’s adoption of these guidelines bas sed on the recent announcement is likely to take place some time next year.
What this would mean isi that the 6% GST would then apply to the purchase of digital service es from providers based outside of Malaysia.
“It is important to have these rules in place, as in their absence, it creates a disparity between local service providers who currently need to charge the GST and foreign service providers who do not.”
The GST in Malaysia has been a success by and large with a total of RM41 bil in taxes collected in 2016.
The Customs is striving to achieve RM42bil in GST collection this year.
UHY Chartered Accountants senior partner Datuk Alvin Tee notes that with many economies well-driven by small and medium enterprises, the majority of the digital economy transactions are not large in value but can be significant in volume. These transactions may prove to be very difficult for the tax authorities to notice and trace, unlike major players such as Google and Amazon which draw attention easily.
He says there are many other challenges in taxing the digital economy, including the difficulty for tax authorities to implement the appropriate platforms to collect the relevant taxes.
“Businesses and consumers may very well want to comply with tax regulations, but compliance will require effective platforms and mechanisms to assist with the collection and remittance of taxes. This is especially so with
transactions becoming more and more
cashless.”GSTtax shouldTee laws. laws,is notof but the only also the existing income opinion that the changes be about amending the
Both areas ultimately provide for the generation of revenue required for the development of the country.
“However, the amendment to regulations will need to be planned carefully in conjunction with their subsequent implementation, monitoring and enforcement. Educating businesses on the impact of such regulation changes
would also require planning, as the absence of such steps would likely lead to new compliance issues.”
It is also imperative, he says, for the Inland Revenue Board to co-ordinate its regulation changes with other tax authorities to ensure relevance and consistency, especially when Malaysia has tax treaties with more than 70 countries.
“As the provisions in Double Tax Agreements (DTAs) currently in place prevail over the provisions of the Income Tax Act 1967, the last thing we would want is for resources to be spent on changing the tax regulations and yet the impact could not be optimised due to the limitation caused by the DTAs,” he points out.
“The digital economy knows no boundary, and consumers can effortlessly seek for alternatives globally if changes in the tax regulations impact them negatively. Therefore, the authorities have to ensure that regulation changes do not drive consumers away but continue to encourage a healthy purchasing pattern,” he adds.
But will the digital companies resist the impending changes?
Most consultants reckon not. Amarjeet says large global digital corporations do not set out to evade tax.
“I don’t think these corporations intentionally ignore the laws of the countries they operate in. Instead, many of them simply arrange their business affairs to get the best tax results possible within the parameters or existing rules. The regulators are now seeking to address the legislative provisions which enable such tax planning.”
However, Amarjeet adds that multinationals are also increasingly aware that where a company is perceived as not paying its fair share of taxes, this can have a serious reputational impact.
“Ultimately, companies need to develop sound in-house tax strategies, which ensure that all tax laws are complied with and which are flexible enough to cope with the changing tax environment.ment This will show regulators and other sstakeholders that tax is taken serioussly by the company,” he says.
A criitical issue, according to Senthuuran, is that the administration of the taxx should be simple. The easier it is to coomply, the lower the cost and the more liikely for businesses to comply, he sayss.
For ssure, there would be issues arising.
One challenge Senthuran reckons is undersstanding which services are going tto be impacted by this change.
“Somme factors to consider include whetheer the foreign service provider is actuallly providing the consumer a service, orr is merely providing and arrangging services for a Malaysian supplier. IIf it is the latter, then there shouldd be no impact from this change.
“For example, in the case of ride-hailing appps, it is ultimately the local driver who prrovides the service to the consumer and receives payment for it, and the commpany is simply providing the platforrm to make bookings and arranggement.”
UHYY’s Tee believes most of the large corporrations would have the resources and exxpertise to comply with the tax regulattions, hence, they should be encourraged to register. However, the same ccannot be said for the small and mediumm enterprises and individual service pproviders.
“It is a common challenge to them, as increased tax compliance generally leads to an increase in administrative work and business costs, subsequently reducing their capacity to generate more income.”
It is still early days, with discussions likely taking place among the various stakeholders.
Different countries have adopted different approaches such as working with credit card companies, which will collect the consumption tax when consumers swipe their cards, which, in turn, will remit it to the Customs.
Whatever the case, the principle behind the move remains the same – that a country is entitled to its fair share of tax revenue when a digital service entity sells a service to a consumer in it.