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Tax Reforms – Actionable Recommendations

December 18, 2018
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Tax Reforms – Actionable Recommendations

By SM Thanneermalai

The national Tax Reform Committee (TRC) has a big task ahead, in reforming taxes to support the government’s agenda of driving growth amidst worrisome geopolitical concerns and tepid local finances.

Commendably, the TRC is moving in the right direction by inviting all the relevant stakeholders (i.e. professional bodies, professional firms, industry organisations, chambers of commerce, Inland Revenue Board, and the Royal Malaysian Customs Department) to present their views.

Speed is of the essence. Ideally, the TRC should provide a preliminary report within a six-month period and complete the assignment within 12 months. If there is any delay, the government will in turn be delayed in considering their recommendations; their recommendations may be out-of-date as the global and local economic conditions would have changed.

Political will is key to implementation. In the past, the government had conducted studies reviewing the tax system. However, the recommendations from those studies and reports were not implemented in most cases. It is important for the TRC to impress on the government to seriously consider implementing their recommendations, otherwise it will be a wasted effort by all parties.

The following are some recommended reforms that should be considered by the TRC:

Review of Incentives

Incentives should not be given to business enterprises that are involved in exploiting our natural resources and who benefit from our markets locally, without adding value in the form of employment, expenditure, transfer of technology and skills.

Mr SM Thanneermalai

Instead, incentives should be made available to businesses locating their operations in Malaysia for efficiency purposes i.e to gain a cost advantage, establish a regional hub, or engage our labour force for their diversity and multilingual fluency. Tax incentives are important for this group of investors as one, there is significant competition from other countries in the region and two, tax incentives are necessary to support operations that may not be highly profitable.

It is important to monitor businesses which benefit from tax incentives to ensure that they comply with the promises made at the time of the application to the authorities. There should also be no discrimination between foreign direct investments and local investments.

Encourage Adoption of Industry 4.0

The government is intent on assisting small and medium enterprises (SMEs) to migrate towards Industry 4.0 (IR4.0) automated manufacturing. Currently, there are incentives, financing assistance and training assistance provided to promote the migration.

However, it is critical to change the mindset of the owners or principal shareholders who are the primary drivers of the SMEs, to encourage them to embrace IR4.0. To motivate them, tax incentives in the form of additional tax deductions, cash grants, etc. should be provided to SME owners and entrepreneurs.

Place Labuan on Par with Singapore

Labuan has a unique role of encouraging captive businesses (i.e. insurance and leasing), and provides a location for other activities such as foundations and offshore businesses.

From 1 January 2019, Labuan Financial Services Authority has made it mandatory for Labuan Offshore companies to meet the substance requirements to avoid being caught within the BEPS Action 5. However, Budget 2019 made changes to the Labuan tax regime by removing the RM20,000 tax ceiling and disallowing 97% of the expenses incurred in the transactions between the Malaysian resident companies and the Labuan offshore companies.

These measures may make Labuan unattractive for Malaysian resident companies to deal with Labuan offshore companies.

If this happens, Malaysian companies dealing with Labuan offshore entities are likely to move their operations to other locations such as Singapore / Hong Kong, which are in the same time zone and serve the same purpose as Labuan.

The TRC should consider making recommendations to the government that will position Labuan on par with Singapore or Hong Kong. The TRC could recommend increasing the tax rate from 3% to possibly 8%, such that it is equivalent to a withholding tax paid on a transaction between Malaysia and Singapore.

Sustainable Tax Revenues

Currently, development expenditure is approximately 17% compared to 83% in operating expenditure. Development expenditure has to significantly increase in order for the country to grow.

Despite the government’s concerted efforts to reduce operating expenditure, it is necessary to also increase tax revenues to narrow the government budget deficit and to increase the development expenditure to help the country grow.

It is inevitable that the government has to consider diversifying its sources of tax revenue away from the current income taxation as the global trend is to lower the corporate tax rates to 20% or less, where even our neighbours Indonesia and Vietnam are following suit.

Alternatively, the TRC should consider taxing income that is not currently taxed (i.e. foreign sourced income), extending the scope of our tax regime from territorial to worldwide. Our economically significant neighbours such as Vietnam, Thailand, Indonesia and the Philippines have a capital gains tax regime; this equally applies to most countries in the world except Singapore and Hong Kong. Now may not be the right time to introduce capital gains tax, but there is a serious need to look into it in the future.

Protect Taxpayer Rights

The current legislation should be reviewed thoroughly to strengthen the taxpayer’s position.

SM Thanneermalai is Managing Director of Thannees Tax Consulting Services Sdn Bhd and Chairman of the Malaysian Tax Research Foundation.

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