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Who Bears the Taxes in the Digital Arena?

June 17, 2019
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Who Bears the Taxes in the Digital Arena?

By SM Thanneermalai

The world is in a predicament on how to tax services provided over the Internet. This becomes even more difficult when the service providers do not have any physical presence within the country. The money flows cannot be stopped as banking systems are transnational and any stoppage would hamper the wider trade flows which will have an impact on the economy.

With the growth of the usage of the Internet to do businesses, taxing it is becoming a necessity.

Importation of Goods

Since goods move physically across borders, the tax authorities can collect the tax at the point of import. This is confined to the value of the goods imported. However, the foreign enterprises that do not have a presence in Malaysia can avoid income taxes.

Importation of Services

This is a bigger dilemma for countries like Malaysia. The challenge for the government now is how to tax the foreign service providers. Some of the companies like Facebook, Google, Microsoft, Alibaba, etc. are huge companies that have significant resources to organise their tax affairs in such a way that they can legitimately avoid paying taxes in countries like Malaysia.

What is the Current Situation?

Malaysia is attempting to tax digital services provided by foreign companies without a presence in Malaysia through the imposition of service taxes and withholding taxes.

Mr Thanneermalai

Service tax

Business-to-business

In Budget 2019, Malaysia widened the service tax net to impose service tax on all imported taxable services, including all types of information technology services. Malaysian businesses, whether they are registered for service tax purposes or not, need to account for the service tax.

The problem here is the definition of “all type of information technology services”. In the Royal Malaysian Customs Department (RMCD)’s Guide on Information Technology Services, examples are provided but are not exhaustive. The Guide doesn’t carry the force of law and therefore taxpayers are left in a dilemma as to whether the services they procure are subject to service tax or not.

As far as the RMCD is concerned, most of the services procured through the Internet are subject to service tax and this leaves the taxpayer with limited options: either pay the tax, or challenge the RMCD in the courts, which will be time consuming and adds to additional costs.

Generally, taxpayers are choosing to pay the taxes as opposed to challenging the RMCD. This adds to the burden of doing business in Malaysia.

Business-to-consumer

The government has announced that from 2020, foreign digital service providers providing more than RM500,000 worth of taxable services should be registered in Malaysia with the RMCD. In simple terms, they want the foreign service providers to collect the tax and pay it over to the RMCD.

The challenge the RMCD will face is whether it can enforce this law on the foreign service provider who has no presence in Malaysia. This is yet to be seen.

In most cases, Malaysian businesses or Malaysian consumers who buy the services are likely to bear the service tax.

Withholding tax

This is under the purview of the Inland Revenue Board Malaysia (IRBM). The withholding tax in question here will principally be withholding tax imposed on royalties.

The definition of royalty in Section 2 of the Income Tax Act 1967 is very wide, and the key subset within this definition that creates a dilemma for taxpayers is the following:

  • the use of, or the right to use in respect of, any copyrights, software, artistic or scientific works, patents, designs or models, plans, secret processes or formulae, trademarks or other like property of rights
  • the use of, or right to use, know-how or information concerning technical, industrial, commercial or scientific knowledge, experience or skill
  • the alienation of any such property, know-how or information

The IRBM in practice takes the view that practically all payments made for Internet services to foreign service providers without a presence in Malaysia is subject to this withholding tax. This interpretation is subject to debate.

This withholding tax in most cases is also borne by the Malaysian taxpayer since the foreign service providers in most cases will not provide the services unless the Malaysian taxpayer bears the tax.

Overall

The burden of taxing foreign digital service providers in most cases ends up with the Malaysian taxpayers, thus adding to his cost of living, or the cost of doing business in Malaysia.

Hopefully the tax reform committee will come up with ideas such that at least the burden of taxation will be shared between the Malaysian taxpayer and the foreign digital service provider.

SM Thanneermalai is the Managing Director of Thannees Tax Consulting Services Sdn.Bhd. and Chairman of the Malaysian Tax Research Foundation. He can be reached at [email protected]